Modifications to the tax treatment of life insurance

by | May 6, 2022

On February 4th, 2022, Law 21,420 was published and modified Law 16,271 on Tax on Inheritance, Assignments and Donations, and eliminated the exemption that Article 20 contained regarding life insurance, consequently taxing the indemnities that the beneficiaries could receive at the time of the death of the insured. Article 17 expressly states that the sums received by the beneficiary of a life insurance are understood to be acquired by succession due to death, and, ultimately, taxed with Inheritance Tax. On April 21st, the Internal Revenue Service (“SII” or “Service”) issued Circular No. 20 to provide instructions related to the legal modification.

Definitions and exclusions

The Circular establishes that, taking into account the legal definition of life insurance contained in the Commercial Code, certain conditions of the contract or of the parties cannot be considered as elements that allow them to be subtracted from the Inheritance Tax. The most relevant conditions indicated by the SII are:

  • Whether it is individual, collective or mass insurance.
  • The death risk coverage is main or accessory.
  • The beneficiaries are legal persons.
  • They involve the payment of a capital or a temporary or life annuity.
  • They are associated with a savings component.
  • They were hired in Chile or abroad.

Additionally, the Circular specifies the life insurance policies that are excluded from the application of the Inheritance Tax by legal mandate:

  • The disability and survival insurance established in Decree Law No. 3,500 of 1980.
  • The mortgage deductions established in the form of life insurance and the default fee.
  • Life annuity insurance contracts agreed with funds capitalized in pension fund managers.

– Resources originating from voluntary pension savings deposits, voluntary contributions or collective voluntary pension savings, and that have been allocated to life insurance policies authorized by the CMF as voluntary pension savings plans, which are taxed at a rate of 15% according to Article 42 Bis of the Income Tax Law (“LIR”).

As well as those insurances that, being of a similar nature, do not meet the definition of the Commercial Code and therefore are not captured by the new Article 17:

  • Damage insurance.
  • Those that, although they cover the risk of death of the insured, do not grant the beneficiary the right to receive a sum, such as those whose purpose is to pay unpaid balances of debts of the insured (relief insurance) or those that cover expenses generated by the death of the insured or his reimbursement.
  • Those that only imply the obligation to pay a sum to the contracting party or to the beneficiaries if the insured survives the stipulated date (such as endowment insurance).
  • Life insurance that implies the obligation to pay a sum to the insured until his death (amounts that may be granted to beneficiaries as a survival pension are not excluded).
  • Personal accident insurance, whether voluntary or mandatory, even when they involve compensating the beneficiaries in the event of the death of the insured (accidental).

The Circular expressly establishes that it can apply the review powers of Art. 63 of the Tax Code to the matter under analysis. This implies that the Service could review those life insurance policies that are initially excluded as detailed above, whose clauses or conditions are not normal market ones or are intended to avoid Inheritance Tax. The power of review is equally applicable, whether the beneficiary is a third party or has the status of heir or legatee.

Taxation

Each beneficiary must pay the inheritance tax, in accordance with the general rules of Law No. 16,271, to the extent that they are pertinent, but exclusively for the sums received on the death of the insured, regardless of the quality of the beneficiary of the life insurance, in accordance with the general rules on succession matters. However, this quality becomes important when determining the responsibility for the correct payment of the tax.

Regarding the taxes contained in the LIR, the Circular expressly establishes that the amounts in question must be considered as non-income income for the beneficiaries, in accordance with the provisions of No. 9 of article 17 of the LIR, since they are understood to be acquired by succession by reason of death.

After the legal modification, insurance companies will not be able to pay sums due for life insurance contracts without previously having proof of payment of the tax. For its part, the Regulations for auxiliaries in the insurance business and claims settlement procedure impose a maximum payment term of 6 days from the notification of the origin of the compensation.

In order to reconcile both regulations, the Circular instructs the insurance companies to deduct from the sum that must be paid to him or the beneficiaries of the life insurance the part of the inheritance tax that corresponds to him or the beneficiaries (whether or not heirs or legatees), applying the pertinent rules established in Law No. 16,271. Complying with said reduction, the companies will be authorized to pay the sums that correspond to the beneficiaries of the life insurance.

If the beneficiary is the heir or legatee of the insured in accordance with the general rules on inheritance matters, the obligation to incorporate said sums as an addition to the taxable base of the taxpayer’s inheritance remains. The amount already paid as tax by the insurance company may be imputed against the inheritance tax that is ultimately determined.

If the beneficiary is of only life insurance, the reduction and whole in fiscal coffers of the inheritance tax, carried out by the insurance company, exhausts the tax liability of the beneficiary. On the other hand, if you are entitled to receive sums from two or more life insurance policies on the occasion of the death of the insured, you must re-settle the inheritance tax by presenting a single declaration that incorporates all of the sums received and pay the resulting tax, prior imputation of the discounts found in fiscal coffers.

Validity

Excluded from the new tax treatment established in article 17 of Law No. 16,271 are life insurance contracts validly signed (perfected) until February 3rd, 2022, even when they are subsequently renewed as a result of operating renewal clauses, whether automatic or not, provided that the same conditions are maintained. The foregoing will not apply to life insurance contracts that undergo modifications as of February 4th, 2022 (such as, for example, contracting additional clauses, expanding claims coverage or other similar modifications).

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