Taxes in the Financial Sector: Chilean Case Ricardo Escobar August 2009

1. Taxes in theFinancial Sector: Chilean Case Ricardo Escobar August 2009

2. In this presentation: • Reserve requirement on capital inflows • Stamp Tax in Chile • VAT treatment of banking sector

3. I. Reserve requirement on capital inflows • During the 90’s a reserve was required on credits and deposits from abroad. • It was a mandatory non-interest bearing foreign currency deposit in the Central Bank, determined as percentage of the relevant capital inflow, that could be withdrawn only after a one-year period. • Alternatively, the equivalent “interest” could be paid up front Main objective: To discourage “hot money” inflows, volatile short-term capital aimed at speculative purposes, to control excessive capital inflows.

4. I. Reserve requirement on capital inflows Main features • It was implemented by July, 1991. • After capital inflow pressures disappeared, the reserve rate was reduced to 0% in 1998.

5. I. Reserve requirement on capital inflows Why was it applied? • Between 1990 and 1997 inclusive, net capital inflows to Chile were extraordinary high. • The private expenditures doubled over the same period (rising at an average rate of 10% per year), boosted by domestic income growth rate, favorable exchange conditions and massive capital inflows. • Due to this scenario, the Central Bank applied a constrictive monetary policy (the real placement rate was near 9% in that period). • The Central Bank established the reserve requirement as a measure to limit capital inflows, attracted by high domestic interest rates, however: that created pressures on the exchange rate, blurring part of the desired consequences of the measure.

6. I. Reserve requirement on capital inflows Consequences • It is still under discussion whether the reserve requirement was a factor of system stability or not. Information from different studies suggest that the measure reduced capital inflows, but the significance of its contribution is a controversial issue. • The defense of the measure is based on macroeconomic considerations: to ease the way for monetary policy and to avoid aggravating economic cycles that might be caused by massive but short-term capital inflows. • Oponents point out that it was not efficient enough to limit the capital inflows, and that it produced microeconomic impacts by difficulting local agents the access to financing and creating extra financing costs. • The measure was lifted by the end of the decade (Asian crisis 1998-99). However, the reserve requirement may be applied in the future by the Central Bank.

7. II. Stamp Tax in Chile • It is a tax applied on documentation related to credit operations, issuance of checks and bank withdrawals. • It is an “old” tax (1974) that is not part of the “wave” of taxes on financial transactions levied by several developing countries for collecting purposes in the 90’s . • Relatively low level of tax revenue from Stamp Tax (3% of the total tax revenue in 2008) • It is a cost-effective tax in respect of compliance and collection.

8. II. Stamp Tax in Chile Tax rates Notes: • According to legal transitory provisions facing the global financial crisis, the tax rates fall in 2009 and 2010. • The stamp tax on check and bank withdrawals was applied on actual transactions and adjusted every six-month period (semester). Thus, tax rates applied in the first and second period of 2007 were US$0,28 and US$0,29 , and the tax rates applied in the first and second period of 2008 were US$0,30 and US$0,31, respectively. This Tax was abolished as from October 1st, 2008.

9. II. Stamp Tax in Chile Tax collection 2008 (Million Dollars) Stamp Tax 3% (963 MMUS$) Other taxes 97% (30.567 MMUS$) Total Revenue = 31.530 MMUS$ Source: Prepared by the Research and Studies Directorate of the SII , based on the reports on fiscal revenues from the General Treasury of the Republic. Nota: 522,46 $/US$ TC average 2008

10. II. Stamp Tax in Chile Tax revenues from Stamp Tax 1998-2008 (Million Dollars) Source: Prepared by the Research and Studies Directorate of the SII , based on the reports on fiscal revenues from the General Treasury of the Republic.

11. Effects of the transitional reduction in Stamp Tax rates Temporary measures regarding Stamp Tax are aimed at facilitating the access to financing, particularly focused on: • Facilitation of access to housing finance for medium-income families. • Financing small and medium-sized enterprises (SMEs), promoting employment with fresh investments. It is estimated that the 70% of the cost of this measure will be aimed at improving liquidity conditions of individuals and small enterprises.

12. III. VAT treatment of banking sector • Interest arising from financial operations, financial instruments and credits are exempt from VAT. • Some currency adjustments, interest and financing expenses of those operations, are not deemed to be an exemption, forming part of the taxable base: • Fees on the use of credit cards and checking accounts. • Fees on international trade operations • Fees on the use of ATMs (cash dispensers) • Leasing • Commission fees on trading operations

13. III. VAT treatment of banking sector • Bank service fees are subject to VAT, except for the charges associated with: • Opening or maintaining a line of credit. • Opening and confirming a letter of credit, as well as its negotiation abroad, financed by the enterprise. • Loan operations through the issuance of a letter of credit. • The issuance of a Bank guarantee for the granting of a credit. These charges are deemed to be interest Reasons for the exemption: • Difficulties to determine sales and purchases of the sector. • Distortions that result from VAT applied on certain bank fees and interest, considering interest as part of added value. The difference between the sale price of bank services and its purchases is the actual added value.

14. III. VAT treatment of banking sector Tax Expense (TE) • In the case of financial services, the tax expense is “negative” due to non-deductible VAT derived from the acquisition of goods and services subject to VAT by these entities. Note: Information from the report “Tax Expense 2009” prepared by the Research and Studies Directorate of the SII.

15. Thank you!!