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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 20-F
(Mark One)    
REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF   
  THE SECURITIES EXCHANGE ACT OF 1934  
  OR  
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE   
  SECURITIES EXCHANGE ACT OF 1934  
  For the fiscal year ended December 31, 2006  
  OR  
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF   
  THE SECURITIES EXCHANGE ACT OF 1934  
  For the transition period from_______ to _______  
  OR  
SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF   
  THE SECURITIES EXCHANGE ACT OF 1934  
 
Commission File Number: 001-10579		  

Compañía de Telecomunicaciones de Chile S.A.
(Exact name of Registrant as specified in its charter)

Telecommunications Company of Chile
(Translation of Registrant’s name into English)

Republic of Chile
(Jurisdiction of incorporation or organization)

Avenida Providencia 111
Santiago, Chile
(Address of principal executive offices)

Securities registered or to be registered pursuant to Section 12(b) of the Act     
   
Title of each class    Name of each exchange on which registered 
   
American Depositary Shares    New York Stock Exchange 
Series A Common Stock    New York Stock Exchange* 
* Listed not for trading, but only in connection with the registration of American Depositary Shares, pursuant to the requirements of the Securities and Exchange Commission.

Securities registered or to be registered pursuant to Section 12(g) of the Act:  None 
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:  None 
Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report:
Series A Common Stock    873,995,447 
Series B Common Stock    83,161,638 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes  No 

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

Yes  No 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”) during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:

Yes  No 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  Accelerated filer  Non-accelerated filer 

Indicate by check mark which financial statement item the registrant has elected to follow:

Item 17  Item 18 

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  No 

TABLE OF CONTENTS

        Page  
 
 
    PART I     
 
ITEM 1.     IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS     3  
ITEM 2.     OFFER STATISTICS AND EXPECTED TIMETABLE     3  
ITEM 3.     KEY INFORMATION     3  
ITEM 4.     INFORMATION ON THE COMPANY     12  
ITEM 4A.     UNRESOLVED STAFF COMMENTS     40  
ITEM 5.     OPERATING AND FINANCIAL REVIEW AND PROSPECTS     41  
ITEM 6.     DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES     62  
ITEM 7.     MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS     73  
ITEM 8.     FINANCIAL INFORMATION     77  
ITEM 9.     THE OFFER AND LISTING     82  
ITEM 10.     ADDITIONAL INFORMATION     84  
ITEM 11.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK     99  
ITEM 12.     DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES     106  
 
    PART II     
 
ITEM 13.     DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES     106  
ITEM 14.     MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS    106  
ITEM 15.     CONTROLS AND PROCEDURES     106  
ITEM 16.     [RESERVED]     107  
ITEM 16A.     AUDIT COMMITTEE FINANCIAL EXPERT     107  
ITEM 16B.     CODE OF ETHICS     107  
ITEM 16C.     PRINCIPAL ACCOUNTANT FEES AND SERVICES     107  
ITEM 16D.     EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES     108  
ITEM 16E.     PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS    108  
 
    PART III     
 
ITEM 17.     FINANCIAL STATEMENTS     109  
ITEM 18.     FINANCIAL STATEMENTS     110  
ITEM 19.     EXHIBITS     111  

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CERTAIN TERMS AND CONVENTIONS

     All references to “Chile” or the “Republic” are references to the Republic of Chile. All references to the “Government” are references to the Government of Chile. Unless otherwise specified, all references to “Telefónica Chile” or the “Company” are references to Compañía de Telecomunicaciones de Chile S.A., a publicly held stock corporation (sociedad anónima abierta) organized under the laws of Chile, and its subsidiaries. All references to “Telefónica” are references to Telefónica S.A., a publicly held stock corporation organized under the laws of the Kingdom of Spain, that owned, directly and indirectly, 44.9% of our ordinary shares at December 31, 2006. All references to “Telefónica Group” are references to Telefónica and its Latin American subsidiaries, including Telefónica Chile.

     Unless otherwise specified, all references to “$,” “US$,” “U.S. dollars” and “dollars” are to United States dollars, references to “Chilean pesos,” “pesos” or “Ch$” are to Chilean pesos, references to “UF” are to Unidades de Fomento, a daily indexed Chilean peso-denominated monetary unit that takes into account the effect of the Chilean inflation rate of the previous month, and references to “UTM” are to Unidad Tributaria Mensual, a monthly indexed Chilean peso-denominated monetary unit that takes into account the effect of the Chilean inflation rate of the month before the previous month. All references to “euros” are to the common currency of the European Union. Unless otherwise specified, all references to “U.S. GAAP” are to generally accepted accounting principles in the United States, and all references to “Ch GAAP” or “Chilean GAAP” are to generally accepted accounting principles in Chile and the related rules of the Superintendencia de Valores y Seguros of Chile, “SVS,” or “Chilean Securities and Exchange Commission.”

PRESENTATION OF FINANCIAL INFORMATION

     This Annual Report contains the audited consolidated balance sheets of Compañía de Telecomunicaciones de Chile S.A. and its Subsidiaries as of December 31, 2006 and 2005 and the related consolidated statements of income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2006 (collectively, the “Audited Consolidated Financial Statements” or “Financial Statements”), which were audited by Ernst & Young and, for the year 2004, by Deloitte & Touche Sociedad de Auditores y Consultores Ltda. The Audited Consolidated Financial Statements have been prepared in accordance with Chilean GAAP, which differs in certain significant respects from U.S. GAAP. See Note 37 to the Audited Consolidated Financial Statements of the Company, included elsewhere in this Annual Report, for a description of the principal differences between Chilean GAAP and U.S. GAAP as they relate to the Company and a reconciliation to U.S. GAAP of net income and shareholders’ equity for the periods and as of the dates covered thereby. As required by Chilean GAAP, the Company publishes its financial statements in Chilean pesos that are adjusted to reflect changes in purchasing power due to inflation. In accordance with the Securities and Exchange Commission rules and regulations, such price-level restatement has not been eliminated in the U.S. GAAP reconciliation of net income and shareholders’ equity. Unless otherwise specified, financial data regarding the Company is presented herein in constant Chilean pesos of December 31, 2006 purchasing power. See Note 2(e) to the Audited Consolidated Financial Statements of the Company.

     Merely for the convenience of the reader, translations of certain amounts into dollars at a specified rate have been included. Unless otherwise specified, or unless the context otherwise requires, the U.S. dollar equivalent for information in Chilean pesos is based on the exchange rate (the “Observed Exchange Rate”) reported by Banco Central de Chile (the “Central Bank”) that is computed, for any date, by averaging the exchange rates of the previous business day’s transactions in Chile’s Mercado Cambiario Formal (the “Formal Exchange Market”). On January 2, 2007, the Central Bank reported that the Observed Exchange Rate with reference to December 29, 2006, the last business day in 2006 for which an exchange rate was reported, was Ch$532.39 = US$1.00. Telefónica Chile does not represent that the Chilean peso or U.S. dollar amounts in this Annual Report actually represent, or could have been or could be converted into U.S. dollars or Chilean pesos, as the case may be, at the rates indicated, or at any particular rate or at all. See “Item 3. Key Information—Exchange Rates” for information regarding historical rates of exchange in Chile from January 1, 2002. Unless otherwise specified, references to the devaluation or the appreciation of the Chilean peso against the U.S. dollar are in nominal terms (without adjusting for inflation), based on the Observed Exchange Rates for the relevant period.

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FORWARD LOOKING STATEMENTS AND ASSOCIATED RISKS

     This Annual Report contains certain “forward-looking statements” within the meaning of Section 21E of the Exchange Act. Some of these forward-looking statements include forward-looking phrases such as “anticipates,” “believes,” “could,” “estimates,” “expects,” “foresees,” “intends,” “may,” “should” or “will continue,” or similar expressions or the negatives thereof or other variations on these expressions, or similar terminology, or discussions of strategy, plans or intentions. These statements also include descriptions in connection with, among other things:

     Such statements reflect our current views regarding future events and are subject to certain risks, uncertainties and assumptions. Many factors could cause actual results, performance or achievements to be materially different from any future results, performance or achievements that forward-looking statements may express or imply, for example:

     If one or more of these risks or uncertainties affects future events and circumstances, or if underlying assumptions do not materialize, actual results may vary materially from those described in this Annual Report as anticipated, believed, estimated or expected. We have no plans to update any industry information or forward-looking statements set out in this Annual Report and have no obligation to update any such statements.

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PART I

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

     Not applicable.

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

     Not applicable.

ITEM 3. KEY INFORMATION

A. Selected Financial Data

     The following table presents selected financial data as of December 31, 2006 and the four previous years. The Consolidated Financial Statements were prepared in accordance with Chilean GAAP, which differs in certain significant respects from U.S. GAAP. Note 37 to the Audited Consolidated Financial Statements provides a summary of significant differences between Chilean GAAP and U.S. GAAP as they relate to us, including the impact of such differences on our net income and shareholders’ equity. Net income and shareholders’ equity in U.S. GAAP are also included in the selected financial data as a reference. The selected financial data should be read in conjunction with the Audited Consolidated Financial Statements and notes thereto, “Item 5. Operating and Financial Review and Prospects” and other financial information included herein.

     The following selected consolidated financial data was affected by certain changes in our corporate structure during the years presented. In particular, the data for 2004 reflects the divestiture and deconsolidation of our mobile subsidiary Telefónica Móvil as it was sold in July 2004, and also reflects the deconsolidation of the information system subsidiary, Sonda, since August 2002. On September 26, 2002, the Company entered an agreement to sell 25% of its 60% ownership of Sonda. The Company’s remaining 35% ownership of Sonda was recognized under the equity method until August 2003, when the Company sold its remaining interest in Sonda.

    2002    2003    2004    2005    2006    2006 
             
    (in millions of constant Chilean pesos as of December 31, 2006, except ratios)   (in millions of
                        U.S. dollars)
Statement of Operations Data:                         
Chilean GAAP                         
Operating Revenues    942,950    881,227    743,471    592,904    577,204                   1,084.2 
Operating Costs and Expenses    (657,245)   (570,266)   (470,120)   (380,888)   (373,025)   (700.7)
Administrative and Selling Costs    (142,809)   (185,890)   (168,491)   (123,091)   (121,555)   (228.3)
Operating Results    142,896    125,071    104,860    88,925    82,624    155.2 
Interest Income    18,277    7,673    9,822    8,152    4,437    8.3 
Interest Expense, Net of Capitalized                         
   Interest    (89,215)   (66,402)   (57,175)   (30,121)   (19,480)   (36.6)
Price Level Restatement and Exchange                         
   Differences(1)   (9,803)   689    9,501    2,962    666    1.3 
Other non-operating income net(7)   (51,428)   (24,440)   328,918    (10,082)   (15,335)   28.8 
Income before Income Taxes    10,727    42,592    395,925    59,836    52,911    99.4 
Income Tax    (29,256)   (31,452)   (65,999)   (34,093)   (29,600)   (55.6)
Net Income (loss)   (19,365)   10,987    329,627    25,712    23,353    43.9 
Dividends Paid(2)   1,486    18,123    670,459    118,172    25,340    47.6 
Chilean GAAP earnings (loss) per                         
   Share(3)   (20.23)   11.48    344.38    26.86    24.40    0.05 
Earnings per ADS(4)   (80.92)   45.92    1,377,52    107.44    97.59    0.18 
Dividends per Share(5)   1.55    18.93    700.47    123.46    26.47    0.05 
Dividends per ADS(4)   6.20    75.74    2,801.88    493.86    105.90    0.20 
Weighted Average Number of Shares                         
   Outstanding   957,157,085    957,157,085    957,157,085    957,157,085    957,157,085     

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    2002    2003    2004    2005    2006    2006 
             
    (in millions of constant Chilean pesos as of December 31, 2006, except ratios)   (in millions of 
                        U.S. dollars)
Statement of Operations Data:                         
U.S. GAAP                         
Net Income (loss) in accordance with                         
   U.S. GAAP    31,743    30,517    21,218    46,594    40,695    76.4 
Net income (loss) from continuing                         
   operations*    15,512    17,348    22,541    46,594    40,695    76.4 
Net income (loss) from discontinuing                         
   operations*    16,230    13,169    (1,323)   -    -    - 
Number of Shares   957,157,085    957,157,085    957,157,085    957,157,085    957,157,085     
Net Income (loss) in accordance with                         
   U.S. GAAP per Share    33.16    31.88    22.17    48.68    42.52    - 
Net Income (loss) from continuing                         
   operations per Share    16.21    18.12    23.55    48.68    42.52    - 
Net Income (loss) from discontinuing                         
   operations per Share    16.96    24.74    (1.38)   -    -    - 
Balance Sheet Data:                         
Chilean GAAP                         
Current Assets    488,808    456,103    446,719    324,992    296,291    556.5 
Property, Plant and Equipment, net    2,123,334    1,983,943    1,462,746    1,327,808    1,229,591    2,309.6 
Other Assets    331,738    265,010    94,581    94,254    90,894    170.7 
Total Assets    2,943,880    2,705,056    2,004,046    1,747,054    1,616.776    3,036.8 
Total Long-Term Debt (including Current                         
   Maturities)(8)   1,232,438    909,545    592,637    512,919    401,590    754.3 
Total Shareholders’ Equity    1,408,979    1,398,876    1,041,753    945,012    900,761    1,691.9 
U.S. GAAP                         
Total Assets    2,963,298    2,730,730    2,008,450    1,746,768    1,624,487    3,051.3 
Shareholders’ Equity    1,264,373    1,273,111    913,558    822,016    797,013    1,497.5 
Paid in Capital    806,464    931,859    931,859    931,859    890,895    1,673.4 
Other Data:                         
Capital Expenditures(6)   154,592    149,659    86,037    77,985    109,003    204.7 
________________________________________
*     
The Company has revised its amounts previously presented under US GAAP to reclassify its discontinued operations for the sale of Telefónica Móvil de Chile S.A. in 2004. These revised numbers are unaudited. Under Chilean GAAP, we are not required to restate or reclassify financial information presented in previous years to reflect significant divestures. For purposes of U.S. GAAP, we are required to eliminate the results of operations of certain divested operations from those of our continuing operations in presenting our U.S. GAAP results. See Note 37 to the Consolidated Financial Statements.
 
(1)
Monetary correction is the aggregate of purchasing power gain (loss) on indexation and gain (loss) on foreign currency transactions. See “Item 5. Operating and Financial Review and Prospects—Impact of Inflation.”
 
(2)
Dividends paid represent the amount of dividends paid in the periods indicated.
 
(3)
Basic earnings (loss) per share have been computed using the weighted average number of shares outstanding during each period presented.
 
(4)
Calculated on the basis that each ADS represents four shares of Series A Common Stock.
 
(5)
Represents an amount equal to the interim dividends declared for each year and the final dividend for the preceding year declared in April of each year. See “Item 8. Financial Information—Dividend Policy and Dividends.”
 
(6)
Represents the amount disbursed in each year, irrespective of the year in which the investment was made.
 
(7)
The Company recorded a non-operating gain associated with the sale of its subsidiary Telefónica Móvil de Chile S.A. to TEM in July 2004.
 
(8)
Total Long-Term Debt (including Current Maturities) includes notes and accounts payable to related companies and capital lease obligations.

Exchange Rates

     Chile’s Ley Orgánica Constitucional del Banco Central de Chile No. 18,840 (the “Central Bank Act”), enacted in 1989, liberalized the rules that govern the purchase and sale of foreign exchange in Chile. Prior to 1989, Chilean law authorized the purchase and sale of foreign exchange only in those cases explicitly authorized by the Central Bank.

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  The Central Bank Act empowers the Central Bank to determine whether certain purchases and sales of foreign exchange must be carried out in the Formal Exchange Market, a market formed by banks and other institutions authorized by the Central Bank for that purpose. The Central Bank has ruled that certain foreign exchange transactions (including those attendant to foreign investments) may be effected only in the Formal Exchange Market. Banks and other institutions may purchase and sell foreign exchange in the Formal Exchange Market at such rates as they freely determine from time to time. The Central Bank reports an Observed Exchange Rate that is computed, for any date, by averaging the exchange rates of the previous business day’s transactions in the Formal Exchange Market.

     Since 1989, the Central Bank has also set a reference exchange rate known as the dólar acuerdo (“Reference Exchange Rate”) that is reset monthly, taking internal and external inflation into account, and is adjusted daily to reflect variations in the parities between the Chilean peso and each of the U.S. dollar, the euro and the Japanese yen.

     The Central Bank Act authorized the Central Bank to carry out its transactions at rates within a specified band set around the Reference Exchange Rate. While the band was in place, the Central Bank generally carried out its transactions at the spot rate. When banks needed to buy or sell U.S. dollars from or to the Central Bank, the Central Bank made such sales at rates as high as the upper limit of the band, and such purchases at rates as low as the lower limit of the band. Banks generally carried out authorized transactions on the Formal Exchange Market at the spot rate, which usually fluctuated within the range of the band.

     In order to keep fluctuations in the average exchange rate within the range of the band, the Central Bank of Chile in the past intervened by buying or selling foreign currency on the formal exchange market. On September 2, 1999, in order to allow for increased exchange rate flexibility, the Central Bank suspended its formal commitment to maintain the exchange rate within a specified band. The Central Bank may, however, still intervene in certain exceptional cases of exchange rate fluctuations to keep the average exchange rate within certain limits, and must inform the market of the reason for its intervention in each such event. Nonetheless, the Central Bank will continue to publish the Reference Exchange Rate as a reference for the market. Purchases and sales of foreign exchange that may be effected outside the Formal Exchange Market can be carried out in the Mercado Cambiario Informal (the “Informal Exchange Market”), a recognized currency market in Chile.

     The following table sets forth the high, low, average and year-end Observed Exchange Rates for U.S. dollars for each year beginning with 2002 and for each of the past six months, as reported by the Central Bank. On April 11, 2007 the Observed Exchange Rate was Ch$534.93 = US$1.00.

    Observed Exchange Rates(1)
    (Ch$ per US$)
   
    Low(2)   High(2)   Average(3)      Period-End 
         
Year ended December 31, 2002    641.75    756.56    688.24    718.61 
Year ended December 31, 2003    593.10    758.21    691.54    593.80 
Year ended December 31, 2004    557.40    649.45    609.51    557.40 
Year ended December 31, 2005    509.70    592.75    559.77    512.50 
Year ended December 31, 2006    511.44    549.63    530.28    532.39 
 
Month ended October 31, 2006    524.12    537.63    530.95    524.75 
Month ended November 30, 2006    523.34    530.61    527.44    527.69 
Month ended December 31, 2006    524.78    534.43    527.58    532.39 
Month ended January 31, 2007    532.39    545.18    540.51    544.49 
Month ended February 28, 2007    535.29    548.67    542.05    540.07 
Month ended March 31, 2007    535.36    541.95    538.45    539.21 
Month ended April 11, 2007    534.93    539.69    537.05    534.93 
________________________________________
Source: Central Bank and Reuters Data Base

(1) Reflects nominal pesos at historical values.

(2) Exchange rates are the actual high and low for each period.

(3) Corresponds to daily average rates during the period.

     Telefónica Chile does not represent that the Chilean peso or U.S. dollar amounts referred to herein actually represent the amounts that were, could have been or could be converted into U.S. dollars or Chilean pesos, as the case may be, at the rates indicated, at any particular rate or at all.

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     The Central Bank regulates the international issuance by Chilean companies of non-peso-denominated debt, including, among other things, the repatriation and exchange for pesos of the foreign currency proceeds from such offerings. See “Item 10. Additional Information—Exchange Controls and Other Limitations Affecting Security Holders.”

B. Capitalization and Indebtedness

     Not applicable.

C. Reasons for the Offer and Use of Proceeds

     Not applicable.

D. Risk Factors

     The following discussion should be read together with this Form 20-F, including the Audited Consolidated Financial Statements, and the notes thereto.

Risks Relating To Our Business

Regulation may adversely affect revenues in certain of Telefónica Chile’s businesses.

     Tariff regulation

     The Chilean Government has historically regulated local telephony services in Chile. The Comisión Resolutiva Antimonopolios (the “Chilean Antitrust Authority”, now known as the “Tribunal de Libre Competencia”), a Chilean government agency responsible for making certain determinations relating to competitive conditions in the telecommunications industry, has determined that Telefónica Chile is a dominant operator of local telephony in many areas of Chile. As a result, the Company is subject to tariff decrees that regulate certain rates and fees the Company can charge for such local telephony services in most of the country. In accordance with the telecommunications law, all the telecommunications operators are subject to regulation of their access charges (the charge to telecommunications operators for accessing another operator’s network) which have been set at different levels depending on the operator. Consequently, costs of accessing different operators’ networks differ. Regulatory changes in approved access charge rates may affect the revenues for local telephony and costs of interconnections to other local operators. Similarly, interconnections to local operators represent costs for the long-distance and mobile businesses.

     Tariff regulation may have a significant impact on Company revenues and its ability to compete in the marketplace, as the Company is required to charge the same tariff to all clients in a designated tariff area. See “Item 4. Information on the Company—Business Overview—Licenses and Tariffs.” In 2006, approximately 31% of Company revenues (including fixed charge, variable charge, access charges and public telephony) were from regulated business activities. The application of the local telephone tariffs, defined by Tariff Decree No. 169 for the period 2004-2009, resulted in a minor impact in the 2004 and 2005 financial statements of Telefónica Chile. In contrast, the introduction of Tariff Decree No. 187 in May 1999 resulted in a reduction of approximately 25% in regulated revenues per line in the first year. Since 1999, the Company has sought administrative relief to correct what it believes are certain errors and illegalities in Tariff Decree No. 187. Upon denial of such relief, and having exhausted the administrative recourses available to it, in March 2002, Telefónica Chile filed a civil lawsuit for damages against the State of Chile, which is currently pending. The Company can give no assurance that future tariff decrees for fixed telephony will not have a material adverse effect on the results of operations or financial position, as such future tariff decrees could cause alterations in demand or traffic volume, or changes in the timing of traffic distribution from more expensive to less expensive time slots.

     Other regulations

     New regulations or changes in the existing regulatory model may adversely affect the Company’s businesses. For instance, in 2006, the Undersecretary of Telecommunications, or Subtel, initiated a process of public inquiry for new regulations relating to IP telephony over broadband. The Company has participated in the public inquiry

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process and together with other industry operators, has presented its opinion to this proposal. See “Item 4. Information on the Company—Business Overview—Licenses and Tariffs.” No assurance can be given that the outcome of this or future regulations will not have a material adverse effect on the Company’s results or financial position.

     The Telecommunications Law also specifies certain causes for which an operator can be sanctioned through penalties or even the termination of its public or intermediate service license, if the operator is in violation of the law or does not comply with the terms and conditions to which the license is subject. If the holder believes that its license has been terminated unlawfully, the holder may appeal the termination in Chilean courts. If a license is terminated, the holder is barred from applying for any license for a period of five years. Any such sanctions could have a material adverse effect on the Company’s results of operations or financial position.

Telefónica Chile faces intense competition.

     Telefónica Chile faces intense competition in every aspect of its business, ranging from existing operators to new entrants. In addition, consolidation is leading to greater levels of competition.

     As part of recent M&A activity underway, primarily in the cable operator business, two leading companies have merged, and now have approximately 90% market share of the paid television market, while also becoming a relevant player in broadband and fixed telephony. Meanwhile, in the mobile telephony business, Telefónica Móviles (TEM) acquired Bellsouth in Chile and the mobile subsidiary of Telefónica Chile. There was also an increase in competition with the entry of new operators in the market, primarily in the long-distance and data transmission businesses, such as the Mexican operator Telmex after acquiring a long-distance carrier and a data transmission operator and additionally, through América Móvil (a Telmex affiliate) entered the local mobile market by acquiring the operator Smartcom, and the change in ownership of Entel which also competes in both markets. Similarly, in September 2005, the local data transmission operator, GTD, acquired the local fixed operator Manquehue. See “Item 4. Business Areas—Market and Competition.”

     In the fixed local telephony market, Telefónica Chile competes with both mobile telephony and other fixed and cable telephony operators, which are not subject to the same tariff regulations as the Company and therefore may compete with different conditions. The Company’s market share has declined from 82% in 2000 to 68% in 2006. In the long-distance services market, Telefónica Chile competes with fifteen other long-distance operators and with mobile telephone operators in the domestic long-distance market. As a result, the Company has faced intense pricing pressure and a decreasing trend in traffic, which may result in further price decreases and market share losses in the future. During 2006, rates for domestic long distance services increased by 3.0% and rates for international long distance services decreased by 9.3% compared to rates as of December 31, 2005. Telefónica Chile also faces increasing competition in broadband services. The development of new technologies, such as wireless accesses like Wi Max or 3G, would increase competition in the market. See “Item 4. Business Areas—Market and Competition.” Increased competition or the entrance of new competitors could adversely affect the Company’s results of operations, financial condition or prospects.

     Changes in technology could affect Telefónica Chile in ways it cannot predict.

     The telecommunications industry as a whole has traditionally been, and is likely to continue to be, subject to rapid and significant changes in technology and the related introduction of new products and services. Although the Company believes that for the foreseeable future, existing and developing technologies will not materially adversely affect the viability or competitiveness of its telecommunications business, there can be no assurance as to the effect of such technological changes on the Company or that the Company will not be required to expend substantial financial resources on the development or implementation of new competitive technologies.

     New services and technological advances may offer additional opportunities to compete against the Company on the basis of cost, quality or functionality. It may not be practicable or cost-effective for the Company to replace or upgrade its installed technologies in response to competitors’ actions. Responding to such change may require the Company to devote substantial financial resources to the development, procurement or implementation of new technologies and to write off obsolete assets relating to its existing technology. If the Company chooses to purchase, or invest in the development of new telecommunications technology, there can be no assurance that such

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new products or services will not serve as a substitute to existing products and services offered by the Company. In the past, the Company has experienced such substitution with the introduction of mobile communications service, which has contributed to the declines in number of fixed lines, volume of traffic and in domestic long-distance traffic.

     Recent trends seen outside of Chile have shown an increased use of IP technology as a substitute for traditional voice services, at lower prices. The Telecommunications Law in Chile requires a regulation to be defined for these services to be offered to the public. Additionally, in 2006, Subtel initiated a process of public inquiry for new regulations relating to IP telephony over broadband. The Company has participated in the public inquiry process, together with other industry operators, and has presented its opinion about the proposal. See “Item 4. Information on the Company—Business Overview—Licenses and Tariffs.” Nevertheless, the use of this technology may serve as a substitute for the Company’s local and long-distance traffic together with pricing pressure.

     As a result, if the Company chooses to introduce any such new telephony products or services, it can give no assurance that the benefits of such new products and services will not be materially offset by declines in existing products and services offered by the Company or that it will be permitted to participate in that business.

     Labor relations may negatively impact Telefónica Chile.

     As of December 31, 2006, approximately 61% of the Company’s employees were union members. As of December 31, 2006, the Company had collective bargaining agreements in force with 22 unions.

     In June 2002, the Company experienced a work stoppage of 28 days that involved 3,445 employees and temporarily caused certain disruptions in the Company’s service to customers. Following the strike, the unions involved in the strike elected to invoke the provisions of Article 369 of the Chilean Labor Code, allowing them to freeze the conditions of the previous labor contract for a period of 18 months, without readjustment. In 2006, eight collective bargaining agreements were successfully negotiated with 21 unions representing 2,141 individuals. As part of the collective bargaining process, in 2006, the remaining employees subject to Article 369 after having applied it since 2002, terminated their claim and renewed their agreements with the Company.

     The Company has taken steps to maintain stable labor relations, such as the contracts for periods from two to three years that were signed after a succesful collective bargaining process, as well as the agreement between the Company and its employees in order to implement a new model of labor relations, which was designed to encourage a greater degree of participation and to address the interests of workers and management alike. However, the Company can provide no assurance that in the future it will be able to successfully negotiate new contracts on favorable terms, or that the unions involved in the negotiations will not choose to implement a labor strike or invoke Article 369 at such time.

     The passage of new outsourcing legislation may adversely affect our operating income.

     New outsourcing legislation took effect in January 2007 which requires certain persons that the Company had treated as outsourced independent contractors to be treated as employees and, therefore, be entitled to certain benefits to which employees are entitled as a matter of Chilean law. The Company estimates that approximately 800 persons that were formally independent contractors will be hired as internal employees between January and April 2007. We estimate that the financial impact of this change will not be material.

     Telefónica is the controlling shareholder of Telefónica Chile, and thus may determine the outcome of actions requiring shareholder approval.

     Telefónica Internacional Chile S.A. (“Telefónica Internacional Chile”) owns 44.89% of the shares of Telefónica Chile. Telefónica Internacional Chile is a 99.9% owned subsidiary of Telefónica Chile Holding B.V., which in turn is indirectly wholly owned by Telefónica. Consequently, Telefónica may have the ability to determine the outcome of any actions requiring shareholder approval. See “Item 10. Additional Information—Memorandum and Articles of Association—Shareholders’ Meetings and Voting Rights.” In addition, Telefónica’s equity stake in Telefónica Chile allows Telefónica to control the Company’s Board of Directors. In accordance with the Company’s Bylaws, at the General Annual Shareholders’ Meeting held on April 14, 2005, Telefónica elected five out of seven members of the Board of Directors.

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     The Company could be adversely affected if major suppliers fail to provide needed equipment and services on a timely basis.

     We depend on suppliers for network infrastructure and equipment to satisfy our operating needs. They may, among other things, extend delivery times, raise prices and limit supply due to their own shortages and business requirements. If these suppliers fail to deliver products and services on a timely basis that satisfies our customers’ demands, the Company could be negatively affected. Similarly, interruptions in the supply of telecommunications equipment for networks could impede network development and expansion.

     Our historical consolidated financial and operating results may not be indicative of future performance.

     The Company has divested subsidiaries in the past years. See “Item 4. Information on the Company—History and Development of the Company—Divestures.” In July 2004, the Company sold its mobile subsidiary, which provided 29.2% of operating revenues in the year ended December 31, 2003, and generated Ch$13,467 million (historic value) in operating income during the same period. The sale of businesses results in the loss of their contributions to our operating results. No assurances can be given that the Company will or will not divest of additional businesses in the future or that such divestitures will or will not affect the Company’s results and access to financing. As a result, our historical consolidated financial results for and as of the end of periods ending on or prior to these transactions may not be indicative of our future operating and financial performance.

     We may not be successful in the development of new businesses or product innovation.

     The Company cannot assure the success of any new services, products or the development of new businesses in the telecommunications market or other markets, or their impact on the Company’s results. This includes the Company’s entrance into the paid television market in the year 2006.

     Certain considerations related to platforms located in other countries

     The Company operates in Chile and most of its systems and platforms are located within Chile. Nevertheless, the Company also relies on technical platforms and other equipments such as television up links located in Perú, as part of shared platforms within the Telefónica Group. As a result, the Company cannot assure that volatility or unfavorable economic, political and social conditions will not materially affect its ability to provide services.

     We may not be able to refinance our outstanding indebtedness.

     The Company’s total financial debt as of December 31, 2006 amounted to Ch$401,590 million (US$754.3 million), with an average maturity of 3.6 years. The Company’s main historical sources of liquidity have been its cash flows from operations, proceeds from borrowings and the issuance of equity. Although in the past Telefónica Chile has relied substantially on public debt issuances and bank loans to meet its financing requirements, in recent years its main sources of liquidity have been cash flow generated from operations and cash flow resulting from savings associated with the refinancing of certain loans and sale of assets. During 2006, the Company continued with debt reductions and the renegotiation of loans, lowering interest rates and extending maturities. These efforts have resulted in a stable level of maturities for the next five years, which are expected to be funded through cash flow generated from operations and refinancing. The Company cannot assure that it will be able to arrange any potential financing to fund these maturities along with capital expenditures and dividends on acceptable terms. Refinancing of debt or increased levels of debt could have negative effects that include: difficulties in obtaining future financing; reductions in credit ratings issued by rating agencies; restrictions over cash flows or operations imposed by lenders; higher rates and reduced flexibility to take advantage of or pursue other business opportunities.

     A system failure could cause delays or interruptions of service, which could cause us to lose customers.

     To provide effective service, we will need to continue to provide our customers reliable service over our network. Some of the risks to our network and infrastructure include:

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     Our operations also rely on a stable supply of utilities. Given recent instability of those supplies, including the supply of gas from Argentina, we can not assure that future institutional instability will not impair our ability to procure required utility services in the future which could adversely impact our operations.

     Prolonged service interruptions could affect our business. We rely heavily on our network equipment, telecommunications providers, data and software to support all of our functions. We rely on our networks and the networks of others for substantially all of our revenues. We are able to deliver services only to the extent that we can protect our network systems against damage from power or telecommunications failures, computer viruses, natural disasters, unauthorized access, theft of copper wires from external networks and other disruptions. During 2006, Telefónica Chile’s networks were impacted due to an increase in thefts of copper cables. These thefts had to be absorbed into the investment plan by devoting approximately Ch$6,000 to replacing the affected networks. While we endeavor to provide for failures in the network by providing backup systems and procedures, we cannot guarantee that these backup systems and procedures will operate satisfactorily in an emergency. Should we experience a prolonged failure, it could seriously jeopardize our ability to continue operations. In particular, should a significant service interruption occur, our ongoing customers may choose a different provider, and our reputation may be damaged, reducing our attractiveness to new customers.

     We may not be successful in the legal proceedings currently pending.

     The Company is a party to lawsuits and other legal proceedings in the ordinary course of its businesses. An adverse outcome in, or any settlement of, these or other lawsuits could result in significant costs. See “Item 8. Financial Information—Consolidated Statements and Other Financial Information—Legal Proceedings.”

Risk Relating To Chile

     A downturn in the Chilean economy may adversely affect Telefónica Chile.

     Nearly all of Telefónica Chile’s customers are Chilean companies or individuals, and substantially all of Telefónica Chile’s operations are located in Chile. For these reasons, the results of the Company’s operations and its financial condition are sensitive to, and dependent upon, the level of economic activity in Chile. Historically, growth in the Chilean telecommunications industry has been tied to the state of Chile’s economy, particularly levels of consumer spending and demand. An economic slowdown may negatively affect the Company business by a decrease in demand and higher customer nonpayment levels.

     The Company can give no assurance that Chile’s economy will continue to grow in the future, nor can it give assurances that future developments in or affecting the Chilean economy will not impair its ability to proceed with its business plan or materially adversely affect its business, financial condition or results of operations.

     Developments in other emerging markets or in the global telecommunications market may adversely affect Telefónica Chile.

     Developments in the global telecommunications market and in other emerging markets, particularly in Latin America, may adversely affect the market for Telefónica Chile’s securities and the availability of foreign capital in Chile. The Company cannot predict whether events in other markets will adversely affect the price of, or market for, its securities.

     The Series A Common Stock of Telefónica Chile is a highly liquid stock in Chile, representing 3.3% of the local IPSA stock index, as of December 31, 2006. Therefore, the Company’s stock price is affected more rapidly and to a higher degree than most other Chilean stocks by upturns or downturns in the domestic and international markets.

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     The Company can give no assurance that negative developments in Latin America or other emerging markets will not occur or that such negative developments would not adversely affect the securities markets in which the Company’s securities trade or affect the Company’s access to sources of financing.

     An increase in inflation may adversely affect Telefónica Chile.

     Chile has experienced high levels of inflation in the past, although inflation has decreased in recent years. High levels of inflation in Chile could adversely affect the Chilean economy and Telefónica Chile’s financial condition and results of operations. The rate of inflation as measured by changes in the Chilean consumer price index in the years 2002 , 2003, 2004, 2005 and 2006, was 2.8%, 1.1%, 2.4%, 3.7% and 2.6% respectively.

     Generally, high levels of inflation will adversely affect the Company’s financial condition to the extent that, during any given period:

     Any significant increase in the level of inflation in the future may adversely affect the performance of the Chilean economy and the operating results of the Company.

     Currency devaluations and foreign exchange fluctuations may adversely affect Telefónica Chile.

     Volatility of the value of the Chilean peso against the U.S. dollar could adversely affect the Company’s financial condition and results of operations. The Chilean peso has been volatile in the past, including an approximate 9.8% nominal devaluation against the U.S. dollar during 2002, but in 2003, 2004 and 2005 the peso recorded a nominal appreciation against the U.S. dollar of 17.4%, 6.1% and 8.1%, respectively, versus the prior year. During 2006, the peso experienced a nominal devaluation of 3.9% . The main drivers of the volatility in the exchange rate in recent years have been the substantial devaluations in other Latin American markets, mainly Brazil, as well as general uncertainty and trade imbalance in global markets. In 2003, 2004 and 2005 Chilean peso appreciation was driven by improvement in Chilean economic indicators together with weakness in the US dollar. The value of the Chilean peso against the U.S. dollar may continue to fluctuate significantly in the future. See “Item 3. Key Information-Selected Financial Data-Exchange Rates.”

     Historically, a significant portion of the Company’s indebtedness has been denominated in U.S. dollars, while a substantial part of its revenues and operating expenses has been denominated in pesos. If the peso’s value declines against the dollar, Telefónica Chile will need more pesos to repay the same amount of dollar-denominated debt. As a result, fluctuations in the Chilean peso to U.S. dollar exchange rate may affect the Company’s financial condition and results of operations. As of December 31, 2006, 66.7% of the Company’s interest-bearing debt was denominated in U.S. dollars and was fully hedged against exchange rate variations between the peso and the U.S. dollar through financial instruments such as forward exchange agreements and cross-currency swaps. The remaining 33.3% of the Company’s interest-bearing debt is UF or peso denominated and therefore not subject to exchange rate risk. The Company’s hedging policy against foreign exchange fluctuations is disclosed in “Item 11. Quantitative and Qualitative Disclosures About Market Risk—Risk of Variations in Foreign Currency Exchange Rates.”

Risk Relating To Our ADSs

     Controls on foreign investment and repatriation of investments in Chile may adversely impact a holder of our ADSs’ ability to obtain and dispose of the shares of our common stock underlying its ADRs.

     Equity investments in Chile by persons who are not Chilean residents are generally subject to exchange control regulations that restrict the repatriation of investments and earnings from Chile. Our ADSs are subject to an ADR foreign investment contract among us, the depositary and the Central Bank of Chile which is intended to grant holders of our ADSs and the depositary access to Chile’s formal exchange market. See “Item 3. Key Information—Exchange Rates.” Pursuant to current Chilean law, our ADR foreign investment contract may not be amended

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unilaterally by the Central Bank of Chile. However, we cannot make any assurances that additional Chilean restrictions applicable to holders of our ADSs, the disposition of underlying shares of our common stock or the repatriation of the proceeds from the disposition of the underlying common stock could not be imposed in the future, nor can we assess the duration or impact of the restrictions if imposed. If for any reason, including changes to our ADR foreign investment contract or Chilean law, the depositary is unable to convert Chilean pesos to U.S. dollars, investors would receive dividends or other distributions in Chilean pesos. Transferees of shares of our common stock withdrawn from the ADR facility will not be entitled to access to the formal exchange market unless the withdrawn shares are redeposited with the depositary.

     The relative illiquidity and volatility of Chilean securities markets could affect the price of our ADSs and common stock adversely.

     Chilean securities markets are substantially smaller and less liquid than the major securities markets in the United States. In addition, Chilean securities markets may be affected materially by developments in other emerging markets, particularly in other countries in South America. The low relative liquidity of the Chilean market may impair the ability of holders of ADSs to sell shares of our common stock withdrawn from the ADS program into the Chilean market in the amount and at the price and time they wish to do so.

     Holders of ADSs may be unable to exercise preemptive rights.

     The Ley Sobre Sociedades Anónimas, Law No. 18,046 and the Reglamento de Sociedades Anónimas (Chilean Corporations Law) and applicable regulations require that whenever we issue new common stock for cash, we grant preemptive rights to all of our shareholders (including holders of ADSs), giving them the right to purchase a sufficient number of shares to maintain their existing ownership percentage. Such an offering would not be possible unless a registration statement under the U.S. Securities Act of 1933, as amended, were effective with respect to such rights and common stock or an exemption from the registration requirements thereunder were available.

     Since we are not obligated to elect to make a registration statement available with respect to such rights and the common stock, holders of ADSs may not be able to exercise their preemptive rights. If a registration statement is not filed or an applicable exemption is not available, the depositary will sell holders’ preemptive rights and distribute the proceeds thereof if a premium can be recognized over the cost of any such sale.

     Holders of ADSs may have fewer and less well-defined shareholders’ rights than with shares of a company in the United States.

     Our corporate affairs are governed by our estatutos, or bylaws, and the laws of Chile. Under such laws, our shareholders may have fewer or less well defined rights than they might have as shareholders of a corporation incorporated in a U.S. jurisdiction.

     Foreign Exchange risks may adversely affect the U.S. dollar amount of dividends payable to holders of our ADSs.

     Chilean trading in the shares of the common stock underlying ADSs is conducted in pesos. Our depositary bank will receive cash distributions that we make with respect to the shares underlying the ADSs in pesos. The depositary will then convert such pesos to U.S. dollars at the then prevailing exchange rate to make dividend and other distribution payments in respect to ADSs. If the Chilean peso depreciates against the US dollar, the value of the ADSs and the distributions ADS holders receive from the depositary may decrease.

ITEM 4. INFORMATION ON THE COMPANY

A. History and Development of the Company

     Telefónica Chile is a corporation organized under the Chilean Corporations Law. Telefónica Chile was incorporated on November 18, 1930 and has a duration through August 10, 2068. The address and telephone numbers of the Company’s registered office and the Company’s agent in the United States are as follows:

Compañía de Telecomunicaciones de Chile S.A.  CT Corporation System 

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Avenida Providencia 111  111 Eight Avenue 
Santiago, Chile  New York, New York 10011 
Telephone: (562) 691 2020  Telephone: (800) 624 0909 

     Telephone service in Chile commenced in 1880 with the formation of Compañía de Teléfonos Edison in Valparaíso. In 1927, the International Telephone and Telegraph Corporation (“ITT”) acquired the Chile Telephone Company, which had 26,205 telephones in operation at the time. In 1930, the Company was formed as a stock company named Compañía de Teléfonos de Chile S.A. In 1971, the Chilean Government intervened to take management control of the Company, and in 1974, the Chilean Government’s Corporación de Fomento de la Producción (“Corfo”) acquired 80% of the total shares issued by the Company, then held by ITT.

     In August of 1987, Corfo announced that it would reduce its shareholdings and privatize the Company by selling approximately 30% of Corfo’s shares in the Company. In January of 1988, 151 million shares of Series A Common Stock of the Company were transferred to Bond Chile. After giving effect to a capital increase in an April 1988 offering and other additional purchases of Series A Common Stock and Series B Common Stock of the Company, Bond Chile owned approximately 50% of the then issued and outstanding capital stock of the Company.

     In April of 1990, TISA, a subsidiary of Telefónica, indirectly acquired the stock of Bond Chile—and thus all of Bond Chile’s interest in the Company. Bond Chile then changed its name to Telefónica Internacional Chile S.A.

     The Company’s July 1990 international offering of American Depositary Shares (“ADSs”) reduced Telefónica Internacional Chile’s ownership to 44.45% of the Company’s issued and outstanding capital stock. Subsequently, payments made by third parties for subscribed but unpaid shares further reduced Telefónica Internacional Chile’s ownership to 43.6% until 2003. In 1999, the Company launched its new brand name, “Telefónica CTC Chile.” After the purchase of an additional 1.3% in July 2004, as of December 31, 2005, Telefónica Internacional Chile’s ownership stake in the Company was 44.9%.

     In accordance with Chilean Decree-Law 3,500, the Company has amended its Estatutos (“Bylaws”) to prohibit any shareholder from owning more than 45% of Telefónica Chile’s capital stock in order to enable all Chilean pension fund managers (“AFPs”) to invest in Telefónica Chile.

     An extraordinary shareholders’ meeting held on April 20, 2006 approved the modification of the Company’s brand name to “Telefónica Chile”. The legal name of the Company has not changed.

     The Company’s website address is www.telefonicachile.cl.

Mergers, Acquisitions and New Subsidiaries

     During the last three years, Telefónica Chile has not participated in any merger or acquisition activities material to the business. However, during 2006, the Company reorganized its subsidiaries in the following manner:

     Also in March 2006, Telefónica Chile long distance subsidiaries, Telefónica Mundo and Globus, merged to form a new subsidiary called Telefónica Larga Distancia. In June 2006, as part of this merger process, a payment of Ch$674 million (historical) was made to 2,375 shareholders of Telefónica Mundo who exercised their right of withdrawal.

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Divestitures

•
On July 3, 2000, the Company sold: (i) its 40% ownership interest in cable TV operator Metrópolis Intercom; (ii) 100% of its wholly owned subsidiary Compañía de Telecomunicaciones de Chile— Plataforma Técnica Red Multimedia S.A., which provided installation and maintenance services for the cable TV network; and (iii) the cable TV network. The sales price for the entire transaction amounted to the Chilean peso equivalent of US$270 million, of which Ch$165,290 million, the equivalent of US$250 million, was paid on October 2, 2000 and the remaining Ch$15,693 million (historic value), equivalent to US$20 million, was paid on July 4, 2005.
 
