We often find that there is no clear understanding of the definition and extension of the term royalty. Generally speaking, a royalty is any payment made due to the use of any kind of intellectual property.
Chilean Income Law does not define what a royalty is, however, it gives examples or describes the burden of withholding tax for each case, distinguishing different tax rates, as follows:
- Royalty payments for the use, enjoyment and exploitation of trademarks, patents, formulas, and other similar services are subject to, without any deductions allowed, up to a 30% WHT.
- Payments for the use, enjoyment or exploitation of patents, utility models, industrial designs and drawings, blueprints or topography of integrated circuits, and of new vegetable varieties, in accordance to the definitions and specifications indicated in our Industrial Property Law and in the statute which regulates the rights to new vegetable varieties, as the case may be, are subject to, without any deductions allowed, up to a 15% WHT.
- Payments for the use, enjoyment and exploitation of computer programs, are subject to, without any deductions allowed, up to a 15% WHT. However, licenses for standard software are exempt of WHT.
In addition, and considering the privileged tax rate for royalties (usually the WHT has a 35% tax rate), Chilean legislation has imposed a limit on the amount of accepted expenses due to royalty payments.
This cap is up to 4% of the payer's gross revenues when payments are made to a non- resident party deemed related. Nevertheless, the 4% limit does not apply if the royalty paid to the related party is subject to a tax rate equal or greater than 30% in the country of residence of said party.
The definition of "royalty", for tax purposes, broadens the legal concept of a royalty substantially to ensure more withholding tax income for the source country; this is the country in which such royalties are used in opposition to the country where the IP was created.
Generally, the definition of royalties for taxation purposes contains ''all cross border payments" under whatever name and in whatever form, for:
- Operational leases and rentals.
- ''Sale'' of non-standardized software.
- Technical services.
- Consultancy services.
- Licensing of patents, trademarks, logos etc.
- Cinema and movie broadcasting rights
- The sale of music CDs and tapes by artists.
- The sale of books.
- Image rights concerning sports people and artists, among others.
As you can see, concepts that are not actually a "royalty" fall into this category, basically with the purpose of taxing these payments when they are remitted abroad.
The taxation of royalties is a tricky matter, as it may involve not only internal income tax law of each country but the application of double taxation agreements. Furthermore, countries such as Brazil or Colombia have a unique interpretation of the concept "royalty".
Our advice would be to ask yourself the following questions:
- What kind of payment are you making?
- Is it actually a royalty?
- Are you giving IP for free to your subsidiary?
- Does this comply with transfer pricing rules?
- What is the correct tax treatment?
- Is the IP duly protected and what consequences does this have from a tax perspective?
- Do you have a properly drafted contract that may be suitable to explain the transaction related to the IP that you might have?
- Is the transaction been completed between related parties, for example between a Holding Company and a subsidiary?
Do the payments exceed the 4% cap? Answering these questions is only a starting point, not only to comply with tax law but moreover, it could lead to significant savings as there may be room for a preferment tax treatment that may not have been explored before.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.