•
On March 24, 2004, Telefónica Chile agreed to sell its 9% ownership interest in Publiguías to Telefónica Publicidad e Información S.A. (TPI), a subsidiary of Telefónica S.A. (Spain). The sale agreement was signed on April 26, 2004 for a sale price of US$14.8 million, equivalent to Ch$9,781 million. The transaction resulted in a positive impact of Ch$5,358 million after taxes (US$8.9 million) on the Company’s financial results in 2004.
 
•
On May 18, 2004, the Board of Directors of Telefónica Chile agreed to recommend to shareholders, the approval of the offer made by a 92.44%-controlled subsidiary of Telefónica S.A, Telefónica Móviles S.A.(TEM), to acquire 100% of the Company’s subsidiary, Telefónica Móvil de Chile S.A. In addition to recommending the sale to shareholders, the Board considered the offer made by TEM and recommended that Management request fairness opinions. These fairness opinions were prepared by JP Morgan and ABN AMRO and confirmed that the price of the transaction was fair to Telefónica Chile shareholders. The transaction required two-thirds shareholders approval at an extraordinary shareholders’ meeting held on July 15, 2004. 69.1% of total shares outstanding approved the sale for US$1.058 million, equivalent to Ch$709,069 million, in addition to Ch$179,480 million (US$263 million) for all amounts owed by Telefónica Móvil de Chile S.A. to Telefónica Chile. The sale generated an after tax profit of Ch$321,071 million (equivalent to US$592.3 million as of December 31, 2005). Additionally, as approved in the extraordinary shareholders’ meeting, and as part of the transaction the Company paid, on August 31, 2004, an extraordinary gross dividend of Ch$421 per share (US$2.5074 per ADR), charged against accumulated retained earnings, and a gross interim dividend of Ch$140 per share (US$0.835808 per ADR) with a charge to net income. The total amount paid in connection with both dividends was approximately US$800 million. Mobile telephony offered attractive growth rates and represented 29.2% of total revenues as of December 31, 2003, and 32.1% of our operating revenues during the first six months of 2004. However, it was a capital-intensive business, with a high market penetration near 60% at time of sale and it faced intense competition which resulted in a low level of profitability for the business. The sale agreement restricts the Company from participating in the mobile telephony business for a period of two years from the date of the sale. Additionally, as part of the sale of Telefónica Móvil de Chile S.A., the Company reached agreements with creditors regarding the following obligations:
 
  (i)     
Syndicated and bilateral loans totaling US$647 million that imposed a limit on the sale of assetsequal to or above 5% of the Company’s consolidated assets. The Company obtained waivers of this limit from 28 national and international banks.
 
  (ii)     
Series F local bonds for a total of US$23 million that contained a prohibition on the sale of suchassets equal to 20% or more of total assets. The terms of the bonds were modified with 84.5% approval from the bondholders.

Capital Expenditures

     Capital expenditures carried out by the Company in 2004, 2005 and 2006 amounted, respectively, to Ch$93,296 million (US$151.2 million; historic value as of December 31, 2004); Ch$73,579 million (US$149.1 million; historic value as of December 31, 2005) and Ch$109,523 million (US$204.7 million as of December 31, 2006). In July 2004, the Company sold its mobile subsidiary Telefónica Móvil de Chile S.A. and thus no longer

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consolidated mobile capital expenditures. Capital expenditures of the mobile subsidiary during the first half of 2004 totaled US$32 million (equivalent to Ch$17,837; historic value as of December 31, 2004), approximately 21% of the Company’s total capital expenditures for the year. Due to the sale of the mobile subsidiary, capital expenditure requirements have been significantly reduced.

     The Company has been steadily adjusting its capital expenditures in local telephony and using its available installed capacity to expand service, rather than creating new lines. During 2006, the Company focused its investment primarily on consolidating broadband growth and launching a new product, digital television. Together these investments consumed 45% of the year’s capital expenditure requirements. The investment plan for the year also included the continued initiative to upgrade the Company’s operational support systems by improving the tools that support its business, technical, and administrative management. With regard to the Company’s traditional business, investment was focused on maximizing installed capacity, marketing telephone lines, and initiating a network improvement and plant modernization plan aimed at increasing quality of service.

     It is important to note that, during 2006, Telefónica Chile’s networks were seriously impacted due to an increase in thefts of copper cables. These thefts had to be absorbed into the investment plan by devoting approximately Ch$6,000 million to replacing the affected networks.

     Since January 2001, all capital expenditures made by the Company have been on projects located within Chile. Capital expenditures have been financed substantially with cash flow generated from operations.

B. Business Overview

     According to Company estimates, as of December 31, 2006, Telefónica Chile owned approximately 67.7% of all fixed telephone lines in the country. As of that date, the Company provides a broad range of telecommunications and other services throughout Chile, including:

     The Company provides all of its fixed telephony services through its own digital telecommunications network, including local telephone service and interconnection services. In addition, our subsidiary Telefónica Larga Distancia S.A. (“Telefónica Larga Distancia”) provides substantially all of its domestic and international long-distance services with its own equipment and long-distance network.

     Chilean law currently requires companies to obtain licenses from the government before providing many telecommunications services. Telefónica Chile holds licenses to provide local telephone service and data transmission services throughout Chile. The Company also holds licenses to provide long-distance service

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throughout Chile and internationally through its subsidiary Telefónica Larga Distancia. In addition, Telefónica Chile held licenses to provide mobile telephony services in Chile through its subsidiary Telefónica Móvil de Chile S.A. until its sale in July, 2004. See “Licenses and Tariffs—Licenses” below.

     Moreover, the Chilean Government sets the maximum prices, fees and charges that Telefónica Chile may charge for certain services including local telephone service, public telephones, interconnection services and related administrative services, unbundled network services, and line connections. The regulation applies to our fixed monthly charge, variable charge, connections and other installations, access charges for rural companies, the number for information services (level 103) through an operator, access charges and interconnections and public telephones. In 2006, approximately 31% of Telefónica Chile’s total operating revenues were generated through the provision of services subject to tariff regulation. The Chilean Government does not currently regulate the prices that Telefónica Chile charges for its other products and services, including, among others, long distance, data transmission, broadband, pay TV, value-added services, directory advertising and sales and leasing of terminal equipment.

Products and Services

     Fixed Telecommunications

     The fixed telecommunications business segment includes all services provided using the fixed line network infrastructure, such as basic telephony that consists of traditional telephone services including fixed charge, variable charge, minute plans (flexible plans), line connections, value-added services, broadband services through ADSL technology, access charges, interconnections and other fixed telecommunications businesses (which include directory advertising, ISP for companies and small and medium businesses, security services such as alarm monitoring through fixed lines, public telephones, pay TV, interior installations and equipment sales and rentals). Fixed telecommunications revenues reached Ch$439,548 million (US$825.6 million), accounting for 76.2% of the Company’s operating revenues in 2006, compared to 76.0% in 2005 and to 60.1% in 2004.

     The Fixed Telecommunications business area uses marketing channels owned by the Company, such as commercial offices and retail stores that sell Telefónica Chile’s products, as well as external marketing channels, such as direct telemarketing sales by third parties, complemented by an external sales force and specialized distributors.

     Basic Telephony

     The Company provides basic telephony to its customers over the public telephone network within the tariff areas defined in the Tariff Decree. Revenues from basic telephony includes: (i) telephone line service fees (fixed monthly charge), (ii) variable charges that includes local traffic defined as measured local service (“MLS”), traffic from local lines to Internet and mobile telephones (“local tranche”) and prepaid traffic through prepaid cards, (iii) flexible plans (plans of minutes), (iv) connections and other installations and (v) certain value-added services that enhance the communications experience of its customers, such as voice mail, call-waiting, call-forwarding, caller-ID, and access to information and entertainment services (600 and 700 numbers), among others.

     During 2006, 384,003 new fixed lines were connected, a 7.2% and 11.9% increase in new line connections as compared to 2005 and 2004, respectively, and 609,201 lines were disconnected, a 76.8% increase compared with 2005 and a 83.1% increase compared with 2004. As a result, lines in service under Fixed Telephony as of December 31, 2006 totaled 2,215,629 representing a decrease of 9.2% as compared to December 31, 2005 and a decrease of 8.7% as compared to December 31, 2004. Of the 2,215,629 lines in service as of December 31, 2006, 11.1% were corporations, 18.0% were small business and professional clients, 70.1% were residential and 0.8% were wholesalers.

     The following table sets forth certain fixed line performance and line connection information for the periods indicated.

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    For the year ended December 31, 
   
    2002    2003    2004    2005    2006 
           
Lines installed    3,023,541    3,037,267    3,043,379    3,007,432    3,021,487 
Fixed lines in service    2,686,695    2,416,779    2,427,364    2,440,827    2,215,629 
Average fixed lines in service    2,732,208    2,558,291    2,406,266    2,451,356    2,332,634 
Lines per 100 inhabitants(1)   17.4    16.1       15.0    15.1    13.4 
Number of new lines connected    340,419    308,266    343,318    358,088    384,003 
Number of lines disconnected    377,034    578,182    332,733    344,625    609,201 
Defects per line (annual average)(2)   0.35    0.35    0.40    0.44    0.54 
Local traffic (in millions of minutes)(3)   15,900    15,178    13,759    12,012    9,643 
________________________________________
   
(1) Telefónica Chile fixed lines per 100 inhabitants. Figures according to projections from Census 2002 which were released in August 2005 (16.5 million inhabitants as of December, 2006).
 
(2) Defects refer to any technical problems occurring in telephone lines, ADSL and equipment as well as in the Company’s external plant and central switches.
 
(3) As of February 1, 2000, per second billing was implemented.
 

     Over the past four years, Telefónica Chile’s fixed line traffic has decreased, mainly due to customers’ greater use of mobile services and electronic communications.

     In order to mitigate the adverse impact of regulation and the decrease in traffic and other negative factors affecting fixed line revenues, Telefónica Chile has focused on offering various non-regulated services over its local network infrastructure, thus adding value to existing fixed lines and mitigating the decrease in revenues per line. The Company markets new services aimed at facilitating customer communications options and increasing the number of successfully completed calls, such as:

     Flexible tariff plans

     In February 2004, Telefónica Chile was authorized to offer alternative tariff plans to the regulated plan consisting of a fixed charge plus variable charge. This new regulatory rule allowed the Company to offer alternatives to the regulated plan without previous authorization by the Regulator and compete by adapting to customers’ needs. These plans are not subject to maximum tariffs or predetermined structures and may include joint offers with other services. According to this, starting in 2004, the Company began to market plans such as: (i) Plans of Minutes, consisting of telephone service with a certain number of minutes for a monthly charge, (ii) Economy Line, consisting of a monthly amount from which customer calls are deducted, allowing for additional calls to be placed by means of prepaid cards (iii) Super Economy Line, which enables customers to make calls for a certain number of minutes through prepaid cards charged on a monthly basis; and (iv) Bundled Services, such as broadband plus minute plans or broadband plus minute plans and pay TV.

     As of December 31, 2006, 1,324,597 lines, which is more than a 100% increase compared with 2005, have been signed up for flexible tariff plans in agreement with Decree No. 742, representing 59.8% of the Company’s total lines in service and thus significantly contributing to the growth of the fixed-line market. Revenues from the new flexible plans represent 15.7% of consolidated revenues compared with 7.9% in 2005.

     Although the effective rates charged for flexible tariff plans are less than those charged in traditional plans, these types of products still allow the Company to use the available capacity of the network to be more competitive.

     Prepaid Services

     The Company has also sought to increase the use of its fixed lines by offering prepaid card services. These services have provided strong support to the development and growth of the fixed line business and have played a role in the development of alternatives to the traditional regulated plan. They have also allowed for the introduction of the prepaid model into new business areas such as wireless broadband (Wi-Fi technologies) and switched Internet. Among the prepaid services, the Tarjeta Línea Propia, or “TLP” card, allows users to make calls from any fixed line telephone (including those blocked for long-distance, cellular or 700 number calls), public telephones and Telefónica Móvil de Chile S.A. or other enabled mobile company phones. This product allows customers to have

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their own versatile, portable virtual line, while controlling and managing their telecommunications expenses. As of December 31, 2006, 16.0 million TLPs were activated in the amount of Ch$1,000 each, representing an increase of 6.7% over 2005 and an increase of 23.7% over 2004. The total number of prepaid lines reached 360,970 in 2006, which represents a decrease of 32.4% and 11.7% from 2005 and 2004, respectively.

     Public Telephones (Payphones)

     Telefónica Chile offers public telephony services and is responsible for the installation and operation of its own public telephones on public roadways and in indoor areas, the marketing of public telephone equipment to private third parties and the fixed telephony installation. Currently, the public telephony market in Chile is made up of seven operators and numerous private parties of which Telefónica Chile has a market share of approximately 30% of payphones. The revenues in this business area are generated by traffic on public phones owned by the Company, the management of its own call centers, maintenance agreements for indoor installations, and post-sales maintenance and business support services provided to third parties such as owners of public telephones purchased from the Company.

     As of December 31, 2006, the Company had installed a total of 10,000 smart public telephones, representing a decrease of 0.6% from 2005 and 2.9% from 2004, which allow the use of coins or prepaid cards to make calls. As of December 31, 2006, the Company also installed 10,523 licensee telephones and community lines, representing a decrease of 20.1% from 2005 and 41.5% from 2004, located inside buildings and communities which allow calls to 800 numbers, prepaid card calls and use of the automatic collect call service.

     Revenues from public telephony in 2006 were Ch$9,963 million (US$18.7 million), which represents 1.7% of total consolidated revenues and a decrease of 0.6% and 13.1% in respect to 2005 and 2004 public telephony revenues, respectively.

     Alarm Monitoring and Security Services

     Telefónica Chile, through its subsidiary Telemergencia, offers home security and home assistance services through monitoring and alarm systems connected to a security platform over its existing fixed telephone lines. Telemergencia offers a wide variety of plans adapted to customers’ needs and budgets, ranging from an alarm monitoring service through telephone lines to the more complex Viginet plan, a digital video-surveillance system that can be operated online from a broadband Internet connection. In 2006, this business reached 55,037 customers, which amounts to a 9.8% decrease from 2005 and 8.0% from 2004. Revenues from Telemergencia in 2006 were Ch$8,825 million (US$16.6 million), which represents 1.5% of total consolidated revenues and an increase of 7.0% and 24.9% in revenues from Telemergencia in 2005 and 2004, respectively.

     Other Fixed Telecommunications Services

     Telefónica Chile sells value-added services to its customers, such as caller ID, voice mail, call waiting, call forwarding, call waiting ID, outbound traffic control to mobile phones, and information and entertainment services (600 and 700 numbers). In addition, Telefónica Chile sells advanced telecommunications equipment to residential, businesses and corporate customers.

     Telefónica Chile also provides its residential customers with access to the Internet over analog lines. The Telefónica Internet Empresas (TIE) subsidiary provides switched Internet browsing services to small and midsized companies through dedicated links and via ADSL.

      Under an agreement with Impresora y Comercial Publiguías S.A. (“Publiguías”), Telefónica Chile receives a percentage of the revenues generated by Yellow Pages and White Pages advertising sales. This agreement was renewed in August 2006 for a five-year period that can be extended by two additional years. Publiguías also prints and distributes telephone directories from the customer database provided by Telefónica Chile. Revenues from other fixed telecommunications services in 2006 were Ch$62,650 million (US$117.7 million), which represents 10.9% of total consolidated revenues and an increase of 1.8% compared to 2005. These revenues represent a decrease of 11.3% in 2005 compared to 2004.

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     Digital Television

     On June 14, 2006, Telefónica Chile launched its pay television service, with a flexible marketing format unique to the local market.

     Telefónica Chile was the first company to provide flexible pay television. Customers pay for what they watch, which means that the services are tailored to the interests and budget of each home. The plan is known as the Telefónica TV Digital offering, and it offers an entry-level plan for Ch$9,900, including a selection of the channels in greatest demand including, among others, the basic version of the Canal del Fútbol (soccer channel), Disney Channel, Discovery Channel, TNT, Sony, Warner, ESPN and Fox. For a variety of prices, the customer has the opportunity to add an assortment of thematic or premium movie plans, family, sports and premiere film channels under this format.

     The service provides national coverage and offers additional services to customers, which include, among others, parental control, an on-screen programming guide, program reminders, access to pay-per-view service and a thematic search feature.

     The pay TV service is provided by the Telefónica Multimedia Chile S.A. subsidiary, and it is marketed in bundles: “Dúo” – combining television and fixed telephone service – and “Trío”, combining television, fixed telephony and broadband service.

     The launch of this service has stimulated the pay television market in Chile, increasing the customer base while facilitating access to this new service for new customers. Growth is achieved by providing flexibility to customers, who can purchase a convenient service tailored to their interests and budgets.

     As of December 31, 2006, after only six months of operation, the Company had 94,209 pay TV customers, representing an 8.7% market share (and making it the number two pay television operator in the country).

     ADSL Broadband Services

     Although broadband service is currently primarily used for high speed Internet access, it also allows the Company to offer customers other services, such as virtual private networks (“VPNs”), security systems with remote monitoring from anywhere in the world (“Viginet”), e-learning, wireless connections, connections to a second PC, intranet IP telephony (voice over IP) for corporate customers and multimedia applications. The broadband service also allows the provision of value-added services, including online antivirus and firewall, parental controls for Internet, and PC technical support, both remote and in-home.

     In 2006, broadband showed strong growth as a result of the Company’s bundling, flexibility and segmentation strategy. The progress achieved in the broadband business has laid the foundation for the development of new services and content, with broadband serving as the primary gateway into Chilean households.

     In this context, various business initiatives were undertaken during the year, including, among others, the implementation of an innovative broadband self-install kit for customers, the addition of a customer PC care service called “Doctor Speedy”, and the ability for customers to have access to all of Telefónica Chile’s Hot Spots throughout the country, free of charge. These initiatives are in addition to the success of the Dúo campaigns, consisting of broadband plus minute plans, the Trío campaigns, incorporating Digital Television, for residential customers, as well as the broadband campaigns for SMEs. Value-added services such as the “Security Suite”, which includes antivirus, firewall and parental control for the Internet, among others, were also launched during the year.

     As of December 31, 2006, ADSL connections totaled 495,479, representing an increase of 57.7% and 146.8% with respect to 2005 and 2004, respectively, of which 77.7% were residential, 16.9% were small business and professional clients, 3.6% were wholesale and 1.8% were corporations, with the most significant growth coming from the residential sectors. These ADSL connections account for 48.6% of connections for the national broadband market (connections at speeds of 128 kbps or higher).

     The following table sets forth the number of ADSL connections in service as of the dates indicated.

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    As of December 31, 
   
    2002    2003    2004    2005    2006 
           
ADSL connections in service    54,163    125,262       200,794    314,177    495,479 
ADSL/Lines in service    2.0%    5.2%       8.3%    12.9%    22.4% 

     In 2006, revenues from broadband were Ch$61,297 million (US$115.1 million), which represent 10.6% of total consolidated revenues and 13.9% of fixed telecommunications revenues. Revenues from broadband have grown by 39.9% and 130.3% compared to 2005 and 2004, respectively.

Long-Distance

     The Long-Distance (“LD”) services and products provided by the Company are not subject to tariff regulation. The Company provides a broad offering of domestic and international LD services, including public and private voice, data and video services, through its subsidiary Telefónica Larga Distancia. The LD business segment also includes the rental of Telefónica Larga Distancia’s LD network to other telecom operators, such as other LD carriers with and without their own networks, as well as mobile companies, including Telefónica Móvil which was sold by Telefónica Chile in July 2004, and ISPs. Telefónica Larga Distancia, like many other long-distance operators, has a business area dedicated to international businesses. This area is involved in negotiating settlement rates and volumes for incoming and outgoing international traffic with different international operators, as well as establishing agreements for the intermediation of international traffic among LD carriers.

     During 2006, the Company recorded a decline of 9.9% in Domestic LD (“DLD”) traffic compared to 2005 and 18.3% compared to 2004 due to the growing use of mobile telephones, e-mail and Internet, and the increase in lines blocked for LD calls. On the other hand, in terms of International LD (“ILD”) business, traffic increased 3.9% compared to 2005 and increased 1.7% compared to 2004, primarily owing to the increased competition in prices for ILD destinations.

     The following table sets forth traffic information for DLD and ILD telephone traffic carried by Telefónica Larga Distancia for the periods indicated.

    2002    2003    2004    2005    2006 
           
DLD traffic (in millions of minutes)   717    647    664    602    542 
Outgoing ILD traffic (in millions of minutes)   66    64    67    66    68 

     The challenges currently facing the long distance business include, among others: (i) its replacement by mobile telephony, e-mail and the Internet, (ii) the increase in domestic lines blocked for long distance calling, and (iii) significant price-competition in international long distance. Nevertheless, Telefónica Chile continues to benefit from the existing infrastructure (since new investment is not required), and the ability to generate cash flows from long distance services. In order to streamline Telefónica Larga Distancia operations, in June 2006, billing and sales functions were outsourced to an independent firm. As a result, the subsidiary has been able to leverage synergies, and its operations have become more flexible. In addition to offering traditional long distance traffic services under the multi-carrier system, the Company’s strategy includes numerous plans to generate traffic, enhance customer loyalty, and maximize usage of the existing network and infrastructure. These plans consist of domestic or international long distance calls at a fixed monthly price, with preferred rates or discounts for the use of frequent routes, on specific schedules, or all day, depending on the plan selected. Highlights for 2006 include the launch of “188 en movimiento” (Mobile 188) and unlimited plans, which are minute plans aimed at Residential customers. As of December 31, 2006, 288,400 customers had plans under contract. This has enabled Telefónica Larga Distancia to overcome the industry’s downward trend.

     In addition, to improve the return on domestic and international LD network capacity, the Company is serving other telecommunications operators’ voice transport and capacity needs, including intermediary service companies with and without their own networks, mobile companies and Internet service providers (ISPs).

     In 2006, revenues from LD were Ch$58,922 million (US$110.7 million), which represent 10.2% of total consolidated revenues. Revenues from LD have decreased by 0.5% and 9.6% compared to 2005 and 2004, respectively.

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     The main sales channels through which the Company offers its long-distance products and services are direct telemarketing sales campaigns conducted by third parties. The Company also uses third-party call centers to sell DLD and ILD traffic plans and other products, such as prepaid cards.

     Corporate Customer Communications and Data

     The Corporate Communications business, through the Telefónica Empresas subsidiary, has the mission of providing a comprehensive response to the communications needs of the larger and more complex organizations in Chile. Clients of Telefónica Empresas include ministries, public institutions, associations, and large corporations, both national and international, that are involved in a broad range of economic activities.

     “Communications” play an essential role in the mission-critical processes of these clients. For this reason, the services provided by Telefónica Empresas are subject to continuous challenges which include increasing capacity, availability and quality standards, and the growing convergence and integration of different technologies. By integrating technologies, this company delivers solutions that add value to each client’s business through new applications that better serve their needs.

     One of the primary services provided by Telefónica Empresas is data transmission, mainly through IP technology-based services. In some cases, circuit-based solutions and value-added services are delivered through data links such as Frame Relay and ATM. Telefónica Empresas also provides corporate clients with basic telephony solutions, advanced solutions, private IP telephony and IP Centrex solutions based on the Next Generation Network infrastructure. In addition to providing a range of solutions such as PABX, videoconferencing and point-to-point data circuits, Telefónica Empresas also offers advanced telecommunications solutions in the form of consulting projects, professional services and outsourcing.

     These services are complemented with international services tailored to client needs. These services take advantage of the Telefónica Group’s network and international presence, delivering value for global clients.

     In 2006, major projects were agreed upon with public sector clients (including, among others, the police department’s logistics department, the special investigation police force, the National Forestry Department and the Department of Justice) as well as important private sector clients. It is important to note that Telefónica Empresas contains a Datacenter which provides a main or backup storage site for hosting equipment. This Datacenter helps to support and ensure business continuity for our clients.

     The Datacenter was certified in 2005 under standard BS 7799-2:2002. This certification means that the Datacenter has a secure information management system for the help desk, operations, reporting, infrastructure, engineering, and implementation, and also guarantees control over the level of security of the information included in the processes. Our Datacenter is expected to obtain ISO-27001 certification during 2007, which will contribute to the ongoing improvements in our Datacenter services.

     In 2006, revenues from the corporate customers communications and data business segment amounted to Ch$76,113 million (US$143.0 million), which represent 13.2% of total consolidated revenues. Revenues from the corporate customers communications and data business segment have decreased by 4.7% and 13.2% compared to 2005 and 2004, respectively.

The following table sets forth the number for some of the Company’s data services as of the dates indicated.

    As of December 31, 
   
    2002    2003    2004    2005    2006 
           
Datared (circuits)   13,496    10,820    9,770    5,821    5,353 
Frame Relay (points)   5,215    5,016    3,892    2,621    1,930 
ATM (points)   1,719    1,790    1,660    1,085    1,101 
Dedicated IP connections    3,788    7,018    10,377    10,869    12,634 

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Other Businesses:

     t-gestiona

     Telefónica Gestión de Servicios Compartidos Chile S.A. (t-gestiona), a subsidiary of Telefónica Chile, provides support services to all Company subsidiaries and other Telefónica Group companies. The provided services include logistics, e-learning, accounting, fund management, collections, insurance, payroll, real estate management and general services. The t-gestiona strategy is focused on positioning itself as a provider of shared services, primarily within the Telefónica Group, as t-gestiona has established an alliance with Telefónica Empresas to market its services. To a lesser extent, t-gestiona provides services to third parties that are not related to the Telefónica Group. This subsidiary’s strategy is based on its unwavering objective of seeking efficient use of resources and continued improvement of its processes.

     Fundación Telefónica

     Fundación Telefónica, a nonprofit organization created to develop and channel community and cultural activities of the Telefónica Group companies in Chile, continues to support digital literacy in Chile by providing Internet training to teachers, community leaders and the disabled.

     Telefónica Internet Empresas

     Telefónica Internet Empresas (TIE), a direct subsidiary of Telefónica Chile since the Company’s organizational restructuring in 2006, provides Internet access services to corporate clients and small and medium-sized businesses over dedicated and switched lines and through ADSL.

Mobile Communications

     In July 2004, Telefónica Chile sold its mobile communications business to Telefónica Móviles S.A. (TEM). See “Item 4. Information on the Company--Divestitures.” As a result, since July 1, 2004, the Company no longer includes Telefónica Móvil de Chile S.A. in its financial statements.

     The mobile communications business segment (“mobile communications”) offered mobile telecommunications products and services through the Company’s former subsidiary, Telefónica Móvil de Chile S.A., and generated revenues from outgoing cellular traffic, interconnection fees from incoming calls from other networks and mobile equipment sales.

Market and Competition

     The telecommunications industry in Chile, including the pay TV business, achieved sales of US$4.7 billion in 2006 an increase of 10.5% from 2005, this increase was largely driven by mobile growth and broadband development. Additionally, it is estimated that investment in the industry in 2006 was approximately US$900 million.

     In 2006, the industry advanced with great momentum toward full market availability of integrated services. In the residential segment, there was significant growth in the area of bundled voice, broadband and television. A similar situation is developing in the small and medium enterprises (SME) segment, where voice and broadband plans are becoming available. The corporate communications segment is witnessing a consolidation of IP networks, making it possible to offer voice and data and facilitating integration toward IT-based business processes. Additionally, there has been massive, across-the-board growth in mobile communications in all of Chile’s social and business strata.

     At the country level, there has been a clear consolidation of a competitive model based on “overlapping” networks that primarily employ the following access technologies:

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     In addition, operators have begun to expand the development of wireless solutions, as evidenced by the deployment of Wi-Fi (Wireless Fidelity) by Telefónica Chile, the launching of a PHS (Personal Handy System) by Telsur, and the recent entry of Transam into local telephony through the GSM standard.

     The most relevant events in 2006 were the launching of satellite digital TV by Telefónica Chile during the second quarter and the mass migration to the GSM standard by Movistar and América Móvil. In late July 2006, the latter changed its local brand from “Smartcom” to “Claro”.

     The rise in thefts of cables from the fixed network is also noteworthy, as it has negatively impacted the quality of service offered by fixed operators, particularly in the low-income sectors of the population.

     The following chart shows the business segments in which the main Chilean telecommunications companies operate:

Company    Fixed
Telephony  		   Broadband (1)   Long-
Distance 		  Mobile
Communications		   Data
Transmission		   ISP
Corporate 		  ISP
Residential		   Pay
TV (10)
                             
Telefónica Chile(2)   a    a    a        a    a        a 
T. Móvil de Chile S.A.(3)           a    a                 
ENTEL(4)   a    a    a    a    a    a    a     
VTR(5)       a    a                a    a 
Claro(6)               a                 
Telmex Chile(7)   (8)       a        a    a    a     
Telefónica del Sur    a    a    a        a    a    a     
Terra Networks                            a     
CMET    a    (8)   a                a    a 
Direct TV                                a 
GTD - Manquehue (9)   a    a    a        a    a    a     

________________________________________
(1)      Broadband with last mile access. Does not include resellers or ISPs and does not consider dedicated accesses to corporations.
 
(2)      In July 2004, the extraordinary shareholders’ meeting of Telefónica Chile approved the offer made by TEM to acquire 100% of the Company’s subsidiary, Telefónica Móvil de Chile S.A. See “Item 4. Information on the Company—History and Development of the Company—Divestitures”
 
(3)      Includes operations from Bellsouth Chile acquired by TEM in 2004. The Antitrust Commission approved the merger of both companies in January 2005.
 
(4)      Telecom Italia sold its stake in Entel Chile (55%) to Chilean investors in 2005.
 
(5)      Includes Metrópolis Intercom merged in July 2005.
 
(6)      Until July 2006 it was named Smartcom. It was acquired by America Movil in August 2005.
 
(7)      Includes operations from AT&T Chile (at present known as Telmex Chile) and Chilesat Corp.
 
(8)      Recently entered into the market and/or without significant operations.
 
(9)      Includes Manquehue Net acquired by GTD in September 2005.
 
(10)      Only those companies that own the infrastructure to provide the service.
 

Telefónica Chile faces intense competition in every aspect of its business activities. Unless otherwise indicated, all statements regarding the competitive position of Telefónica Chile are based on the Company’s internal estimates.

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Fixed telecommunications

     The fixed telephony market in Chile reached approximately 3.3 million lines as of December 2006, reflecting a decrease of close to 4.7% with respect to year-end 2005. The rate of penetration of fixed lines, as of December 2006, was 19.8 lines per 100 inhabitants, slightly lower than the 21.1 rate for 2005.

     Although Telefónica Chile operates approximately 67.8% of the local fixed lines in service in Chile, our market share has been declining for the past six years. Factors that have contributed to our declining market share include the intense competition in key niches of the market due to the aggressive offers of competitors.

     Currently, there are seven operators that provide fixed telephone service and, in the aggregate, operate the total number of fixed lines in service in Chile as of December 31, 2006. In certain areas of the Santiago Metropolitan Region, Complejo Manufacturero de Equipos Telefónicos S.A.C.I. (“CMET”), GTD S.A. (“Grupo Teleductos”) that includes operations from Manquehue Net and Telesat S.A., VTR Telefónica S.A. (“VTR”), which is an 80% subsidiary of Liberty Media, Entel Telefonía Local S.A. (“Entelphone”), which is a local telephony subsidiary of Empresa Nacional de Telecomunicaciones S.A. (“Entel”) and Compañía Nacional de Teléfonos (“Telefónica del Sur” or “Telsur”), hold licenses to provide local service. Furthermore, two companies, Telsur and its subsidiary Compañía Telefónica de Coyhaique S.A. (“Telcoy”), have licenses to provide local service in southern Chile. Telsur in Regions X and XI and Telcoy in Regions XI and XII. Additionally, Telmex operates in the corporate segment of the main cities in the country after acquiring Chilesat operations in 2003. The initial licenses have been modified over the years, extending the license areas of the local telephone service providers, mainly VTR (in all Regions except Region X, XI and XII) and Telefónica del Sur (in Regions VIII and IX). Apart from Telefónica Chile, three other companies provide local telephone service in rural areas. Telefónica Chile also competes with providers of private communications systems, particularly in areas of significant business activity.

     Broadband

     Broadband connections (ADSL, cable modem and Wireless Local Loop (WLL)) in Chile currently represent 93% of all Internet connections (broadband, narrowband and dedicated). Broadband penetration of total homes in Chile has increased from 17% in 2005 to 23% at the end of 2006. Moreover, broadband connections grew to 1,020,000 connections by year-end 2006, posting a 38% increase, while dial-up access dropped by 61% to 65,000 connections. As of December 2006, ADSL broadband connections represented 58% of the country’s total broadband use. Also during 2006, the deployment of Wi-Fi (Wireless Fidelity) continued, enabling cable-free high-speed Internet connections. As of December 2006, there are an estimated 585 HotSpots installed throughout the country, making Chile the leading Latin American country in the deployment of this technology.

     There are seven operators in the Chilean broadband market (broadband being defined as connections of 128 kbps or more) using the different technologies. One of the seven operators provides broadband service utilizing cable modems (VTR, which merged with Metrópolis Intercom), five utilizing only ADSL technology (Telefónica Chile, Telefónica del Sur, GTD, CMET and Telmex) and one utilizing ADSL and WLL technology (Entel). The Company estimates that, as of December 31, 2006, its ADSL service (including direct sales and as a wholesale provider) accounted for approximately 49% of all broadband access over 128 kbps offered in Chile.

     Long Distance

     The LD telephony market in Chile maintains its trend toward decreased traffic, observed since 1999. Thus, annual domestic LD traffic decreased by 11.5% in 2006, while international LD traffic fell by 15.3% . These results are primarily due to the growth in mobile telephony and Internet communications.

     Although there are 39 operators authorized to offer LD services in the country, as of December 2006, only 30 offered the service and 18 of those companies accounted for approximately 99% of all LD traffic. Three of these companies, Telefónica Larga Distancia, Entel and Telmex, operate their own LD networks. These three operators accounted for 79% of DLD traffic and 87% of the outgoing ILD traffic in 2006, according to Company estimates. The following companies are the other main operators which offer LD services in Chile under the Multicarrier System: Telefónica del Sur Carrier S.A., a subsidiary of Telefónica del Sur; GTD Larga Distancia S.A.; VTR Global Carrier S.A.; Micarrier Telecomunicaciones S.A., a subsidiary of Entel; and, Telmex 171 (formerly Carrier 171 Chilesat) and AT&T Chile S.A., both subsidiaries of Telmex. In 2006, Telefónica Larga Distancia’s market

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share represented approximately 36.3% of DLD voice traffic and 34.1% of outgoing ILD voice traffic, maintaining market leadership in DLD while holding the number-two position in ILD, according to Telefónica Chile estimates.

     Corporate Customer Communications and Data

     An increase in competition was observed in the corporate communications and data transmission market in Chile because of the increased aggressiveness exhibited by operators. To remain competitive, operators are continuing to migrate their traditional services (ATM, Frame Relay and Datared) to IP networks and expand their services into Outsourcing of Information Technology Services. As of December 2006, there are eight operators in the country’s major cities and only three have national infrastructure coverage. Telefónica Chile estimates that as of December 31, 2006 its share of the total revenues generated by the market for these services was approximately 44%.

     In 2006, Telefónica Empresas showed significant growth in the Hosting and Solutions and IP Services product lines. It also positioned itself as a major player in Electronic Billing services (approximately 19% of market share), as well as providing outsourcing solutions, data networking, and multicompany voice solutions for the financial sector. Moreover, the Company estimates that it had approximately 33% of the corporate market share for dedicated Internet access. In this market, the Company competes mainly with Entel, Telmex Chile (formerly AT&T Chile and Chilesat), Teleductos, Telsur, as well as other competitors.

     Security

     With a market share of 28%, Telemergencia is now the market’s second leading alarm monitoring company, behind ADT which has 44% of the market, according to Company’s estimates.

Mission and Corporate and Business Strategy

     Telefónica Chile’s mission is to lead in the growth and innovative development of the Information Society in Chile by building relationships of deep-seated trust and mutual benefit with customers, employees, shareholders, the government, and the country at large. Telefónica Chile thus underscores its sense of responsibility and unwavering commitment to the development of Chile. For these reasons, in 2006, Telefónica Chile invested more than US$100 million in the development of broadband technologies, television and IP solutions, representing more than 50% of the Company’s total capital expenditures. Telefónica Chile’s corporate and business strategy is focused on being the most competitive, leading telecommunications company in Chile. Telefónica Chile’s primary focus is on the customer, who constitutes the basis for growth and drives the Company’s goal of creating value for all of its stakeholders. In this context, the Company’s strategic priority is to position itself as the market’s preferred brand through:

Management’s strategy to achieve these objectives is based on: 

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The strategic focuses by business area are:

Residential Segment

Small and Medium Enterprises Segment

Corporate Communications Segment

Wholesale Segment

Quality of Service

     Improving the quality of service provided by the Company to its customers is one of the biggest challenges facing Telefónica Chile, in its efforts to consolidate its competitive and leadership positions. During 2006, the Company faced an extensive and persistent problem with copper cable theft, damaging its network and placing further demands on the already depleted installment and repair capacity. This situation has had a significant impact on the Company’s quality indicators, and as a result the Company has made a commitment to improve its levels of quality through a process of profound change. This process will take time, and it will operate on a number of levels.

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In 2006, Telefónica Chile implemented a new “quality organization” in line with the Telefónica Group’s regional structure. The primary objective of the quality organization is to help operating areas reach the proposed levels of quality.

Licenses and Tariffs

     Licenses

     Under Law No. 18,168 (as amended, and together with the regulations promulgated thereunder, the “Telecommunications Law”), companies must obtain licenses in order to provide the following telecommunications services:

     Only corporate entities may obtain licenses. Licenses specify the conditions that the license holder must fulfill in order to install, operate and develop the service and business that are the subject of the license. Licenses granted from 1994 for public and intermediate services generally have 30-year terms and may be renewed indefinitely for 30-year periods at the request of the operator (although certain licenses held by Telefónica Chile have longer terms).

     Holders of local telephone service licenses are required to provide service to all parties located in the license area that have requested such service within two years of such request. In addition, license holders must provide service to all parties situated outside the license area who are willing to pay for the line extensions required to reach their location from the license holder’s facilities.

     The Telecommunications Law requires that holders of public telecommunications service licenses interconnect their networks to other networks providing the same type of service. This requirement is intended to ensure that subscribers and users of public services are able to communicate with each other, both inside the country and abroad. The same requirement applies to holders of intermediate service licenses for long-distance services, who are required to interconnect their networks to the local telephone network. The Chilean telecommunications authority, the Subsecretaría de Telecomunicaciones, (“Subtel”), sets the tariffs applicable to services provided through the interconnection of networks, in accordance with the procedures established in the Telecommunications Law. The structure, level and indexing of these interconnection rates are fixed by a tariff decree.

     More than one service license may be granted for the same geographic area. Moreover, in instances where the number of licenses to be granted is limited by technical or other concerns, such licenses are awarded through a public bidding process.

     The Telecommunications Law specifies certain causes for which an operator can be sanctioned through the termination of its public or intermediate service license. A license may be terminated, after notice of noncompliance with the applicable technical regulations, by executive decree, if the operator is in violation of the law or does not comply with the terms and conditions to which the license is subject. If the holder believes that its license has been terminated unlawfully, the holder may appeal the termination in Chilean courts. If a license is terminated, the holder is barred from applying for any license for a period of five years.

     The following table provides the breakdown of those products and services offered by Telefónica Chile that are regulated under the 2004-2009 tariff regime (Tariff Decree No. 169) or unregulated, require or do not require licenses.

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Services Subject to Tariff Regulation     Activities Not Subject to Tariff Regulation 
   
License Required(1)   License Required    License Not Required 
     
Local telephone service    Domestic long-distance service    Sale of advertising in telephone 
           directories 
Access charges and    International long-distance service    Direct marketing 
   interconnections         
Public telephones (1)   Mobile communications(2)   Sales and leasing of telephone and 
           facsimile equipment and private 
           exchanges (“PABX”)
Line connections    Public data transmission    Supplementary services 
Unbundled network services(3)   Other Unbundled network    Broadband 
       services(3)    
    Pay TV     

________________________________________
(1)      All services subject to tariff regulation require licenses, except the public telephony. However, Telefónica Chile’s public telephone services are regulated.
 
(2)      The interconnection fee for calls to the mobile networks is regulated under the CPP structure. See “—Licenses and Tariffs—Calling Party Pays Structure.” The mobile business was sold in July 2004.
 
(3)      Only the unbundling of the local network, as defined by the Antitrust Commission, is regulated.
 

     Licenses Held by Telefónica Chile

     Telefónica Chile holds the following licenses for the provision of telecommunications services:

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Development of Other Telecommunications Projects in Chile

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The Tariff System

     Pursuant to the Telecommunications Law, prices for public telecommunications services and intermediary telecommunications services in Chile are not regulated unless the Antitrust Commission specifically rules that the conditions existing on the market are insufficient to ensure a free pricing system, in which case maximum tariffs for certain telecommunications services must be subject to tariff regulation. The Antitrust Commission may subject any telephony service to price regulation, except for mobile telephone services to the public which are expressly exempted under the Telecommunications Law. In addition, maximum prices for interconnection services (mainly inter-company access fees for network usage) are, as a matter of law, subject to tariff regulation and are set in accordance with procedures established by the Telecommunications Law.

     Also pursuant to the Telecommunications Law, once the Antitrust Commission has determined that tariff regulation is warranted, the structure, level and indexing of the maximum tariffs that may be charged for tariff-regulated services are fixed by a joint decree issued by the Ministry of Transport and Telecommunications and the Ministry of Economy, together the Ministries. These Ministries determine such maximum tariffs by applying to each regulated company an economic model based on the costs, efficiency and growth rates of a hypothetical company that provides only regulated services, and calculating a rate of return on such services in line with the hypothetical company’s market cost of capital. Telefónica Chile’s actual rate of return, however, may vary from the predictions of the model. Each maximum tariff takes into account the relevant cost components associated with providing the regulated service, and is adjusted monthly in accordance with the tariff index (the “Tariff Index”), as contemplated in the tariff structure and described below. A distinct Tariff Index exists for each individual regulated service that reflects the different theoretical cost components associated with each such service.

     As part of the tariff-setting process, license holders prepare studies of each regulated service that they provide in each license area, calculating the incremental development costs and the long-term average cost with respect to each such service for a five-year period. The purpose of these studies is to assist the Ministries in determining the structure and level of future tariffs for each regulated service in each license area.

     Regulatory Framework

     The first five-year tariff period commenced in 1989, at which time the Antitrust Commission determined that the conditions prevailing in the local, domestic long-distance and international long-distance markets did not guarantee free competition and therefore would be subject to regulation. However, according to Resolution No. 515, in April 1998 the Antitrust Commission determined that only local services, public telephone services and line connections offered by dominant companies would be subject to tariff regulation. In addition, Resolution No. 515 included the unbundled network services among the services subject to tariff regulation. As of December 31, 2006, 17 contracts, had been signed with eight companies for the provision of unbundled network services.

     On January 18, 2001, the Company estimated that market conditions had changed and consequently asked the Antitrust Commission to deregulate local telephone rates charged to the public, stating, in its opinion, that the then-existing market conditions had not yet warranted deregulation throughout the country. However, on July 11, 2001, by Resolution No. 611, the Antitrust Commission rejected the Company’s petition although, the Antitrust Commission asked the National Economic Attorney General’s Office to monitor the evolution of the market in order to detect changes as they occur that could lead to the deregulation of certain services in certain geographic areas. The Antitrust Commission also decided that Telefónica Chile could request authorization to offer alternative tariff plans and request the authority to issue complementary resolutions to Tariff Decree No. 187, which would allow for differentiated rates within each tariff area. In accordance with this decision, in the second half of 2001, the Company submitted a proposal to Subtel for alternative tariff plans for different customer categories. In this regard, on May 24, 2002, Subtel approved the Company’s proposal to offer prepaid service for fixed line customers. Moreover, on August 24, 2002, the Ministries issued Decree No. 455, which approved a high usage plan oriented toward residential customers and a very high usage plan oriented toward corporate customers, which were based on a flat monthly fee.

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     Tariff Structure for 1999-2004

     In April of 1998, the Antitrust Commission determined that Telefónica Chile would be regulated as the dominant operator in all regions of Chile, except in Region X and Region XI and Easter Island. As determined by the Antitrust Commission, the dominant operator for Region X was Telefónica del Sur, for Region XI was Telcoy and for Easter Island was Entelphone. In this regard, Tariff Decree No. 187 was in effect since May 5, 1999 until May 5, 2004, setting maximum prices that the Company could charge for regulated services in those regions in which it was determined to be the dominant operator.

     Based on the Company’s estimates, the impact of the tariff structure defined by Tariff Decree No. 187 for the period of 1999–2004 resulted in a 24.7% decrease in annual revenue derived from regulated services per telephone line for the Company in the first year, taking into account tariff reductions in the fixed monthly charge, the variable charge per minute and local tranche and access charges, and assuming stable traffic per line. This decrease included an average reduction of 17.1% in revenues from subscribers (fixed charge and variable charge) and of 72.9% in revenues from access charges paid by interconnected companies, which were mainly long-distance carriers.

     Tariff Setting Process for Telefónica Chile’s Services for 2004-2009: Tariff Decree No. 169

     On January 13, 2003, Telefónica Chile requested that the Antitrust Commission, on the basis that market conditions are sufficient to guarantee healthy competition, rule in favor of fully deregulating tariffs in specific geographical areas. The Company also requested that, in cases where conditions are not sufficient to guarantee competition, the Antitrust Commission define the services that will be subject to tariff regulation by the corresponding ministries, nonetheless affording the Company the flexibility to offer alternative tariff plans different from the regulated rates without previous authorization.

     On May 22, 2003, the Antitrust Commission issued Resolution No. 686. This Resolution ruled against deregulation of rates charged by Telefónica Chile for services to the public. The Antitrust Commission did not issue a specific pronouncement regarding the request for tariff flexibility. In view of this, on September 1, 2003, the Company submitted to the Antitrust Commission a request for an explanation and expansion of Resolution No. 686 regarding tariff flexibility.

     Thus, on October 13, 2003 the Antitrust Commission issued Resolution No. 709, unanimously approving the Company’s September 1, 2003 request for local telephony services tariff flexibility and making it possible to offer alternative plans within a framework of conditions to be subsequently specified by the regulator. The Company requested that, by way of general framework governing implementation of such tariff flexibility, the regulators confirm the terms previously set forth by the Ministries as part of the process.

     On February 26, 2004 a rule of procedures regarding how the Company may offer alternative tariff plans was published in the Official Gazette. Some relevant aspects are that no previous authorization is required to offer these plans. Plans are not subject to maximum tariffs or predetermined structures and may include joint offers with other telecommunications and non-telecommunications services. As of December 31, 2006, the Company had launched more than 530 alternative plans under the new flexible tariff in local telephony services.

     By Open Resolution No. 1,559, dated December 1, 2006, the Office of the Undersecretary of Telecommunications lowered the average monthly consumption of “heavy use” plans to 7,000 minutes per client for 2007, compared to 9,500 minutes for 2006.

     Resolution No. 686 of May 2003, also defined the services subject to tariff regulation by the Ministries for the 2004–2009 tariff decree, which were substantially similar to the services regulated in Tariff Decree No. 187.

     In February 2005, Tariff Decree No. 169 was approved and published in the Official Gazette. Starting in May 2005 the Company began charging customers with the published rates retroactively from May 6, 2004, as required by the Telecommunications Law. The tariffs published on February 11, 2005, do not materially differ from those used to provision revenues from May 6, 2004 to December 31, 2004 in our consolidated financial statements. In addition to the new tariffs, Tariff Decree No. 169 also provides for seven tariff areas compared to four in the previous decree, three time slots (normal from 8:00 to 19:59 hrs.; reduced from 20:00 to 24:00 hrs.; and night from 0:00 to 8:00 hrs on weekdays) versus two in Tariff Decree No. 187, adjustments in the composition of the tariff

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indicator and a new prepaid tariff. The average variation in tariffs between Tariff Decree No. 169 and the existing Tariff Decree, based on 2003 traffic, is as follows:

    Average Tariff Variation Between 
    Decree No. 169 and Decree 
    No. 187(1)
   
Fixed Charge    +7.7% 
Variable Charge—Measured Local Service (MLS)   -18.3% 
Local Tranche (to Mobile and Rural operators)   +48.2% 
Local Tranche (to Internet and 10X numbers)   +28.3% 
Access Charge    +49.1% 

________________________________________
(1)      Traffic is weighted according to 2003 Company traffic in the different time slots. 2003 was used as the reference year, because 2004 traffic was influenced by the impact of two different tariffs (under Tariff Decrees No. 187 and No. 169). Tariff Decree No. 169 also introduced a regulated prepaid tariff which amounted to Ch$150.48 in Chilean pesos as of Dec. 2002 (excluding VAT).
 

     A Tariff Index has also been defined to adjust monthly maximum regulated tariffs, which is different for the fixed monthly charge and the variable charges (including the variable charge per minute, the local interconnection charge and access charges) taking into account: (i) the monthly variation of the wholesaler price index (WPI) for domestic goods, (ii) the monthly variation of the WPI for imported goods, (iii) consumer price index, (iv) wholesaler price index, (v) access charge index (for variable charge only), and (vi) the prevailing corporate income tax rate. The use of the Tariff Index permits the Company to significantly minimize the impact of inflation on its revenues from tariff-regulated services.

     The following is the tariff index for Tariff Decree No. 169:

            Index of            Access 
            wages and            charge 
Index    WDGPI(1)   WIGPI(2)   salaries    CPI(3)   WPI(4)   index(5)
             
Fixed Charge    36%    21.3%    -    12.4%    30.3%    - 
Variable Charge MLS    9.5%    34.0%    -    19.4%    26.3%    10.8% 

________________________________________
(1)      WDGPI: Wholesaler domestic goods price index
 
(2)      WIGPI: Wholesaler imported goods price index (U.S. dollar component)
 
(3)      CPI: Consumer price index
 
(4)      WPI: Wholesaler price index
 
(5)      Access charge index: A composite of access charges for non-Telefónica Chile operators
 

     Multicarrier System

     On March 10, 1994, Law No. 19,302 amended the Telecommunications Law to introduce the Multicarrier System for long-distance services. Among other things, the Multicarrier System permits local telephone service providers to obtain licenses to supply domestic and international long-distance services through a subsidiary or affiliate using their own equipment. Under this system, users are able to select long-distance carriers on a dialed or pre-subscribed basis.

     Calling Party Pays Structure (CPP)

     Calling Party Pays was implemented on February 23, 1999. Under this tariff structure, local telephone companies pay mobile telephone companies an interconnection charge for calls placed from fixed networks to mobile networks.

     On April 12, 2004, the Chilean General Comptroller approved the tariff decrees for mobile interconnection tariffs and interconnection facilities of the mobile telephony networks, applicable to the operators in this market for the 2004–2009 period, which were published in the Official Gazette on April 14, 2004. These decrees were applied

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retroactively to January 23, 2004 for mobile operators, except for Telefónica Móvil de Chile S.A. for which it is applied retroactively to February 12, 2004. The tariff decrees stipulate three time slots defined as “peak,” “reduced” and “night” and new per minute tariffs for the period. Tariffs implied a decline of 26.5% in the first year compared to the average tariff in Chilean pesos as of December 2002 with a subsequent 0.5% decrease per year thereafter. The new tariffs imply an average decrease of 27.4% for the period of 2004–2009 in comparison with the average tariff in Chilean pesos as of December 2002.

     In July 2004, the Company sold its mobile subsidiary and therefore is no longer regulated in this business. See “History and Development of the Company—Divestitures” above.

     Lawsuit Against the State of Chile

     On October 31, 2001, Telefónica Chile filed an administrative motion for reconsideration with the Ministries, to correct the following errors in the issuance of Tariff Decree No. 187: a mathematical error in determining the fixed monthly charge for telephone line service; unlawful application of the depreciation method; failure to consider the costs of telephone directories; incorrectly assuming lower investments related to the location of switching centers; erroneous application of the same local telephone service non-payment rate to the Calling Party Pays service; and failure to scale access charges and local tranche charges. On January 29, 2002, the Ministries issued a joint response rejecting the administrative motion filed by Telefónica Chile.

     Upon exhausting the administrative recourses available to correct what the Company believes are illegal actions taken in the tariff-setting process discussed above, in March 2002, Telefónica Chile filed a lawsuit for damages against the State of Chile. This legal action seeks damages in the amount of Ch$181,038 million (US$274 million, historical value as of the date of the lawsuit), plus adjustments and interests, covering past and prospective losses through May 2004 arising from errors incurred in Tariff Decree No. 187. Experts’ reports have been presented on various aspects of the case supporting the position held by Telefónica Chile’s position. On March 29, 2005, the judge called the period of discussion and proof provision from the interested parties to a close, in order to issue a sentence in first instance. A variety of expert reports have been presented on various aspects of the case supporting the position held by Telefónica Chile. The next phase in the process is the lower court’s decision, which had not been issued as of December 31, 2006. No assurance can be given as to the outcome or the timing of a final ruling.

     For further information regarding the lawsuit filed by the Company against the State of Chile, see “Item 8. Financial Information—Legal Proceedings.”

     RedVoiss Lawsuit

     On January 20, 2005, Telefónica Chile rejected every aspect of the complaint filed by the IP telephony company RedVoiss before the National Attorney for Economic Matters, alleging attempts to hinder free competition and the development and growth of broadband, particularly broadband IP telephony, by contractually prohibiting the provision of telephone services through the Internet broadband service provided by Telefónica Chile.

     Subsequently, RedVoiss filed a complaint before the Antitrust Commission based on the same allegations, and Telefónica Chile answered, again along the same lines, on March 14, 2005. In addition, the Company filed a counterclaim action against RedVoiss for hindering free competition by providing telephone service without the license required by law.

     On August 16, 2005, Telefónica Chile was notified of a complaint entered by the National Attorney for Economic Matters against the Company based on the same actions alleged by RedVoiss. In the complaint, the National Attorney for Economic Matters primarily asked the Antitrust Commission to find that Telefónica Chile infringed on free competition by creating artificial barriers to entry for new competitors. In addition, the National Attorney for Economic Matters asked the Court to void the clause prohibiting voice over IP and further requested a yearly fine of 350 Annual Tax Units (Chilean inflation-adjusted monetary unit, equivalent to Ch$386,472 or (US$726) at December 31, 2006) or any other amount deemed appropriate by the Commission. Lastly, the President of Chile was asked to examine the possibility of amending the current regulatory framework as needed. On September 2, 2005, Telefónica Chile formally rejected all charges contained in the complaint filed by the National Attorney for Economic Matters. On October 4, 2005, the Antitrust Commission accepted the Company’s request to

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advance to the evidence stage of the proceedings, and the Commission subsequently commenced the process of receiving and examining evidence.

     On October 26, 2006, the Company was notified of the Antitrust Commission’s ruling. The ruling accepted, in part, the complaint filed by Voissnet S.A. and the requirement of the National Economic Attorney General’s Office, and fined Telefónica Chile 1,500 Annual Tax Units (approximately Ch$580 million or US$1.1 million).

     On November 8, 2006, Telefónica Chile filed an appeal before the Supreme Court asking that the sentence be revoked and the Company be exonerated from any sanction. The Supreme Court has accepted the appeal for processing but has yet to set a date to hear arguments from the parties.

     Key Proposed Changes to the Regulatory Framework

     Commission of Telecommunications Experts

     On May 17, 2006, the Minister of Transportation and Telecommunications convened a commission of experts for the purpose of preventing regulations from becoming obsolete. This commission will perform its duties in two stages. During the initial stage, over a 90-day period, terms of reference for a telecommunications industry review were to be crafted. The second stage calls, over the course of one year, for proposing regulations consistent with industry demands; generating greater competition; eliminating barriers to entry and identifying consumer guarantees and rights.

     On October 11, 2006, the commission of experts issued a report entitled “Strategic Review of Telecommunications Regulations – Terms of Reference”, containing terms of reference for a future review of the telecommunications industry and identifying basic policy considerations which include the promotion of competition, tariff and access fee regulation, radio-electric spectrum management, equitable access to basic telecommunications services, quality of service and the regulatory institutional framework.

     Public Inquiries on Regulations for Network Unbundling and IP Telephony Services

     In July and August 2004, Subtel initiated a process of public inquiries addressed to the main participants in the telecommunications industry in connection with their proposals regarding Network Unbundling and IP Telephony.

     The Network Unbundling proposal (which was presented at a new public inquiry in December 2004) defines the service and its operating conditions, and includes new services which depart from those provided under Tariff Decree No. 169. Additionally, it creates new obligations for companies subject to network unbundling (obligation to invest, new client rights, differences in requirements based on technology type, among others). Furthermore, the new proposal creates a resale obligation for mobile operators and regulates resale conditions for wholesalers of alternative plans, which Telefónica Chile offers.

     As a participant in the aforementioned public inquiries, the Company studied the proposal and submitted its opinion and legal objections. These include the fact that most of the provisions contained in the proposal are a matter of law and not of resolution, while other aspects of the proposal impair rights which are guaranteed by the Constitution.

     The proposal for IP Telephony defines a special type of telephony over broadband, which is provided over existing infrastructure and with lower regulatory requirements than traditional telephony. This discriminates against traditional local operators, which are subject to different conditions for the same service. The Company, along with other operators, presented its comments on, and legal objections to, the proposal, calling it, among other things, discriminatory and likely to inhibit investment in new infrastructure and broadband.

     On December 20, 2006, Subtel made a public inquiry on the proposed rules that govern the public voice over Internet service. As was required, Telefónica Chile provided its comments and proposals on January 26, 2007.

     From the new Regulation presented by Subtel, the most relevant proposals were:

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     Telefónica Chile remitted its observations on January 26, 2007. 
     

     Thirty companies provided comments. In general, the telephone companies approve of the Regulation and favor the application of regulations similar to those of the public telephone service to voice over Internet. Companies from the computer sector, however, support having less regulations over this service.

     Public inquiry on “Bill amending law No. 18,168 (the General Telecommunications Act) so as to create a panel of experts to resolve disputes arising in the telecommunications industry”

     On September 6, 2006, Subtel announced a public inquiry on a bill to create a panel of experts, made up of seven professionals, to resolve disputes in the telecommunications industry. The document proposes, among other things, a list of matters to be resolved by the panel, the panel’s powers and duties, its composition (five engineers and two attorneys named by the Antitrust Commission), and the areas where it lacks jurisdiction. The costs of the panel will be borne by the concession holders on a prorated basis, which may take into account the value of their assets and/or the estimated number of disputes affecting them as well as the nature and complexity of these disputes.

     Telefónica Chile duly submitted its proposal and comments, along with Movistar, Telmex, Telefónica del Sur and Telcoy, GTD, VTR, Entel, SOFOFA, Colegio de Ingenieros, and Instituto Libertad y Desarrollo.

     The Ministry of Transportation and Telecommunications, acting through Subtel, is preparing an amended draft of the General Telecommunications Act.

     Public inquiry on “Removing obstacles for telecommunications development in the short term”

     On May 18, 2006, Subtel made a public inquiry to identify barriers and obstacles in the technical and regulatory standards that are impairing efficient market development in terms of competition, investment incentives and protection of users and customers of telecommunications services. In order to create a more equitable and competitive sector, this public consultation is ultimately aimed at identifying changes that can be made in the short term, such as repealing, amending, formally interpreting or making additions to any obsolete, ambiguous or missing legal provisions.

     On October 13, 2006, Subtel published a response to the 350 contributions received, addressing, among others, proposals by Telefónica Chile, Movistar, Telmex, Terra, Entel, VTR, Telefónica del Sur, Colegio de Ingenieros, and Grupo GTD. Part of the response includes a list of the commitments and actions that Subtel will take to address the problems. In accordance with its commitments made in the response document, Subtel is devoting efforts to help modify the technical norms. At present, 11 exempt resolutions that approve modifications of technical norms and regulations have been published.

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     Bill to amend the free competition act

     On June 6, 2006, the Chilean government announced a legal initiative seeking to amend the law on free competition to eliminate the implicit risks in market concentration. This initiative is aimed at taking preventive action and increasing the maximum penalty that the Antitrust Commission may impose from 20,000 to 30,000 Annual Tax Units (US$ 22 million).

     Permit for limited cable television service

     By Open Resolution No. 1,605 dated December 23, 2005, Subtel granted Telefónica Multimedia Chile S.A. (formerly Tecnonáutica S.A.), a subsidiary of Telefónica Chile, a permit to operate limited satellite television service throughout Chile.

     In addition, pursuant to Subtel Resolution No. 81, dated February 21, 2006, Telefónica Multimedia Chile S.A. also holds a permit to provide limited television service over the Telefónica Chile broadband network for an unlimited term throughout the main communities of Chile, with the exception of the Region III and the Metropolitan Region. The license to provide this service using that technology for some communities in the Metropolitan Region was granted through Subtel Resolution No.260 of year 2007.

     Subtel also issued a technical standard to the effect that cable television service may be provided by means of any technology over physical networks, thereby covering the use of the ADSL broadband network to provide television service.

     The claim filed against Telefónica Chile by two television channels, Televisión Nacional and Canal 13, for including their broadcast signals in the pay television services distributed by the Company, was declared inadmissible by the Santiago Court of Appeals. This decision was subsequently upheld by the Supreme Court.

     Public hearings on digital terrestrial television

     On November 17, 2006, Telefónica Chile S.A. participated in a program of public hearings on the introduction of Digital Terrestrial Television (DTT) in Chile in order to help define the technical standard for DTT in Chile. The Minister of Transportation and Telecommunications opened the first public hearing and was joined by the Chairman of the National Television Council, representatives of the FUCATEL media observatory and representatives of the cable TV company VTR Banda Ancha S.A.

     In November and December, additional public hearings were held.

     Subtel reported that the technical standard on Digital Terrestrial Television will be released in early 2007 upon completion of the study it is conducting and the public hearings.

     Law Project that modifies the Telecommunications Development Fund

     Currently, companies with public and intermediate telecommunications service concessions that offer long distance services and companies with limited television service permits are required to participate in a Telecommunications Development Fund. In order to participate in this fund, these companies are required to create separate corporations, which are subject to the laws and standards governing publicly traded companies and to the regulation of the Superintendency of Securities and Insurance. However, Congress is evaluating a bill that would eliminate the obligation to create separate corporations to enable the concessionaries and permit holders to participate directly in the fund.

C. Organizational Structure

     Telefónica Internacional Chile owns 44.9% of all shares of Telefónica Chile and is a 99.9%-owned subsidiary of Telefónica Chile Holding B.V., which in turn is an indirectly wholly owned subsidiary of Telefónica S.A. which is a Spanish telecommunications company, and is a public corporation listed on the Madrid, London, Paris, Frankfurt, Tokyo, New York, Lima, São Paulo and Buenos Aires stock exchanges. Telefónica S.A. also has ownership interests in the following companies that operate in the Chilean market: Atento Chile S.A., Terra

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Networks Chile S.A., Telefónica International Wholesale Services Chile S.A., Telefónica Móviles Soluciones y Aplicaciones S.A., Telefónica Móviles de Chile S.A. y Telefónica Móviles Chile S.A.

Subsidiaries and Certain Affiliates of Telefónica Chile

     The following chart sets forth the organization of Telefónica Chile’s subsidiaries and affiliates, all of which are Chilean corporations, except for TBS Celular Participaçoes S.A., which is a Brazilian corporation. Percentage ownership information is as of December 31, 2006.

     Telefónica Chile operates the Company’s local telephone service activities, the Company’s core business area. Telefónica Chile’s other business activities are managed through the following operating subsidiaries:

(*) Telefónica Chile holds 28.84% of Atento Chile S.A. through the additional equity interest of 1.4% from its subsidiaries Telefónica Larga Distancia and Telefónica Empresas.

Note: During 2006, the Company underwent a process of restructuring its organizational structure, with the goal of reducing costs and simplifying the Company’s management. In January 2006, the indirect subsidiaries, Telefónica Internet Empresas S.A. and Tecnonaútica S.A., became subsidiaries of Telefónica CTC Chile. Additionally, on February 28, 2006, Compañía de Telecomunicaciones de Chile S.A. acquired the remainder of Compañía de Telecomunicaciones de Chile Equipos y Servicios S.A. and dissolved this subsidiary. As a result, assets and liabilities of the subsidiary Compañía de Telecomunicaciones de Chile Equipos y Servicios S.A. were transferred to the parent company, which will be the continuing legal entity.

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Additionally, at Telefonica Mundo’s and Globus’ extraordinary shareholders’ meetings held on April 19, 2006, the merger of both companies was approved, effective as of May 1, 2006. The name of the company changed to Telefonica Larga Distancia S.A.

In September, 2006, the subsidiary Instituto Telefónica Chile S.A. was created, to continue to offer training and education services, in accordance to the Chilean Law N°19,518.

     Subsidiaries and Related Companies

     Telefónica Larga Distancia

     Telefónica Larga Distancia S.A. (“Telefónica Larga Distancia”), formerly Telefónica Mundo S.A., a subsidiary formed in 1989 is the Company’s domestic and international long-distance subsidiary carrier. See “—Business Overview—Licenses and Tariffs—The Tariff System—Multicarrier System” and “—Business Overview—Licenses and Tariffs—Licenses.”

     The Government granted Telefónica Larga Distancia licenses to provide domestic and international long-distance services with its own equipment effective August 27, 1994.

     On October 14, 1998, Telefónica Chile completed its acquisition of 99.9% of the equity securities of VTR Larga Distancia, a telecommunications company offering data transmission and domestic and international long-distance services throughout Chile. The long-distance business of VTR Larga Distancia was transferred to a newly created Company long-distance subsidiary, Globus, and the data transmission business of VTR Larga Distancia was later absorbed by Telefónica Empresas, the subsidiary which largely forms the Company’s Corporate Customers Communications and Data business area. In 2006, Telefónica Larga Distancia was formed out of the merger of Globus with Telefónica Mundo.

     Telefónica Larga Distancia currently operates the most extensive fiber-optic network in the country, stretching from Region I (the Peruvian border) to Region XII (Punta Arenas), including connections to Peru and Argentina. In 2006, a new tranche of the network was inaugurated from Region X (Puerto Montt) to Region XII, passing through Argentina between Aduana Pajaritos (Region X) and Cerro Redondo (Region XII Telefónica Larga Distancia also operates digital satellite and microwave links). In addition, Telefónica Larga Distancia participates actively in the development and use of submarine fiber-optic networks such as Unisur, Americas I, Americas II, Atlantis II, Columbus II, Panamericano, Maya I, TPC-5, Pencan 5, Taino Caribe, Sea Me We and SAM-1 (Emergia), and in the Hispasat, Intelsat, Nahuelsat and Panamsat satellite systems.

     Telefónica Empresas

     In 1992, Telefónica Empresas CTC Chile S.A. (“Telefónica Empresas”) began operating Telefónica Chile’s private telecommunications services (including data transmission, and the sale and rental of networks and equipment) and managing the Company’s large business and institutional customer accounts.

     CTC-Equipos

     As of February 28, 2006, Compañía de Telecomunicaciones de Chile Equipos y Servicios S.A. (“CTC-Equipos”) was dissolved by transferring its assets and liabilities to Compañía de Telecomunicaciones de Chile S.A. that will be its continuing legal entity. CTC-Equipos operated Telefónica Chile’s public and rural telephone operations and provided home telephone installations, mainly for residential customers.

     t-gestiona

     On August 1, 2001, Telefónica Gestión de Servicios Compartidos Chile S.A. (“t-gestiona”) began operations. This subsidiary is responsible for the provision of support services to other business areas of the Company, including: logistics delivery, e-learning, fund management, insurance, collection, personnel, tax, real estate administration and general services.

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     Instituto Telefónica

     In November 2006, a former Telefónica Chile subsidiary, Telepeajes, changed its name to Instituto Telefónica Chile and also changed its corporate purpose to training under the terms set forth in Law 19,518, including training in private security matters.

     Atento Chile

     Atento Chile S.A. (“Atento Chile”) was created on May 5, 1999. Currently Telefónica Chile holds 28.84% (27.41% directly and 1.43% indirectly) of this affiliate, which operates an integrated global call-center business platform among its members. Atento Chile offers Telefónica Chile directory assistance, technical assistance and customer complaint management, as well as general commercial and sales information.

     Telemergencia

     Telefónica Asistencia y Seguridad S.A. (“Telemergencia”) was created in 2001 to offer security services through alarm monitoring systems connected to the phone line, as well as home assistance services. Currently, Telefónica Chile holds 99.9% of the equities securities of this subsidiary.

     Fundación Telefónica

     Fundación Telefónica Chile (“Fundación Telefónica”) has existed since 1999 when it was created to contribute to the improvement of living conditions for the most vulnerable social groups, encouraging the development of education and equal opportunity by applying new information technologies to the learning process. The equity interest of Telefónica Chile in this subsidiary amounts to 50.0%.

     TBS Celular

     The primary purpose and activity of TBS Celular Participações S.A. (“TBS Celular”) is to hold the shares of Compañía Riograndense de Telecomunicaciones (CRT) acquired through an international bidding process conducted pursuant to Edital COD 04/96, or any other shares that may be offered in the future. In addition, TBS Celular performs any and all activities pertaining to the management of CRT, as well as to acquire an interest as a partner or shareholder in other companies in connection with its primary activities. The ownership interest of Telefónica Chile in this company is 2.61%.

     In February 2006, CRT merged with Vivo Participações S.A. (formerly Telesp Celular Participações S.A.), therefore Telefónica Chile now indirectly holds a 0.124% of Vivo Participações S.A. through TBS Celular.

D. Property, Plant and Equipment

     The principal plant and equipment of the Company consists of outside plant and switching equipment and operating units that are located throughout the country. Furthermore, an extensive network consisting of 687 central switches linked by 57,552 kilometers of copper cabling and 5,746 kilometers of local fiber opticare installed. These represent 3.0 million lines, of which 2.2 million are in service. Within the xDSL broadband network, the Company has deployed 1200 broadband nodes (DSLAM) with capacity to serve roughly 600,000 clients. In addition, in June 2006, Telefónica Chile launched a new satellite digital television service closing 2006 with 94,209 clients with an average of 2.5 STB (Set-Top Box) per home. Additionally, Telefónica Chile’s long distance subsidiary currently owns the longest LD fiber-optic network in the country (4,200 kilometers), which includes connections to Peru and Argentina. The Company’s land and buildings principally consist of its telephone exchanges and other technical, administrative and commercial properties. As of December 31, 2006, the Company’s telephone plants and equipment represented 70.8% of its gross fixed assets (including depreciation); construction in progress represented 2.4%, land and buildings represented 20.8%, and furniture, office equipment and other assets represented 6.0% .

     Substantially all of Telefónica Chile’s telephone exchanges are situated within buildings owned by the Company. Telefónica Chile also owns its corporate headquarters located at Avenida Providencia 111 in Santiago. This building, which houses the Company’s principal offices, was completed in October 1996 and currently provides office space for the majority of the administrative and technical staff of Telefónica Chile and its

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subsidiaries. The assets of Telefónica Chile and its subsidiaries are insured, subject to standard deductibles and other terms and conditions, for all events of physical damage and loss of revenue resulting from service outages. As of December 31, 2006, the value of the assets and operating revenue insured totaled approximately Ch$1,298,377 million (US$2.439 million), which consisted of Ch$869,370 million (US$1.633 million) in insured assets and Ch$429,007 million (US$806 million) in insured revenues.

ITEM 4A. UNRESOLVED STAFF COMMENTS

     None.

 

 

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ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

     The information in this Item 5 should be read in conjunction with the Company’s Audited Consolidated Financial Statements and the notes thereto included elsewhere in this Annual Report. The Audited Consolidated Financial Statements have been prepared in accordance with Chilean GAAP, which differs in some significant respects from U.S. GAAP. See Note 37 of the Company’s Audited Consolidated Financial Statements for a description of the main differences between Chilean GAAP and U.S. GAAP and a reconciliation to U.S. GAAP of net income and total shareholders’ equity.

Overview

     Telefónica Chile is the largest local telephony operator in Chile, with a market share, as of December 31, 2006, of 68% (according to Company estimates). The Company provides a broad range of telecommunications services throughout Chile, including local telephone service, domestic and international long-distance service, data transmission, broadband access and services, dedicated lines, terminal equipment sales and leasing, public telephone service, interconnection services, certain value-added services, Internet access for corporate customers and, since June 2006, now provides pay television service. Until June 30, 2004, Telefónica Chile provided mobile communications services. These services ended as a result of the sale of the mobile subsidiary in July 2004. The key performance indicators for each of these services are described in detail in “Item 4. Information on the Company—Business Overview—Products and Services.”

     Several of the factors described below have been particularly significant in the recent years and are expected to continue to influence our financial results in the future. See also “D. Trend Information.” The most significant factors that influence our financial results are as follows:

     Regulation

     The Company’s results from operations are significantly affected by the regulatory regime to which it is subject. In particular, the maximum rates and fees that the Company can charge for certain local telephony services, which together accounted for 42% of the Company’s operating revenues in 2006 are set by tariff, and this tariff does not equally apply to other local telephony operators, mobile phone service providers and cable telephony operators with which the Company competes.

     On May 4, 2004, a new Tariff Decree No. 169 for the period between May 6, 2004 and May 6, 2009 was issued by Subtel. This Tariff Decree was ratified and published in the Official Gazette on February 11, 2005. The maximum rates applicable under the new tariffs principally affect revenues from local telephone services, public telephone service “payphones,” fixed-line connections and other services associated with local telephone service. The application of the local telephone tariffs, defined by Tariff Decree No. 169 for the period 2004–2009, resulted in a minor impact in the 2004 and 2005 financial statements of Telefónica Chile. See “Item 4. Information on the Company—Business Overview—Licenses and Tariffs—The Tariff System.”

     In February 2004, Telefónica Chile was authorized to offer alternative tariff plans to the regulated plan consisting of a fixed charge plus variable charge. This new regulatory rule allowed the Company to offer alternatives to the regulated plan without previous authorization by the Regulator and compete by adapting to customers’ needs. These plans are not subject to maximum tariffs or predetermined structures and may include joint offers with other services. As of December 31, 2006, 1,324,597 lines have been signed up for flexible tariff plans, representing 59.8% of the Company’s total lines in service. Although the effective rates charged for flexible tariff plans are less than those charged in traditional plans, these types of products still allow the Company to use the available capacity of the network to be more competitive, helping to counteract the fall in fixed lines, as they are marketed as part of bundles with broadband and television. See “Item 4. Information on the Company—Business Overview—Products and Services.”

     Sale of the mobile telephone business

     Results of operations for the year ended December 31, 2004 reflect the effects of the sale of our subsidiary Telefónica Móvil de Chile S.A. in July 2004, which produced a gain of approximately Ch$321,071 million. As of July 2004, the Company no longer consolidated the mobile operations.

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Telefónica Móvil de Chile S.A. accounted for 29.2% of our operating revenues in 2003 and 32.1% of our operating revenues during the first six months of 2004.

     The sale agreement restricts the Company from participating in the mobile telephony business for a period of two years from the date of the sale.

     New TV business

     To strengthen the Company’s leadership and broadband growth, in June 2006, Telefonica Chile launched a new pay TV service to its different client segments. This product has enabled the Company to strengthen client loyalty and earn new customers using the current infrastructure, increasing the revenue per client.

     The pay TV service is provided by the Telefónica Multimedia Chile S.A. subsidiary, and it is marketed in bundles: “Dúo”, combining television and fixed telephone service, and “Trío”, combining television, fixed telephony, and broadband service.

Critical Accounting Policies

     This operating financial review and prospects is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in Chile. The preparation of financial statements in accordance with GAAP requires our management to make estimates. Ultimate results could differ from those estimated if our estimates or assumptions used do not actually occur.

     We believe the following represents our critical accounting policies. Our accounting policies are more fully described in Note 2 to our Consolidated Annual Financial Statements. The most critical accounting policies adopted in preparing the Consolidated Annual Financial Statements according to Chilean GAAP relate to:

     Property, Plant and Equipment. The Company believes that the accounting estimates related to the establishment of the depreciable lives of assets is a “critical accounting estimate” because it requires management to make assumptions about technology evolution and competitive uses of assets. Management’s assumptions about technology and its future development require significant judgment because the timing and impacts of technological advances are difficult to predict. For a description of our principal assets and what their depreciable lives are, see Note 2 of our Audited Consolidated Financial Statements included herein. Depreciation represented 37.8%, 39.8% and 41.9% of total operating costs and expenses for the years 2004, 2005 and 2006, respectively.

     Impairment of Long-lived Assets. We evaluate finite-lived assets we hold and use for impairment when there are changes in circumstances which indicate that the carrying amount of the assets may not be recoverable. Recoverability of assets to be held and used is measured under Chilean GAAP by comparison of the carrying amount of an asset to its recoverable amount, calculated as discounted future net cash flows expected to result from the use of the asset and eventual disposition. Should a comparison of undiscounted cash flows versus book value indicate inability to recover the asset’s book value, the measurement of the impairment would be performed as described above. The most significant estimates made in determining discounted future net cash flows include the selection of the appropriate discount rates and the number of years on which to base the cash flow projection, as well as historical results adjusted for anticipated operating conditions.

     The number of years included in the discounted cash flows is, in our opinion, subject to various factors which may differ from experience due to the rapid changes in technology in our industry. The factors which we take into consideration when establishing these lives are:

     Assumptions about the revenue stream included in such cash flows are estimable in those lines of our business which are regulated by tariffs. For those which are not, we take into consideration our operational strategy for increasing volume of customers or revenues versus the additional costs which would be incurred related to these increases in order to arrive at our projected cash flows.

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     Should our strategy or our basis for these assumptions change, the results of any recoverability test which we may be required to perform would differ.

     Impairment of Goodwill. Goodwill includes the cost of acquired subsidiaries in excess of the book value of the net assets recorded in connection with acquisitions. Accounting for goodwill requires management’s estimate regarding the amortization period and the recoverability of the carrying value of goodwill. As prescribed under Chilean GAAP, there is a maximum amortization period of 20 years. Factors that are considered in estimating the useful life of goodwill include:

     Under Chilean GAAP, we would test goodwill for impairment using the same methodology described above for long-lived assets in estimating the future net cash flows made by management. These include the determination of the projected sales growth and projected amounts for capital expenditures. In making these assumptions, we consider historical results adjusted to reflect current and anticipated operating conditions. Because a change in these assumptions can result in a significant change in the recorded amount of goodwill, we believe the accounting for goodwill is one of our critical accounting policies.

     The Company has evaluated the recoverability of its recorded goodwill in accordance with Technical Bulletin No. 56 and No. 72, based on the fair values of the assets and liabilities acquired, any excess of the purchase of assets and the liabilities assumed will be allocated to goodwill. As of December 31, 2005 and 2006, there were no indicators of an impairment of goodwill.

     Allowance for Doubtful Accounts. The Company estimates its doubtful account provision primarily based on analysis of history and future expectations of our retail and our corporate customers in each of our operating companies. Our assumptions are reviewed at least quarterly and adjustments are made to our bad debt allowance as appropriate. For both our retail and corporate customers, we use a statistical model based on our aging of accounts receivable balances. Our risk categories, risk percentages and reserve balance assumptions built into the model are reviewed monthly and the bad debt allowance is adjusted accordingly.

     The allowance for doubtful accounts was Ch$64,607 million and Ch$66,846 million as of December 31, 2005 and 2006, respectively.

     Severance Indemnity. We sponsor a severance indemnity plan for employees which is treated, for accounting purposes, as a defined benefit plan. The defined benefit pension plan pays benefits to employees at retirement using formulas based on participants’ years of service and compensation. These obligations are recorded at the present value of the liability determined using an annual discount rate of 6% considering the projected service periods of the employee determined on the basis of actuarial assumptions, at each year-end based on the current salary. We fund these plans as claims are incurred.

     Recorded severance indemnities reflect our best estimate of the future cost of honoring our obligations under these benefit plans. We believe the accounting estimate relating to costs for pensions is a critical accounting estimate because changes in actuarial assumptions can materially affect the projected benefit obligations and net periodic pension costs. Should these assumptions change, our pension benefit obligation would require increase or decrease in the balance sheet and the recording of the offsetting effect in the income statement.

     In the year 2005, changes to the underlying assumptions were implemented in the determination of the projected benefit obligation based on actuarial valuation. In the year 2006, the underlying discount rate was changed from 7% to 6%. The effects of these changes are described in Note 3 to the “financial statements”.

     Access Costs. Access costs are costs incurred for transmission of voice and data over other carriers’ networks. These costs consist of both fixed payments and variable amounts based on actual usage and negotiated or regulated contract rates. We expense access costs as incurred. Accordingly, at each balance sheet date, we record our best

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estimate of the access costs incurred but not yet billed based on internal usage reports. Once we receive an invoice from a carrier, a process of reconciling that carrier’s invoice to our internal usage reports begins. In certain cases, this reconciliation process can take several months to complete. Once the reconciliation is complete, we agree with the carrier on the final amount due. In most cases, this process does not result in significant adjustments to our estimates. Accordingly, at each balance sheet date, we accrue access costs for estimated expenses that have not yet been billed by other carriers and for amounts for which the reconciliation of the carriers’ invoices to our internal usage reports has not been completed. Because of the significance of access costs, the complexity of the systems that capture usage information and the number of different negotiated and regulated rates, we believe that the estimation of access cost accruals is a critical accounting policy.

     Derivatives. The Company’s financial derivative instruments are primarily foreign currency forward exchange contracts to purchase US dollars and cross country interest rate swaps. The Company records these financial derivative contracts at fair value. Estimates of fair values of financial instruments for which no quoted prices or secondary market exists have been made using valuation techniques such as forward pricing models, present value of estimated future cash flows, and other modeling techniques. These estimates of fair value include assumptions made by the Company about market variables that may change in the future. Changes in assumptions could have a significant impact on the estimate of fair values disclosed. The net asset (liability) recorded under Chilean GAAP related to financial derivative instruments was Ch$(28,939) million and Ch$(27,663) million as of December 31, 2005 and 2006, respectively.

     Income and Deferred Taxes. In accordance with Chilean law, the Company and each of its subsidiaries compute and pay taxes on a separate basis. We estimate our actual current tax exposure while assessing temporary differences resulting from differing treatment of items, such as depreciation, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. As a transitional provision under Chilean GAAP, we recorded a contra asset or liability offsetting the effects of the deferred tax assets and liabilities not recorded prior to January 1, 2000. Such contra asset or liability amounts must be amortized to income over the estimated average reversal periods corresponding to the underlying temporary differences to which the deferred tax asset or liability relates, calculated using the tax rates in effect at the time of reversal. We then assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is unlikely, we establish a valuation allowance. In order for us to estimate the realizable value of deferred tax assets and the average reversal periods of contra assets or liabilities, we must make assumptions about future events that are highly uncertain at the time of estimation. For example, we make estimates of future earnings, including estimates of future interest rates, exchange rates, and cost trends. Revisions to the estimated realizable value of deferred tax assets or estimated average reversal periods of contra assets or liabilities could cause our provision for income taxes to vary significantly from period to period.

     The net deferred tax liability was Ch$44,177 million, Ch$47,658 million, and Ch$41,132 million as of December 31, 2004, 2005 and 2006, respectively.

     Provisions. Provisions are recorded when, at the end of the periods, the Company has a present obligation as a result of past events, whose settlement requires an outflow of resources that is considered probable and can be measured reliably. This obligation may be legal or constructive, arising from, but not limited to, regulation, contracts, common practice or public commitments, which have created a valid expectation for third parties that the Company will assume certain responsibilities. The amount recorded is the best estimation performed by the management in respect of the expenditure that will be required to settle the obligation, considering all the information available at the closing date, including the opinion of external experts, such as legal advisors or consultants.

     If we are unable to reliably measure the obligation, no provision is recorded and information is then presented in the notes to the Consolidated Financial Statements.

     Because of the inherent uncertainties in this estimation, actual expenditures may be different from the originally estimated amount recognized.

     Convergence of Chilean accounting standards with International Financial Reporting Standards (IFRS). In 2004, the SVS began working to promote the convergence of Chilean accounting standards with International

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Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB), as recommended by the World Bank. At the end of 2005, the SVS established a timeline, such that publicly listed companies will be required to apply the new set of rules beginning on January 1, 2009. Several different regulatory organizations have been collaborating on this initiative, in particular the Chilean Association of Accountants, which is in charge of the convergence process in Chile. The financial statements for the years ended December 31, 2009 and thereafter must be presented in accordance with IFRS, and they must include comparative information for the previous period.

     For a description of significant differences between Chilean GAAP and US GAAP, please see Item 18. Financial Statements – Note 37 – Differences Between Chilean And United States Generally Accepted Accounting Principles.

A. Operating Results

     Figures from previous years in the following discussion are adjusted for general price-level changes and expressed in millions of constant Chilean pesos as of December 31, 2006.

Net Income and Operating Revenues for 2004, 2005 and 2006.

     The following table presents historical information regarding the contribution, by amount and as a percentage of total operating revenues, of each of the Company’s business segments to the Company’s total operating revenues during the periods indicated below, calculated in accordance with Chilean GAAP.

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Operating Revenues

    Years ended December 31, 
   
    2004    2005    2006 
       
         % of Total         % of Total         % of Total 
         Operating         Operating         Operating 
    Revenues     Revenues    Revenues     Revenues    Revenues     Revenues 
             
    (in millions of constant Ch$ as of December 31, 2006, 
    except percentage amounts)
Fixed Telecommunications    446,609    60.1%    450,748    76.0%    439,548    76.2% 
Basic Telephony    317,169    42.7%    300,464    50.7%    264,380    45.8% 
         Telephone line service fee    155,283    20.9%    126,134    21.3%    80,678    14.0% 
         Variable charge    125,020    16.8%    98,943    16.7%    69,869    12.1% 
         Connections and other installations    4,121    0.6%    3,349    0.6%    1,482    0.3% 
         Plans of minutes (tariff flexibility)(1)   9,194    1.2%    46,687    7.9%    90,429    15.7% 
         Value-added services    18,074    2.4%    19,884    3.4%    16,562    2.9% 
         Other basic telephony revenues    5,477    0.7%    5,467    0.9%    5,360    0.9% 
Broadband    26,615    3.6%    43,802    7.4%    61,297    10.6% 
Access charges and Interconnections    33,411    4.5%    44,928    7.6%    51,221    8.9% 
         Domestic long-distance    10,705    1.4%    10,561    1.8%    8,494    1.5% 
         International long-distance    2,969    0.4%    2,421    0.4%    1,597    0.3% 
         Other interconnection services    19,737    2.7%    31,947    5.4%    41,130    7.1% 
Other Fixed Telecommunications                         
    businesses    69,412    9.3%    61,553    10.4%    62,650    10.9% 
         Directory Advertising    6,221    0.8%    5,482    0.9%    4,342    0.8% 
         ISP-switched and dedicated    3,298    0.4%    2,583    0.4%    2,226    0.4% 
         Security services (Telemergencia)   7,066    1.0%    8,251    1.4%    8,825    1.5% 
         Public telephones    11,464    1.5%    10,025    1.7%    9,963    1.7% 
         Interior installations    33,081    4.4%    31,331    5.3%    30,654    5.3% 
         Equipment marketing    8,281    1.1%    3,881    0.7%    2,848    0.5% 
Pay Television(5)   -    0.0%    -    0.0%    3,792    0.7% 
Long-Distance(2)   65,146    8.8%    59,190    10.0%    58,922    10.2% 
Corporate Communications Customer    87,694    11.8%    79,853    13.5%    76,113    13.2% 
Other Businesses(3)   4,172    0.6%    3,113    0.5%    2,621    0.5% 
Mobile Communications(4)   139,850    18.8%    -    0.0%    -    0.0% 
Total Operating Revenues    743,471    100.0%    592,904    100.0%    577,204    100.0% 
________________________________________
(1)
Beginning in February 2004, the Company was allowed to offer different plans for fixed telephony as alternatives to the regulated plan. See “Item 4. Information on the Company—Business Overview—Licenses and Tariffs.”
 
(2)
Revenues from long-distance service include revenues from long-distance traffic and the rental of the long-distance network to other telecommunications operators.
 
(3)
Revenues from other businesses include revenues from Tecnonáutica and t-gestiona, among others.
 
(4)
On July 23, 2004, Telefónica Chile sold to TEM 100% of the Company’s subsidiary, Telefónica Móvil de Chile S.A. The transaction was approved by shareholders in an extraordinary shareholders’ meeting held on July 15, 2004.
 
(5)
Pay TV business launched on June 14, 2006
 

Results of Operations for the Year Ended December 31, 2006 Compared to the Year Ended December 31, 2005

     Operating Revenues

     Operating revenues decreased by 2.6% to Ch$577,204 million (US$1,084.2 million) in 2006 from Ch$592,904 million in 2005. The decrease is mainly due to a 12% drop of revenues from basic telephony and a 4.7% decrease of corporate communications revenues, due to lower traffic and revenues from services. This, however, was partially compensated by a 93.7% increase of revenues from flexible plans and a 39.9% increase from broadband revenues.

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     Revenues from Fixed Telecommunications Services

     Fixed telecommunications revenues, which accounted for 76.2% of the Company’s operating revenues in 2006, decreased by 2.5% to Ch$439,548 million (US$825.6 million) compared to Ch$450,748 in 2005. The fixed telecommunications business segment includes revenues from (i) basic telephony that consists of traditional telephone service, (ii) broadband services, (iii) access charges and interconnections and (iv) other fixed telecommunications business (which includes directory advertising, ISP for companies and small and medium businesses, security services such as alarm monitoring through fixed lines, public telephones and interior installations, equipment sales and rental and others).

     Basic Telephony. Revenues from basic telephony represented 60.1% of all revenues from fixed telecommunications services in 2006, which includes telephone line service fees (fixed monthly charges), variable charges, connections and other installations, plans of minutes associated to tariff flexibility and certain value-added services, among others. Basic telephony revenues decreased 12% in 2006 to Ch$264,380 million (US$496.6 million) from Ch$300,464 million in 2005, mainly due to: (i) a 36.0% decrease in revenues from fixed monthly charges to Ch$80,678 million (US$151.5 million) in 2006 from Ch$126,134 million in 2005, primarily because of a decrease in the number of lines that are charged fixed monthly and variable charges, as part of those with traditional lines (subject to tariff regulation) that have migrated to flexible plans such as “minute plans” and “prepaid plans,” which do not charge a monthly telephone line service fee (fixed charge); and (ii) a 29.4% decrease in revenues from variable charges to Ch$69,869 million (US$131.2 million) in 2006 from Ch$98,943 million in 2005, as a result of a 21.3% decrease in local traffic and the migration of traditional clients to flexible plans.

     Additionally, basic telephony revenues were impacted by a 55.7% decrease in revenues from installations and connections, to Ch$1,482 million (US$2.8 million) in 2006 from Ch$3,349 million in 2005. They were also affected by a 16.7% decrease in value added services to Ch$16,562 (US$31 million) in 2006 from Ch$19,884 million in 2005. However, the implementation of minute plans allowed by new tariff flexibility generated revenues in the amount of Ch$90,429 million (US$169.9 million) increasing 93.7% in comparison to the previous year. See “Item 4. Information on the Company—Business Overview—Licenses and Tariffs—The Tariff System.” As part of those with traditional lines (subject to tariff regulation) have migrated to flexible plans, revenues from fixed monthly charge, variable charge and flexible plans together decreased 11.3% mainly because of the lower average traffic per line. As of December 31, 2006, average lines in service decreased 4.8% as compared to year 2005.

     Other basic telephony revenues include revenues from, among other things, operator services and rural telephony and dedicated lines for the Internet. These revenues decreased 2% in 2006 to Ch$5,360 million (US$10.1 million) as compared to Ch$5,467 million in 2005.

     Broadband Services. Broadband revenues represented 13.9% of all revenues from fixed telecommunications services in 2006, and include revenues from broadband Internet access provided by the Company through ADSL to residential, small and medium-sized companies and to corporate customers. Broadband revenues grew 39.9% to Ch$61,297 million (US$115.1 million) in 2006 as compared to Ch$43,802 million in 2005, owing to a 57.7% increase in ADSL connections in the year. As of December 31, 2006, the number of broadband connections totaled 495,479.

     Access charges and interconnection. Access charges and interconnection include revenues from interconnection charges generated by long-distance carriers, as well as those paid by other telecommunications operators that use Telefónica Chile’s network and data-processing services such as metering, rating, billing and collections offered to long-distance operators. Access charges and interconnection revenues increased by 14.0% to Ch$51,221 million (US$96.2 million) in 2006 from Ch$44,929 million in 2005. This was mainly due to a 28.7% increase of other interconnection services. There was a decrease of 19.6% and 34.0% in domestic long-distance and international long-distance access charges revenues, respectively, mainly due to an 18% decrease in access charges traffic.

     Other fixed telecommunications business. Other fixed telecommunications business revenues represented 14.3% of all revenues from fixed telecommunications services in 2006, which includes revenues generated by the Company’s contract with Publiguías. Pursuant to the agreement, Telefónica Chile receives a percentage of the revenues generated by the sale of advertisements in the Yellow Pages and the White Pages, published by Publiguías,

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revenues from Internet access provided by the subsidiary Telefónica Internet Empresas (TIE) to switched and dedicated customers, revenues originated in the subsidiary Telemergencia (home security services), and revenues from public telephones, interior installations and terminal equipment marketing that includes the sale and leasing of telecommunications equipment, such as telephones, facsimiles and multiple lines. These revenues increased by 1.8% in 2006 to Ch$62,650 million (US$117.7 million) as compared to Ch$61,553 million in 2005, mainly due to a 7.0% increase in revenues from home security services reaching Ch$8,825 million (US$16.6 million) in 2006 compared to Ch$8,251 million in 2005 and revenues from digital television services reaching Ch$3,792 million (US$7.1 million) during the present year. This was offset by a 26.6% decrease in terminal equipment marketing, a 2.2% decrease in revenues from interior installation, a 20.8% decrease in phonebook advertising revenues and a 13.8% decrease in revenues from switched and dedicated ISP services.

     Revenues from Long-Distance Services

     Revenues from the long-distance business segment, which accounted for 10.2% of total revenues in 2006, decreased by 0.5% to Ch$58,922 million (US$110.7 million) compared to Ch$59,190 million in 2005. Long-distance revenues include revenues from domestic and international long-distance traffic carried by the Company, as well as revenues from the rental of the Company’s long-distance network to other telecom operators. The decrease in long-distance revenues was mainly attributable to a 7.1% decrease in DLD revenues and an 8.1% decrease in rental capacity. However, this was compensated by a 13.5% increase of revenues from ILD.

     The increase in ILD revenues is mainly due to the absence in 2006 of an extraordinary charge associated with incoming ILD traffic revenues of Ch$2,612 million (US$4.9 million) in 2005.

     Revenues from Corporate Customers Communications

     Revenues from the Corporate Customers Communications and Data business segment, which accounted for 13.2% of the Company’s revenues in 2006, decreased by 4.7% to Ch$76,113 million (US$143.0 million) compared to Ch$79,853 million in 2005. Corporate Customers Communications and Data includes revenues from (i) the sale and rental of telecommunications equipment to large corporate customers (i.e., fax, PABX, etc.), (ii) complementary telephone services, such as 800 numbers and digital communication services, (iii) data services, including ATM, Frame Relay, data equipment and services related to the IP network, and (iv) dedicated links and other services, including videoconference, Datared, E1 Links and VSAT, housing and hosting and consulting services to large corporate customers.

     The decrease in revenues was mainly due to (i) a 6.8% decrease in data services revenues to Ch$26,757 million (US$50.3 million) from Ch$28,709 million in 2005 together with a 17.1% decrease in revenues from terminal equipment marketing and a 8.3% fall in revenues from complementary services. Revenues from circuits and others partially compensated this with an 8.0% increase during 2006. Data links through the IP network continued to grow (dedicated IP) reaching a 16.2% increase during this year.

     Revenues from Other Businesses

     Revenues from other businesses, which accounted for 0.5% of the Company’s revenues in 2006, decreased by 15.8% to Ch$2,621 million (US$4.9 million) as compared to Ch$3,133 million in 2005. Revenues from other businesses include revenues from other subsidiaries including Tecnonáutica and t-gestiona, among others.

Operating Costs and Administration and Selling Expenses

     Operating costs and administrative and selling expenses decreased by 1.9% to Ch$494,580 million (US$929.0 million) in 2006, as compared to Ch$503,979 million in 2005. This was a result of a Ch$12,090 million (US$22.7 million) decrease in salaries, due to the restructuring carried out in early 2006, and a 1.7% decrease in other operational costs, which was partially offset by an increase in depreciation costs.

     Operating costs and expenses. Operating costs and expenses decreased by 2.1% to Ch$373,025 million (US$700.7 million) in 2006, as compared to Ch$380,888 million in 2005, mainly because of other operating costs, which represented 35.7% of total operating costs and expenses in 2006, decreased by 7.0% to Ch$133,577 million (US$250.9 million) from Ch$143,602 million in 2005, due to lower general expenses and a reduction in

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uncollectible accounts costs. During 2006, the Company continued implementing strict policies to control uncollectibles such as automatic disconnections of lines with more than 120-day past due invoices and strict policies for admitting new customers. Provisions for doubtful accounts as a percentage of revenues was 3.2% as of December 31, 2006, compared to 3.6% in the previous year.

     The above was partly offset by the increase in operating salaries and related costs, which represented 8.9% of total operating costs and expenses during 2006. Operating salaries and related costs increased by 1.3% to Ch$44,232 million (US$83.1 million) from Ch$43,612 million in 2005. In addition, depreciation, which accounted for 52.5% of total operating costs and expenses, increased 1.4% to Ch$196,146 million (US$368.4 million) in 2006 from Ch$193,673 million in 2005, mainly due to the review of the useful lives of assets.

     Administrative and selling expenses. Administrative and selling expenses, which accounted for 24.6% of total operating costs and administrative and selling expenses in 2006, decreased by 1.2% to Ch$121,555 million (US$228.3 million) from Ch$123,091 million in 2005, mainly due to salary savings due to personnel reductions at the beginning of 2006. Operating salaries and related costs, which represented 20.3% of total operating costs and expenses during 2006, decreased by 34.2% to Ch$24,416 million (US$45.9 million) from Ch$37,126 million in 2005. The above was partly offset by higher costs and sales commissions related to broadband business (ADSL), television and corporate communications.

Operating Income

     Operating income decreased by 7.1% to Ch$82,624 million (US$155.2 million) during 2006 from Ch$88,925 million in 2005, due to a 2.6% decrease in operating revenues and a 1.9% decrease in operating expenses.

Other Income (Expenses) or Non-Operating Results

     Interest income. Interest income decreased by 45.6% to Ch$4,437 million (US$8.3 million) in 2006 from Ch$8,153 million in 2005, mainly due to higher fund volumes transitorily destined to financial investments during 2005.

     Interest expense. Interest expense decreased by 35.3% to Ch$19,480 million (US$36.6 million) in 2006 from Ch$30,121 million in 2005, mainly due to a small financial debt and a better international risk classification, varying from BAA2 to BAA1.

     Price level restatement and exchange differences, net. Price level restatement and exchange differences, recorded a net gain in the amount of Ch$666 million in 2006, as compared to a gain of Ch$2,962 million in 2005.

     Price level restatement registered a gain of Ch$501 million (US$0.9 million) in 2006 as compared to a gain of Ch$1,986 million in 2005. The price level restatement reflects the net impact on the Company’s accounts of purchasing power gain and loss on indexing. The Company will recognize a purchasing power gain or a loss on indexing on its statement of operations whenever the Company’s average monetary liabilities for a given period during which inflation occurs (determined monthly) exceed or fall below its average monetary assets. The Company’s average UF and Chilean peso denominated liabilities and revenues fell below its average UF and Chilean peso denominated assets and expenses, resulting in a purchasing-power gain for the period, as shown in Note 27 to the Audited Consolidated Financial Statements. The principal inflation index-linked unit used in Chile is the UF, a rate that is set monthly for each day of the coming month to reflect the prior month’s change in the Chilean CPI. As of December 31, 2006, one UF was equal to Ch$18,336.38 (US$34.4) .

     Exchange rate differences registered a gain of Ch$165 million (US$0.3 million) from exchange rate differences in 2006, as compared to a gain of Ch$976 million from exchange rate differences in 2005, as shown in Note 28 to the Audited Consolidated Financial Statements. To the extent that, during any given period, the Company has net liabilities denominated in a foreign currency (such as the U.S. dollar or euros) and the Chilean peso may depreciate or appreciate in nominal terms against that currency, the Company may recognize for that period a foreign exchange loss or gain. Nevertheless the conservative hedging policy of the Company for foreign-currency denominated interest-bearing debt allows the Company to minimize the exchange rate variation risk in results. During 2006, appreciation of the inflation-adjusted Chilean peso against the U.S. dollar was 1.72% .

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     Other non-operating results. Other non-operating results recorded a loss of Ch$29,713 million (US$55.8 million) in 2006, compared to a loss of Ch$29,089 million in 2005, resulting in a 2.1% increase in loss.

     The Company recognized: (i) a charge of Ch$9,529 million (US$17.9 million) in 2006 as compared to Ch$2,071 million in 2005 for severance payments; (ii) a charge of Ch$2,534 million (US$4.8 million) in 2006 as compared to Ch$2,886 million in 2005 for provision for obsolete assets; (iii) a write-off of out-of-service property, plant and equipment, for Ch$1,516 million (US$2.9 million) in 2006 as compared to Ch$4,471 million in 2005; and (iv) lawsuit indemnities and other provisions for Ch$1,665 million (US$3.1 million) in 2006 as compared to Ch$1,189 million in 2005.

     Income Taxes. The Company recorded an income tax charge in the amount of Ch$29,600 million (US$55.6 million) in 2006 corresponding to an effective consolidated tax rate for the Company of 55.9% compared to an income tax charge of Ch$34,093 million in 2005 corresponding to an effective consolidated tax rate for the Company of 57.0%. Income taxes include current income tax expenses, taxes provision for the period, as well as deferred taxes from the period and from previous periods (complementary accounts), as shown in Note 8(c) to the Audited Consolidated Financial Statements. The Company’s effective income tax rate in 2006 was principally affected by a charge of Ch$13,815 million (US$26.0 million) which represented the effect of amortization of deferred assets and liabilities of complementary accounts associated with deferred taxes incurred during previous periods, by price-level restatement not accepted for tax purposes of Ch$2,621 million (US$4.9 million) and by other non-deductible items of Ch$3,618 million (US$6.8 million).

     The income tax charge includes a charge of Ch$16,932 million (US$31.8 million) related to the reversal of temporary differences associated with deferred tax liabilities related mainly to accelerated depreciation due to the fact that investments have decreased in the last six years generating lower temporary liabilities than temporary assets and Ch$19 million for tax benefits from loss carry forwards.

Net Income (Loss)

     As a result of the above, Telefónica Chile’s net results amounted to a net income of Ch$23,353 million (US$43.9 million) in 2006, as compared to a net income of Ch$25,712 million recorded in 2005. For 2006, the contribution to the consolidated net income by business segment was as follows: (i) a net loss of Ch$5,789 million in fixed telephony; (ii) net income of Ch$15,122 million in long distance; (iii) net income of Ch$13,297 million in corporate customers communications and data; and (iv) a net income of Ch$723 million in other businesses.

Results of Operations for the Year Ended December 31, 2005 Compared to the Year Ended December 31, 2004

     Results of operations for the year ended December 31, 2004, reflect the effects of the sale of our subsidiary Telefónica Móvil de Chile S.A. in July 2004, which produced a gain of approximately Ch$321,071 million. As of July 2004, the Company no longer consolidated the mobile operations. In order to assist the reader in understanding the effect after the sale of the mobile subsidiary on our reported results the following table shows operating results of the Company excluding the mobile operations.

    2003(1) (excluding    2004(1) (excluding        04/03    05/04 
    mobile operations)   mobile operations)   2005    Variation    Variation 
           
Operating Revenues excluding mobile operations    635,095    609,792    592,905    -4.0%    -2.8% 
Operating Expenses and    -524,669    -501,248    -503,980    -4.5%    0.5% 
    Administrative and Selling Expenses                     
Operating Income excluding mobile operations    110,426    108,544    88,925    -1.7%    -18.1% 
 
Operating Revenues from mobile operation    246,132    133,679    -         
Operating Expenses from mobile operation    -231,487    -137,363    -         
Operating Income    125,070    104,860    88,925    -16.2%    -15.2% 
________________________________________
(1)
The subsidiary Telefónica Móvil de Chile was sold in July 2004, thus year 2004 only includes 6 months of results for the mobile business. We believe that consideration of operating revenues and costs excluding mobile operations is important to an understanding of our operations because we sold our mobile subsidiary in July 2004 and as a result 2005 revenues and operating costs are not comparable to those including mobile operations in 2003 and 2004.
 

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     Operating Revenues

     Operating revenues decreased by 20.3% to Ch$592,904 million (US$1,109.4 million) in 2005 from Ch$743,471 million in 2004. The decrease in revenues is mainly explained by the deconsolidation of Telefónica Móvil de Chile S.A. in July 2004. On July 23, 2004, the Company sold 100% of the shares of its mobile subsidiary, Telefónica Móvil de Chile S.A to TEM. Consequently, as of July 1, 2004, the Company no longer consolidated the mobile revenues in its operating activities. Excluding revenues of the mobile business in year 2004, total consolidated revenues would have decreased 2.9% mainly because of a 5.3% decrease in revenues from the fixed telecommunications business, explained by a drop in revenues from basic telephony, compensated in part by increases in revenues from broadband and access charges, as explained below.

     Revenues from Fixed Telecommunications Services

     Fixed telecommunications revenues, which accounted for 76.0% of the Company’s operating revenues in 2005, increased by 0.9% to Ch$450,747 million (US$843.4 million) compared to Ch$446,609 in 2004. The fixed telecommunications business segment includes revenues from (i) basic telephony that consists of traditional telephone service, (ii) broadband services, (iii) access charges and interconnections and (iv) other fixed telecommunications business (which includes directory advertising, ISP for companies and small and medium businesses, security services such as alarm monitoring through fixed lines, public telephones and interior installations and equipment sales and rental).

     Basic Telephony. Revenues from basic telephony represented 66.7% of all revenues from fixed telecommunications services in 2005, which includes telephone line service fees (fixed monthly charges), variable charges, connections and other installations, plans of minutes associated to tariff flexibility and certain value-added services, among others. Basic telephony revenues decreased 5.3% in 2005 to Ch$300,464 million (US$562.2 million) from Ch$317,169 million in 2004, mainly explained by a (i) 18.8% decrease in revenues from fixed monthly charges to Ch$126,133 million (US$236.0 million) in 2005 from Ch$155,283 million in 2004, mainly because of a decrease in the number of lines that are charged fixed monthly and variable charges, as part of those with traditional lines (subject to tariff regulation) have migrated to flexible plans such as “minute plans” and “prepaid plans,” which do not charge a monthly telephone line service fee (fixed charge), which offset the 7.7% average increase in rates applied since May 2004, in accordance to the new Tariff Decree No. 169. See “Item 4. Information on the Company—Business Overview—Licenses and Tariffs—The Tariff System”; and (ii) a 20.9% decrease in revenues from variable charges to Ch$98,943 million (US$185.1 million) in 2005 from Ch$125,020 million in 2004, as a result of a 12.7% decrease in local traffic, the migration of traditional clients to flexible plans and the 18.3% average rates decrease applied since May 2004, in accordance with new Tariff Decree No. 169.

     Additionally, basic telephony revenues were impacted by an 18.7% decrease in revenues from installations and connections, to Ch$3,348 million (US$6.3 million) in 2005 from Ch$4,121 million in 2004, principally because of a 26.4% drop in other installations, such as replacement of lines and charges for transferring and moving fixed lines, of Ch$1,842 million (US$3.4 million) in 2005 from Ch$2,503 million in 2004. The aforementioned were partially offset by a 10% increase in value added services to Ch$19,883 (US$37.2 million) in 2005 from Ch$18,074 million in 2004. Similarly, the implementation of minute plans allowed by new tariff flexibility, generated revenues in the amount of Ch$46,687 million (US$87.4 million). See “Item 4. Information on the Company—Business Overview—Licenses and Tariffs—The Tariff System.” As part of those with traditional lines (subject to tariff regulation) have migrated to flexible plans, revenues from fixed monthly charge, variable charge and flexible plans together decreased 5.1% because of the lower average traffic per line. As of December 31, 2005 average lines in service increased 1.9% as compared to year 2004.

     Other basic telephony revenues include revenues from, among other things, operator services and rural telephony and dedicated lines for the Internet. These revenues decreased slightly 0.2% in 2005 to Ch$5,467 million (US$10.2 million) as compared to Ch$5,477 million in 2004.

     Broadband Services. Broadband revenues represented 9.7% of all revenues from fixed telecommunications services in 2005, and include revenues from broadband Internet access provided by the Company through ADSL to residential, small and medium-sized companies and to corporate customers. Broadband revenues grew 64.6% to

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Ch$43,802 million in 2005 as compared to Ch$26,615 million in 2004, owing to a 56.5% increase in ADSL connections in the year. As of December 31, 2005, the number of broadband connections totaled 314,177.

     Access charges and interconnection. Access charges and interconnection include revenues from interconnection charges generated by long-distance carriers, as well as those paid by other telecommunications operators that use Telefónica Chile’s network and additionally data-processing services such as metering, rating, billing and collections offered to long-distance operators. Access charges and interconnection revenues increased by 34.5% to Ch$44,928 million (US$84.1 million) in 2005 from Ch$33,411 million in 2004. In spite of a decrease of 1.3% and 18.5% in domestic long-distance and international long-distance access charges revenues, respectively, mainly explained by a 23.5% decrease in access charges traffic, other interconnection services increased 61.9% mainly owing to a 38% increase in revenues from mobile to fixed-access charges from Ch$5,834 million in 2004 to Ch$8,027 million in 2005 (US$15.0 million). This increase in mobile to fixed access charges was associated with higher mobile penetration in Chile, which reached 69 lines per 100 inhabitants as of December 31, 2005, and that since July 2004 the Company began recognizing revenues from access charges and rental capacity from the former mobile subsidiary Telefonica Móvil de Chile S.A. Prior to the sale of the mobile subsidiary in July 2004, such revenues were accounted for as intercompany transactions and eliminated in consolidation. Revenues from unbundled services and other services provided to other telecom operators increased from Ch$1,382 million in 2004 to Ch$2,310 million (US$4.3 million) in 2005. The application of the new tariff decree since May 2004 had a positive effect in access charge revenues since the average access charge rate increased 49.1%, see “Item 4. Information on the Company—Business Overview—Licenses and Tariffs—The Tariff System.”

     Other fixed telecommunications business. Other fixed telecommunications business revenues represented 13.7% of all revenues from fixed telecommunications services in 2005, which includes revenues generated by the Company’s contract with Publiguías. Pursuant to the agreement, Telefónica Chile receives a percentage of the revenues generated by the sale of advertisements in the Yellow Pages and the White Pages, published by Publiguías, revenues from Internet access provided by the subsidiary Telefónica Internet Empresas (TIE) to switched and dedicated customers, revenues originated in the subsidiary Telemergencia (home security services), revenues from public telephones, interior installations and terminal equipment marketing that includes the sale and leasing of telecommunications equipment such as, among other things, telephones, facsimiles and multiple lines. These revenues decreased by 11.3% in 2005 to Ch$61,553 million (US$115.2 million) as compared to Ch$69,412 million in 2004. This is mainly due to a 53.1% decrease in equipment marketing explained by lower sales of telecommunications equipment and PABX; (ii) a 5.3% decrease in revenues from interior installation; and (iii) a 12.5% decrease in public telephones due to a 24.6% decrease in traffic and a 15.0% decrease in average number of public telephones. These decreases were partly offset by a 16.8% increase in revenues of home security services.

     Revenues from Long-Distance Services

     Revenues from the long-distance business segment, which accounted for 10.0% of total revenues in 2005, decreased by 9.1% to Ch$59,189 million (US$110.8 million) compared to Ch$65,146 million in 2004. Long-distance revenues include revenues from domestic and international long-distance traffic carried by the Company, as well as revenues from the rental of the Company’s long-distance network to other telecom operators. The decrease in long-distance revenues was mainly attributable to a 21.5% decrease in ILD revenues and an 8.8% decrease in DLD revenues, partly compensated by a 12.8% increase in rental capacity. Revenues from rental capacity were positively affected by the incorporation of revenues from media and circuit rental to Telefónica Móvil de Chile S.A after the sale of the mobile subsidiary to TEM in July 2004. Prior to the sale these rentals were accounted for as intercompany transactions.

     The decrease in ILD revenues is mainly due to (i) an extraordinary charge associated with incoming ILD traffic revenues of Ch$2,612 million (US$4.9 million) in 2005, which also had an effect on operating costs (excluding this effect ILD revenues decreased 11.2%); (ii) a 2.1% decrease in ILD traffic; and (iii) a 6.8% decrease average tariff for ILD. Similarly, the decrease in DLD revenues is explained by a 9.4% decrease in DLD traffic and a 5.6% decrease in average tariff for DLD as a result of increased competition and the effect of mobile and Internet substitution.

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     Revenues from Corporate Customers Communications

     Revenues from the Corporate Customers Communications and Data business segment, which accounted for 13.5% of the Company’s revenues in 2005, decreased by 8.9% to Ch$79,856 million (US$149.4 million) compared to Ch$87,694 million in 2004. Corporate Customers Communications and Data includes revenues from (i) the sale and rental of telecommunications equipment to large corporate customers (i.e., fax, PABX, etc.), (ii) complementary telephone services, such as 800 numbers and digital communication services, (iii) data services, including ATM, Frame Relay, data equipment and services related to the IP network, and (iv) dedicated links and other services, including videoconference, Datared, E1 Links and VSAT, housing and hosting and consulting services to large corporate customers.

     The decrease in revenues was mainly due to (i) a 12.9% decrease in data services revenues to Ch$28,709 million (US$53.7 million) from Ch$32,948 million in 2004, mainly as a result of the reclassification of revenues from interconnection services to wholesalers (broadband for wholesalers), which were reclassified as fixed telecommunications revenues in the amount of Ch$1,606 million (US$3.0 million), and (ii) a 15.2% decrease in complementary services to corporate customers to Ch$14,974 million (US$28.0 million) from Ch$17.668 million in 2004 because of the reclassification of information of service income toward value added service of fixed telecommunication. Excluding those revenues in 2004, complementary service grew 8.7% because of an increase in sales levels in the high consumption plans associated with tariff flexibility, where lines with high consumption plans for voice grew 58.9% as compared to 2004. Revenues from terminal equipment marketing and circuits and others fell 4.9% and 0.9%, respectively, because of the migration from traditional technologies to more advanced data technologies. In 2005, ATM links and Datared decreased by 34.6% and 40.4%, while data links through the IP network (dedicated IP) grew 4.7%.

     Revenues from Other Businesses

     Revenues from other businesses, which accounted for 0.5% of the Company’s revenues in 2005, decreased by 25.4% to Ch$3,112 million (US$5.8 million) as compared to Ch$4,172 million in 2004. Revenues from other businesses include revenues from other subsidiaries including Tecnonáutica and t-gestiona, among others.

Operating Costs and Administration and Selling Expenses

     Operating costs and administrative and selling expenses decreased by 21.1% to Ch$503,980 million (US$94.0 million) in 2005, as compared to Ch$638,611 million in 2004. When the mobile operations are excluded in 2004, consolidated operating costs and administrative and selling expenses increased slightly by 0.6% in relation to 2004. We believe that consideration of operating costs and administrative and selling expenses excluding mobile operations is important to an understanding of our operating costs because we sold our mobile subsidiary in July 2004 and as a result operating costs and administrative and selling expenses including mobile operations are not comparable between 2004 and 2005.

     Operating costs and expenses. Operating costs and expenses decreased by 19.0% to Ch$380,888 million in 2005, as compared to Ch$470,119 million in 2004, mainly because (i) operating salaries and related costs, which represented 11.5% of total operating costs and expenses during 2005, decreased by 14.1% to Ch$43,612 million from Ch$50,821 million in 2004, mainly due to lower salary costs as a consequence of deconsolidation of the mobile business as of July 2004, (ii) depreciation, which accounted for 50.9% of total operating costs and expenses, decreased 16.7% to Ch$193,673 million in 2005 from Ch$232,374 million in 2004, mainly due to the deconsolidation of the mobile business, and (iii) other operating costs, which represented 37.7% of total operating costs and expenses in 2005, decreased by 23.2% to Ch$143,602 million from Ch$186,924 million in 2004, due mainly to the deconsolidation of the mobile business as of July 2004, and reduction in uncollectible accounts costs mainly in the fixed telecommunications business. During 2005, the Company implemented stricter policies to control uncollectibles such as automatic disconnections of lines with more than 120-day past due invoices and stricter policies for admitting new customers. Provisions for doubtful accounts as a percentage of revenues was 3.7% as of December 31, 2005, compared to 4.6% in the previous year (excluding mobile operations).

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     Administrative and selling expenses. Administrative and selling expenses, which accounted for 24.4% of total operating costs and administrative and selling expenses in 2005, decreased by 26.9% to Ch$123,092 million (US$230.3 million) from Ch$168,491 million in 2004, mainly due to the deconsolidation of the mobile business as of July 2004. For the ongoing operations there were also salary savings due to personnel reductions in the administrative and sales areas partly offset by (i) a one-time charge related to the long-distance settlement rates, in the amount of Ch$8,235 (US$15.4 million) in 2005, and (ii) higher costs and sales commissions related to broadband business (ADSL) and corporate communications, and advertising campaigns launched in 2005 related to ADSL and flexible plans.

Operating Income

     Operating income decreased by 15.2% to Ch$88,925 million (US$166.4 million) during 2005 from Ch$104,860 million in 2004, due to a 20.3% decrease in operating revenues and a 21.1% decrease in operating expenses, as explained above, taking into account the fact that the Company no longer consolidated the Mobile subsidiary beginning in July 2004.

Other Income (Expenses) or Non-Operating Results

     Interest income. Interest income decreased by 17.0% to Ch$8,153 million (US$15.3 million) in 2005 from Ch$9,822 million in 2004, mainly explained by higher interest income in 2004 from financial investments made with available funds arising from the sale of the mobile subsidiary in July 2004.

     Interest expense. Interest expense decreased by 47.3% to Ch$30,121 million (US$56.4 million) in 2005 from Ch$57,175 million in 2004, mainly due to (i) a 21.0% decrease in the Company’s average interest-bearing debt, as well as lower average interest rates resulting from the renegotiation of spreads on outstanding loans and a decrease in local and international interest rates, (ii) the positive impact of the appreciation of the Chilean peso against the U.S. dollar (gains and losses from transactions entered into to hedge our foreign currency exposure are reflected under exchange differences, net), and (iii) a charge of Ch$8,561 million (US$15.5 million) recognized in 2004, related to the repurchase of US$182 million in Yankee Bonds carried out in fourth quarter of 2004, at a price above its par value.

     Price level restatement and exchange differences, net. Price level restatement and exchange differences, recorded a net gain in the amount of Ch$2,962 million in 2005, as compared to a gain of Ch$9,501 million in 2004.

     Price level restatement registered a gain of Ch$1,986 million (US$ 3.7 million) in 2005 as compared to a charge of Ch$4,407 million in 2004. The price level restatement reflects the net impact on the Company’s accounts of purchasing power gain and loss on indexing. The Company will recognize a purchasing power gain or a loss on indexing on its statement of operations, whenever the Company’s average monetary liabilities for a given period during which inflation occurs (determined monthly) exceed or fall below its average monetary assets. The Company’s average UF and Chilean peso denominated liabilities and revenues fell below its average UF and Chilean peso denominated assets and expenses, resulting in a purchasing-power gain for the period, as shown in Note 26 to the Audited Consolidated Financial Statements. The principal inflation index-linked unit used in Chile is the UF, a rate that is set monthly for each day of the coming month to reflect the prior month’s change in the Chilean CPI. As of December 31, 2005, one UF was equal to Ch$17,974.81.

     Exchange rate differences registered a gain of Ch$976 million (US$1.8 million) from exchange rate differences in 2005, as compared to a gain of Ch$13,908 million from exchange rate differences in 2004, as shown in Note 27 to the Audited Consolidated Financial Statements. The gain registered in 2004 was mainly due to the gain obtained through forward agreements contracted by the Company to hedge against exchange rate variations after receiving US$ dollars for the sale of Telefónica Móvil de Chile S.A. in July 2004. To the extent that, during any given period, the Company has net liabilities denominated in a foreign currency (such as the U.S. dollar or euros) and the Chilean peso may devaluate or appreciate in nominal terms against that currency, the Company may recognize for that period a foreign exchange loss or gain. Nevertheless the conservative hedging policy of the Company for foreign-currency denominated interest-bearing debt allows the Company to minimize the exchange rate variation risk in results. During 2005, appreciation of the inflation-adjusted Chilean peso against the U.S. dollar was 11.3% .

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     Other non-operating results. Other non-operating results recorded a loss of Ch$29,089 million in 2005, compared to a gain of Ch$291,066 million in 2004. This item was particularly impacted in 2004 by non-operating gain of Ch$350,090 million (net of goodwill amortization) and by Ch$6,878 million from the sale of subsidiary Telefónica Móvil de Chile S.A. and the sale of the participation in Publiguías. respectively.

     In addition, the Company recognized (i) a charge of Ch$2,071 million (US$3.9 million) in 2005 as compared to Ch$6,584 million in 2004 for severance payments; (ii) a charge of Ch$2,265 million (US$4.2 million) in 2005 as compared to Ch$10,118 million in 2004 for provision for obsolete assets; and (iii) a write-off of out-of-service property, plant and equipment, for Ch$4,471 million (US$8.4 million) in 2005 as compared to Ch$8,465 million in 2004.

     Income Taxes. The Company recorded an income tax charge in the amount of Ch$34,093 million (US$63.8 million) in 2005 translating into an effective consolidated tax rate for the Company of 57.0% compared to an income tax charge of Ch$65,999 million in 2004 translating into an effective consolidated tax rate for the Company of 16.7%. In 2004, income tax included taxes paid associated with the gain for the sale of Telefónica Móvil de Chile S.A. in July 2004, which amounted Ch$36,928 million (US$69.1 million). Income taxes include current income tax expenses, taxes provision for the period, as well as deferred taxes from the period and from previous periods (complementary accounts), as shown in Note 7(c) to the Audited Consolidated Financial Statements. The Company’s income tax charge of Ch$34,093 million in 2005 was composed of a Ch$24,561 million (US$46.0 million) current income tax expense, and a total of Ch$9,532 million (US$18.2 million) charge for deferred taxes, explained by Ch$13,896 million (US$26.1 million) which represented the effect of amortization of deferred assets and liabilities of complementary accounts associated with deferred taxes incurred during previous periods and by Ch$4,364 million (US$8.2 million) of a reverse of temporary differences associated with deferred tax liabilities related mainly to accelerated depreciation due to the fact that investments have decreased in the last six years generating lower temporary liabilities than temporary assets.

Net Income (Loss)

     As a result of the above, Telefónica Chile’s net results amounted to a net income of Ch$25,712 million (US$48.3 million) in 2005, as compared to a net income of Ch$329,627 million recorded in 2004. For 2005, the contribution to the consolidated net income by business segment was as follows: a net income of Ch$12,301 million in fixed telephony, net income of Ch$1,594 million in long distance, net income of Ch$11,004 million in corporate customers communications and data, and a net income of Ch$812 million in other businesses.

     B. Liquidity and Capital Resources

     Sources of Liquidity

     The Company’s main historical sources of liquidity have been its cash flows from operations, proceeds from borrowings and the issuance of equity. Although in the past Telefónica Chile has relied substantially on public debt issues and bank loans to meet its financing requirements, since 2001 its main sources of liquidity have been cash flow generated from operations and free cash resulting from savings associated with the refinancing of certain loans. The current working capital level is sufficient to meet present requirements. If any additional working capital is needed in the future, the Company will evaluate additional financing.

     During 2006, Telefónica Chile continued to pursue its strategy of improving its financial structure by focusing capital expenditures on Company businesses with the highest expected returns and reducing capital expenses.

     During 2006, the cash flow statements show net cash from operating activities totaling Ch$234,631 million (US$440.7 million), compared to Ch$226,267 million in 2005, as a result of: (i) a net income of Ch$23,353 million (US$43.9 million) in 2006 as compared to net income of Ch$25,712 million in 2005; (ii) a gain on sale of property, plant and equipment of Ch$369 million (US$0.7 million) in 2006, as compared to a loss on sale of property, plant and equipment of Ch$21 million in 2005; (iii) depreciation and amortization charges of Ch$209,931 million (US$394 million) as compared to Ch$205,761 million in 2005; (iv) an increase in operating assets of Ch$19,686 million (US$36.9 million) in 2006 compared to a decrease in operating assets of Ch$66,003 million in 2005; and (v) a decrease in operating liabilities of Ch$781 million (US$1.5 million), compared to a decrease of Ch$98,520 million in 2005. The smaller decrease in 2006 is due to the fact that, although accounts payable fell, in 2006 the amount of

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income tax payable dropped by less than it had between 2004 and 2005, offsetting the decrease in accounts payable. The effect of these factors was partly offset by lower charges to income that do not represent cash flows for a net amount of Ch$232,156 million (US$436.1 million) in 2006, compared to Ch$233,019 in 2005. The difference is due to lower price-level restatement and foreign currency translation differences in 2006, offset by higher depreciation and goodwill depreciation.

     Net cash used in financing activities reached Ch$181,661 million (US$341.2 million) in 2006 as compared with Ch$205,394 million in 2005. Cash in 2006 was mainly used for dividend payments of Ch$25,340 million ( US$47.6 million), a capital reduction of Ch$40,596 million (US$76.3 million) and payments of obligations with the public of Ch$188,405 million (US$353.9 million).

     Net cash used in investing activities reached Ch$108.021 million (US$202.9 million) in 2006, compared to Ch$88,254 million in 2005. The cash used in investing activities in 2006 was principally associated with the acquisition of property, plant and equipment.

     The Company’s shareholders’ equity as of December 31, 2006 and 2005 was Ch$900,761 million (US$1,691.9 million) and Ch$945,012 million respectively. The decrease in shareholders’ equity as of December 31, 2006 was primarily attributable to the payment, during 2005, of dividends totaling Ch$25,183 million (US$47.3 million historic value), as well as a capital reduction of Ch$40,201 million historic value (US$75.5 million historic value), in order to distribute additional cash to shareholders.

     On January 24, 2006, the Company’s Board of Directors decided to call an extraordinary shareholders’ meeting for April 20, 2006, with the objective to decide on a capital reduction of Ch$40,200,513,570 (US$75,509,520) and a reform of the Company by-laws to reflect such a capital reduction. The capital reduction and amendment of the Company’s by-laws were approved at the extraordinary shareholders’ meeting held on April 20, 2006, and the capital reduction was paid to shareholders on June 15, 2006. On March 14, 2006, an extraordinary Series F local bondholders’ meeting was held, where bondholders approved the elimination of the clause in the bond agreement that prohibits a capital reduction and also agreed to change some covenants to match the covenants of the Company’s other debt agreements outstanding.

Outstanding Indebtedness

     Following its privatization in 1988, the Company pursued an aggressive development plan to expand its fixed line network at that moment and develop other telecommunications services, such as long-distance service, mobile telephony and data transmission services. To fund the capital expenditures associated with this expansion, the Company has raised capital by issuing debt through domestic and international offerings, including the issuance of Yankee and Euro Bonds, and has borrowed funds from commercial banks in the form of syndicated and bilateral loans. The Company has also accessed the local Chilean capital markets through the issuance of medium and long-term bonds, primarily sold to pension funds, insurance companies and other institutional investors, commercial paper, and through borrowing from commercial banks.

     During 2006, the Company issued Ch$73,000 million (US$137.1 million) of new debt through issuances of commercial paper and local debentures. Commercial paper is a public debt instrument in the local market, which can be issued as a credit line or as a fixed amount with maturities of up to 36 months in different currencies and rates, allowing financing flexibility. The detail of debt issued by the Company during 2006 is as follows:

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     During 2006, debt repayments equivalent to US$315 million, consisted of US$206 for the repayment of Yankee bonds in January and July, as well as US$107 million in commercial paper paid at maturity in March and April, and US$2 million for the repayment of local Series F bonds, in April and October.

     The following table sets forth the Company’s outstanding debt as of December 31, 2006:

  As of December 31, 2006 
   
  Total Debt
Outstanding 		   Short- 
Term 
Portion 		   Long-
Term 
Portion 		   Type of Debt   Date
Incurred 		   Original Principal
Amounts
Borrowed(1) (2)		   Interest
Rate 		   Maturity 
               
               
                   
  (in millions of constant Chilean Pesos as of December 31, 2006, except as indicated)
Long-Term Obligations                               
   including current maturities:                               
Long-Term Obligations with Banks:                               
Citibank  80,514    656    79,858    Syndicated loan    2005    US$150 mm    Libor +0.31    2008 
Banco BBVA, Bancomer and  80,593    734    79,859    Syndicated loan    2005    US$150 mm    Libor +0.334    2011 
   Others                               
CALYON, New York and Others  106,647    169    106,478    Syndicated loan    2004    US$200 mm    Libor +0.35    2009 
Banco Santander  65,632    446    65,186    Bilateral loan    2005    UF 3,555,000           TAB360+ 0.45    2010 
                 
                               
          Total Long-Term                               
               Obligations with Banks  333,386    2,005    331,381                     
Bonds and Debentures:                               
Series F  12,598    1,465    11,133    Local bond    1991    UF 1,500,000           6.00%    2016 
Series L  55,384    375    55,009    Local bond    2006    UF 3,000,000           3.75%    2012 
                 
 
         Total Bonds and Debentures  67,982    1,840    66,142                     
Capital Lease Obligations:                               
Leasing Obligations         222    12    210    Leasing    -    -    8.10%    2015 
                 
Total Long-Term Debt (including  401,590                             
                 
     current maturities)                              
Total Debt Outstanding  401,590                             
                 

________________________________________
(1)      In original currency of debt as incurred.
 
(2)      U.S. dollar and euro amounts expressed in millions.
 

     In addition to available cash as of December 31, 2006, the Company has the ability to draw up to approximately Ch$1,200 million (US$2.3 million) from unused lines of credit granted by Chilean banks.

     Some of the Company’s indebtedness is governed by instruments and agreements that contain restrictive covenants with which the Company is obligated to comply. During the last four years the Company has been renegotiating its outstanding debt in order to improve its rates and maturities, but also to establish less restrictive covenants. Under terms of the Company’s syndicated loan agreements the Company must maintain a leverage ratio (as defined in each respective agreement) equal to or lower than 1.6. Additionally, the covenants for the local bonds require that the Company must maintain a leverage ratio (as defined in the local bond agreement) less than or equal to 1.6. In addition, the Investment and Financing Policy for 2006 approved by Telefónica Chile’s shareholders at the General Annual Shareholders’ Meeting held in April 2006 specifies that the maximum consolidated debt-to-equity ratio may not exceed 1.6. As of December 31, 2006, the Company was in compliance with all financial covenants set forth under the agreements governing its debt obligations and with all other covenants in these agreements. As of December 31, 2006, the Company had a leverage ratio of 0.79 and an interest coverage ratio of 18.7.

     During 2006, the ratings agency Moody’s upgraded its rating from Baa2 to Baa1 with a stable outlook, and Fitch Ratings reaffirmed Telefónica Chile’s rating at BBB+ with a stable outlook.

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Capital Expenditures and Other Liquidity Requirements

     Debt Prepayment and Repayment

     In 2006, the Company continued its strategy of strengthening its financial structure and reducing financial expenses. Telefónica Chile achieved a significant decrease in its total financial debt through greater cash flow, which enabled the Company to reduce its debt through repayments on Yankee bonds in the U.S. market and the maturity of commercial paper issued on the local market.

     During 2006, the Company’s sources of financing were operating resources, the issuance of local Series “L” bonds and the issuance of commercial paper. These sources allowed investments of US$205 million, debt repayments equivalent to US$315 million, and the payment of dividends equivalent to US$123 million. Debt repayments consisted of US$206 million for the repayment of Yankee bonds in January and July, as well as US$107 million in commercial paper paid at maturity in March and April, and US$2 million for the repayment of local Series F bonds, in April and October.

     Debt Renegotiation

     On March 14, 2006, a meeting of series “F” bondholders was held in order to amend the original credit agreement. The following amendments were agreed upon: (i) to change the limit of the consolidated and individual debt-to-equity ratio from 1.5 to 1.6 times; (ii) to eliminate the restriction on the interest coverage ratio; (iii) to amend the clause prohibiting capital reductions; and (iv) to eliminate the prohibition on stock repurchases. The objective of these amendments was to align the financial restrictions in the public debt contracts of the Company.

     As of December 31, 2006, the Company’s total interest-bearing debt of Ch$401,590 million (US$754.3 million) had decreased by 21% from the prior year-end, resulting in a ratio of total liabilities to equity of 0.79 and an interest coverage ratio of 18.7.

     Capital Expenditures

     Capital expenditures have been designated primarily for those business areas presenting the greatest potential. With regard to the Company’s traditional business, investment was focused on maximizing installed capacity, marketing telephone lines, and starting a network improvement and plant modernization plan, aimed at a high standard of quality of service. In 2006, Telefónica Chile’s investments totaled Ch$ 109,003 million (US$204.7 million) as compared with Ch$76,402 million (US$149.1 million) (historic value) in 2005.

     The main focus of these investments was consolidating broadband growth and launching a new product, digital television. This new product complements Telefónica Chile’s telecommunications and entertainment service bundles, integrating voice, data, and digital quality television into a flexible package that can be tailored to each customer’s needs. Thus 23.9% of capital expenditures was invested in broadband, 20.9% in Television services, 17.9 in data transmission, 20.4% in local telephony and the remaining 16.9% was invested in other areas, including the Company’s systems and long distance.

     The investment plan for the year also included continuing the initiative to upgrade the Company’s operational support systems by improving the tools that support its business, technical, and administrative management.

     It is important to note that, this year, Telefónica Chile’s networks were seriously impacted by an increase in thefts of copper cables. These thefts had to be absorbed into the investment plan by devoting US$13 million to the replacement of the affected networks.

     The management expects to maintain a similar level of capital expenditures in future years in addition to the capital expenditures required for the provision of pay TV services to its different client segments. The management reviews the capital expenditures program periodically and adjustments are made as appropriate, due to changes in markets conditions, general economic conditions in the country, business competition and other factors.

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     Foreign Exchange and Interest Rate Risk Management

     The Company obtains financing abroad mainly in US dollars and, in certain cases, with floating interest rates. As a result, Telefónica Chile is exposed to financial risks related to foreign exchange and/or interest rate fluctuations. For this reason, Telefónica Chile periodically reviews its exposure to foreign exchange and interest rate risk to determine the levels of coverage required for each period. See “Item 3. Key Information—Risk Factors.” Currency devaluations and foreign exchange fluctuations may adversely affect Telefónica Chile.

     In 2006, the Company continued its policy of hedging 100% of its financial debt against foreign exchange fluctuations. Of the Company’s total long-term debt (including current maturities) of Ch$401,590 million (US$754.3 million) as of December 31, 2006, 33.3% was denominated in Chilean pesos and 66.7% was denominated in foreign currencies, mainly the U.S. dollar. It is important to note that US$156 million of 8.375% Yankee Bond matured on January 1, 2006, further reducing the Company’s exposure to U.S. dollar fluctuations.

     As of December 31, 2006, 16.7% of the Company’s long-term interest-bearing debt, including current portion and foreign currency and Chilean peso-denominated debt, was exposed to interest rate fluctuations. The remaining 83.3% of the Company’s interest-bearing debt was insulated from interest rate fluctuations: 66.3% was hedged and 17.0% was fixed-rate debt. As of December 31, 2006, the Company had outstanding cross-currency swaps of Ch$266,196 million (US$500 million), which serve to hedge against dollar-peso exchange rate fluctuations and, at the same time, effectively change its floating rate to a fixed rate. See “Item 11. Quantitative and Qualitative Disclosures about Market Risk.”

Impact of Inflation

     The Company is required under Chilean GAAP to restate its non-monetary assets, UF and foreign-currency denominated monetary assets and liabilities, shareholders’ equity, and income and expense accounts to reflect the effect of variations in the purchasing power of the Chilean peso. However, Chilean peso-denominated monetary assets and liabilities are typically not restated. See Note 27 of the Audited Consolidated Financial Statements.

     Non-monetary assets, UF-denominated monetary assets and liabilities, shareholders’ equity, and income and expense accounts are generally restated using the Chilean CPI, based on the “prior month rule,” in which inflation adjustments are based on the Chilean CPI at the end of the month preceding the period-end. Inflation, as measured by the Chilean CPI, was 2.5%, 3.6% and 2.1% for the twelve-month periods ended November 30, 2004, 2005 and 2006, respectively. Monetary assets and liabilities in foreign currencies are restated at period-end exchange rates. In the Company’s case, the amount of monetary correction for any period will depend primarily on the amount of foreign-currency denominated monetary assets and liabilities and the effect of adjustments for inflation on monetary assets and liabilities.

     The following table sets forth the accounting treatment of the effect of inflation on Telefónica Chile’s statement of operations for the periods indicated:

    Year ended December 31, 
   
    2004    2005    2006    2006 
         
    (in millions of constant Ch$     
    as of December 31, 2006)   (US$ millions)
 
Price Level Restatement    (4,407)   1,986       501    0.9 
         Purchasing-power gain    10,030    19,857     10,949    20.6 
         Loss on indexation    (14,437)   (17,871)   (10,448)   (19.6)
Exchange Differences                 
   (gain (loss) on foreign currency transactions)   13,908           976       165    0.3 
Price level restatement and exchange differences, net    9,501    2,962       666    1.3 

Recent Accounting Pronouncements Under U.S. GAAP

(i)      In February 2006, the FASB issued SFAS 155, “Accounting for Certain Hybrid Financial Instruments - an amendment of FASB Statements No. 133 and 140”. The new statement:
 

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  a)      permits fair value re-measurement of any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation;
 
  b)      clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS 133, “Accounting for Derivative Instruments and Hedging Activities”;
 
  c)      establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation;
 
  d)      clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives; and
 
  e)      amends SFAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”, to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument.
 
      SFAS 155 generally is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Company does not anticipate that the adoption of this statement will have a material effect on its financial position, results of operations or cash flows.

(ii)     
In June 2006, the FASB issued FASB Interpretation 48 (FIN 48), “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109”. This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation also provides guidance on derecognition, classification and other matters, FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company has not determined the effect, if any, the adoption of FIN 48 will have on the Company’s financial position and results of operations.
 
(iii)     
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements”. This statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements, SFAS 157 is effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact that will result from the adoption of SFAS 157.
 
(iv)     
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158 (SFAS 158), “Employer’s Accounting for Defined Pension and Other Postretirement Plans – an amendment of FASBStatements No. 87, 88, 106 and 132(R)”. This statement requires the recognition of the funded status of a benefit plan in the statement of financial position. It also requires the recognition as a component of other comprehensive income (OCI), net of tax, of the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost pursuant to statements 87 or 106. The statement also has new provisions regarding the measurement date as well as certain disclosure requirements. The statement was effective at fiscal year end 2006 and the Company adopted the statement at that time. With the adoption of SFAS 158, the Company recorded ThCh$240,390 as a component of the ending balance of accumulated other comprehensive income, net of tax.
 
(v)     
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities”. SFAS No. 159 permits measurement of recognized financial assets and liabilities at fair value with some exceptions. Changes in the fair value of items for which the fair value option is elected should be recognized in income or loss. The election to measure eligible items at fair value is irrevocable and can only be made at defined election dates or events, generally on an instrument by instrument basis. Items for which the fair value option is elected should be separately presented or be parenthetically disclosed in the statement of financial position. SFAS No. 159 also requires significant new disclosures that apply for interim and annual financial statements. SFAS No. 159 will be effective for fiscal years beginning after November 15, 2007 with earlier adoption permitted, if certain conditions are met. The Company is currently determining the policy of adoption as well as the resulting effect of SFAS No. 159 on the consolidated financial statements.
 

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C. Research and Development, Patents and Licenses, Etc.

     The Company does not incur any material research and development expenses. The Company has a technological development unit responsible for developing solutions to satisfy technical needs of different business units of the Company. No separate investment budget is allocated to that unit’s activities, which are based on specific project tasks.

     The Company holds no material patents and does not grant to others material licenses on its intellectual property. In connection with its provision of telecommunications services, the Company plans infrastructure development based upon present and projected future demand for such services. The Company mainly acquires the necessary technology, including equipment, from third parties.

D. Trend Information

     Regulatory Environment. The Chilean Government has historically regulated local telephony services in Chile. The Chilean government through the Chilean Antitrust Authority agency responsible for making certain determinations relating to competitive conditions in the telecommunications industry, has determined that Telefónica Chile is a dominant operator of local telephony in many areas of Chile. As a result, the Company is subject to tariff decrees that regulate certain rates and fees the Company can charge for such local telephony services in most of the country. Tariff regulation, which is set every five years, may have a significant impact on Company revenues and its ability to compete in the marketplace, as the Company is required to charge the same tariff to all clients in a designated tariff area.

     Recent trends seen outside of Chile have shown an increased use of IP technology as a substitute for traditional voice services at lower prices. The Telecommunications Law in Chile requires a regulation to be defined for these services to be offered to the public. On December 20, 2006, the Office of the Undersecretary of Telecommunications announced a public consultation on a bill created to define the rules that govern the public voice over Internet service in order to identify matters that should be included in the rules. Telefónica Chile together with other industry operators, sent its comments and proposals on January 26, 2007, as required by the public consultation. Depending on their final outcome, these new regulations proposed by Subtel may adversely affect the Company’s businesses. Nevertheless, the use of this technology may serve as a substitute for the Company’s local and long-distance traffic. See “Item 4. Information on the Company—Business Overview—Licenses and Tariffs.”

     The Chilean Economy. The Company’s operations are located almost entirely in Chile, therefore, the Company’s operating and financial performance is sensitive to, and dependent upon, the level of economic activity in Chile. For the last seven years the Chilean economy has experienced positive growth, with an expansion of GDP at rates of 2.2% in 2002, 3.9% in 2003, 6.2% in 2004, 6.3% in 2005 and 4.2% in 2006. The Central Bank’s concern for price stability has translated into the application of an inflation-targeting monetary approach. Since 2001, the inflation target has been defined as a symmetrical range from 2.0% to 4.0%, centered on 3.0%, which must be met permanently over a medium-term horizon of two years. Due to this policy, the inflation reached 1.1% in 2003, 2.4% in 2004, 3.7% in 2005 and 2.6% in 2006. The current account had a surplus of 1.5% of GDP in 2004, 0.6% in 2005 and 2.7% in 2006. Annual average unemployment declined from 9.0% in 2002 to 8.0% in 2006 therefore, household spending is setting a foundation for the current expansion. During 2006, fiscal revenue reached record levels, driven by the high prices of commodities, particularly copper, resulting in a fiscal surplus equal to an estimated 8.2% of GDP. Meanwhile, domestic demand increased by approximately 7.3%, domestic consumption grew by approximately 7.1%, and investment grew by approximately 5.0%. In spite of the favorable economic climate, there can be no assurance that the consumption of our products and services will grow in the same proportion.

     Increased Competition, New Entrants and M&A Activities. Telefónica Chile faces intense competition in every aspect of its business. Telefónica Chile competes with both mobile telephony and other fixed and cable telephony operators, none of which are subject to the same tariff regulations as the Company and therefore compete under different conditions. The Company’s market share in fixed lines has declined from 82% in 2000 to 68% in 2006. In 2004 and 2005, the competitive environment has led to major merger and acquisition activity, primarily in the cable operator business, where the top two companies consolidated and cover nearly 90% of the paid TV market, while also becoming a relevant player in broadband and fixed telephony. Additionally, in the mobile telephony business,

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in 2004 Telefónica Móviles (TEM) acquired Bellsouth in Chile and the mobile subsidiary of Telefónica Chile in order to merge these two companies. During 2005, the Mexican operator America Móvil (subsidiary of Telmex) acquired the local mobile operator Smartcom; Telecom Italia sold its controlling stake in Entel to the local group Almendral; and the fixed network operator Manquehue Net was acquired by the local data transmission operator, GTD Group. In 2006, Telefónica Chile entered the pay TV market, where the dominant operator (the cable company VTR) covers approximately 90% of the market. Since its launch in June 2006, the Company’s market share reached 9% as of December 31, 2006.

     There is also an increase in competition with the entry of new operators in the market, primarily in the long-distance and data transmission businesses. Telefónica Chile competes with fifteen other long-distance operators and with mobile telephone operators in the domestic long-distance market. As a result, the Company has faced intense pricing pressure, and a decreasing trend in traffic, which may result in further price decreases and market share losses in the future.

     The mobile telephony market has continued to grow, reaching a penetration in the market of about 78 lines per 100 inhabitants as of December 31, 2006, as compared with only 20 lines per 100 inhabitants in the local service. The Company has experienced substitution since the introduction of mobile communications service, which has contributed to the declines in number of fixed lines, volume of local traffic and in domestic long-distance traffic.

     See also “Overview.”

E. Off-Balance Sheet Arrangements

     There are no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.

F. Tabular Disclosure of Contractual Obligations

     The following table summarizes the Company’s contractual cash obligations and commercial commitments as of December 31, 2006 and the liquidity requirements for such obligations in the future periods specified.

    Payments due by period 
    (in millions of constant Ch$ as of December 31, 2006)
   
        Less than            More than
Contractual Obligations:    Total     1 year    1-3 years    3-5 years     5 years 
           
Long-term debt, including current maturities(1)   401,334    3,811    188,956    147,664    60,903 
Capital (Finance) Lease Obligations(1)   419    45    91    91    192 
Operating Lease Obligations    -    -    -    -    - 
Purchase Obligations    -    -    -    -    - 
Other Long-Term Liabilities Reflected on the                     
   Company’s Balance Sheet under the GAAP of                     
   the primary financial statements(2)   306,483    157,810    28,390    5,831    114,452 
Other accounts payable and                     
   due to related company(1)   33,007    33,007    -    -    - 
Total contractual obligations    741,243    194,673    217,437    153,586    175,547 
           

________________________________________
(1)      Includes accrued interest as of December 31, 2006.
 
(2)      Other long-term liabilities include dividends payable, notes payable, miscellaneous accounts payable, accruals, withholdings and deferred taxes, severance indemnity obligations and other liabilities.
 

ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

A. Directors and Senior Management

     The Company is managed by its Board of Directors, which, in accordance with the Company’s Estatutos, or Bylaws, must consist of seven directors and their respective alternate directors. Six of the directors, together with

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their respective alternate directors, are elected by holders of the Series A Common Stock, each for a three-year term, at the General Annual Shareholders’ Meeting. Holders of the Series B Common Stock elect one director and one alternate director for a three-year term at the General Annual Shareholders’ Meeting.

     If a vacancy occurs on the Board of Directors during the course of any three-year term (for example, upon resignation of a director), the alternate director corresponding to the vacant position serves as director for the balance of the term. If such an alternate director resigns, dies or by virtue of law becomes unable to serve as a director, the Board of Directors then appoints a new alternate director to serve until the date of the next General Annual Shareholders’ Meeting, when an election of the entire Board of Directors must take place.

     Telefónica Chile’s Board of Directors was elected for a three-year term at the General Annual Shareholders’ Meeting held April 14, 2005. Alternate directors, participate in discussions at the Board meetings but are entitled to vote only when their respective principal directors are absent. The Bylaws also require that the directors and alternate directors elected by the holders of Series B Common Stock be shareholders of the Company.

     On April 27, 2006, Chairman of the Board Emilio Gilolmo was appointed, as was his alternate, Mr. José María Alvarez-Pallete. On the same date, the alternate directors Mr. Juan Carlos Ros and Mr. Guillermo Ansaldo, resigned their positions and Mr. Manuel Alvarez-Tronge and Mr. Manoel Amorim, respectively, were named as their replacements until the next General Shareholders’ Meeting. As a result of the change in Chairman, the entire Board of Directors must be renewed at the 2007 General Shareholders’ Meeting. On November 22, 2006, Mr. Manoel Amorim resigned as Series A alternate director.

     The Board of Directors appoints a General Manager (also known as the Chief Executive Officer) and such other executive officers as are deemed appropriate to implement the Board’s policies and decisions. The Chief Executive Officer of a public Chilean corporation cannot also serve as a director of such corporation.

     The Board of Directors must meet at least once per month.

     As of February 28, 2007, the Company’s directors and executive officers were:

Directors (1)    
Name    Position 
   
Emilio Gilolmo López (1)   Chairman of the Board of Directors and Director 
       Series A Common Stock 
Narcís Serra Serra    Deputy Chairman of the Board of Directors and 
       Director Series A Common Stock 
Andrés Concha Rodríguez    Director Series A Common Stock 
Fernando Bustamante Huerta    Director Series A Common Stock 
Patricio Rojas Ramos    Director Series A Common Stock 
Hernán Cheyre Valenzuela    Director Series A Common Stock 
Marco Colodro Hadjes    Director Series B Common Stock 
José María Alvarez-Pallete    Alternate—Director Series A Common Stock 
Manuel Alvarez-Tronge (1)   Alternate—Director Series A Common Stock 
Luis Cid Alonso    Alternate—Director Series A Common Stock 
Benjamín Holmes Bierwirth    Alternate—Director Series A Common Stock 
Carlos Díaz Vergara    Alternate—Director Series A Common Stock 
Alfonso Ferrari Herrero    Alternate—Director Series B Common Stock 
 
Executive Officers     
José Molés Valenzuela(2)   General Director and Chief Executive Officer 
Cristián Aninat Salas    General Counsel and Secretary of the Board of 
       Directors 
Julio Covarrubias Fernández    Vice President—Chief Financial Officer and General 
       Manager of t-gestiona 
Manuel Plaza Martin    Vice President—Technology and Operations 
César Valdés Morales (3)   Vice President—Commercial and Administrative 

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       Services 
Luis Fernando de Godoy    Vice President—Small Businesses and Professionals 
Vacant (4)   Vice President—Strategy and Corporate Development 
Francisco Javier de Miguel del Val (5)   Vice President—Internal Auditing 
Rafael Zamora Sanhueza (6)   Vice President—Telefónica Empresas 
Rubén Sepúlveda Miranda    Vice President—Human Resources 
Diego Martínez-Caro    Vice President—Management Control and Chief 
       Accounting Officer 
Humberto Soto Velasco    Vice President—Regulation and Wholesalers 
Juan Antonio Etcheverry (7)   Vice President—Residential Communications 

________________________________________
(1)     
The Board of Directors was elected for a three-year period at the General Shareholder’s Meeting held on April 14, 2005. As of April 27, 2006, Mr. Bruno Philippi resigned as Chairman of the Company and the Board of Directors named Mr. Emilio Gilolmo as his replacement. On the same date, the alternate directors Mr. Juan Carlos Ros and Mr.Guillermo Ansaldo resigned their positions and Mr. Manuel Alvarez-Tronge and Mr.Manoel Luiz Ferrao de Amorim, respectively, were named as their replacements until the next General Shareholders’ Meeting. As a result of the change in Chairman, the entire Board of Directors must be renewed at the 2007 General Shareholders’ Meeting. On November 22, 2006, Mr. Manoel Amorim resigned as Series A alternate director.
 
(2)      Appointed in September 2005.
 
(3)      Effective February 19, 2007. Previously this position was held by Franco Faccilongo Forno, who resigned effective January 12, 2007.
 
(4)      This position was held by Nicolás Domínguez until November 30, 2006.
 
(5)      Effective February 1, 2007. Previously this position was held by Jesús Javier García Cuadrado, who resigned effective December 31, 2006.
 
(6)      Effective January 1, 2007. This position was previously held by Ricardo Majluf.
 
(7)      Effective January 1, 2007. This position was previously held by Rafael Zamora.

     Certain of the Company’s directors also serve as directors or officers of other companies, including related companies (where noted below) and other companies in the Chilean telecommunications industry. See “Item 7. Major Shareholders and Related Party Transactions.”

     Set forth below is a brief biographical description of the directors and executive officers of the Company. All ages of directors and executive officers are stated as of March 31, 2007.

Directors

     Emilio Gilolmo López, 65, became a Series A director and the Chairman of the Board of Directors in April 2006. Within the Telefónica Group he has served as member of the Board of Sogecable S.A. and Chairman of Lolafilms S.A. He has vast experience in the banking industry and as a professor in constitutional law at Complutense University of Madrid and the diplomatic academy. He is Vice President of the Spanish federation of human rights protection, of the “Club Siglo XXI” and sponsor of the Ortega y Gasset foundation. He holds a law degree and a political science degree from the Universidad de Madrid.

     Narcís Serra Serra, 64, became a Series A director and Deputy Chairman of the Board in July 2004. He is the Chairman of Fundación CIDOB, of the National Museum of Art of Catalunya, Deputy Chairman of Catalunya’s Advisory Board of Telefónica S.A., member of the Board of TELESP, Telefónica Internacional, S.A. and Caixa Catalunya. Currently, he is a professor of Economic Theory at Universidad Autónoma de Barcelona. He holds an economics degree from Universidad de Barcelona and a Ph.D. in economics from Universidad Autónoma de Barcelona.

     Andrés Concha Rodríguez, 63, became a Series A director on April 26, 2001. He holds a bachelor’s degree in economics from the University of Chile. At present he is the General Director of the Chilean Federation of Industry,

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member of the Board of Security Holdings, a financial institution, and a member of the Board of Pilmaiquen Electrical Co.

     Fernando Bustamante Huerta, 67, became a Series A director on April 26, 2001. He is the Chairman of the Board of Metro S.A. He is a general manager and partner of Inversiones El Olivar Ltda. He holds an accounting degree from Universidad de Chile.

     Patricio Rojas Ramos, 46, became a Series A director in April 2005. He is a partner of P. Rojas & Asociados, an economic consulting company. Currently, he is professor of the Department of Economics at the Universidad Católica de Chile. He holds an economics degree from the Universidad Católica de Chile and a Ph.D. from MIT.

     Hernán Cheyre Valenzuela, 52, became a Series A director on April 15, 2004. He is the Chairman of Econsult, a consulting company. He holds a commercial engineering degree from the Universidad Católica de Chile and a master’s degree in economics from the University of Chicago.

     Marco Colodro Hadjes, 65, became a Series B director on January 28, 2005. He has been Manager of International Commerce of Banco Central de Chile, Deputy Chairman of Banco del Estado de Chile and Chairman of Televisión Nacional de Chile. He holds an economics degree from the Universidad de Chile and a doctorate from the University of Paris.

     José María Alvarez-Pallete, 43, became a director on April 22, 2003. In September 1999 he became CFO of Telefónica, S.A. He was appointed Chairman and Chief Executive Officer of Telefónica Internacional on July 24, 2002. He is a member of the following Boards of Directors: Telefónica de España, Telefónica Móviles, Telefónica Móviles España, Telefónica Data, Telefónica Internacional, Telefónica de Argentina, Telesp, Telefónica Chile, Telefónica de Perú, Cointel, Compañía de Teléfonos de Chile Transmisiones Regionales, Telefónica Larga Distancia de Puerto Rico, China Netcom, and the Supervisory Board of Cesky Telecom. Mr. Álvarez-Pallete holds a graduate degree in economics from the Complutense University of Madrid. He also studied economics at the Université Libre de Belgique.

     Manuel Alvarez Trongé, 50, became a Series A alternate director in April 2006. He also serves as Secretary of the Board of Telefónica Internacional S.A. in Spain. He worked as a lawyer at the Superintendencia de Seguros de la Nación (the National Superintendent of Insurance) and served as Counsel of the Ministry of Justice of Peru and a Legal Manager of Perez Companc S.A. He has also been a professor at Austral, Saint Andrews and Buenos Aires Universities. He holds a law degree from Universidad de Buenos Aires.

     Luis Cid Alonso, 58, became an alternate Series B director in May 1995, a Series B director in December 1998 and a Series A Alternate director in February 2005. He is the Chairman of IEDE, UEA, OTIC and Past President of Cámara Oficial Española de Comercio de Chile. He is a member of the following Boards of Directors: Aenor Chile, Fundación Eurochile, Cogan, Grupo Norte (Chile) and Rutas del Pacífico.

     Benjamin Holmes Bierwirth, 58, became an alternate Series A director in April 2005. He is a member of the Board of Zofri S.A., La Fuente Editores and Laboratorio City. He is also the Chairman of Sociedad de Inversiones y Asesorías Frutillar and founding partner of Portal del Arte S.A. He holds a commercial engineering degree from the Universidad de Chile.

     Carlos Díaz Vergara, 44, became an alternate Series A director on April 15, 2004. He is a member of the Risk Rating Commission for securities that can be purchased by pension funds. Currently, he holds the positions of Dean and Professor at the School of Business and Economics at the Universidad de los Andes and Professor in the Department of Economics at the Universidad Católica de Chile. He holds a commercial engineering degree from the Universidad Católica de Chile, and has a master’s degree in economics from the University of California, Los Angeles.

     Alfonso Ferrari Herrero, 65, became an alternate Series B director on April 26, 2001. He is a director of Telefónica S.A. (Spain), Telefónica Internacional S.A. and Telefónica de Perú S.A.A., the Chairman of the Commission of Appointments and Payments of Telefónica de S.A., and President of the Audit Committee of Telefónica de Perú S.A.A. He holds a Ph.D. in electrical engineering from the Madrid University’s Politechnical School and a master’s degree in business administration from Harvard University.

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     There is one vacant alternate Series A director position as a result of Mr. Manoel Amorim’s resignation on November 22, 2006.

Executive Officers

     José Molés Valenzuela, 51, has been CEO of Telefónica Chile since September 1, 2005 and was appointed General Director of Telefónica Móviles México in 2003. Between 2000 and 2003 he was General Director of Telefónica Móviles operations in Argentina, Brazil and Chile. He holds a degree in electronic engineering from UNED in Spain, and an MBA from Universidad de Salvador, Argentina (recognized by Deusto, Spain) as well as a diploma in marketing from UADE, Buenos Aires, Argentina.

     Cristián Aninat Salas, 52, the Secretary of the Board of Directors since 1997 and the current General Counsel of Telefónica Chile, joined the Company in 1994. He holds a law degree from the Universidad Católica de Chile.

     Julio Covarrubias Fernández, 49, the Chief Financial Officer of Telefónica Chile and General Manager of t-gestiona, joined Telefónica Chile in May 1995. He holds an industrial civil engineering degree from the Universidad Católica de Chile and a master’s degree in business administration from Cornell University.

     Manuel Plaza Martin, 51, Vice President of Technology and Operations, joined Telefónica Chile in January 2006. He held the same executive position in Telefónica del Perú since January 2005. He holds a technical industrial engineering degree from Universidad de Valladolid de Madrid.

     César Valdés Morales, 42, Vice President of Commercial and Administrative Services, joined Telefónica Chile in 1991. He has held executive positions at both the Company, in the Systems Development area, and within Telefónica Latin America, in Global Project Development and IT Services and Development. He holds a degree in industrial civil engineering from the Universidad Católica de Chile, as well as postgraduate degrees in company and IT management.

     Luis Fernando de Godoy, 43, Vice President of Small and Medium Business and Professionals, joined Telefónica Chile in 2004. From 2001 to 2004 he worked as Business Director in Telefónica Brazil. He holds a marketing degree in Escola Superior de Propaganda e Marketing (ESPM) and a master’s degree in business administration in Fundacão Getulio Vargas. (CEAG-FGV).

     Juan Antonio Etcheverry, 40, Vice President of Residential Customers, joined Telefónica Chile in January 2007. He holds a degree in industrial civil engineering from the Universidad de Chile.

     Francisco Javier de Miguel del Val, 39, Vice President of Internal Auditing, joined Telefónica Chile in February 2007. Prior to joining the Company, he held positions as head of financial management and manager of internal auditing for Telefónica Spain. He holds a degree in law from the Universidad Autónoma de Madrid, a master’s degree in taxation from the Centro de Estudios Financieros and a master’s degree in real estate law and legal practice from the Universidad Complutense de Madrid, Spain.

     Rubén Sepúlveda Miranda, 41, the Vice President of Human Resources, joined the Company in June 2006. He holds a degree in commercial engineering and a master’s degree in human resources management from the Universidad de Santiago de Chile, as well as a diploma in strategic human resources management from the Universidad Adolfo Ibañez.

     Diego Martínez-Caro, 36, Vice President of Management Control and Chief Accounting Officer, joined Telefónica Chile in 2004. He held the same executive position in Telefónica del Perú since 2001. He holds a Degree in Economics from Universidad Complutense de Madrid and a master’s degree in business administration from IESE - Navarra University.

     Humberto Soto Velasco, 48, the Vice President of Regulation and Wholesalers, joined Telefónica Chile in July 2002. He holds an electrical civil engineering degree from the Universidad de Chile.

     Rafael Zamora Sanhueza, 41, the Vice President of Telefónica Empresas, joined Telefónica Chile in 1991. His experience at the Company includes head positions in the control and planning area, as well as the residential

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customers area. He holds a degree in civil industrial engineering and a master’s degree in industrial engineering from the Universidad de Chile.

B. Compensation of Directors and Officers

     Each director and alternate director, with the exception of the Chairman of the Board and the Deputy Chairman of the Board, receives compensation equal to 120 UTMs (US$7,259 as of December 31, 2006) per month for attending Board meetings and for expenses, provided he has attended at least one Board meeting in the month.

     The Chairman of the Board of Directors receives twice the compensation received by other directors. The Deputy Chairman of the Board of Directors receives 1.5 times the compensation received by other directors.

     The compensation for Board members and their alternate directors is decided at the General Annual Shareholders’ Meeting. For the year ended December 31, 2006, the compensation paid to directors and executive officers of the Company was as follows:

        In Thousands of Ch $ 
     
            Other 
        Compensation    Compensation 
Name    Position    2006    2006 (*)
       
Emilio Gilolmo López(1)   Chairman and Director Series A    61,625     
       Common Stock         
Narcís Serra Serra(2)   Deputy Chairman and Director Series    69,333     
       A Common Stock         
Andrés Concha Rodriguez    Director Series A Common Stock    34,698    1,650 
Fernando Bustamante Huerta    Director Series A Common Stock    46,230     
Patricio Rojas Ramos(4)   Director Series A Common Stock    46,253     
Hernán Cheyre Valenzuela(3)   Director Series A Common Stock    46,253    1,650 
Marco Colodro Hadjes(4)   Director Series B Common Stock    46,253     
 
José María Alvarez-Pallete(1)   Alternate—Director Series A    38,578     
       Common Stock         
Manuel Alvarez Tronge    Alternate—Director Series A    23,119     
       Common Stock         
Luis Cid Alonso    Alternate—Director Series A    46,253     
       Common Stock         
 
Benjamín Holmes Bierwirth(4)   Alternate—Director Series A    46,253     
       Common Stock         
Carlos Díaz Vergara(3)   Alternate—Director Series A    46,253     
       Common Stock         
Alfonso Ferrari Herrero    Alternate—Director Series B    46,222    551 
       Common Stock         
 
Bruno Philippi Irarrázabal(1)       30,882     
Juan Carlos Ros Brugueras(1)       15,371     
Guillermo Ansaldo Lutz (1) (4)       17,219     
Manoel Luiz Ferrao de Amorin(5)       11,511     
       
 
Sub-Total (Directors)       672,306    3,851 
       
Executives 70 persons        6,463,376     
 
Total        7,135,682    3,851 

________________________________________
(*)
Others refers to compensation paid to the Audit Committee (created in July 2005). The Audit Committee is responsible for matters such as External Auditing, Financial Statements and Internal Auditing. 
 
(1)
On April 27, 2006, the Board of Directors of Telefónica Chile approved various changes in its makeup. It accepted the resignations tendered by Series A director and Chairman of the Board Mr. Bruno Philippi and Series A alternate Mr. José María Alvarez-Pallete. Mr. Emilio Gilolmo López was appointed Series A director and Chairman of the Board, and Mr.

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José María Alvarez-Pallete was appointed as Mr. Gilolmo’s alternate. On the same date, Series A alternate directors Messrs. Juan Carlos Ros and Guillermo Ansaldo resigned and were replaced, respectively, by Messrs. Manuel Alvarez Trongé and Manoel Amorín.
   
(2)      Appointed as Deputy Chairman on July 20, 2004.
 
(3)      Director since April 15, 2004, elected at the General Shareholders’ Meeting.
 
(4)      Director since April 14, 2005, elected at the General Shareholders’ Meeting.
 
(5)      Resigned on November 22, 2006.
 

     As of April 2001, it was resolved at the shareholders’ meetings for each of the Company’s significant subsidiaries (i.e., subsidiaries in which the Company had more than a 50% stake) to eliminate directors’ fees. Consequently, during 2006, no fees were paid to directors of subsidiaries. In the case of each subsidiary, the decision to eliminate directors’ fees was adopted by the board of directors and approved by its shareholders.

     The Company does not compensate directors by other means such as through bonuses, profit-sharing plans, stock option plans, or pension, retirement or similar benefits.

C. Board Practices

     The Company’s directors are elected for a three-year term at the General Annual Shareholders’ Meeting. The current Board of Directors was elected at the General Annual Shareholders’ Meeting held on April 14, 2005. Due to the appointment of a new Chairman of the Board in April 2006, the entire Board must be renewed at the 2007 General Shareholders’ Meeting. The Company has no service contracts with its directors.

Directors’ Committee

     According to Law 19,705, effective as of December 20, 2000, all limited liability public companies with a market capitalization greater than UF1,500,000 (equivalent to approximately US$51.7 million as of December 31, 2006) must appoint a directors’ committee composed of three directors, the majority of whom must be independent from the controlling shareholder.

     The Company’s current directors’ committee (the “Directors’ Committee”) was created by the Company’s Board on April 14, 2005. The budget for this committee and the monthly compensation of the committee members and alternate committee members for the year 2006 were approved at the General Annual Shareholders’ Meeting of the Company held on April 20, 2006.

     The main functions of the Directors’ Committee are (i) to review the account inspectors’ report and the external auditors’ report, (ii) to propose external auditors and local credit-rating agencies to the Company’s Board of Directors, (iii) to examine all applicable transactions involving directors and related parties under Articles 44 and 89 of the Chilean Corporations law and (iv) to review the salaries and bonuses of the Company’s senior executives. In addition, Telefónica Chile’s Directors’ Committee examines all transactions involving the Company’s CEO and other senior executive officers. The Directors’ Committee examines, proposes and makes recommendations to the Board of Directors that are not binding upon the Board.

     During 2006, the Directors’ Committee held monthly meetings to review the matters entrusted to it as is stipulated in the corresponding Committee acts. Additionally, the Committee approved the quarterly financial statements submitted to it by management.

     Each member and alternate member of the Directors’ Committee receives compensation equal to UF30 (approximately US$1,033) per month for attending Directors’ Committee meetings, provided that he has attended at least one Directors’ Committee meeting in such month. The annual budget of the Directors’ Committee amounts to Ch$75 million (approximately US$140,874).

     As of April 14, 2005, the Directors’ Committee comprises the following persons:

Regular Member    Alternate Member 
   
Emilio Gilolmo López(1)   José María Alvarez-Pallete 

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Patricio Rojas Ramos    Benjamín Holmes Bierwirth 
Hernán Cheyre Valenzuela    Carlos Díaz Vergara 

(1) Effective April 27, 2006, Mr. Bruno Philippi resigned. The Board of Directors named Mr. Emilio Gilolmo as his replacement.

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For the year ended December 31, 2006, the following table lists the members of and the compensation paid to the Directors’ Committee:

        Total Compensation 
        (in thousands of 
        constant Ch$ as of 
Directors    Position    December 31, 2006)
     
Emilio Gilolmo López(1)   Director Series A Common Stock    3,848 
Patricio Rojas Ramos(2)   Director Series A Common Stock    6,598 
Hernán Cheyre Ramos(3)   Director Series A Common Stock    6,598 
José María Alvarez-Pallete    Alternate—Director Series A    0 
       Common Stock     
Benjamín Holmes Bierwirth(2)   Alternate—Director Series A    6,598 
       Common Stock     
Carlos Díaz Vergara(3)   Alternate—Director Series A    6,598 
       Common Stock     
 
Bruno Philippi Irarrázabal(1)       2,202 
     
 
 
Total        32,443 

________________________________________
(1)      Effective April 27, 2006, Mr. Bruno Philippi resigned. The Board of Directors named Mr. Emilio Gilolmo as his replacement.
 
(2)      Position held since April 14, 2005.
 
(3)      Position held since April 15, 2004.
 

Audit Committee

     On July 21, 2005, an Audit Committee was created with a total of three independent members, in compliance with Rule 10A-3 of the Securities and Exchange Commission under the Sarbanes-Oxley Act. The Board of Directors named Mr. Andrés Concha, Mr. Alfonso Ferrari and Mr. Hernán Cheyre as audit committee members, with Mr. Cheyre serving as financial expert.

     The audit committee supervises the process of financial reporting, internal control systems over financial reporting and general oversight of the external auditors, as well as dealing with any related complaints.

     At the General Shareholders’ Meeting held on April 20, 2006, compensation for audit committee members was set at UF15 per session, with a maximum of six sessions per year. A detail of compensations paid in 2006 can be found under Compensation of Directors and Officers. The expense budget for the audit committee was set at Ch$37 million (approximately US$69,000) for the year 2006.

     For further information please see “Significant Differences in Corporate Governance Practices from U.S. Companies” below.

Significant Differences in Corporate Governance Practices from U.S. Companies

     The following is a comparison of corporate governance practices followed by U.S. companies listed with the NYSE and our practices:

     According to the NYSE, listed U.S. companies must have a majority of independent directors who must meet at regularly scheduled executive sessions without management. According to Chilean law, our directors cannot serve as executives, accountants, auditors or CEO of the Company, though they need not be otherwise “independent” as defined by the NYSE. Our directors may meet individually or collectively with those they deem necessary to inform themselves and to make decisions regarding the Company. See “Item 6. Directors, Senior Management and Employees” for a list of our board members.

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     According to the NYSE, listed U.S. companies must adopt corporate guidelines that govern directors responsibilities, qualifications, compensation and education, management succession and an annual performance evaluation of the board. Chilean law, which we follow, dictates the composition, duration, duties and responsibilities of board members, as well as sanctions for non-compliance of these. Chilean law also requires that, at each Annual Shareholders’ Meeting, board remuneration must be approved, which we did on April 14, 2005. See “Item 6. Directors, Senior Management and Employees—Compensation of Directors and Officers.”

     According to the NYSE, listed U.S. companies must have an internal audit function to provide management with ongoing assessments of the company’s risk management process and the system of internal controls. Although there is no local law requirement to do so, the Company does have an internal audit department that conducts the assessment.

     According to the NYSE, listed U.S. companies, beginning the earlier of the first annual shareholders’ meeting after January 15, 2004 and October 31, 2004, must have an audit committee consisting of a minimum of three independent Board members who are financially literate and at least one who is a designated financial expert, while foreign companies, such as Telefónica Chile, have to meet this requirement starting on July 31, 2005. Listed U.S. companies must also have compensation and nominating and corporate governance committees composed entirely of independent directors. Chilean law does not require these committees. However, Chilean Law does require open stock companies with a market capitalization above UF1.5 million (approximately US$532 million) to have a Directors’ Committee, made up of three board members that are “independent,” as defined by Chilean law below, of the controlling shareholders and whose remuneration is determined by shareholders at the Annual Shareholders’ Meeting, to perform the following functions:

      a)      review and approve reports from account inspectors and external auditors, as well as the Company’s balance sheet and financial statements;
 
  b)      propose external auditors and rating agencies to the board;
 
  c)      review and inform the board of related party transactions;
 
  d)      review compensation and compensation plans for company executives; and
 
  e)      any other matters stipulated according to company bylaws, board, or shareholders’ meeting decisions.

     Chilean law states that a director is independent when, excluding the votes from the controlling shareholder and their related parties, the director would have been elected. Accordingly, a director that is independent under Chilean law may not be independent under the NYSE’s corporate governance rules or under the SEC’s audit committee independence rules. The Company’s Directors’ Committee consists of three board members and their respective alternates, two of which are independent of the controlling shareholder, as defined by Chilean law. Chilean law has no requirement for members to be financial experts.

     According to the NYSE, listed U.S. companies’ CEOs must certify to the NYSE each year that they are not aware of any violation by the company of NYSE corporate governance listing standards. According to Chilean law, there is no such requirement, and this provision of the NYSE does not apply to foreign private issuers, such as Telefónica Chile. However, according to the NYSE, all foreign private issuers, including Telefónica Chile, must report to the NYSE when they become aware of a violation of the corporate governance listing standards and must provide an annual written affirmation to the NYSE of its compliance with the applicable NYSE audit committee rules and disclosure of significant differences with NYSE corporate governance rules applicable to domestic companies.

D. Employees

     As of December 31, 2006, Telefónica Chile (excluding its subsidiaries) employed 2,962 persons. Telefónica Chile’s subsidiaries employed 698 persons as of December 31, 2006.

     The table below sets forth the total number of employees as of December 31 of each year indicated, and the change from December 31 of the preceding year.

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    Number of     
Year 
   Employees    % Change 
     
2004    3,774    -20.0% 
2005    3,910    +3.6% 
2006    3,660    -6.4% 

     The table below sets forth the breakdown of the Company’s employees as of December 31 of each year indicated, and the change from December 31 of the preceding year.

                % Change
Between
2006 and
2005 
               
Company 
   Number of Employees   
   
    2004    2005    2006   
         
Parent Company    2,817     2,945    2,962    +0.6% 
Long-Distance    149    143    29    -79.7% 
Corporate Customer Communications    417    417    412    -1.2% 
Others    391    405    257    -36.5% 
         
Total    3,774     3,910    3,660    -6.4% 
         

     The 6.4% decrease in the parent company with respect to 2005 is due primarily to the implementation of a retirement plan in early 2006 and the ongoing pursuit of organizational efficiencies in the various areas of the Company.

     In 2004, a new collective bargaining agreement was finalized with “Federación Zonas” (unions from regions), an umbrella organization grouping seven unions and representing 247 employees. This agreement maintained the changes that had already been introduced for other unions. Thus, over 97% of workers are currently subject to more flexible conditions allowing the Company to better adapt to customer needs, not only in scheduling, but also in compensation and incentives.

     In 2005, 61.7% of the employees (2,431 persons) were members of 22 unions. During 2005, four unions negotiated contracts with the Company representing 286 employees. Only 74 employees elected to invoke Article 369 of the Chilean Labor Code and freeze the conditions of the previous labor contract for a period of 18 months starting in July 2005.

     In 2006, eight collective bargaining agreements were finalized with 21 unions representing 2,141 Company employees. As of December 2006, 61% of Company employees were unionized, and 100% of these employees had signed a contract for a period of three to four years. The most relevant change introduced in these collective bargaining agreements was the inclusion of variable compensation linked directly to business targets. During this process, certain union organizations decided to discontinue application of Article 369 after having applied it since 2002. This article allowed unionized employees to freeze the conditions of their contracts until the next collective bargaining process.

     As of December 31, 2006, the Company’s severance indemnity provisions reached Ch$35,988 million (US$67.6 million). In the beginning of 2006, the Company carried out a structural reorganization. As a result, 589 employees were laid off and Ch$9,471 million was recognized in severance indemnities during the year. Under the law enacted in November 1980 that privatized the Chilean social security system, the Company is required to deduct from employees’ monthly wages a contribution to a personal pension fund owned by each employee, managed by Administradoras de Fondos de Pensiones or AFPs (Chilean Pension Funds), individually selected by the employee. Compulsory contribution, which currently amounts to approximately 13% of monthly taxable income (“MTI”) (up to a maximum MTI of UF60, equivalent to approximately US$2,066.5 per month), includes the costs of life insurance and disability insurance coverage. The Company’s statutory social security obligation is fully satisfied by the deduction and delivery to the corresponding AFP of such monthly contributions on behalf of the respective employees.

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     Additionally, Chilean employees contribute 7% of their MTI (up to a maximum MTI of UF60, equivalent to approximately US$2,066.5 per month), to an ISAPRE (Chilean Health Insurance System) individually selected by the employee.

E. Share Ownership

     As of March 31, 2007, 4,200 shares of Series A Common Stock and 3 shares of Series B Common Stock were owned by the persons listed in Item 6.A as directors and officers, including those who held their positions as of December 31, 2006 and who are no longer officers or members of Telefónica Chile’s Board of Directors. None of these persons owns more than 1% of any class of the Company’s outstanding shares. In addition, the persons listed in Item 6.A as directors and officers, including those directors who held their positions as of December 31, 2006 and who are no longer officers or members of Telefónica Chile’s Board of Directors, own 56 shares of Telefónica Larga Distancia S.A.

     As of March 31, 2007, 124 non-executive employees of the Company owned 339,528 shares of Series A Common Stock and 40 non-executive employees of the Company owned 124,831 shares of Series B Common Stock, collectively representing 0.05% of the Company’s outstanding shares. There are no plans for employees to purchase stock options.

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

A. Major Shareholders

     The following table sets forth certain information, on a subscribed share basis, as of March 31, 2007, with respect to each shareholder known to the Company to own beneficially 5% or more of any class of the Company’s shares of common stock and all directors and executive officers of the Company as a group:

    Series of    Number of Shares         
Name and Address of Beneficial Owner    Common Stock    Beneficially Owned    % of Series    % of Total 
         
Telefónica Internacional Chile    A    387,993,524    44.39    40.5 
   Avenida Santa María 0792, 4 Piso    B    41,739,487    50.19    4.4 
   Santiago, Chile                 
Citibank, N.A., as depositary(1) (73 registered holders)   A    116,158,091    13.29    12.4 
   111 Wall Street                 
   New York, NY 10043, USA                 
AFP Habitat S.A    A    61,152,400    6.99    6.4 
   Avenida Providencia 1909    B    5,813,466    6.99    0.6 
   Santiago, Chile                 
AFP Provida S.A    A    61,079,380    6.89    6.4 
   Avenida Pedro de Valdivia 100    B    4,626,981    5.56    0.5 
   Santiago, Chile                 
All directors and executive officers,                 
   as a group (4 persons)   A    4,200    (2)   (2)
    B    3    (2)   (2)

________________________________________
(1)      Pursuant to the requirements of Chilean law, all shares of Series A Common Stock represented by ADSs are registered to Citibank, N.A., as depositary (the “Depositary”).
 
(2)      Represents less than 1%.
 

     The following table provides information, as of March 31, 2007, with respect to the shares owned by the persons listed in Item 6.A as directors and officers, as well as those who held their positions as of December 31, 2006 and who are no longer officers or members of Telefónica Chile’s Board of Directors:

    Number of    Number     
    Series A    of Series B     
Name
   Shares    Shares    Total 
       
 
Marco Colodro Hadjes        2       2 
Franco Faccilongo Forno (1)            2,100    0       2,100 

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    Number of    Number     
    Series A    of Series B     
Name    Shares    Shares    Total 
       
 
Alfonso Ferrari Herrero        1       1 
Rafael Zamora Sanhueza             2,100    0       2,100 
________________________________________
(1) Resigned effective January 12, 2007.

     The table below sets forth certain information, as of December 31, 2006, with respect to the twelve largest shareholders of Series A and B Common Stock:

    Number of Series A    Number of Series         
    Shares    B Shares    Total    % of Total 
         
Telefónica Internacional Chile S.A    387,993,524    41,739,487    429,733,011    44.9% 
Citibank N.A. (1)   105,307,375    0    105,307,375    11.0% 
AFP Provida S.A. (2)   61,179,123    5,819,981    66,999,104    7.0% 
AFP Habitat S.A. (2)   61,152,400    5,813,466    66,965,866    7.0% 
AFP Cuprum S.A. (2)   38,061,323    3,859,418    41,920,741    4.4% 
AFP Bansander S.A. (2)   31,656,237    2,295,763    33,952,000    3.5% 
Citibank Chile Cta. De Terceros Cap. XIV                 
    Res    33,756,939    0    33,756,939    3.5% 
AFP Santa María S.A    24,379,690    2,238,363    26,618,053    2.8% 
Celfin Capital S.A. Corredores de Bolsa    9,773,121    519,693    10,292,814    1.1% 
AFP Planvital S.A    8,937,995    627,281    9,565,276    1.0% 
Banchile Corredores de Bolsa S.A    8,120,696    643,385    8,764,081    0.9% 
Ultra Fondo de Inversiën    8,048,354    0    8,048,354    0.8% 
Subtotal    778,366,777    63,556,837    841,923,614    88.0% 
Other Shareholders    95,628,670    19,604,801    115,233,471    12.0% 
Total    873,995,447    83,161,638    957,157,085    100.0% 
________________________________________
(1)
Depositary Bank acting on behalf of the Company’s ADS holders.
 
(2)
Pension fund.
 

     In July 2004, Telefónica Internacional increased the percentage of ownership from 43.6% to 44.9% .

     As of December 31, 2004, 2005 and 2006, Citibank, N.A., as Depositary for the Company’s American Depositary Receipts (“ADRs”), owned approximately 11.64%, 11.51%, and 11.00% of the Company’s shares, respectively. AFP Habitat, a Chilean pension fund, owned approximately 6.99%, 7.00%, and 7.00% as of December 31, 2004, 2005 and 2006, respectively. AFP Provida, a Chilean pension fund, owned approximately 6.59%, 6.75%, and 7.00% as of December 31, 2004, 2005 and 2006, respectively. During the year ended December 31, 2006, life insurance companies decreased their investment in the Company to 0.6%, from 1.4% in December 2005, whereas general insurance companies increased their investment to 0.7%, from 0.01% in December 2005.

     As of March 31, 2007, ADR holders (through the Depositary) held 12.14% of Telefónica Chile’s total shares, represented by 63 registered shareholders. The remaining 87.86% of the Company’s total shares were held locally, in Chile, represented by 12,462 shareholders. All of the Company’s shareholders have identical voting rights. The Company’s Series A Shareholders vote to elect six of the seven members of the board of directors and the Series B shareholders elect one member to the board of directors.

Controlling Shareholder

     Telefónica Internacional Chile owns 44.9% of all shares of the Company. Telefónica Internacional Chile is a 99.9% owned subsidiary of Telefónica Chile Holding B.V., which is indirectly wholly owned by Telefónica S.A., through its subsidiary TISA.

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B. Related Party Transactions

     Article 89 of the Chilean Corporations Law requires that a company’s transactions with related parties (defined as entities that belong to the same group of companies) be on similar terms to those customarily prevailing in the market. Directors and executive officers of companies that violate Article 89 are liable for losses or damages resulting from such violations. In addition, Article 44 of the Chilean Corporations Law provides that any transaction in which a director has a personal interest or is acting on behalf of a third party may be approved in advance by the board of directors only if the board of directors is informed of such director’s interest and if the terms of such transaction are similar to those prevailing in the market. If a transaction involves an amount greater than UF20,000 (approximately US$688,833), the board of directors must be presented with a report as to whether the terms of the proposed transaction are comparable to those prevailing in the market before such transaction takes effect. If it is impossible for the board of directors to determine the prevailing market terms, the board can appoint two independent appraisers and make a decision regarding the transaction in question only after the reports of both appraisers are received. If the opinions of two independent appraisers significantly differ, or if the terms and conditions of the action or contract in question are unfavorable to the shareholders of the Company, shareholders representing at least five percent of the issued voting stock may request that the board of directors summon a special meeting of shareholders to approve such transaction. Two-thirds of the issued voting stock must approve the transaction at such meeting. Resolutions approving such transactions must be reported to the Company’s shareholders at the next shareholders’ meeting. Violation of Article 44 may result in imposition of administrative or criminal sanctions upon responsible parties, and the Company, its shareholders, or interested third parties who suffer losses as a result of such violation have the right to receive compensation in certain situations.

     In accordance with Section 402 of the Sarbanes-Oxley Act of 2002, since July 2002, the Company has not and will not extend any loans to directors and officers. As of December 31, 2006, the Company does not have any outstanding loans to its directors or executive officers.

     In the ordinary course of its business, the Company engages in a variety of transactions with certain of its affiliates, primarily for the purchase, at fair market prices negotiated on an arm’s-length basis, of goods or services that may also be provided by other suppliers. The Directors’ Committee is informed of all such transactions in advance, and such transactions are approved by the Board of Directors. “See Item 6. Directors, Senior Management and Employees—Directors Committee.” Below are descriptions of such transactions with affiliates that are material to either the Company or the related counterparty. Financial information concerning these transactions is also set forth in Note 6 to the Audited Consolidated Financial Statements. As of December 31, 2006, the receivables from related parties amounted to Ch$17,421 million (US$32.7 million) and the accounts payable to related parties amounted to Ch$33,007 million (US$62 million). The income and expenses from related party transactions resulted in a net expense of Ch$49,604 million (US$93 million).

     Transactions with Telefónica España

     Since June 30, 1992, the Company, through its subsidiary Telefónica Larga Distancia, has had a correspondence agreement with Telefónica providing for the exchange of international long-distance traffic between Chile and Spain. This agreement, which has an indefinite term subject to cancellation by either party on six months’ notice, generated income of Ch$200 million, Ch$657 million and Ch$438 million for the years ended December 31, 2004, 2005 and 2006, respectively. The outstanding balances under the agreement in favor of the Company, as of December 31, 2005 and 2006, were Ch$819 million and Ch$702 million (US$1.3 million), respectively. There were balances payable by the Company amounting to Ch$35 million (ThUS$66) as of December 31, 2006. There were no outstanding balances payable by the Company as of December 31, 2005.

     Transactions with Telefónica Internacional Chile

     In 1997, the Company entered into an agreement of technical service with Telefónica Internacional Chile (TISA) through which Telefónica Internacional Chile coordinates certain joint activities among the members of the Telefónica Group on behalf of the Company. Under the agreement, the Company incurred expenses of Ch$574 million in 2004, Ch$583 million in 2005 and Ch$581 million (US$1.1 million) in 2006. There were no outstanding balances in favor of the Company as of December 31, 2005 and 2006. There were balances payable at December 31, 2005 and 2006 amounting to Ch$286 million and Ch$286 million (US$0.5 million), respectively.

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     On December 20, 1996, the Company entered into a current account agreement with Telefónica Internacional Chile, which provides for transfer of funds between the two parties. This short-term loan was fully paid in July 2004. These transactions with Telefónica Internacional Chile generated expenses of Ch$275 million in 2004. There were no income or expenses generated in the years 2005 and 2006. There was no interest payable for 2005 and 2006. There were no outstanding balances in favor of Telefónica Chile as of December 31, 2005 and 2006.

     Transactions with Terra Networks Chile S.A.

     On April 30, 1998, the Company entered into an agreement with Terra Networks Chile S.A. (“Terra Networks Chile”) a subsidiary of Telefónica S.A., pursuant to which the Company provided collection services to Terra Networks Chile. Furthermore, on June 1, 1999, the Company entered into an agreement with Terra Networks Chile pursuant to which Terra Networks Chile provides internet access to certain Chilean schools, the costs of which are to be paid by the Company to Terra Networks Chile. Telefónica Chile also has an agreement to purchase online advertising from Terra Networks Chile for itself and its subsidiaries for the five years between 1999 and 2004. This contract was renewed and expires in December 2005. The Company recorded a net income of Ch$3,689 million, Ch$4,394 million and Ch$5,413 million (US$10.2 million) in the years 2004, 2005 and 2006, respectively, under these agreements. The Company had balances receivable from Terra Networks Chile of Ch$1,137 million and Ch$1,894 million (US$3.6 million) as of December 31, 2005 and 2006, respectively. Balances payable to Terra Networks Chile from the Company under these agreements amounted to Ch$4,242 million and Ch$5,336 million (US$10.0 million) as of December 31, 2005 and 2006, respectively.

     Transactions with Atento Chile

     On September 1, 1999, the Company and Atento Chile, a 28.84% affiliate of the Company, signed an outsourcing agreement. The agreement comprises several contracts for services to be provided by Atento Chile to the Company’s business units and customers. Such services include directory assistance, technical assistance and customer complaint management, as well as general commercial and sales information. These contracts were all in effect during 2006. Certain contracts expired on December 31, 2006, and the remaining contracts will expire on June 30, 2007. Similar agreements, involving all of the Company’s subsidiaries, were also in effect during 2006. Pursuant to all of the agreements discussed above, the Company recorded total net expenses of Ch$16,861 million, Ch$14,032 million and Ch$15,870 million (US$29.8 million) in 2004, 2005 and 2006, respectively. The outstanding balances payable to Atento Chile were Ch$675 million and Ch$3,310 million (US$6.2 million) as of December 31, 2005 and 2006, respectively. The outstanding balances payable in favor of the Company as of December 31, 2005 and 2006 were Ch$419 million and Ch$478 million (US$0.9 million), respectively.

     Transactions with Correspondents of Telefónica Group

     In the year 2004, correspondent agreements were entered into with members of Telefónica Group. These members are Telefónica Argentina, Telefónica Sao Paulo, Telefónica Guatemala, Telefónica Perú, Telefónica Puerto Rico and Telefónica El Salvador. These agreements generated net income of Ch$250 million, Ch$166 million and Ch$259 million (US$0.5 million) for the years ended December 31, 2004, 2005 and 2006, respectively. The outstanding balances payable by the Company as of December 31, 2005 and 2006 were Ch$260 million and Ch$1,086 million (US$2.0 million), respectively. The outstanding balances in favor of the Company as of December 31, 2005 and 2006 were Ch$1,848 million and Ch$2,204 million (US$4.1 million), respectively.

     Transaction with Telefónica Soluciones de Informática y Comunicaciones de España, S.A.U..

     During 2002, the Company sold to Telefónica Procesos de Tecnología de Información S.A. (“TPTI”), an affiliate of the Company, the ATIS license related to certain billing and customer care relationship applications that were developed by Telefónica Chile for the use of Telefónica Group for US$21.7 million (equivalent to Ch$11,553 million as of December 31, 2006). TPTI then granted Telefónica Chile a license to use these applications. Subsequently, in 2004, Telefónica Soluciones de Informática y Comunicaciones de España, S.A.U. (“T.Soluciones”) purchased TPTI’s consulting, technology and systems business areas. As a result, the contract between the Company and TPTI was transferred to T.Soluciones. This agreement generated income of Ch$22 million (approximately US$41,000) for the year ended December 31, 2006, and it did not generate income or expenses for 2004 or 2005. There was an outstanding balances in favor of the Company of Ch$1,366 as of December 31, 2005,

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and there were no balances in favor of the Company as of December 31, 2006. There were no balances payable by the Company as of December 31, 2005 or 2006.

     Transactions with Telefónica Móviles S.A.

     In July 23, 2004, Telefónica Chile sold 100% of its participation in Telefónica Móvil de Chile S.A. to Telefónica Móviles S.A. (TEM). The final price of the sale totaled US$1.321 million, which included a US$1.058 million payment for Telefónica Móvil de Chile S.A.’s outstanding equity, equivalent to Ch$736,325 million, and TEM’s assumption of Ch$168,000 million (US$263 million) (historic value) of the existing debt of Telefónica Móvil de Chile S.A. with Telefónica Chile. For this transaction, the Company reported a net gain of Ch$321,071 million (Ch$303,540 historic value, equivalent to US$470.0 million) in 2004. There were no balances in favor or payable to us with respect to this transaction. All the amounts disclosed in this paragraph are historic values as of July 23, 2004.

     Transactions with Telefónica Móviles de Chile S.A.

     After the sale of Telefónica Móvil de Chile S.A., this company changed its name to Telefónica Móviles de Chile S.A. As of December 31, 2005 and 2006, respectively, the Company recognized a balance in favor of Ch$6,636 million and Ch$8,458 million (US$15.9 million), mainly related to access charges and rental of capacity. As of December 31, 2005 and 2006, respectively, the Company recognized a balance payable of Ch$14,979 million and Ch$14,592 million (US$27.4 million), mainly related to mobile interconnections (CPP). Transactions with Telefónica Móviles de Chile for the years ended December 31, 2004, 2005 and 2006 generated net expenses of Ch$12,265 million, Ch$29,095 and Ch$28,043 (US$52.7), respectively.

     Transactions with Telefónica Móviles Chile Companies

     As a result of long-distance contracts with Telefónica Móviles Chile Inversiones S.A., Telefónica Móviles Chile S.A. and Telefónica Móviles Chile Larga Distancia S.A., the Company recognized a total balance in favor of Ch$1,174 million and Ch$1,086 million (US$2.0 million) as of December 31, 2005 and 2006, respectively, and a total balance payable of Ch$4,531 million and Ch$2,530 (US$4.6 million). For the years ended December 31, 2005 and 2006, these contracts generated total net expenses of Ch$9,968 million and Ch$7,561 million (US$14.2 million), respectively. No income or expenses were generated in the year ended December 31, 2004.

     Transactions with Telefónica International Wholesale Services Group

     The Company has an agreement with companies belonging to the Telefónica Wholesale International Services (“TIWS”) Group, including Telefónica Wholesale International Services Chile (formerly Emergia Chile S.A.), Telefónica Wholesale International Services Spain and Telefónica Wholesale International Services Uruguay, for international data traffic services. The agreements with the TIWS companies were all effective during 2006 and have different expiration dates, depending on the nature of each specific contract. These agreements generated net expenses of Ch$1,537 million, Ch$2,800 million and Ch$3,850 million for the years ended December 31, 2004, 2005 and 2006, respectively. The outstanding balances under the agreement in favor of Telefónica Chile as of December 31, 2005 and 2006 were Ch$566 million and Ch$881 million (US$1.7 million), respectively. The Company had balances payable of Ch$912 million and Ch$5,108 million (US$9.6 million) in 2005 and 2006, respectively.

C. Interest of Experts and Counsels

     Not applicable.

ITEM 8. FINANCIAL INFORMATION

A. Consolidated Statements and Other Financial Information

     See Item 18 for a listing of the Company’s Audited Consolidated Financial Statements, included in this Annual Report.

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Legal Proceedings

     Unless expressly stated otherwise in this section, the amounts of judgments and claims for damages, as stated in Chilean pesos, do not include readjustment for inflation, interest and costs, which may be required at final judgment. When a judgment or claim is stated in a readjusting unit of currency, such as the UF, no further inflation readjustment is required.

Claims presented by VTR Telefónica S.A.

     On June 30, 2000, VTR Telefónica S.A. filed a plenary suit, charged in Chilean pesos, requesting payment of Ch$2,204 million (US$4.1 million), plus sums accrued during the suit, to cover access charges for the use of its networks. VTR bases its complaint on the differences that occurred as a result of the reduction of access charge tariffs after Tariff Decree No. 187 came into effect. Telefónica Chile responded to the complaint by arguing that the tariffs for access charges that both parties must pay for the reciprocal use of their networks are regulated under a contract signed between Telefónica Chile and VTR. VTR, however, does not recognize this contract. VTR’s complaint has been accepted and their requested compensation has been ordered. The Company filed an appeal for annulment before the Court of Appeals of Santiago, which is currently pending.

     In connection to the above proceeding, two additional judicial proceedings are underway. The first was filed before Subtel in 2002 by VTR for alleged non-payment of invoices for access charges set by D.S. 26. VTR has requested that Telefónica Chile be forced to pay such invoices and pay the fines imposed by the General Telecommunications Laws. This case has been suspended by order of the Minister until a sentence is provided in the judicial proceeding filed by VTR in 2000. The second judicial proceeding underway was filed by Telefónica Chile on June 6, 2003, for VTR’s non-payment of access charges in accordance with the contract signed between the parties. This case has been suspended until a sentence is provided in the 2002 suit.

     In turn, on December 21, 2005 Telefónica Chile sued VTR for non-payment of automatic reversal of charges service (800 service) in the amount of Ch$1,500 million (US$2.8 million), plus sums accrued during the course of the trial. Based on the same argument, VTR filed a countersuit for the same concepts in the amount of Ch$1,200 million (US$2.1 million). This judicial process is in the first stage of processing.

Labor lawsuits

     In the course of normal operations, labor lawsuits have been filed against the Company.

     To date, among others, there are labor proceedings involving former employees, who claim wrongful dismissal. These employees did not sign termination releases or receive staff severance indemnities. On various occasions, the Supreme Court has reviewed the judgments handed down on the matter, accepting the argument of the Company and ratifying the validity of the terminations.

     There are, in addition, other lawsuits involving former employees, whose staff severance indemnities have been paid and their termination releases signed, and who, in spite of having chosen voluntary retirement plans or having been terminated due to company needs, intend to have the terminations voided. Of these lawsuits, to date, two have received a judgment favorable to the Company, rejecting the annulments.

     Certain unions have filed complaints before the Santiago Labor Courts, requesting damage payments for various concepts.

Lawsuits against the Government

(i)
On October 31, 2001, Telefónica Chile filed an administrative motion before the Ministry of Transport and Telecommunications and the Ministry of Economy, requesting correction of the errors and illegalities in Rate Decree No. 187 of 1999. On January 29, 2002, the Ministries issued a joint response rejecting the administrative recourse, after having “carefully evaluated, only the viability and timeliness of the petition made, considering the set of circumstances that concur in the problem stated and the prudence that must orient public actions”, adding that such rejection “has had no other motivation than to protect the general interest and progress of the telecommunications services”.
 

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Upon extinguishing the administrative instances to correct the errors and illegalities involved in the tariff setting process of 1999, in March 2002, Telefónica Chile filed a lawsuit for damages against the State of Chile for the sum of Ch$181,038,411,056, plus readjustments and interest, which covers past and future damages until May 2004. A decision is still pending in this case.
 
(ii)
Telefónica Chile and Telefónica Larga Distancia filed a plenary damage indemnity lawsuit against the Government of Chile, claiming damages due to modification of telecommunications networks related to work performed by highway concessionaries from 1996 to 2000.

The Government of Chile forced both companies to pay for the transfer of their communications networks due to the construction of public works on concession under the Concessions Law. The related damages amount to:

     a. – Compañía de Telecomunicaciones de Chile S.A.: Ch$1,929,207,445

     b. – Telefónica Larga Distancia S.A.: Ch$2,865,208,840

The process is currently at the final sentencing stage.

Voissnet Accusation

     On January 20, 2005, Telefónica Chile responded to a claim made by Voissnet filed before the National Economic Attorney General’s Office based on alleged anti-competitive practices. Such practices were said to be with respect to the development and growth of Internet technology, mainly of broadband telephony, and access to broadband, since they prohibit carrying voice using the Internet broadband access provided by Telefónica Chile. Voissnet wants the TDLC to compel Telefónica Chile to allow third parties to provide IP Telephony through the ADSL Internet owned by Telefónica Chile.

     On October 26, 2006, the Company was notified of the Antitrust Commission’s decision, which, in part, accepted Voissnet S.A.’s claim as well as the requirement of the National Economic Attorney General’s Office. Telefónica Chile was fined 1,500 UTA.

     On November 8, 2006, Telefónica Chile S.A. filed an appeal before the Supreme Court asking that the sentence be revoked and the Company be exonerated from any sanction. The appeal was accepted for processing and, at this time, the Supreme Court has not set a date to hear the allegations of the parties.

Manquehue Net

     On June 24, 2003, Telefónica Chile filed a forced contract compliance with damage indemnity complaint against Manquehue Net in the amount of ThCh$3,647,689 in addition to the sums accrued during substantiation of the proceeding, before the mixed arbitration court of Mr. Víctor Vial del Río. Likewise, and on the same date, Manquehue Net filed a discounts compliance complaint (in the amount of UF107,000), in addition to an obligation to perform complaint (signing of 700 service contract). On June 5, 2004, following the evidence presentation stage, the arbitrator summoned the parties to hear sentencing.

     On April 11, 2005, the Court notified the first instance sentence that accepted the complaint filed by Telefónica Chile, condemning Manquehue Net to pay approximately Ch$452 million and at the same time accepted the complaint filed by Manquehue Net condemning Telefónica Chile to pay UF47,600.

     Telefónica Chile filed an appeal for annulment, which is currently pending before the Court of Appeals of Santiago.

Chilectra and CGE

     In June 2006, Telefónica Chile filed complaints against Chilectra S.A. and Río Maipo (currently CGE Distribución) in which it requests a readjusted refund of the Reimbursable Financial Contributions (AFR) (“Aportes Financieros Reembolsables”) made by the Company between 1992 and 1998 in relation to the Electrical Law. The restitution amounts claimed are ThCh$899,658 and ThCh$117,350, respectively. The lawsuits are currently in the discussion stage.

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Protection Motion

     On June 28, 2006, the television channels UCTV and TVN filed a petition for protection against Telefónica Chile. These channels are included in the Company’s Digital Television Plan. In their petition, they requested a court order prohibiting their inclusion in the Digital Television Plan. On June 30, 2006, the Court of Appeals declared the petition inadmissible. The decision was confirmed on July 4, 2006, when the motion to set aside was rejected.

Dividend Policy and Dividends

Dividend Policy

     Telefónica Chile’s dividend policy (including the policy set by the Board of Directors with respect to the payment of interim dividends for each year) is announced at the General Annual Shareholders’ Meetings of the Company. At such meetings, the Board of Directors presents for the shareholders’ consideration and approval its proposals for a final dividend for the preceding year.

     The Company implements its dividend policy in compliance with Chilean law, pursuant to which the Company’s Bylaws provide that the Company must distribute a cash dividend in an amount at least equal to 30% of its net income for the relevant year, unless otherwise decided by unanimous vote of the shareholders of the issued and subscribed shares.

     On September 21, 2004, Telefónica Chile’s Board of Directors amended the Company’s dividend policy, increasing the distribution of dividends to 100% of annual profits, and approved the proposal to the shareholders of the distribution of accumulated retained earnings as of December 31, 2004. This policy has been maintained during 2005 and 2006.

     The dividend policy for future years will be in line with the Company’s “Financial Plan,” which focuses primarily on a gradual increase in the rate of self-financing, so as to adjust the financial structure of the Company to the requirements of the Development Plan. However, this dividend policy will depend on several factors, including the amount of net income generated each year, economic projections that may periodically be made, or certain other events that may affect the Company’s ability to distribute dividends. The availability of funds will also determine the degree of compliance with the dividend policy. Telefónica Chile’s Board of Directors plans to maintain a dividend policy keeping the Company’s cash flow for the coming years and the projected performance of its financial indicators. Therefore, the 2007 dividend policy contemplates distributing 100% of net profits for each fiscal year through the payment of an interim dividend in November and a final dividend in May of the following year, subject to approval at the respective General Annual Shareholders’ Meeting.

     At its meeting on February 26, 2007, the Company’s Board of Directors voted to modify the dividend policy by adding the following: “In addition to paying dividends equivalent to 100% of net income, for the following fiscal year, to the extent that there is a free cash flow and the Company’s business-related obligations have been fulfilled, the Board’s intention is to distribute a portion of this free cash flow to shareholders. This distribution will be proposed at a shareholders’ meeting to be called for this purpose.”

Dividends

     Dividends are paid to shareholders of record on the fifth business day (including Saturdays) prior to the payment date. The following table sets forth the amounts per share of annual dividends paid out of the Company’s earnings in the years 2002 through 2006. These amounts represent, for each year, a sum of the interim dividends plus the final dividend paid with respect to such year. No dividends were paid in 2002 and 2003 (the dividend paid in July 2003 was charged against retained earnings).

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    Dividends Paid    Total Dividends Paid 
     
    Per Share(1)   Per Share(1)   Per ADS 
       
    Dividends                 
    against Net    Additional             
Fiscal Year    Income    Dividends    Total (Ch$)(2)   Total (US$)(3)   Total (US$)(3)
           
2002    0.0      0.0      0.0    0.000     0.000 
2003    0.0(4)   17.5(5)   17.5    0.029     0.116 
2004    264.6(6)   394.3(7)   658.9    1.182     4.728 
2005    69.8(8)   51.0(9)   120.8    0.236     0.943 
2006    16.3(10)   42.0(11)   58.3    0.110     0.440 
________________________________________
(1)
Represents dividend amounts paid with respect to Series A and B Common Stock. Per share information does not take into account any Chilean withholding tax.
 
(2)
Amounts shown are presented in Chilean historic pesos.
 
(3)
Translated into U.S. dollars at the Observed Exchange Rates as of December 31 of the respective year. Per ADS information is based on four underlying shares of Series A Common Stock per one ADS and does not take into account any Chilean or U.S. withholding tax.
 
(4)
As a result of a net loss sustained by the Company in year 2002, the Company did not distribute any dividends with respect to net income for the year 2002.
 
(5)
Extraordinary dividend charged to retained earnings as of December 31, 2002.
 
(6)
Includes a final dividend corresponding to the period 2003 for an amount of Ch$3.2 per share, and interim dividends of Ch$131.44 and Ch$130.00 per share charged against 2004 net income.
 
(7)
Dividend charged to retained earnings as of December 31, 2003.
 
(8)
Includes a final dividend of Ch$58.8 charged to net income as of December 31, 2004. It also includes an interim dividend of Ch$11 per share charged to 2005 net income.
 
(9)
Dividend charged to retained earnings as of December 31, 2004.
 
(10)
Includes a final dividend of Ch$15.31 per share charged to 2005 net income and an interim dividend of Ch$11.0 per share, charged to 2006 net income.
 
(11)
At the extraordinary shareholders’ meeting held April 20, 2006, a capital reduction was approved in the amount of Ch$40.2 billion, equivalent to Ch$42 per share, and was paid on June 15, 2006.
 

     The final dividend corresponding to 2006 net income will be submitted for shareholder approval at the Shareholders’ Meeting of April 2007. The total amount of the proposed dividend is Ch$12,866,433,152, equivalent to Ch$13.4 per share.

     On July 11, 2003, the extraordinary shareholders’ meeting of Telefónica Chile approved the payment of an extraordinary dividend amounting to Ch$17.5 per share. The gross dividend amounted to Ch$70.0 per ADR and was paid in Chile on July 30, 2003 and paid to ADR holders by Citibank N.A. on August 1, 2003.

     On May 7, 2004, a final dividend charged against net income of the period 2003 was paid for an amount of Ch$3.2 per share.

     On July 15, 2004, as a result of the Telefónica Móvil de Chile S.A. sale, shareholders agreed to approve the dividend payment of US$800 million. The Board of Directors agreed to pay US$200 million of the dividend as an interim dividend for 2004 and shareholders approved a US$600 million dividend to be charged against retained earnings. Therefore, the distribution was an interim dividend of US$0.21 per share, charged against fiscal year 2004 profits and a dividend of US$0.63 per share, charged against accumulated retained earnings. These dividends were paid on August 31, 2004. See “Item 4. Information On The Company—Divestitures.”

     On November 4, 2004, in line with the dividend policy approved in September 2004, the Company distributed an interim gross dividend of Ch$130 per share or US$0.21 per share, charged against fiscal year 2004.

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     Dividends paid during 2004, as part of the Telefónica Móvil de Chile S.A. transaction and the new dividend policy, resulted in the distribution of 29% of the value of the stock.

     On May 30, 2005, a final dividend charged against net income 2004 was paid for an amount of Ch$58.8 per share or US$0.10 per share. Also, on May 30, 2005, an interim dividend of Ch$51.0 per share or US$0.10 per share was paid and charged to 2004 retained income.

     On November 30, 2005, an interim dividend of Ch$11 per share or US$0.01 per share was paid and charged to 2005 net income.

     On June 22, 2006, a final dividend of Ch$15.31 per share or US$0.03 per share was paid and charged to 2005 net income.

     On June 15, 2006, a capital reduction of Ch$42.0 per share or US$0.08 per share was paid to shareholders.

     On November 23, 2006, an interim dividend of Ch$11.0 per share or US$0.02 per share was paid to shareholders and charged to 2006 net income.

     At its meeting on February 26, 2007, the Company’s Board of Directors agreed to propose a capital reduction of Ch$48,815,011,335 (Ch$51 per share) at the extraordinary shareholders’ meeting to be held on April 13, 2007.

     Dividends received by the Company’s shareholders that are not Chilean residents, including holders of ADSs, are subject to Chilean withholding tax. See “Item 10. Additional Information—Taxation—Chilean Tax Considerations.”

     As a general requirement, shareholders who are not residents of Chile must register with the Central Bank to have dividends, sale proceeds, or other amounts with respect to their shares remitted outside of Chile through the formal currency market. Under the Foreign Investment Contract (as defined below in “Item 10. Additional Information—Exchange Controls and Other Limitations Affecting Security Holders”), the Depositary has been granted access to the Formal Exchange Market to convert cash dividends from pesos to dollars and to pay such dollars to ADR holders outside of Chile.

B. Significant Changes

     No undisclosed significant change has occurred since the date of the Audited Consolidated Annual Financial Statements.

ITEM 9. THE OFFER AND LISTING

A. Offer and Listing Details

Common Stock Prices and Related Matters

     Shares of Series A Common Stock and Series B Common Stock are currently traded in Chile on the Bolsa de Comercio de Santiago (the “Santiago Stock Exchange”). Such shares are also listed on the Bolsa de Corredores-Bolsa de Valores (the “Valparaíso Stock Exchange”) and on the Bolsa Electrónica de Chile-Bolsa de Valores (the “Electronic Stock Exchange”). The Santiago Stock Exchange is Chile’s principal exchange accounting for approximately 89% of all equity traded in Chile during 2006. Approximately 11% of equity trading in Chile during 2006 was conducted on the Electronic Stock Exchange, an electronic trading market that was created by banks and non-member brokerage houses, and less than 1% of equity was traded on the Valparaíso Stock Exchange.

     Since July 20, 1990, shares of Series A Common Stock are traded in the United States on the New York Stock Exchange (the “NYSE”) in the form of ADSs, which are evidenced by ADRs. Originally, each ADS represented 17 shares of Series A Common Stock. Effective January 2, 1997, this ratio was changed to four shares of Series A Common Stock per ADS. Pursuant to the requirements of Chilean law, all shares of Series A Common Stock represented by ADSs are owned of record by Citibank, N.A., as Depositary.

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     The table below sets forth, for the periods indicated, the reported high and low closing sales prices for the shares of the Company’s Series A Common Stock and Series B Common Stock on the Santiago Stock Exchange and the high and low sales prices of the ADSs as reported by the NYSE.

    Santiago Stock Exchange    NYSE 
     
    (Ch$ per Share(1))   (US$ per ADS(2))
    High    Low    High    Low 
         
    Series A    Series B    Series A    Series B         
             
2002    2,620    1,855    1,450    1,100    15.75    7.90 
2003    2,600    2,200    1,610    1,200    15.91    8.81 
2004    2,390    2,150    1,450    1,240    16.83    9.40 
2005    1,710    1,610    1,091    1,000    11.88    8.55 
2006    1,264    1,080    860    779    9.70    6.40 
 
2005                         
         First quarter    1,710    1,610    1,550    1,450    11.88    10.80 
         Second quarter    1,650    1,600    1,410    1,325    11.52    9.57 
         Third quarter    1,588    1,465    1,434    1,330    11.67    10.20 
         Fourth quarter    1,459    1,351    1,091    1,000    11.10    8.55 
2006                         
         First quarter    1,264    1,060    1,055    1,000    9.70    8.02 
         Second quarter    1,195    1,080    910    900    9.18    6.47 
         Third quarter    995    861    860    779    7.53    6.40 
         Fourth quarter    1,082    990    935    845    8.28    6.94 
         October    1,020    900    935    845    7.59    6.94 
         November    1,082    990    975    875    8.15    7.53 
         December    1,075    951    1,050    935    8.28    7.97 
2007                         
         First quarter    1,260    1,100    1,055    970    9.43    8.04 
         January    1,260    1,080    1,055    970    9.43    8.04 
         February    1,255    1,100    1,110    1,000    9.27    8.42 
         March    1,245    1,070    1,106    1,025    9.32    8.20 
________________________________________
(1)
Chilean pesos are reflected at historic values.
 
(2)
1 ADS = 4 shares of Series A Common Stock.
 

     On April 30, 2006, there were 29,039,523 ADSs (equivalent to 116,158,091 shares of Series A Common Stock) outstanding, held by approximately 63 holders of record. On that date, such ADSs represented 12.14% of the total number of issued and outstanding shares of the Company’s common stock.

Debt Securities

     The Company’s 7.625% Notes due July 15, 2006 and 8.375% Notes due January 1, 2006 (together, the “Debt Securities”) were traded primarily in the over-the-counter market. However, these Notes matured in 2006, and as of December 31, 2006, the Company does not have debt securities that trade in the over-the-counter market in the United States.

B. Plan of Distribution

     Not applicable.

C. Markets

     See “Item 9. A. The Offer and Listing—Offer and Listing Details—Common Stock Prices and Related Matters.”

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D. Selling Shareholders

     Not applicable.

E. Dilution

     Not applicable.

F. Expenses of the Issue

     Not applicable.

ITEM 10. ADDITIONAL INFORMATION

A. Share Capital

     Not applicable.

B. Memorandum and Articles of Association

     Set forth below is certain information concerning Telefónica Chile’s capital stock and a brief summary of certain significant provisions of the Company’s Bylaws and Chilean law. This description does not purport to be complete and is qualified by reference to the Bylaws, which have been attached as an exhibit to this Annual Report.

Organization and Register

     Telefónica Chile is a publicly held stock corporation (sociedad anónima abierta) organized under the laws of Chile and was incorporated on November 18, 1930, as recorded on page 426 No. 158 of the Commercial Record of Santiago of the year 1931, and has a duration through August 10, 2068. The purpose of the Company is to provide a broad range of telecommunications and related broadcasting services, as more fully set forth in Article Four of the Bylaws.

Shareholders’ Rights

     Shareholders’ rights in Chilean companies are governed generally by a company’s bylaws (which effectively serve the purpose of both the articles, or certificate, of incorporation and the bylaws of a corporation in the United States). Additionally, the Chilean Corporations Law and the Supreme Decree 587 (the “Regulations on Corporations”) govern the operation of companies and provide for the upholding of shareholder rights. Finally, Decree-Law 3500, which regulates the pension funds, permits the investment by pension funds in stock of qualified companies, indirectly affects corporate governance and prescribes certain rights of shareholders.

     The Chilean securities markets are principally regulated by the SVS (Chilean Security and Exchange Commission) under the Securities Market Law and the Corporations Law. These two laws contain disclosure requirements, impose restrictions on insider trading and price manipulation, and provide protection of minority investors. The Corporations Law clarifies rules and requirements for establishing “open” corporations while eliminating authority supervision of “closed” companies. Open corporations are those which: (i) have 500 or more shareholders, (ii) have 100 or more shareholders who own as a group together at least 10% of the subscribed capital (excluding those whose individual holdings exceed such percentage), or (iii) register in the securities record on a voluntary basis or in compliance with a legal requirement. Telefónica Chile is an open corporation. The Securities Market Law establishes requirements for public offerings, stock exchanges and brokers and outlines disclosure requirements for companies that issue publicly offered securities.

     Under Articles 12 and 54 and Title XV of the Securities Market Law, certain information regarding transactions in shares of open corporations must be reported to the SVS and be informed to the Chilean exchanges on which such shares are listed. Holders of shares of open corporations are required to report the following to the SVS and the Chilean exchanges:

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      (i)
any acquisition or sale of shares that results in the holder’s acquiring or disposing of 10% or more of an open corporation’s capital; and
 
  (ii)
any acquisition or sale of shares or options to buy or sell shares, in any amount, if made by a holder of 10% or more of an open corporation’s capital or if made by a director, liquidator, main officer, general manager or manager of such corporation.
 

     Persons or entities intending to acquire control of an open corporation are also required to inform the public in advance through a notice published in a Chilean newspaper. The notice must disclose the price and conditions of any negotiations. Prior to such publication, a written communication to such effect must be sent to the SVS and the Chilean exchanges.

     The Company’s Bylaws (Article 5 Bis), as well as Decree-Law 3500 (Article 112), establish rules regarding limits of concentration of the Company’s share capital. According to the law, the maximum amount of shares that a person can accumulate, directly, indirectly or through related persons, is 65% of the capital with voting rights. However, the Company’s Bylaws establish a concentration limit of 45% of the capital with voting rights. With the objective of maintaining the concentration limits, the Company cannot issue a quantity of shares that surpasses the concentration limit.

     If a shareholder accumulates more than 45% of the capital with voting rights, such shareholder must sign a commitment to deconcentrate this ownership stake. Said commitment must be in the form of a public deed and an extract of the commitment must be published in the Official Gazette and in a newspaper of nationwide circulation (Decree-Law 3500, Articles 124 and 128). The commitment must include a time limit within which the deconcentration of the ownership must be realized, which may not exceed five years from the date of the signing of the commitment. If the deconcentration does not occur within the agreed time period, the issuer must sell in a stock exchange, on behalf and at the risk of the shareholder, the number of shares necessary to reduce such shareholder’s ownership to the 45% limit.

     The Bylaws (Article 40 Bis) and Decree-Law 3500 (Article 116) also establish the following regulations related to concentration of capital: no shareholder may exercise, personally or through others, the right to vote the shares held in excess of the maximum limit of concentration established in the Bylaws, that is, more than 45% of the capital with voting rights; and no person may represent shareholders that, as a group, own more than 45% of the Company’s capital with voting rights. One share represents the right to one vote and, when a shareholder gives another person the right to represent him in a shareholders’ meeting, this representation must be for the total amount of shares that he owns.

     Under articles 28, 29, and 67 No. 5 of the Chilean Corporate Law, a capital reduction requires the approval of shareholders by a shareholders’ meeting with a minimum quorum of two thirds of the outstanding shares with voting rights. In addition, there must be a publication of the reform extract accepting a capital reduction and after a 30-day waiting period, the capital reduction will become effective through either the allotment of capital or the company’s purchase of its own shares. The 30-day time period provides third parties and minority shareholders the opportunity to exercise their corresponding rights through revocable shares. In addition, under Article 69 of the Tax Code, a company cannot realize capital reductions without previous authorization of the Internal Tax Service.

Capitalization

     Under Chilean law, a corporation “issues” its stock as soon as the shareholders authorize an increase in such corporation’s capital. When a shareholder subscribes for shares, the shares are registered with such shareholder’s name, and the shareholder is treated as a shareholder for all purposes, except receipt of dividends, unless otherwise stipulated in the Bylaws of the corporation. The shareholder becomes eligible to receive dividends once such shareholder has paid for the shares. If a shareholder does not pay for shares for which such shareholder has subscribed on or prior to the date agreed upon for payment, the corporation is entitled to auction the shares on the stock exchange, and has a cause of action against the shareholder for the difference between the subscription price and the price received at auction. However, until such shares are sold at auction, the shareholder continues to exercise all his rights (except the right to receive dividends). Authorized shares that have not been paid for within

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the maximum period of three years from the date of issuance determine that the capital of the corporation is automatically reduced to the amount effectively paid within such period.

     The Company’s Bylaws authorize two classes of common stock, Series A Common Stock and Series B Common Stock. The rights of both series of shares are identical, except that the holders of Series B Common Stock are entitled as a class only to (i) elect one of seven directors and an alternate director for that director and (ii) name one of three liquidators of Telefónica Chile in the event of its dissolution.

Director Requirements

     The Bylaws establish that the Board of Directors shall consist of seven directors, six to be elected by the holders of Series A Common Stock and one to be elected by the holders of Series B Common Stock. One alternate director will be elected for each director and will replace that director if the director is unable to attend a meeting or serve a full term. Only the director and alternate director elected by the holders of the Series B Common Stock are required to be stockholders in the Company.

     The Company’s Bylaws (Article 18), as well as the Chilean Corporations Law (Article 38), stipulate that the Board of Directors can only be fully dissolved by a General or Special Shareholders’ Meeting (as defined below). The individual or collective dissolution of the Board of Directors by one or more of the Board members is not allowed.

     The Bylaws require that any act or contract by the Company in which a director or an officer, or a party related to them, holds an interest must be previously approved by two-thirds of the Board of Directors, and the terms of the act or contract must be adjusted to similar equity conditions to those prevailing in the market.

     The Company’s Bylaws include a chapter governing the creation and functions of the Directors’ Committee, which was created by the Board of Directors on April 26, 2001. For more information on the Directors’ Committee, see “Item 6. Directors, Senior Management and Employees—Board Practices—Directors’ Committee.”

Preemptive Rights and Increases of Share Capital

     The Chilean Corporations Law grants certain preemptive rights to shareholders of all Chilean companies. Thus, options to purchase shares from capital increases or convertible securities have to be offered, at least one time, preferentially to shareholders on a pro rata basis.

Dividend and Liquidation Rights

     In accordance with Chilean Corporate law, the Company must distribute mandatory cash dividends of at least 30% of its net income of the year calculated in accordance with Chilean GAAP, unless otherwise decided by a unanimous vote of the shareholders. See “Item 8. Financial Information—Dividend Policy and Dividends.” In addition, under Chilean Law dividends can only be paid from net income or retained earnings.

     At the option of the Company, the portion of any dividend that exceeds the mandatory limits established pursuant to Chilean law may be paid in cash, in shares of the Company or in shares of open corporations held by the Company. Shareholders who do not expressly elect to receive a dividend other than in cash are legally presumed to have decided to receive the dividend in cash.

     Dividends that are declared but not paid within the appropriate time period set forth in the Bylaws for payment of such dividends (as to minimum dividends, 30 days after declaration; as to optional dividends, the date set for payment at the time of declaration) are adjusted to reflect the change in the value of the UF from the date set for payment to the date such dividends are actually paid. Such dividends also accrue interest for operations readjustable during such period. The right to receive a dividend lapses if it is not claimed within five years after the time the dividend becomes due. In the event of a liquidation of the Company, the holders of fully paid shares would participate in a pro rata distribution of assets available after all creditors have been paid.

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Shareholders’ Meetings and Voting Rights

     The General Annual Shareholders’ Meeting of the Company is held during the first four months of each year. Extraordinary meetings of shareholders may be called by the Board of Directors when deemed appropriate or when requested by shareholders representing at least 10% of the issued voting shares or by the SVS. Notice to convene the General Annual Shareholders’ Meeting or a Special Shareholders’ Meeting is given by means of a notice published in a newspaper of Telefónica Chile’s corporate domicile (currently, Santiago) or in the Official Gazette in the prescribed manner by the law and its rule. Notice must also be mailed to each shareholder and given to the SVS at least 15 days prior to the meeting.

     The quorum to constitute a shareholders’ meeting is established by the presence, in person or by proxy, of shareholders representing at least the absolute majority of the issued voting shares of the Company; if a quorum is not present at the first meeting, the meeting can be reconvened and shareholders present at the reconvened meeting are deemed to constitute a quorum regardless of the percentage of the shares represented. The agreements will be adopted by the absolute majority of the present or represented shares with voting rights. However, if a shareholders’ meeting is called for the purpose of: (i) transformation, merger or division of the Company, (ii) an amendment to the term of duration or early dissolution, (iii) a change in corporate domicile, (iv) a decrease of corporate capital, (v) approval of capital contributions or assessments of assets other than cash, (vi) modification of the faculties reserved to shareholders or limitations of attributions on the Board of Directors, (vii) reduction in the number of Directors comprising the Board, (viii) the sale, transfer or disposition of 50% or more of the Company’s assets, either including or excluding their corresponding liability, or the formulation or modification of any business plan which includes the sale, transfer or disposition of the Company’s asset in such percentage, (ix) the form of distributing corporate benefits, (x) real or personal guarantees to caution liabilities of any third party, in an amount exceeding 50% of the Company’s total assets, (xi) the purchase by the Company of the Company’s issued stock in accordance with Articles 27A and 27B of Law 18,046, (xii) corrections of formal defects with regard to the Company’s incorporation or amendments to the Bylaws relating to any of the matters enumerated above, or (xiii) any other alluded to in the Bylaws, the vote required at such meeting is two-thirds of the issued voting Shares as established in Article 44 of the Bylaws of the Company.

     The Company’s Bylaws (Article 45 Bis), as well as Decree-Law 3500 (Article 121), state that the approval of 75% of voting shares is required in a Special Shareholders’ Meeting, in order to modify the following provisions or bylaws:

      (a)
the share concentration limit of 45% of the capital with voting rights;
 
  (b)
the quorum of two-thirds of the Board of Directors that is required for the prior approval of the agreements and contracts between the Company and its majority shareholders, board members and executive officers, or persons related to them;
 
  (c)
the obligation of the Board of Directors to always act within the limits determined by the investment and financing policy approved by the General Annual Shareholders’ Meeting;
 
  (d)
the obligation of the General Annual Shareholders’ Meeting to approve the investment and financing policy proposed by management;
 
  (e)
the fact that the following matters are subject to approval of a Special Shareholders’ Meeting: the sale of assets or rights of the Company that have been declared essential to its operations in the investment and financing policy, as well as the creation of encumbrances upon such assets, and the modification of the investment and financing policy approved at the General Annual Shareholders’ Meeting;
 
  (f)
the requirement that no shareholder may exercise, personally or through others, the right to vote shares held in excess of 45% of the capital with voting rights and that no person may represent shareholders that, as a group, own more than 45% of the capital with voting rights;
 
  (g)
the rules that regulate the withdrawal rights of the AFPs;
 

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      (h)
the obligation to present to the General Annual Shareholders’ Meeting and to send to shareholders a copy of the account inspectors’ report and of the investment and financing policy; and
 
  (i)
the obligation of the General Annual Shareholders’ Meeting to designate two account inspectors and two alternate account inspectors to examine the accounts, inventory, balance sheet and other financial statements.
 

     Chilean law does not require a publicly traded company to provide the level and type of information that United States securities laws require a reporting company to provide to its shareholders in connection with a solicitation of proxies. Under Chilean law, a notice of a shareholders’ meeting listing matters to be addressed at the meeting must be mailed not later than 15 days prior to the date of a meeting. In the case of a General Annual Shareholders’ Meeting, an annual report of the Company’s activities, which includes audited financial statements for the Company, must also be mailed to certain shareholders (corresponding to the higher value between (i) those shareholders owning 90% of the shares, and (ii) those shareholders representing 35% of total shareholders which have an investment higher than 120 UF). Additionally, the Company regularly provides, and management intends to continue to provide, a proposal for the final dividend, a statement of the proposed dividend policy for interim dividends for the then current year and a statement of Telefónica Chile’s Investment and Financing Policy required by Decree-Law 3500 discussed below. See “Item 8. Financial Information—Dividend Policy and Dividends.”

     The Chilean Corporations Law provides that, whenever shareholders representing 10% or more of the issued voting shares so request, a summary of the comments and proposals that shareholders requested in relation to the businesses of the company must be included as an exhibit to the company’s annual report. The Chilean Corporations Law also provides that, whenever the board of directors of an open company convenes a general meeting of shareholders, solicits proxies for the meeting, and distributes information supporting its decisions or other similar materials, it must include pertinent comments and proposals requested by such shareholders.

     Only shareholders registered as such with the Company at least five days prior to the date of a shareholders’ meeting are entitled to attend and vote their shares. Shareholders may appoint another individual (who need not be a shareholder) as their proxy to attend and vote on their behalf. Every shareholder entitled to attend and vote at a shareholders’ meeting has one vote for each share subscribed. The Company’s Bylaws (Article 46), as well as the Chilean Corporations Law (Article 68), stipulate that the shares belonging to shareholders who, during a period of over five years, have not collected dividend payments that the Company has distributed and have not attended shareholders’ meetings that were held, are not considered for quorum purposes or for the voting majorities required at the shareholders’ meetings. When one of the mentioned conditions ceases to occur, those shares must again be considered for the above-mentioned purposes.

     Subject to the terms of the Deposit Agreement among the Company, the Bank of New York, as Depositary, and the owners and holders of ADRs, dated as of July 19, 1990, as amended and restated in the Amended and Restated Deposit Agreement among the Company, Citibank, N.A., as Depositary, and the owners and holders of ADRs, dated as of January 2, 1997, and the Second Amended and Restated Deposit Agreement, dated as of June 1, 1998, among Telefónica Chile, Citibank, N.A., as Depositary, and the owners and holders of ADRs, the holders of ADRs have the right to instruct the Depositary as to the exercise of voting rights with respect to the underlying common shares. The Depositary is not permitted to vote any of the underlying shares as to which it has received no instructions from the holders of ADRs.

Approval of Financial Statements and Investment and Financing Policy

     The Board of Directors is required to submit the Company’s financial statements to the shareholders annually for their approval. If the shareholders reject the financial statements, the Board of Directors must submit new financial statements not later than 60 days from the date of the meeting. If the shareholders reject the new financial statements, the entire Board of Directors is deemed removed from office and a new Board of Directors is elected at the same meeting. Directors who individually approved such financial statements rejected by the Company’s shareholders are disqualified for re-election for the ensuing period.

     As mandated by Decree-Law 3500 (discussed below) and as required by Telefónica Chile’s Bylaws, at each General Annual Shareholders’ Meeting, shareholders of the Company must consider for approval a statement of

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general investment directives and limitations proffered by management. At the General Annual Shareholders’ Meeting held in April 2006, the Investment and Financing Policy for 2006 was approved by Telefónica Chile’s shareholders.

     The Company’s current Investment and Financing Policy requires that the maximum consolidated debt-to-equity ratio of Telefónica Chile and its subsidiaries not exceed 1.6.

     Under the terms of the Investment and Financing Policy notwithstanding the restrictions imposed by law or by the Bylaws on the grant of real or personal guarantees to secure third-party obligations, the Company’s management may not agree to grant real or personal guarantees to secure obligations of the Company or of third parties, other than subsidiaries, except upon shareholder approval at an extraordinary shareholders’ meeting. Cash obligations arising from amounts payable for the purchase of goods or real estate are exempt from the foregoing, if they are secured by the assets purchased. The Company may agree to restrictions on the distribution of dividends with lenders only after shareholder approval at a General Annual Shareholders’ Meeting or at an extraordinary shareholders’ meeting.

     The Investment and Financing Policy for 2006 also contains restrictions on the disposition of assets or property rights that are essential for the functioning of the Company, including the networks, central switches, equipment and parcels of land used to provide services pursuant to government licenses. Such assets may, however, be modified or replaced for reasons of technical or economic obsolescence. As of the General Annual Shareholders’ Meeting held in April 2006, the Company’s essential assets also included 51% of the shares of subsidiaries Telefónica Empresas and Telefónica Larga Distancia.

     Finally, the Investment and Financing Policy, approved at the General Annual Shareholders’ Meeting, established that the Company will concentrate investment resources in all areas of its business defined in its Bylaws.

Right of Dissenting Shareholders to Tender Their Shares

     The Chilean Corporations Law provides that, at an extraordinary shareholders’ meeting upon any of the resolutions enumerated below, dissenting shareholders acquire the right to withdraw from a Chilean company and to compel that company to repurchase their shares, subject to certain terms and conditions.

     “Dissenting” shareholders are defined as (i) shareholders who vote against a resolution and thus acquire the right to withdraw from the company, or (ii) shareholders who are absent from a shareholders’ meeting and who state in writing to the company their opposition to the resolution adopted at such a meeting. Dissenting shareholders must manifest their withdrawal rights by tendering their stock to the company within 30 days of adoption of the resolution in question (except in the case of pension fund shareholders, as discussed below).

     The price paid to a dissenting shareholder of a public (open) company for such shares is the weighted average of the closing sale prices for the company’s shares, as reported on the relevant stock exchanges, for the 60-day period preceding the event giving rise to the withdrawal right.

     Under the Chilean Corporations Law, a dissenting shareholder’s right to withdraw arises upon adoption of resolutions concerning the following matters:

      (a)
transformation of the company;
 
  (b)
merger of the company with another entity;
 
  (c)
disposition of 50% or more of the corporate assets under the terms described in “Item 10. Additional Information—Memorandum and Articles of Association—Shareholders’ Meetings and Voting Rights”;
 
  (d)
grant of real or personal guarantees to secure third-party obligations in an amount exceeding 50% of the corporate assets;
 

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      (e)
creation of preferential rights for a class of shares or modification of those already existing, in which case the right to withdraw only accrues to the dissenting shareholder of the class or classes of shares adversely affected;
 
  (f)
corrections of formal defects with regard to the company’s incorporation or amendments to the Bylaws relating to any of the matters enumerated above;
 
  (g)
such other causes as may be established by the Company’s bylaws and the Chilean Law;
 

Registrations and Transfers

     The Company’s shares are registered by the Company acting as its own transfer agent, as is customary among Chilean corporations. In the case of jointly owned shares, an attorney-in-fact must be appointed to represent the joint owners in the Company.

C. Material Contracts

     There were no material contracts signed in the year 2006.

D. Exchange Controls and Other Limitations Affecting Security Holders

     Telefónica Chile has outstanding ADRs and Debt Securities. Each of these securities is subject to requirements as to issuance and other matters established by the Central Bank.

     The Central Bank is, among other things, responsible for monetary policies and for exchange controls in Chile. Appropriate registration of a foreign investment in Chile permits the investor to access the formal currency market. Foreign investments can be registered with the Foreign Investment Committee under Decree-Law 600 of 1974, as amended, or with the Central Bank under the Central Bank Act. The Central Bank Act is an organic constitutional law requiring a “special majority” vote of the Chilean Congress to be modified.

     Chapter XIV of Title I of the Compendium of Rules on Foreign Exchange (the “Compendium”) issued by the Central Bank authorizes qualifying Chilean issuers to offer convertible debentures or debt securities both in Chile and abroad. Pursuant to an amendment of the Compendium issued by the Central Bank on April 19, 2001, any new international issue of convertible debentures or debt securities must be carried out through the Formal Exchange Market, and the participants must inform the Central Bank of the issuance. However, all issuances of debt made prior to the April 19, 2001 amendment of the Compendium, including certain of the Debt Securities of the Company, remain subject to the rules and regulations as in effect at the time of their respective issuances.

     The following is a summary of the relevant portions of the Central Bank’s regulations regarding issuance of convertible debentures and debt securities denominated in currencies other than pesos in the international markets. This summary does not purport to be complete and is qualified in its entirety by reference to Resolution No. 254-15-921029, which has been incorporated by reference as an exhibit to the Company’s Registration Statement on Form F-3 (File No. 333-5184), as filed with the Commission on July 22, 1996 and as amended on January 7, 1999, and by reference to the resolutions of the Central Bank authorizing the issuance of the debt securities which are the subject of the above-referenced Registration Statement.

     Debt securities must have an average weighted term of not less than four years, weighted on the basis of principal installments and on the assumption that, if the issuer has the ability to call the debt securities, they will be deemed to have been called at the earliest possible date for purposes of this requirement. Convertible debt securities offered internationally must first be offered to existing shareholders of the issuer in a preemptive rights offering. Subscribers in such an offering must purchase the debentures with pesos and receive peso-payable debt securities whereas international investors must purchase the debt securities in a foreign currency. Persons not residing or domiciled in Chile may exchange their peso-payable debt securities for the foreign-currency payable debt securities, subject to compliance with certain conditions.

     The Compendium also requires that the foreign currency proceeds from the international sale of debt securities either be brought to Chile and exchanged for Chilean pesos in the Formal Exchange Market or be held outside of

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Chile and used for (i) direct payment abroad of expenses incurred in connection with import operations, contracting services abroad, issue of securities abroad; (ii) repayment at maturity of external indebtedness registered with, and approved by, the Central Bank; and (iii) direct investment in financial instruments abroad. If the foreign currency proceeds are used to finance investments outside of Chile or to repay obligations of foreign branches and/or subsidiaries, no access to the Formal Exchange Market is given.

     Until September of 1998, the Compendium made foreign loans granted to (including international debt offerings issued by) Chilean individuals or companies subject to a mandatory deposit of an amount equal to 30% of the proceeds of the loan in a one-year, non-interest bearing U.S. dollar account with the Central Bank (or to payment of a charge to the Central Bank on the next business day after the time the foreign currency is converted into Chilean pesos in an amount equal to interest on such deposit at the rate of the twelve-month LIBOR for U.S. dollar deposits plus 4.0% for one year). On June 26, 1998, the Central Bank lowered the amount of this mandatory deposit to 10% of loan proceeds, and further reduced this amount to 0% on September 17, 1998. Although the mandatory deposit was eliminated from the Compendium on April 19, 2001, it is still within the Central Bank’s powers, according to its organic law, to reinstate such mandatory deposit requirement.

     International investors must purchase internationally offered debt securities with foreign currency and receive foreign currency-payable securities.

     A foreign investment and exchange contract was entered into by the Central Bank, the Company and The Bank of New York as depositary in 1990 (the “Foreign Investment Contract”) pursuant to Article 47 of the Central Bank Act and to Chapter XXVI of the Compendium (“Chapter XXVI”). On December 30, 1996, the Foreign Investment Contract was amended to incorporate the designation of Citibank N.A. as the successor depositary for Telefónica Chile’s ADR program. Although an amendment made by the Central Bank on April 19, 2001, repealed Chapter XXVI, it continues to be enforceable with respect to contracts entered into pursuant to Chapter XXVI, such as the Foreign Investment Contract.

     The following is a summary of certain provisions of the Foreign Investment Contract. This summary does not purport to be complete and is qualified in its entirety by reference to Chapter XXVI and the Foreign Investment Contract.

     Under the Chapter XXVI and the Foreign Investment Contract, the Central Bank grants to the Depositary, on behalf of ADR holders, and to any non-Chilean investor who withdraws shares of Series A Common Stock upon delivery of ADRs (such shares being referred to herein as “Withdrawn Shares”) access to the formal currency market to convert pesos to dollars (and remit such dollars outside of Chile) with respect to shares of Series A Common Stock represented by ADSs or Withdrawn Shares, including amounts received as (a) cash dividends, (b) proceeds from the sale in Chile of Withdrawn Shares (subject to receipt by the Central Bank of a certificate from the holder of the Withdrawn Shares (or from an institution authorized by the Central Bank) that such holder’s residence and domicile are outside of Chile and a certificate from a Chilean exchange (or from a brokerage or securities firm established in Chile) that such Withdrawn Shares were sold on a Chilean exchange), (c) proceeds from the sale in Chile of rights to subscribe for additional shares of Series A Common Stock, (d) proceeds from the liquidation, merger or consolidation of the Company, and (e) other distributions, including without limitation, those resulting from any re-capitalization, as a result of holding shares of Series A Common Stock represented by ADSs or Withdrawn Shares. Transferees of Withdrawn Shares are not entitled to any of the foregoing rights under Chapter XXVI. Investors receiving Withdrawn Shares in exchange for ADRs have the right to redeposit such shares in exchange for ADRs, provided that the conditions to redeposit are satisfied.

     Shares of Series A Common Stock acquired as described above may be deposited for ADRs and receive the benefits of the Foreign Investment Contract, subject to receipt by the Central Bank of a certificate from the Depositary stating that such deposit has been made and that the related ADRs have been issued along with a declaration from the person making such deposit waiving the benefits of the Foreign Investment Contract with respect to the deposited shares.

     Access to the Formal Exchange Market under any of the circumstances described above is not automatic. Pursuant to Chapter XXVI, such access requires the Central Bank’s approval of a request presented through a

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banking institution established in Chile. The Foreign Investment Contract provides that, if the Central Bank has not acted on such request within a period of seven business days, the request will be deemed approved.

     The Central Bank regulations provide that a person who brings foreign currency to Chile for the purpose of purchasing shares of Series A Common Stock must convert such currency into pesos on the same date and has five banking business days within which to invest in such shares in order to receive the benefits of the Foreign Investment Contract. If such person decides within such period not to acquire the shares, such person can access the Formal Exchange Market to reacquire dollars, provided that the applicable request is presented to the Central Bank within seven banking business days of the initial conversion into pesos. Shares of Series A Common Stock acquired as described above may be deposited for ADSs and receive the benefits of the Foreign Investment Contract, subject to: (i) receipt by the Central Bank of a certificate from the Depositary stating that such deposit has been made and that the related ADRs have been issued, and (ii) receipt by the custodian bank for the ADRs of a declaration from the person making such deposit waiving the benefits of the Foreign Investment Contract with respect to the deposited shares.

     Under current Chilean law and judicial precedents, the Foreign Investment Contract cannot be changed unilaterally by the Central Bank. While the authorization to issue the Debt Securities is a unilateral act of the Central Bank, other authorizations of the Central Bank have not been historically rescinded. Although this area was significantly liberalized as a result of the amendment made by the Central Bank on April 19, 2001, additional Chilean restrictions applicable to the holders of Debt Securities or ADRs, to the disposition of any such security, or the repatriation of the proceeds from such disposition, may be imposed in the future. There can be no assessment of the duration or impact of such restrictions, if imposed.

     The Central Bank regulations that became effective on July 4, 1995 (the “New Central Bank Regulations”) required persons bringing foreign currency into Chile for the purpose of acquiring pesos to purchase securities to either (1) establish a non-interest bearing deposit with the Central Bank of Chile for a one-year term in an amount equal to 30% of foreign currency brought into Chile, or (2) pay a charge to the Central Bank at the time the foreign currency is converted into pesos in an amount equal to interest on such deposit for one year at the rate of 12-month LIBOR plus 4%. The New Central Bank Regulations were amended in October of 1996 to make them applicable to persons bringing foreign currency into Chile for the purpose of purchasing securities from certain issuers thereof as part of a capital increase by the issuer. However, these rules do not apply to foreign investments made for purposes of purchasing newly issued shares under Chapter XXVI and an ADR investment contract. The New Central Bank Regulations apply to subsequent transactions in which foreign currency is brought into Chile to purchase securities in secondary market transactions. On September 17, 1998, the Central Bank eliminated this mandatory deposit requirement. Despite this elimination, the Central Bank may at any time reinstate its deposit requirements in any amount up to 40%. Although the mandatory deposit was eliminated from the Compendium on April 19, 2001, its imposition still constitutes one of the Central Bank’s powers.

     The New Central Bank Regulations may affect the price and volume of trading in securities in Chile, including the price and volume of trading in the Company’s common stock. The New Central Bank Regulations may also affect the amount of any differential in prices between American Depositary Shares evidencing securities of Chilean issuers, including the Company’s ADSs, and prices of the underlying securities in Chile, including the common stock. However, the Company is unable to assess at this time the impact of the New Central Bank Regulations on the securities markets in Chile, the market for the Company’s common stock in Chile or the market for its ADRs. The Company is unable to predict whether (and, if so, how or when) the New Central Bank Regulations will be modified or terminated or what effect any such modifications or termination will have on the securities markets in Chile, the market for the Company’s common stock or the market for its ADRs.

E. Taxation

     The following discussion contains a description of the material Chilean and U.S. federal income tax consequences of the acquisition, ownership and disposition of shares of Series A common stock or ADSs (evidenced by ADRs) representing shares of Series A Common Stock by certain holders. This summary is based upon the tax laws of Chile and the United States as in effect on the date of this annual report, which are subject to change, possibly with retroactive effect, and to differing interpretations. You should consult your own tax advisors as to the

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Chilean, U.S. federal or other tax consequences of the acquisition, ownership and disposition of shares of Series A Common Stock or ADSs, including, in particular, the effect of any state, local or non-U.S., or non-Chilean tax laws.

Chilean Tax Considerations

     The following discussion summarizes the principal Chilean tax consequences of the acquisition, ownership and disposition of shares of Series A Common Stock, or any ADSs representing such Series A Common Stock by an individual holder who is not domiciled or resident in Chile or by a legal entity not organized under the laws of Chile and with no permanent establishment in Chile (a “Foreign Holder”). For purposes of Chilean taxation, an individual holder is a resident of Chile if such holder has resided in Chile for more than six consecutive months in any one calendar year, or for a total of more than six months in two consecutive years. A Chilean citizen generally will be treated as a domiciliary and resident of Chile for Chilean tax purposes unless such person can demonstrate the contrary.

     To date, there is no income tax treaty in force between Chile and the United States.

Deposit and Withdrawal of Series A Common Stock in Exchange for ADSs

     The deposit and withdrawal of shares of Series A Common Stock in exchange for ADSs is not subject to any Chilean taxes. As to the tax basis of shares of Series A Common Stock received by a Foreign Holder in exchange for ADSs, the Company has obtained a Ruling (the “Ruling”) from the Chilean tax authorities that provides that the Chilean tax authorities will abide by the valuation procedure set forth in the Depositary Agreement, which values shares at the highest price at which shares of Series A Common Stock were traded on the Santiago Stock Exchange on the date of the withdrawal of the shares of Series A Common Stock from the Depositary.

Taxation of Dividends

     Cash dividends paid by the Company with respect to the shares of Series A Common Stock held by Foreign Holders will be subject to a Chilean withholding tax at the rate of 35% (the “Withholding Tax”), which is withheld and paid over by the Company. A credit against the Withholding Tax is available based on the level of corporate income tax actually paid by the Company on the income to be distributed (the “First Category Tax”). Full applicability of the First Category Tax credit at the 17.0% rate results in an effective Withholding Tax rate of 21.7%. Consequently, the Withholding Tax rate with respect to dividends fluctuates between 21.7% and 35.0%, depending on whether or not the Company is subject to the First Category Tax.

     The First Category Tax credit, if available, does not reduce the Withholding Tax on a one-for-one basis because it also increases the base on which the Withholding Tax is imposed. In addition, if the Company distributes less than all of its distributable income, the credit for First Category Tax paid by the Company is reduced proportionately. The example below illustrates the effective Chilean Withholding Tax burden on a cash dividend received by a Foreign Holder, assuming a Withholding Tax rate of 35%, an effective First Category Tax at the maximum rate of 17.0%, and a distribution of 100% of the Company’s net income that is distributable after payment of the First Category Tax.

Example:                     Ch$ 
   
Company taxable income                           100 
   First Category Tax (17% of Ch$100)   (17)
   
   Net distributable income    83 
   Dividend distributed by the Company    83 
Withholding Tax     
   (35% of the Company’s taxable income)   (35)
   Credit for First Category Tax    17 
   
   Net Withholding Tax    (18)
   
Net dividend received         65 (83-18)
   
   
Effective dividend withholding tax rate         21.7% (18/83)

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     The foregoing tax consequences apply to cash dividends paid by the Company to the Depositary as representative of the holders of ADSs. The Ruling provides that disbursements of such cash dividends by the Depositary to the holders of ADSs will not be subject to Chilean taxation. Dividend distributions made in property (other than shares of Series A Common Stock) will be subject to the same Chilean tax rules as cash dividends based on the fair market value of such property. Stock dividends are not subject to Chilean taxation.

     A capital reduction, such as the one that was approved by the Company’s shareholders at the April 20, 2006 shareholder’s meeting, is generally tax free to holders of Series A Common Stock or ADSs except in certain circumstances, such as the existence of: (i) pending taxable net income from prior periods, (ii) pending net income (retained earnings), and (iii) capitalized share premiums generated by above market price capital increases on which the Company elected to not pay taxes at the time of issuance. The effective tax rate applicable to the capital reduction paid in 2006 was 29.41%, due to the fact that condition (i), pending taxable net income from prior periods, was met. The average First Category Tax credit rate applicable to the capital reduction was 8.59691255% of the amount paid, as detailed in the example below.

Example: Effective Tax Rate for Capital Reduction Payment    Ch$
   
Amount of Dividend Received    100.00 
Withholding Tax     
   35% of the dividend received + Credit for First Category Tax =100+8.59691255    (38.00)
   Credit for First Category Tax    8.59 
   
   Net Withholding Tax    (29.41)
   

Taxation of Capital Gain on the Sale of Shares of Series A Common Stock and ADSs

      (1)      The Ruling provides that gains from sales or other dispositions of ADSs are not subject to any Chilean taxes, provided that such sales occur outside of Chile.
 
  (2)      Taxation of shares acquired on or before April 19, 2001
 
    A gain recognized on a sale or exchange of shares (as distinguished from sales or exchanges of ADSs representing such shares) will be subject to both a 17% Chilean income tax and the 35% Chilean withholding tax (the former being creditable against the latter) if either the foreign holder:
 
        • Has held the shares for less than one year since exchanging ADSs for the shares; or
 
        • Acquired and disposed of the shares in the ordinary course of its business or as an habitual trader ofshares.
 
     In all other cases, gain on the disposal of shares will be subject to a 17% Chilean income tax but will not be subject to the 35% Chilean withholding tax.
 
     This rule also applies for the disposal of shares not qualifying for the exemption in (3), below.
 
  (3)      Taxation on shares acquired after April 19, 2001
 
   

On November 7, 2001, the income tax law was amended in order to create a tax exemption on capital gains arising from the sale of shares of listed companies traded in the stock markets. Although there are certain restrictions established in the amended income tax law, in general terms, the amendment provides that in order to have access to the capital gain exemption: (i) the shares must be of a public stock corporation with a certain minimum level of trading in a stock exchange, (ii) the sale must be carried out in a Chilean stock exchange, or in another stock exchange authorized by the SVS, or in a tender offer subject to Chapter XXV of the Chilean Securities Market Law, (iii) the shares which are being sold must have been acquired on a stock exchange, or in a tender offer subject to Chapter XXV of the Chilean Securities Market Law, or in an initial public offering (due to the creation of a company or to a capital increase), or due to the exchange of convertible bonds, and (iv) the shares must have been acquired after April 19, 2001.

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The tax basis of shares received in exchange for ADSs will be the acquisition value of the shares. The valuation procedure set forth in the deposit agreement, which values shares at the highest price at which they trade on the Santiago Stock Exchange on the day of the exchange, will determine the acquisition value for this purpose. Consequently, the conversion of ADSs into shares and the immediate sale of the shares for the value established under the deposit agreement will not generate a capital gain subject to taxation in Chile.

     The distribution and exercise of preemptive rights relating to shares of Series A Common Stock will not be subject to Chilean taxes, however, amounts received in exchange for the sale of preemptive rights will be subject to Chilean income taxes at an effective rate of 35%.

Other Chilean Taxes

     Although there is no direct authority on this point, as a practical matter there are no Chilean inheritance, gift or succession taxes applicable to the ownership, transfer or disposition of ADSs by a Foreign Holder, but such taxes generally will apply to the transfer at death or by gift of the shares of Series A Common Stock by a Foreign Holder. There are no Chilean stamp, issue, registration or similar taxes or duties payable by holders of debt securities and holders of shares of Series A Common Stock or ADSs.

Withholding Tax Certificates

     Upon request, the Company will provide to Foreign Holders appropriate documentation evidencing the payment of the Chilean Withholding Tax (net of the applicable First Category Tax). For further information, the investor should contact:

Citigroup
Depositary Receipt Services
388 Greenwich Street 14th floor
New York, New York 10013, USA

U.S. Federal Income Tax Considerations

     The following discussion is a summary of the material U.S. federal income tax consequences of the acquisition, ownership and disposition of shares of Series A Common Stock or ADSs by U.S. Holders, as defined below, but does not purport to be a comprehensive description of all of the tax considerations that may be relevant to a particular investor’s decision to acquire such securities. This discussion deals only with shares of Series A Common Stock and ADSs held as capital assets for U.S. federal income tax purposes and it does not describe all of the tax consequences that may be relevant to U.S. Holders subject to special rules, such as:

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     This discussion is based on the Internal Revenue Code of 1986, as amended (referred to herein as the “Code”), final, temporary and proposed Treasury regulations, administrative pronouncements of the U.S. Internal Revenue Service (the “IRS”) and judicial decisions, all as currently in effect, all of which are subject to change, possibly with retroactive effect. This discussion is also based in part on representations by the depositary and assumes that each obligation under the Deposit Agreement and any related agreement will be performed in accordance with its terms. Holders of shares of Series A Common Stock or ADSs should consult their own tax advisors regarding the application of the U.S. federal income tax laws to their particular situations as well as any tax consequences arising under the laws of any state, local or non-U.S. taxing jurisdiction.

     As used herein, the term “U.S. Holder” means a beneficial owner of Series A Common Stock or ADSs that is for U.S. federal income tax purposes:

The U.S. federal income tax treatment of a partner in a partnership that holds Series A Common Stock or ADSs will depend on the status of the partner and the activities of the partnership. Partners in such partnerships should consult their own tax advisors.

General

     In general, for U.S. federal income tax purposes, a U.S. Holder of ADSs will be treated as the beneficial owner of the shares of the Series A Common Stock represented by those ADSs. Accordingly, deposit and withdrawals of shares of Series A Common Stock in exchange for ADSs will not result in the realization of gain or loss for U.S. federal income tax purposes.

     The U.S. Treasury has expressed concerns that parties to whom depositary shares such as the ADSs are pre-released may be taking actions that are inconsistent with the claiming of foreign tax credits by U.S. Holders of the ADSs. Such actions would also be inconsistent with the claiming of the reduced rate of tax, described below, applicable to dividends received by certain non-corporate holders. Accordingly, the analysis of the creditability of Chilean taxes and the availability of the reduced tax rate for dividends received by certain non-corporate holders, each described below, could be affected by actions taken by parties to whom the ADSs are pre-released.

     This discussion assumes that the Company has not been, and will not become, a passive foreign investment company, a “PFIC,” for U.S. federal income tax purposes, as described more fully below.

Taxation of Dividends

     Distributions made by the Company of cash or property (other than certain pro rata distributions of common shares) generally will constitute a taxable dividend to the extent paid out of the Company’s current or accumulated earnings and profits, as determined under U.S. federal income tax principles. Since the Company does not maintain calculations of its earnings and profits under U.S. federal income tax principles, a U.S. Holder will generally be required to treat such distributions as taxable dividends. The full amount of any dividend paid in respect of shares of Series A Common Stock or ADSs (including the amount of Chilean taxes withheld therefrom) will be included in the gross income of a U.S. Holder as foreign source dividend income at the time that the dividend is received by the U.S. Holder, in the case of shares of Series A Common Stock, or by the depositary, in the case of ADSs. Subject to applicable limitations and the discussion above regarding concerns expressed by the U.S. Treasury, under current law, dividends paid to non-corporate U.S. Holders in taxable years beginning prior to January 1, 2011 will be

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subject to taxation at a maximum rate of 15%. Dividends paid by us will not be eligible for the dividends received deduction generally allowed to U.S. corporations under the Code.

     The amount of any dividend paid in Chilean pesos generally will be calculated by reference to the exchange rate for converting Chilean pesos into U.S. dollars in effect on the date that the dividend is received by the U.S. Holder, or, in the case of ADSs, by the depositary, regardless of whether the payment is in fact converted into U.S. dollars. If the dividend is converted into U.S. dollars on the date of receipt, U.S. Holders generally should not be required to recognize foreign currency gain or loss in respect of the dividend income. A U.S. Holder may recognize foreign currency gain or loss, which would be treated as ordinary gain or loss, if the dividend is not converted into U.S. dollars on the date of receipt. U.S. Holders should consult their own tax advisors regarding the calculation and U.S. federal income tax treatment of foreign currency gain or loss. The amount of any distribution of property other than cash will be the fair market value of such property on the date of distribution.

     Subject to certain limitations and restrictions that may vary depending on a holder’s particular circumstance, and subject to the discussion above regarding concerns expressed by the U.S. Treasury, a U.S. Holder will be entitled to a foreign tax credit against its U.S. federal income tax liability for the net amount of Chilean income taxes (after reduction for the credit for First Category Tax) withheld. The limitation on foreign taxes eligible for credit is determined separately with respect to specific classes of income. U.S. Holders should consult their own advisors regarding the availability of foreign tax credits in light of their particular circumstances. Instead of claiming a credit, U.S. Holders may, at their election, deduct such otherwise creditable Chilean taxes in computing their taxable income, subject to generally applicable limitations under U.S. law.

Taxation of Capital Gains or Losses

     Upon a sale or other disposition of Series A Common Stock or ADSs, a U.S. Holder generally will recognize gain or loss equal the difference between the amount realized on such sale or other disposition (including any Chilean taxes withheld) and the holder’s adjusted tax basis in the shares of Series A Common Stock or ADSs. Such gain or loss will be capital gain or loss, and will be long-term capital gain or loss if the U.S. Holder held the shares of Series A Common Stock or ADSs for more than one year. The deductibility of capital losses is subject to limitations under the Code.

     Any capital gain or loss recognized by a U.S. Holder generally will be treated as U.S. source income or loss for U.S. foreign tax credit purposes. Subject to certain conditions and limitations under U.S. federal tax law, any Chilean tax imposed on the sale or other disposition of shares of Series A Common Stock or ADSs will generally not be available as a credit against such holder’s U.S. federal income tax liability, unless the holder has other income from foreign sources, in the appropriate category, for purposes of the foreign tax credit rules. Instead of claiming a credit, a U.S. Holder may, at its election, deduct such otherwise creditable Chilean taxes in computing its taxable income, subject to generally applicable limitations under U.S. law. U.S. Holders should consult their own tax advisors regarding the application of the foreign tax credit limitation rules to the sale or other disposition of Series A Common Stock or ADSs.

Passive Foreign Investment Company Rules

     The Company believes that it will not be considered a PFIC for U.S. federal income tax purposes for 2006, and does not expect to be considered a PFIC in the foreseeable future. However, because PFIC status depends upon the composition of a company’s income and assets (including, among others, less than 25 percent owned equity investments) from time to time, there can be no assurance that the Company will not be considered a PFIC for any taxable year. If the Company were treated as a PFIC for any taxable year during which a U.S. Holder held a share of Series A Common Stock or an ADS, certain adverse consequences would apply to the U.S. Holder, including the imposition of higher amounts of tax than would otherwise apply to a U.S. Holder and additional tax form filing requirements. U.S. Holders are urged to consult their own tax advisors regarding the U.S. federal tax consequences if the Company were considered a PFIC.

Information Reporting and Backup Withholding

     Payment of dividends and sales proceeds that are made within the United States or through certain U.S.-related financial intermediaries generally are subject to information reporting and backup withholding unless (i) the holder

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is a corporation or other exempt recipient or (ii) in the case of backup withholding, the holder provides a correct taxpayer identification number and certify that it is not subject to backup withholding. The amount of any backup withholding from a payment to a holder will be allowed as a credit against such holder’s U.S. federal income tax liability, if any, and may entitle such holder to a refund, provided that the required information is timely furnished to the IRS.

     U.S. HOLDERS AND PROSPECTIVE PURCHASERS OF SHARES OF OUR SERIES A COMMON STOCK OR ADSs SHOULD CONSULT THEIR OWN TAX ADVISORS AS TO THE CHILEAN, U.S. FEDERAL, STATE, LOCAL AND OTHER TAX CONSEQUENCES OF THE ACQUISITION, OWNERSHIP AND DISPOSITION OF SHARES OF OUR SERIES A COMMON STOCK OR ADSs BASED UPON THEIR PARTICULAR CIRCUMSTANCES.

F. Dividends and Paying Agents

     Not applicable.

G. Statement by Experts

     Not applicable.

H. Documents on Display

     Telefónica Chile will provide without charge to each person to whom this Annual Report is delivered, upon written, e-mail or oral request from any such person, a copy of any or all of the documents referenced in this Annual Report. Written requests for such copies should be directed to either of the following contacts:

Compañía de Telecomunicaciones de Chile S.A.
Avenida Providencia 111, 22nd floor
Santiago, Chile
Attention: Sofia Chellew
                 Head of Investor Relations

E-mail and oral requests for copies of such documents may be made to Telefónica Chile at sofia.chellew@telefonicachile.cl or at 56-2-691-3867.

I. Subsidiary Information

     Not applicable.

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ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Overview

     The following discussion about the Company’s risk management activities includes forward-looking statements that involve risk and uncertainties. Actual results could differ materially from those projected in such forward-looking statements.

     The Company faces market risk exposure in two categories: interest rate fluctuations and exchange rate fluctuations.

     The primary interest rate risk that the Company faces is the effect on its fluctuating rate loans of a rise in the LIBOR rate. The Company had outstanding as of December 31, 2006, long-term fluctuating rate-based loans in the amount of Ch$333,386 million (US$626.2 million), including current maturities and accrued interest. As of December 31, 2005, long-term fluctuating rate-based loans in the amount of Ch$328,221 million (US$616.5 million), including current maturities and accrued interest, were outstanding.

     The primary exchange rate risk that the Company faces is the depreciation of the peso against the U.S. dollar, due to the fact that, although a substantial portion of the Company’s long-term liabilities are dollar-denominated, the Company’s revenues are largely denominated in Chilean pesos. The Company had, as of December 31, 2006, Ch$267,754 million (US$502.9 million) in dollar-denominated, interest-bearing, long-term liabilities (including current maturities and accrued interest) compared to Ch$374,878 million (US$704.1 million) in dollar-denominated, interest-bearing, long-term liabilities, including current maturities and accrued interest as of December 31, 2005.

     The Company periodically reviews its exposure to risks arising from fluctuations in foreign exchange rates and interest rates, and determines at its senior management level how to hedge such risks. Subject to this review process, the Company manages foreign currency and interest rate risks through hedging transactions in the Chilean and foreign derivative markets and through other mechanisms, such as the purchasing in the Chilean capital markets of dollar-denominated marketable securities with floating LIBOR-based interest rates. The Company has entered into interest rate swaps, forward rate agreements, cross-currency swaps, interest rate collars and foreign currency forward contracts with respect to a portion of its borrowings. The Company uses such derivative instruments to reduce risk by offsetting market exposure. The derivative instruments held by the Company are not leveraged and are not held for trading.

     In the normal course of business, the Company also faces risks that are either non-financial or non-quantifiable. Such risks principally include political risk, credit risk and legal risk, and are not represented in the tables below. See Item 3. “Key Information—Risk Factors.”

Risk of Variations in Floating Interest Rates

     The major part of Chilean peso-denominated debt is variable-rate UF-denominated. In 2006, of the total Chilean peso-denominated debt, 49.0% was floating-rate debt and 51.0% was fixed-rate debt. Of the Company’s long-term interest-bearing debt denominated in foreign currencies, as of December 31, 2006, 100% was floating-rate debt, compared to 29.9% fixed-rate debt and 70.1% floating-rate debt as of December 31, 2005. In 2006 and 2005, all of the Company’s foreign currency long-term floating-rate debt was tied to LIBOR.

     In order to reduce the impact of interest rate fluctuations on its debt obligations, the Company can enter into interest rate swaps (derivatives), which are contracts in which two parties agree to exchange periodic interest payments, whereby the Company typically agrees to make payments, based on a fixed interest rate applied to a notional principal amount on designated dates, to a counterparty that, in turn, agrees to make payments based on a floating rate, such as LIBOR, applied to the same notional amount.

     As of December 31, 2006, 16.7% of the Company’s long-term interest-bearing debt, including current portion and foreign currency and Chilean peso-denominated debt, was exposed to interest rate fluctuations. The remaining 83.3% of the Company’s interest-bearing debt was insulated from interest rate fluctuations: 66.3% was hedged through the instruments set forth in the following table, and 17.0% was fixed-rate debt. As of December 31, 2006, the Company had outstanding cross-currency swaps for a liability of Ch$266,196 million (US$500 million), which

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serve to hedge against dollar-peso exchange rate fluctuations and, at the same time, effectively change its floating rate to a fixed rate.

     As of December 31, 2005, 23.9% of the Company’s long-term interest-bearing debt, including current portion and foreign currency and Chilean peso-denominated debt, was exposed to interest rate fluctuations. The remaining 76.1% of the Company’s interest-bearing debt was insulated from interest rate fluctuations: 48.3% was hedged through the instruments set forth in the following table, and 27.8% was fixed-rate debt. As of December 31, 2005, the Company had outstanding cross-currency swaps for a liability of Ch$219,770 million (US$412.8 million), which serve to hedge against dollar-peso exchange rate fluctuations and, at the same time, effectively change its floating rate to a fixed rate.

     The following table summarizes the long-term interest-bearing debt obligations (including current maturities and accrued interest) and derivative instruments held by the Company as of December 31, 2006 and 2005. The Company enters into interest rate swaps and/or cross-currency swaps and/or zero-cost collar contracts or any other hedging instrument to achieve synthetically the appropriate level of variable and fixed-rate debt approved by senior management. For debt, the tables present principal payment obligations by maturity date and the related average interest rate. For collars, the tables present the notional amounts and cap and floor rates by contractual dates. Average interest rates for liabilities are calculated based on the prevailing interest rate as of December 31 of each year, for each loan. Dollar-denominated liabilities have been converted into Chilean pesos based on the Observed Exchange Rate as of December 31, 2006, which was Ch$532.39 = US$1.00.

  As of December 31, 2006 Expected Maturity Date 
   
  Average
Interest
Rate(2)		   2007    2008    2009    2010    2011    Thereafter    Total Long-
Term Debt
(including
current
portion)		    Fair
Value(1)
                 
                 
                 
                 
                   
  (in millions of constant Chilean pesos as of December 31, 2006)
Long-Term                                   
   Interest-Bearing Debt:                                   
Fixed rate                                   
(Ch$-denominated) (3) 4.18%    1,852    1,335    1,335    1,335    1,335    61,012    68,204    68,175 
(US$-denominated)(2) -    -    -    -    -    -    -    -    - 
 
Variable rate                                   
(Ch$-denominated) (3) 3.16%    446    -    -    65,186        -    65,632    65,632 
(US$-denominated)(2) 5.70%    1,559    79,859    106,478    -    79,858    -    267,754    267,754 
 
Interest Rate Derivatives                                   
Cross-currency Swaps:                                   
Notional amount of variable to                                   
   fixed (US$-denominated)(3)     -    79,859    106,478    -    79,859    -    -    - 
Average pay rate  -    -    2.49%    3.46%    -    4.17%    -    -    - 
Average received rate  -    -    5.73%    5.79%    -    5.75%    -    -    - 

________________________________________
(1)      These figures were calculated based on the discounted value of future cash flows expected to be received or paid, considering current discount rates that reflect the different risks involved. See “Additional Disclosure Requirements” to Note 37 of the Audited Consolidated Financial Statements for more information regarding the fair value of financial instruments and derivatives.
 
(2)      “Average interest rate” means, for variable rate debt, the average prevailing interest rate as of December 31, 2006 on Telefónica Chile’s variable rate debt and, for fixed rate debt, the average prevailing interest rate as of December 31, 2006 on Telefónica Chile’s fixed rate debt.
 
(3)      These figures were calculated based on the Observed Exchange Rate as of December 31, 2006, which was Ch$532.39 = US$1.00.
 
    As of December 31, 2005 Expected Maturity Date 
   
    Average 
Interest 
Rate(2)		   2006    2007    2008    2009    2010   Thereafter    Total Long-
Term Debt
(including
current
portion)		   Fair Value(1)
                   
                   
                   
                   
                     
            (in millions of constant Chilean pesos as of December 31, 2006)        
Long-Term                                     
   Interest-Bearing Debt:                                     
Fixed rate                                     

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    As of December 31, 2005 Expected Maturity Date 
   
    Average 
Interest 
Rate(2)		   2006    2007    2008    2009    2010   Thereafter    Total Long-
Term Debt
(including
current
portion)		   Fair Value(1)
                   
                   
                   
                   
                     
(Ch$-denominated)   6.05%       1,500       1,330       1,330       1,330       1,330       7,362       14,182       14,182    
(US$-denominated)(2)   8.19%       112,228       -       -       -       -       -       112,228       111,766    
 
Variable rate                                     
(Ch$-denominated)   2.32%       329       -       -       -       65,242       -       65,571       65,571    
(US$-denominated)(2)   4.75%       1,019       -       78,489       104,653       -       78,489       262,650       262,650    
 
Interest Rate Derivatives                                     
Cross-currency Swaps:                                     
Notional amount of variable to                                     
   fixed (US$-denominated)(3)   -       -       -       78,489       104,653       -       36,628       -       -    
Average pay rate    -       -       -       2.49%       3.46%       -       4.47%       -       -    
Average received rate    -       -       -       4.65%       4.90%       -       4.64%       -       -    

________________________________________
(1)      These figures were calculated based on the discounted value of future cash flows expected to be received or paid, considering current discount rates that reflect the different risks involved. See “Additional Disclosure Requirements” to Note 37 of the Audited Consolidated Financial Statements for more information regarding the fair value of financial instruments and derivatives.
 
(2)      “Average interest rate” means, for variable rate debt, the average prevailing interest rate as of December 31, 2005 on Telefónica Chile’s variable rate debt and, for fixed rate debt, the average prevailing interest rate as of December 31, 2005 on Telefónica Chile’s fixed rate debt.
 
(3)      These figures were calculated based on the Observed Exchange Rate as of December 31, 2005, which was Ch$512.50 = US$1.00.
 

Risk of Variations in Foreign Currency Exchange Rates

     The Company does not hedge its Chilean peso-denominated debt. The part of Chilean peso-denominated debt is UF-denominated, and therefore indexed to Chilean inflation.

     As of December 31, 2006, 66.7% of the Company’s interest-bearing debt (including current portion) was dollar-denominated and fully hedged against exchange rate variations between the peso-UF and the U.S. dollar through the instruments set forth in the tables below. The remaining 33.3% of the Company’s interest-bearing debt is UF- or Chilean peso-denominated and, therefore, not subject to exchange rate risk. As of December 31, 2005, 82.5% of the Company’s interest-bearing debt (including current portion) was dollar-denominated and fully hedged against exchange rate variations between the peso-UF and the U.S. dollar through the instruments set forth in the tables below. The remaining 17.5% of the Company’s interest-bearing debt is UF- or Chilean peso-denominated and therefore not subject to exchange rate risk.

     Telefónica Chile enters into forward contracts pursuant to which it agrees to purchase dollars for UF at an agreed exchange rate on a particular date. The maturities of the forward contracts match certain of Telefónica Chile’s foreign exchange-denominated liabilities in order to hedge those liabilities. The purpose of the Company’s foreign-currency hedging activities is to protect the Company from the risk of devaluation of the Chilean peso against the dollar. Telefónica Chile’s risk is the replacement cost, at current market value, of the transactions in the event of default by counterparties. Management believes that the risk of incurring such losses is remote and that any losses would be immaterial, although no assurance can be given to this effect.

     As of December 31, 2006, the Company had the equivalent of Ch$267,754 million (US$502.9 million) in U.S. dollar-denominated, interest-bearing, long-term debt (including current portion) outstanding. Most of Telefonica Chile’s debt denominated in foreign currencies is in U.S. dollars. To reduce the impact of any depreciation of the Chilean peso against the dollar, as of December 31, 2006, the Company had entered into, on a short-term basis, exchange rate forward contracts for U.S. dollars in exchange for Chilean pesos or UF in the amount of Ch$21,098 million (US$39.6 million), and had entered into a cross-currency interest rate swap for the purchase of U.S. dollars in the equivalent amount of Ch$294,405 million (US$553 million).

     As of December 31, 2005, the Company had the equivalent of Ch$374,878 million (US$704.1 million) in U.S. dollar-denominated, interest-bearing, long-term debt (including current portion) outstanding. Most of Telefonica Chile’s debt denominated in foreign currencies is in U.S. dollars. To reduce the impact of any depreciation of the

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Chilean peso against the dollar, as of December 31, 2005, the Company had entered into, on a short-term basis, exchange rate forward contracts for U.S. dollars in exchange for Chilean pesos or UF in the amount of Ch$60,347 million (US$113.4 million), and had entered into a cross-currency interest rate swap for the purchase of U.S. dollars in the equivalent amount of Ch$245,785 million (US$461.7 million).

     The tables below provide information about the Company’s borrowings and derivative financial instruments that are sensitive to foreign currency exchange rates. For the U.S. dollar-denominated debt, the tables present principal cash flows by maturity date. For the forward contracts, the tables present the amount of foreign currency that Telefónica Chile has contracted to purchase and the average UF-US$ exchange rates by contractual dates.

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    As of December 31, 2006 Expected Maturity Date 
   
    Average
Interest
Rate(1)		   2007    2008    2009    2010    2011    Thereafter    Total Long-
Term Debt
(including
2007
Maturities)		    Fair
Value(3)
                   
                   
                   
                   
                     
    (Ch$ equivalent in millions, except exchange rates)
On-Balance Sheet Financial                                     
   Instruments:                                     
Liabilities long-term interest-                                     
   bearing debt:                                     
Fixed rate (US$)(2)   -    -    -                   -    -    -                 -    -    - 
Variable rate (US$)   5.70%    1,559    79,859         106,478    -    79,858                 -    267,754    267,754 
 
Anticipated Transactions and                                     
   Related Derivatives                Expected transaction date             
Forward Exchange Agreements                                     
(Receive US$/pay Ch$):                                     
Liability        7,040    -                   -    -    -                 -    7,040    7,040 
Average contractual exchange        1.009                             
   rate                                     
   (Ch$/US$)           -                   -    -    -                 -    -    - 
(Receive Ch$/pay US$):                                     
Liability        14,058    -                   -    -    -                 -    14,058    14,058 
Average contractual exchange        0.0019                             
   rate                                     
   (US$/Ch$)           -                   -    -    -                   -    -    - 
(Receive Real/pay US$):                                     
Liability        71    -                   -    -    -                 -    71    71 
Average contractual exchange        2.4675                             
   rate                                     
   (US$/Real)           -                   -    -    -                   -    -    - 
Cross-Currency Swaps                                     
(Receive US$/pay UF)                                    
Liability        -    90,138         120,358    -    83,909                 -    294,405    294,405 
Average contractual exchange            0.0326    0.0328        0.0304             
   rate                                     
   (UF/US$)   -    -            -                       -    -    - 

________________________________________
(1)      “Average interest rate” means, for variable rate debt, the average prevailing interest rate as of December 31, 2006 on Telefónica Chile’s variable rate debt and, for fixed rate debt, the average prevailing interest rate as of December 31, 2006 on Telefónica Chile’s fixed rate debt.
 
(2)      The UF-dollar exchange rate differs from the peso-dollar exchange rate in that the UF automatically adjusts in accordance with Chilean inflation and is tied in part to the peso-dollar exchange rate.
 

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    As of December 31, 2005 Expected Maturity Date 
   
    Average
Interest
Rate(1)		   2006    2007    2008    2009    2010    Thereafter    Total Long-
Term Debt
(including
2006
Maturities)		    Fair
Value
                   
                   
                   
                   
                     
         (Ch$ equivalent in millions, except exchange rates)
On-Balance Sheet Financial                                     
   Instruments:                                     
Liabilities long-term interest-                                     
   bearing debt:                                     
Fixed rate (US$)(2)   8.19%    112,228           -    -    -           -    -    112,228    111,766 
Variable rate (US$)   4.75%    1,019         -    78,489    104,653           -    78,489    262,650    262,650 
 
Anticipated Transactions                                     
   and Related Derivatives                Expected transaction date             
Forward Exchange                                     
   Agreements                                     
(Receive US$/pay UF):(2)                                    
Liability        35,835           -    -    -           -    -    35,835    35,835 
Average contractual exchange        0.0308                             
   rate                                     
   (UF/US$)                -    -    -           -    -    -    - 
(Receive US$/pay Ch$):                                     
Liability        24,512           -    -    -           -    -    24,512    24,512 
Average contractual exchange        1.0184                             
   rate                                     
   (Ch$/US$)                    -    -    -             -    -    -    - 
(Receive Real/pay US$):                                     
Liability        71           -    -    -           -    -    71    71 
Average contractual exchange        2.6081                             
   rate                                     
   (US$/Real)                    -    -    -             -    -    -    - 
Cross-Currency Swaps                                     
(Receive US$/pay UF)                                    
Liability        -           -    87,435    118,794           -    39,556    245,785    245,785 
Average contractual exchange                0.0317    0.0324        0.0308         
   rate                                     
   (UF/US$)   -    -             -                     -        -    - 

________________________________________
(1)      “Average interest rate” means, for variable rate debt, the average prevailing interest rate as of December 31, 2005 on Telefónica Chile’s variable rate debt and, for fixed rate debt, the average prevailing interest rate as of December 31, 2005 on Telefónica Chile’s fixed rate debt.
 
(2)      The UF-dollar exchange rate differs from the peso-dollar exchange rate in that the UF automatically adjusts in accordance with Chilean inflation and is tied in part to the peso-dollar exchange rate.
 

     In addition, during 2006, the Company held U.S. dollar-denominated marketable securities such as U.S. dollar-denominated debentures of the Chilean Central Bank (“BCD” and “BCU”). The total fair value of these securities is Ch$16,278 million.

     During 2005, the Company held U.S. dollar-denominated marketable securities such as U.S. dollar-denominated debentures of the Chilean Central Bank (“BCD” and “BCU”). The total fair value of these securities is Ch$16,081 million.

     The tables below provide information about the Company’s U.S. dollar-denominated marketable securities that are sensitive to foreign currency exchange rates and present principal cash flows by maturity date.

    As of December 31, 2006
Maturity Date(1)
                                 
    Average
Interest
Rate(2)		   2007    2008       2009    2010    2011    No 
Contractual
Maturity 		   Fair Value 
             
             
                   
(in Ch$ millions as of December 31, 2005)

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    As of December 31, 2006 
    Maturity Date(1)
   
    Average
Interest
Rate(2)		   2007    2008       2009    2010    2011    No
Contractual
Maturity 		   Fair Value 
                 
                 
                 
Marketable securities:                                 
BCD    5.00%    14,315    -    -    -           -    -    14,315 
BCU    5.00%    -    -    1,963    -           -    -    1,963 
   Total        -    -    -    -           -    -    16,278 
                 
                 

________________________________________
(1)      These figures, calculated based on the Observed Exchange Rate as of December 31, 2006, which was Ch$532.39 = US$1.00, reflect the amount Telefónica Chile would receive if the U.S. dollar-denominated marketable securities were held to maturity.
 
(2)      Securities coupon. Effective average rates for BCD and BCU are 5.35% and 2.9%, respectively.
 
    As of December 31, 2005 
    Maturity Date(1)
   
    Average
Interest
Rate(2)		   2006    2007    2008    2009    2010    No
Contractual
Maturity 		   Fair Value 
                 
                 
                 
            (in Ch$ millions as of December 31, 2005)        
Marketable securities:                                 
BCD    5.00%           -    14,097               -    -           -    -    14,097 
BCU    5.00%           -           -               -    1,984           -    -    1,984 
   Total               -    -               -    -           -    -    16,081 
                 
                 

________________________________________
(1)      These figures, calculated based on the Observed Exchange Rate as of December 31, 2005, which was Ch$512.50 = US$1.00, reflect the amount Telefónica Chile would receive if the U.S. dollar-denominated marketable securities were held to maturity.
 
(2)    Securities coupon. Effective average rates for BCD and BCU are 5.06%, and 3.14%, respectively.
 

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ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

     Not applicable.

PART II

ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

     None.

ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS

     None.

ITEM 15. CONTROLS AND PROCEDURES

     Evaluation of disclosure controls and procedures. Under the supervision and with the participation of our management, including our Chief Executive Officer, Chief Financial Officer and Chief Accounting Officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2006. Based on that evaluation, our Chief Executive Officer, Chief Financial Officer and Chief Accounting Officer have concluded that these controls and procedures are effective in ensuring that all material information required to be filed in this Annual Report has been made known to them in a timely fashion.

     Management’s Annual Report on Internal Control over Financial Reporting. The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) or 15d-15(f) promulgated under the Securities Exchange Act of 1934 as a process designed by, or under the supervision of, the Company’s Chief Executive Officer, Chief Financial Officer and Chief Accounting Officer and effected by the Company’s Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:

     Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transaction and dispositions of the assets of the Company;

     Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and

     Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use of disposition of the Company’s assets that could have a material effect on the financial statements.

     Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

     The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006. In making this assessment, the Company’s management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework.

     Based on our assessment, management believes that, as of December 31, 2006, the Company’s internal control over financial reporting is effective based on those criteria.

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     Management’s assessment of the effectiveness of internal control over financial reporting as of December 31, 2006, has been audited by Ernst & Young Ltda., an independent registered public accounting firm, as stated in their report, which is included under “Item 18 Financial Statements”.

     Changes in internal controls. No significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses, were made as a result of the evaluation.

ITEM 16. [RESERVED]

ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT

     On July 21, 2005, an “Audit Committee” was created with a total of three independent members pursuant to the requirements of the Sarbanes-Oxley Act. The members of this Committee are Mr. Andrés Concha, Mr. Alfonso Ferrari and Mr. Hernán Cheyre. Mr. Hernán Cheyre was appointed as “Audit Committee Financial Expert” as defined by the Securities and Exchange Commission.

ITEM 16B. CODE OF ETHICS

     We have adopted a code of ethics that applies to our Principal Executive Officer, Principal Financial Officer, Principal Accounting Officer, Controller, and to persons performing similar functions. The complete code of ethics is available on the Telefónica Chile website (www.telefonicachile.cl).

ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES

     Ernst &Young Ltda. has served as the Company’s independent public accountants for each of the financial years in the two-year period ended December 31, 2006, for which audited financial statements appear in this annual report on Form 20-F.

     The following table presents the aggregate fees for professional services and other services rendered by Ernst & Young Ltda (the “current audit firm”) to the Company in 2005 and 2006.

    As of December 31, 
   
    2005    2006 
     
    (in thousands of Chilean pesos as 
    of 
    December 31, 2006)
Audit Fees(1)   291,030    645,277 
Audit-Related Fees(2)   -    - 
Tax Fees(3)   -    - 
All Other Fees(4)   -    - 
     
     Total    291,030    645,277 
     
     

________________________________________
(1)      Audit Fees consist of fees billed for the annual audit services engagement and other audit services, which are those services that only the external auditor reasonably can provide, and include the group audit, statutory audits, comfort letters and consents, attest services, and assistance with and review of documents filed with the SEC.
 
(2)      Audit-related Fees consist of fees billed for assurance and related services that are reasonably related to the performance of the audit or review of our financial statements or that are traditionally performed by the external auditor, and include consultations concerning financial accounting and reporting standards, internal control reviews of new systems, programs and projects, review of security controls and operational effectiveness of systems, review of plans and controls for shared service centers, due diligence related to acquisitions, accounting assistance and audits in connection with proposed or completed acquisitions, and employee benefit plan audits.
 
(3)      Tax Fees include fees billed for tax compliance services, including the preparation of original and amended tax returns and claims for refund, tax consultations, such as assistance and representation in connection with tax
 

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  audits and appeals, tax advice related to mergers and acquisitions, transfer pricing, and requests for rulings or technical advice from taxing authorities, tax-planning services, and expatriate tax-planning and services.
 
(4)      All Other Fees include fees billed for training, forensic accounting, data security reviews, treasury control reviews and process improvement and advice, and environmental, sustainability and corporate social responsibility advisory services.
 

     Audit Committee Pre-Approval Policies and Procedures

     According to Article 52 of Chilean Corporations Law No. 18,046, the engagement of external auditors is approved by shareholders each year at the Company’s General Annual Shareholders’ Meeting. As such, the Board of Directors of the Company does not have a policy for hiring external auditors. The Company’s Directors’ Committee is responsible for proposal of external auditors made by the Board to shareholders at the General Annual Shareholders’ Meeting in accordance with the Chilean Corporations Law. At the General Annual Shareholders’ Meeting held in April 2005, Company Shareholders approved the engagement of Ernst & Young Ltda. for the twelve-month period ending April 2006. At the General Annual Shareholders’ Meeting held on April 20, 2006, Company shareholders approved the engagement of Ernst & Young Ltda. for the next twelve-month period ending April 2007, for the amounts of UF20,000 for the audit and between UF7,700 to UF12,000 for compliance work relating to the Sarbanes-Oxley Act requirements.

     During 2006, the Company’s principal accountants did not render any non-audit services. The Company has not permitted the principal accountants to render any non-audit services. The Company’s Directors’ Committee approves all audit, audit-related services, tax services and other services provided by auditing firms. The Audit Committee’s main duties are related to Independent Audits, disclosure of Financial Statements and Internal Audits.

ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES

     Not applicable.

ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS

     None.

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PART III

ITEM 17. FINANCIAL STATEMENTS

     Not applicable.

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ITEM 18. FINANCIAL STATEMENTS

The following financial statements (beginning on page F-1), together with the related Reports of Independent Registered Public Accounting Firm, are filed as part of this Annual Report.

Report of Independent Registered Public Accounting Firm for the years 2005 and 2006 Report of Independent  F-1
Registered Public Accounting Firm for the year 2004  F-2
Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting  F-3
Consolidated Balance Sheets as of December 31, 2005 and 2006  F-4
Consolidated Statements of Income for each of the three years in the period ended December 31, 2006  F-6
Consolidated Statement of Changes in Equity for each of the three years in the period ended December 31, 2006  F-7
Consolidated Statements of Cash Flow for each of the three years in the period ended December 31, 2006  F-8
Notes to the Consolidated Financial Statements  F-9

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ITEM 19. EXHIBITS

Exhibit No. 
   Description 
   
1.1   
English translation of the Bylaws (Estatutos) of the Company, as amended, which includes its corporate charter. (4)
     
2.1   
The instruments defining the rights of holders of the outstanding long-term debt securities of the Company and its subsidiaries are omitted pursuant to Instruction 2(b)(i) of the Instructions to the Exhibits of Form 20-F. The Company hereby agrees to furnish copies of these instruments to the Securities and Exchange Commission upon request. 
     
4.1   
English translation of Contract for the Sale of Sonda Shares between Telefónica Empresas CTC Chile S.A. and Inversiones Pacífico II Limitada dated September 26, 2002.(1)
     
4.2   
English translation of Contract for the Sale of Sonda Shares between Telefónica Empresas CTC Chile S.A. and Inversiones Santa Isabel Limitada dated September 26, 2002.(1)
     
4.3   
English translation of the Option Agreement between Telefónica Empresas CTC Chile S.A. and Inversiones Santa Isabel Limitada dated September 26, 2002.(1)
     
4.4   
English translation of Contract for the Sale of Sonda Shares between the seller Telefónica Empresas CTC Chile S.A. and the buyers Inversiones Pacífico II Limitada, Inversiones Atlántico Limitada and Santa Isabel Limitada dated August 27, 2003.(2)
     
4.5   
English translation of Contract for the Sale of 9% ownership interest in Publiguías between the seller Telefónica Chile S.A. and the buyer Telefónica Publicidad e Información S.A. (TPI) dated April 26, 2004. (3)
     
4.6   
English translation of Contract for the Sale of Telefónica Móvil de Chile S.A. shares between the seller Telefónica Chile S.A. and the buyer Telefónica Móviles S.A. (TEM) dated July 23, 2004. (3)
     
8.1    List of Subsidiaries of the Company. 
     
11.1    Code of Ethics(2)
     
12.1   
     
12.2   
     
12.3   
     
13.1   
     
13.2   
     
13.3   

________________________________________
(1)      Filed as an Exhibit to the Company’s annual report on Form 20-F for the fiscal year ended December 31, 2002 and incorporated by reference hereto.
 
(2)      Filed as an Exhibit to the Company’s annual report on Form 20-F for the fiscal year ended December 31, 2003 and incorporated by reference hereto.
 
(3)      Filed as an Exhibit to the Company’s annual report on Form 20-F for the fiscal year ended December 31, 2004 and incorporated by reference hereto.
 
(4)      Filed as an Exhibit to the Company’s annual report on Form 20-F for the fiscal year ended December 31, 2005 and incorporated by reference hereto.
 

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SIGNATURES
 
 
      The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.

 

  COMPAÑÍA DE TELECOMUNICACIONES DE CHILE, S.A.
     
 
By:
     /S/ Julio Covarrubias
     
    Name:   Julio Covarrubias
    Title:     Chief Financial Officer

Date: April 13, 2007

 

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COMPAÑIA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES

Audited Consolidated Financial Statements as of
December 31, 2005 and 2006 and for each of the three years in the period ended December 31, 2006
together with the Reports of Independent Registered Public Accounting Firms

 

 

 

(Translation of financial statements originally issued in Spanish)

TABLE OF CONTENTS

    Page 
 
Report of Independent Registered Public Accounting Firm for the years 2005 and 2006   F-1
Report of Independent Registered Public Accounting Firm for the year 2004   F-2
Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting   F-3
Consolidated Balance Sheets as of December 31, 2005 and 2006   F-4
Consolidated Statements of Income for each of the three years in the period ended December 31, 2006   F-6
Consolidated Statement of Changes in Equity for each of the three years in the period ended December 31, 2006   F-7
Consolidated Statements of Cash Flow for each of the three years in the period ended December 31, 2006   F-8
Notes to the Consolidated Financial Statements   F-9
 
Ch$ : Chilean peso     
ThCh$: Thousands of Chilean pesos.     
UF : The Unidad de Fomento, or UF, is an inflation-indexed peso-denominated monetary unit in Chile. The daily UF 
rate is fixed in advance based on the change in the Chilean Consumer Price Index of the previous month. 
US$ : United States dollars     
ThUS$: Thousands of United States dollars.     

Table of Contents

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders of
Compañía de Telecomunicaciones de Chile S.A.:

We have audited the accompanying consolidated balance sheets of Compañía de Telecomunicaciones de Chile S.A. and its subsidiaries (the “Company”) as of December 31, 2005 and 2006, and the related consolidated statements of operations, changes in shareholders’ equity and cash flows for each of the two years in the period ended December 31, 2006. Our audits also included the financial statement Schedule II - Valuation and Qualifying Accounts. These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Compañía de Telecomunicaciones de Chile S.A. and subsidiaries at December 31, 2005 and 2006, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2006, in conformity with accounting principles generally accepted in Chile, which differ in certain respects from US generally accepted accounting principles (see Note 37 to the consolidated financial statements). Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

As described in Note 3 to the financial statements, beginning on January 1, 2005, the Company implemented changes in estimates regarding its accounting for staff severance indemnities to record the future obligation using actuarial valuation, and regarding its process to record accounts receivable and payable from international traffic.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated January 24, 2007, except for internal control over financial reporting related to Notes 35 and 37 of the 2006 consolidated financial statements as to which the date is April 12, 2007, expressed an unqualified opinion thereon.

ERNST & YOUNG LTDA. 

Santiago, Chile
January 24, 2007
(Except as to Notes 35 and 37 as to which the date is April 12, 2007)

F-1

Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders of Compañía de Telecomunicaciones de Chile S.A.:

We have audited the accompanying consolidated statements of operations and cash flows of Compañía de Telecomunicaciones de Chile S.A. and Subsidiaries (the “Company”) for the year ended December 31, 2004 (all expressed in constant Chilean pesos). Our audit also included the financial statement schedules listed in the index to Item 18. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the results of the operations and the cash flows of Compañía de Telecomunicaciones de Chile S.A. and subsidiaries for the year ended December 31, 2004, in conformity with accounting principles generally accepted in Chile. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.

As detailed in Note 26 a), on July 23, 2004, the Company sold its subsidiary Telefónica Móvil de Chile S.A. As a result of this transaction, the Company recognized a gain on disposal of ThCh$303,540,170 (historical), net of taxes and goodwill write-off.

Accounting principles generally accepted in Chile vary in certain significant respects from accounting principles generally accepted in the United States of America. Information relating to the nature and effect of such differences is presented in Note 37 to the consolidated financial statements.

 


Deloitte.
Santiago, Chile

June 10, 2005

F-2

Table of Contents

Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting

The Board of Directors and Shareholders of Compañía de Telecomunicaciónes de Chile S.A.:

We have audited management’s assessment, included in the accompanying management’s report on internal control over financial reporting, that Compañía de Telecomunicaciónes de Chile S.A. and subsidiaries (the “Company”) maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the 2005 and 2006 consolidated financial statements of Compañía de Telecomunicaciones de Chile S.A. and our report dated January 24, 2007, except as to Notes 35 and 37 as to which the date is April 12, 2007 expressed an unqualified opinion thereon.

ERNST & YOUNG LTDA. 

Santiago, Chile
January 24, 2007
(Except for internal control over financial reporting related to Note 35 and 37 of the 2006 consolidated financial statements as to which the date is April 12, 2007)

F-3

Table of Contents

COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2005 and 2006
(Restated for general price-level changes and expressed in thousands of constant Chilean pesos
as of December 31, 2006 except as stated)

      As of December 31, 
     
ASSETS  Notes    2005    2006    2006 
         
      ThCh$    ThCh$    ThUS$ 
              (Note 2)
CURRENT ASSETS:               
     Cash      6,424,238    10,074,960    18,924 
     Time deposits  (4)   86,753,294    27,543,715    51,736 
     Marketable securities, net  (5)   16,078,005    16,263,602    30,548 
     Accounts receivable, net  (6)   151,965,200    176,310,318    331,168 
     Notes receivable, net  (6)   3,433,457    4,125,379    7,749 
     Other receivables  (6)   12,271,773    10,524,404    19,768 
     Due from related companies  (7a)   14,546,828    17,421,462    32,723 
     Inventories, net      2,867,731    5,259,293    9,879 
     Prepaid taxes      4,731,578    2,965,213    5,570 
     Prepaid expenses      2,655,976    922,191    1,732 
     Deferred taxes, net  (8b)   11,930,838    13,932,290    26,169 
     Other current assets  (9)   11,333,038    10,948,558    20,565 
         
 
         TOTAL CURRENT ASSETS      324,991,956    296,291,385    556,531 
         
 
PROPERTY, PLANT AND EQUIPMENT  (11)            
     Land      27,852,723    27,858,064    52,326 
     Buildings and improvements      791,790,968    785,112,256    1,474,694 
     Machinery and equipment      2,723,729,586    2,762,527,493    5,188,917 
     Other property, plant and equipment      264,559,181    316,701,911    594,868 
     Technical revaluation      9,948,548    9,463,656    17,776 
     Accumulated depreciation      (2,490,072,578)   (2,672,072,073)   (5,019,013)
         
 
         TOTAL PROPERTY, PLANT AND EQUIPMENT, NET      1,327,808,428    1,229,591,307    2,309,568 
         
 
OTHER NON-CURRENT ASSETS               
     Investment in related companies  (12)   7,996,697    8,109,310    15,232 
     Investment in other companies      4,179    4,179    8 
     Goodwill, net  (13)   18,838,807    15,954,977    29,969 
     Long term receivables  (6)   15,706,980    13,607,076    25,558 
     Intangibles,net  (14)   37,809,712    35,272,664    66,253 
     Other non-current assets  (15)   13,897,470    17,945,351    33,707 
         
 
         TOTAL OTHER ASSETS      94,253,845    90,893,557    170,727 
         
 
 
TOTAL ASSETS      1,747,054,229    1,616,776,249    3,036,826 
         

The accompanying notes 1 to 37 are an integral part of these consolidated financial statements

F - 4

Table of Contents

COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2005 and 2006
(Restated for general price-level changes and expressed in thousands of constant Chilean pesos
as of December 31, 2006 except as stated)

      As of December 31, 
     
LIABILITIES AND SHAREHOLDERS’ EQUITY  Notes    2005    2006    2006 
         
      ThCh$    ThCh$    ThUS$ 
              (Note 2)
CURRENT LIABILITIES:               
     Current maturities of long-term debt  (16)   1,347,294    2,005,114    3,766 
     Commercial paper  (18a)   58,285,826    -    - 
     Current maturities of bonds payable  (18b)   113,712,131    1,839,758    3,456 
     Current maturities of other long-term obligations      16,862    11,722    22 
     Dividends payable      1,755,595    1,598,709    3,003 
     Trade accounts payable  (19)   78,087,761    107,216,258    201,387 
     Other payables  (20)   20,939,772    13,926,967    26,159 
     Due to related companies  (7b)   26,408,461    33,007,160    61,998 
     Accruals  (21)   10,299,309    8,381,697    15,744 
     Withholdings      12,584,338    16,586,668    31,155 
     Deferred Revenue      10,981,319    10,099,258    18,970 
     Other current liabilities      849,241    -    - 
         
 
             TOTAL CURRENT LIABILITIES      335,267,909    194,673,311    365,660 
         
 
   LONG-TERM LIABILITIES               
     Long-term debt with banks and               
          financial institutions  (17)   326,873,609    331,380,831    622,440 
     Bonds payable  (18b)   12,453,342    66,141,943    124,236 
     Other accounts payable  (23)   26,013,822    28,210,503    52,988 
     Accruals  (21)   36,078,910    35,525,488    66,728 
     Deferred taxes, net  (8b)   59,588,547    55,064,116    103,428 
     Other liabilities      4,095,910    3,788,895    7,116 
         
 
          TOTAL LONG-TERM LIABILITIES      465,104,140    520,111,776    976,936 
         
 
   CONTINGENCIES AND COMMITMENTS  (31)   -    -    - 
 
   MINORITY INTEREST  (24)   1,670,081    1,230,287    2,311 
 
   SHAREHOLDERS' EQUITY  (25)            
     Paid-in capital      931,859,276    890,894,953    1,673,388 
     Other reserves      (1,788,017)   (3,000,511)   (5,636)
     Retained earnings      14,940,840    12,866,433    24,167 
         
 
          TOTAL SHAREHOLDERS' EQUITY      945,012,099    900,760,875    1,691,919 
         
 
TOTAL LIABILITIES, MINORITY INTEREST 
     AND SHAREHOLDERS' EQUITY 		     1,747,054,229    1,616,776,249    3,036,826 
         
         

The accompanying notes 1 to 37 are an integral part of these consolidated financial statements

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Table of Contents

COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31, 2004, 2005 and 2006
(Restated for general price-level changes and expressed in thousands of constant Chilean pesos
as of December 31, 2006 except as stated)

      For the years ended December 31, 
     
  Notes    2004    2005    2006       2006 
           
      ThCh$    ThCh$    ThCh$     ThUS$ 
                  (note 2)
 
OPERATING REVENUES      743,470,466    592,904,274    577,203,534    1,084,174 
Operating costs      (470,119,649)   (380,887,804)   (373,024,912)   (700,661)
           
 
Gross profit      273,350,817    212,016,470    204,178,622    383,513 
Administrative and selling expenses      (168,491,083)   (123,091,244)   (121,554,811)   (228,319)
           
 
OPERATING RESULTS      104,859,734    88,925,226    82,623,811    155,194 
           
 
 
NON-OPERATING RESULTS:                   
         Interest income      9,822,201    8,152,458    4,436,559    8,333 
         Equity in earnings of equity-method investees  (12)   761,908    1,748,329    1,949,359    3,662 
         Other non-operating income  (26a)   502,951,353    3,170,833    1,616,867    3,037 
         Equity in losses of equity-method investees  (12)   (187,934)   (33,193)   (33,628)   (63)
         Amortization of goodwill  (13)   (148,511,412)   (1,616,816)   (2,222,691)   (4,175)
         Interest expense and other      (57,175,378)   (30,120,752)   (19,480,089)   (36,590)
         Other non-operating expenses  (26b)   (26,095,860)   (13,351,580)   (16,644,682)   (31,264)
         Price-level restatement, net  (27)   (4,407,261)   1,985,668    500,929    941 
         Foreign exchange gain, net  (28)   13,908,037    976,129    164,889    310 
           
 
NON-OPERATING (LOSS) INCOME, NET      291,065,654    (29,088,924)   (29,712,487)   (55,809)
           
 
INCOME BEFORE INCOME TAXES                   
    AND MINORITY INTEREST      395,925,388    59,836,302    52,911,324    99,385 
 
INCOME TAXES  (8c)   (65,998,904)   (34,093,408)   (29,599,897)   (55,598)
           
 
INCOME BEFORE                   
 MINORITY INTEREST      329,926,484    25,742,894    23,311,427    43,787 
 
MINORITY INTEREST  (24)   (299,385)   (30,724)   41,619    78 
           
 
NET INCOME FOR THE YEAR      329,627,099    25,712,170    23,353,046    43,865 
           

The accompanying notes 1 to 37 are an integral part of these consolidated financial statements

F - 6

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COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
For the years ended December 31, 2004, 2005 and 2006
(Restated for general price-level changes and expressed in thousands of constant Chilean pesos
as of December 31, 2006 except as stated)

          Net income            Total 
  Paid-in    Other    (loss) for    Retained    Interim    shareholders' 
  capital    reserves    the year    Earnings    dividend    equity 
  ThCh$    ThCh$    ThCh$    ThCh$    ThCh$    ThCh$ 
             
2004                       
Balances as of December 31, 2003  859,490,281    (791,199)   10,133,882    421,404,583    -    1,290,237,547 
Transfer of 2003 net income to retained earnings  -    -    (10,133,882)   10,133,882    -    - 
Accumulated adjustment for conversion differences  -    (425,240)   -    -    -    (425,240)
Final dividend 2003  -    -    -    (3,062,903)   -    (3,062,903)
Final dividend  -    -    -    (385,685,783)   -    (385,685,783)
2004 interim dividend  -    -    -    -    (252,992,348)   (252,992,348)
Price-level restatement  21,487,256    (21,212)   -    6,016,572    (2,311,551)   25,171,065 
Net income for the year  -    -    311,628,674    -    -    311,628,674 
             
 
Balances as of December 31, 2004  880,977,537    (1,237,651)   311,628,674    48,806,351    (255,303,899)   984,871,012 
Balances as of December 31, 2004 restated  931,859,276    (1,309,132)   329,627,099    51,625,211    (270,049,231)   1,041,753,224 
             
                       
2005                       
Balances as of December 31, 2004  880,977,537    (1,237,651)   311,628,674    48,806,351    (255,303,899)   984,871,012 
Transfer of 2004 net income to retained earnings  -    -    (311,628,674)   311,628,674    -    - 
Accumulated adjustment for conversion differences  -    (469,034)   -    -    -    (469,034)
Absorption interim dividend  -    -    -    (255,303,899)   255,303,899    - 
Final dividend 2004  -    -    -    (56,324,775)   -    (56,324,775)
Final dividend  -    -    -    (48,806,351)   -    (48,806,351)
2005 interim dividend  -    -    -    -    (10,528,728)   (10,528,728)
Price-level restatement  31,715,192    (44,556)   -    -    (21,058)   31,649,578 
Net income for the year  -    -    25,183,320    -    -    25,183,320 
             
 
Balances as of December 31, 2005  912,692,729    (1,751,241)   25,183,320    -    (10,549,786)   925,575,022 
Balances as of December 31, 2005 restated  931,859,276    (1,788,017)   25,712,170    -    (10,771,330)   945,012,099 
             
 
2006                       
Balances as of December 31, 2005  912,692,729    (1,751,241)   25,183,320    -    (10,549,786)   925,575,022 
Transfer of 2005 net income to retained earnings  -    -    (25,183,320)   25,183,320    -    - 
Capital Decrease  (40,200,514)   -    -    -    -    (40,200,514)
Absorption interim dividend  -    -    -    (10,528,728)   10,528,728    - 
Final dividend 2005  -    -    -    (14,654,592)   -    (14,654,592)
2006 interim dividend  -    -    -    -    (10,528,728)   (10,528,728)
Adjustment of foreign investment conversion reserve  -    (530,149)   -    -    -    (530,149)
Price-level restatement, net  18,402,738    (44,867)   -    -    63,173    18,421,044 
Other reserves  -    (674,254)   -    -    -    (674,254)
Net income for the year  -    -    23,353,046    -    -    23,353,046 
             
 
Balances as of December 31, 2006  890,894,953    (3,000,511)   23,353,046    -    (10,486,613)   900,760,875 
             
             
 
ThUS$ (note 2) 1,673,388    (5,637)   43,865    -    (19,697)   1,691,919 
             

 

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COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 2004, 2005 and 2006
(Restated for general price-level changes and expressed in thousands of constant Chilean pesos
as of December 31, 2006 except as stated)

  For the years ended December 31, 
   
 
  2004    2005    2006    2006 
         
 
  ThCh$    ThCh$    ThCh$    ThUS$ 
              (note 2)
Net income for the year  329,627,099    25,712,170    23,353,046    43,865 
Sales of assets:               
       (Gain) loss on sales of property, plant and equipment  16,181    21,738    (369,370)   (694)
       Gain on sales of investments  (498,573,176)   -    -    - 
 
Debits (credits ) to income that do not represent operating cash flows:               
       Depreciation in operating income for the year  241,080,624    198,189,266    204,027,048    383,229 
       Other depreciation  6,701,327    2,724,767    879,772    1,652 
       Amortization of intangibles  2,724,861    4,847,335    5,024,127    9,437 
       Provisions and write offs  37,603,098    24,902,211    18,166,959    34,123 
       Equity in earnings of equity method investees  (761,908)   (1,748,329)   (1,949,359)   (3,662)
       Equity in losses of equity method investees  187,934    33,193    33,628    63 
       Amortization of goodwill  148,511,412    1,616,816    2,222,691    4,175 
       Price-level restatement, net  4,407,261    (1,985,668)   (500,929)   (941)
       Foreign exchange (loss) gain  (13,908,037)   (976,129)   (164,889)   (310)
       Other credits to income that do not represent cash flows  (1,062,897)   (291,238)   (348,448)   (654)
       Other debits to income that do not represent cash flows  12,228,052    5,706,348    4,765,168    8,951 
 
Changes in operating assets (increase) decrease:               
       Trade accounts receivable  (14,296,772)   (6,020,873)   (25,378,648)   (47,669)
       Inventories  (14,278,177)   2,248,105    (1,691,020)   (3,176)
       Other assets  24,067,225    69,775,880    7,383,569    13,869 
 
Changes in operating liabilities increase (decrease):               
       Accounts payable related to operating activities  (65,365,732)   (74,456,219)   9,437,998    17,728 
       Interest payable  (7,760,572)   1,748,841    1,090,622    2,049 
       Income taxes payable (net) 46,847,566    (23,756,730)   (16,247,098)   (30,517)
       Other accounts payable related to non-operating activities  (6,769,161)   1,727,998    5,574,141    10,470 
       V.A.T. and other similar taxes payable  3,211,066    (3,783,493)   (636,558)   (1,196)
 
Minority interest  299,385    30,724    (41,619)   (78)
         
 
NET CASH FLOWS FROM OPERATING ACTIVITIES  234,736,659    226,266,713    234,630,831    440,714 
         
 
NET CASH USED IN FINANCING ACTIVITIES               
Issuance of Commercial papers and Bonds  36,873,322    70,465,529    73,366,735    137,806 
Dividends paid  (670,458,928)   (118,171,643)   (25,340,206)   (47,597)
Capital Decrease  -    -    (40,596,288)   (76,253)
Loans repaid  (18,176,890)   (35,093,202)   -    - 
Repayment of Commercial papers and Bonds (less) (225,844,067)   (122,595,127)   (188,404,582)   (353,885)
Repayment of other loans from related companies (less) (23,608,290)   -    -    - 
Other sources of financing  -    -    (687,110)   (1,291)
         
 
Net cash used in financing activities  (901,214,853)   (205,394,443)   (181,661,451)   (341,220)
         
 
NET CASH (USED IN) PROVIDED BY INVESTMENT ACTIVITIES               
Sales of property, plant and equipment  189,504    1,263,681    1,502,949    2,823 
Sales of permanent investments  720,552,658    -    -    - 
Sales of other investments  18,064,197    12,143,501    -    - 
Collection of documented loans to related companies  179,865,476    -    -    - 
Other investment income  -    26,866    -    - 
Acquisition of property, plant and equipment (less) (93,295,579)   (73,579,347)   (109,523,791)   (205,721)
Acquisition of intangibles  (7,262,498)   (7,946,870)   -    - 
Investments in financial instruments (less) (11,561,019)   (19,146,457)   -    - 
Permanent investments (less) -    (49,591)   -    - 
Other investment activities (less) (3,280,068)   (965,524)   -    - 
         
 
Net cash (used in) provided by investment activities  803,272,671    (88,253,741)   (108,020,842)   (202,898)
         
 
NET CASH FLOWS FOR THE YEAR  136,794,477    (67,381,471)   (55,051,462)   (103,404)
 
EFFECT OF INFLATION ON CASH AND CASH EQUIVALENTS  (6,713,663)   (1,574,386)   (863,534)   (1,622)
         
 
NET (DECREASE) INCREASE OF CASH AND CASH EQUIVALENTS  130,080,814    (68,955,857)   (55,914,996)   (105,026)
 
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR  36,137,096    166,217,910    97,262,053    182,689 
         
 
CASH AND CASH EQUIVALENTS AT END OF YEAR  166,217,910    97,262,053    41,347,057    77,663 
         

The accompanying notes 1 to 37 are an integral part of these consolidated financial statements

F - 8

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COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements

Note 1. Composition of Consolidated Group and Registration with the Securities Registry:

Compañía de Telecomunicaciones de Chile S.A. and subsidiaries (“Telefónica Chile S.A.” or the “Company”) provides telecommunication services within Chile which consist of local and long distance telephone services and certain broadband services.

The Company is an open-stock corporation that is registered in the Securities Registry under No. 009 and is therefore subject to supervision by the Chilean Superintendency of Securities and Insurance (“SVS”) as well as by the United States Securities and Exchange Commission (“SEC”) since issuing American Depositary Receipts (“ADRs”) in 1990.

Subsidiary companies registered with the Securities Registry are:

            Participation 
(direct & indirect)
as of December 31, 
       
Subsidiaries   Taxpayer    Registration    2004    2005    2006 
    Number    Number    %    %    % 
           
 
Telefónica Larga Distancia S.A. (1)   96.551.670-0    456    99.16    99.16    99.31 
Globus 120 S.A. (1)   96.887.420-9    694    99.99    99.99    - 
Telefónica Asistencia y Seguridad S.A.    96.971.150-8    863    99.99    99.99    99.99 

(1) On April 19, 2006, Telefónica Mundo S.A. changed its name to Telefónica Larga Distancia S.A. On May 1, 2006, Telefónica Larga Distancia S.A. absorbed Globus 120 S.A.

Note 2. Summary of Significant Accounting Policies:

a) Accounting period:

These consolidated financial statements (hereinafter the “financial statements”) are presented as of and for the years ended December 31, 2005 and 2006. (The following presentation of Form 20-F includes comparable disclosures and information of the income and cash flow statements for the year ended December 31, 2004. Originally this additional information was not presented in the local consolidated financial statements as of December 31, 2006).

b) Basis of preparation:

The consolidated financial statements have been prepared in accordance with Generally Accepted Accounting Principles in Chile (“Chilean GAAP”) and standards set forth by the Chilean Superintendency of Securities and Insurance. In the event of discrepancies between the generally accepted accounting principles in Chile issued by the Chilean Accountants Association and the standards set forth by the SVS, the standards set forth by the SVS shall prevail for the Company.

(c) Basis of presentation:

The comparative balances as of December 31, 2004 and 2005 have been price-level restated in order to allow comparison with the 2006 financial statements as detailed in Note 2e. For comparison purposes, certain reclassifications have been made to the 2004 and 2005 financial statements.

For the convenience of the reader, the financial statements have been translated from Spanish to English.

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COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

Note 2. Summary of Significant Accounting Policies, (continued):

(d) Basis of consolidation:

The financial statements include the assets, liabilities, income and cash flows of Compañía de Telecomunicaciones de Chile (the “Parent Company”) and subsidiaries. Significant intercompany transactions have been eliminated, and the participation of minority investors has been recognized as Minority Interest (see Note 24).

The Company consolidates the following companies:

        Ownership participation percentage 
     
        2004    2005    2006 
         
Taxpayer    Company name                     
No.        Total    Total    Direct   Indirect    Total 
               
 
96.551.670-0    Telefónica Larga Distancia S.A. (5)   99.16    99.16    99.31    -    99.31 
96.961.230-5    Telefónica Gestión de Servicios Compartidos Chile S.A.    99.99    99.99    99.99    -    99.99 
74.944.200-k    Fundación Telefónica Chile    50.00    50.00    50.00    -    50.00 
96.971.150-8    Telefónica Asistencia y Seguridad S.A.    99.99    99.99    99.99    -    99.99 
90.430.000-4    Telefónica Empresas CTC Chile S.A.    99.99    99.99    99.99    -    99.99 
78.703.410-1    Telefónica Multimedia Chile S.A. (1)   99.99    99.99    99.99    -    99.99 
96.834.320-3    Telefónica Internet Empresas S.A. (2)   99.99    99.99    99.99    -    99.99 
96.811.570-7    Instituto Telefónica Chile S.A. (3)   79.99    79.99    -    99.99    99.99 
96.545.500-0    CTC Equipos y Servicios de Telecomunicaciones S.A. (4)   99.99    99.99    -    -    - 
96.887.420-9    Globus 120 S.A. (5)   99.99    99.99    -    -    - 

(1) On January 26, 2006, Telefónica Internet Empresas S.A. sold 449,081 shares of Tecnonáutica S.A. to Telefónica Chile S.A. for ThCh$ 1,624,273 (historical) corresponding to its participation in that company. On that same date, CTC Equipos y Servicios de Telecomunicaciones S.A. sold 1 share to Telefónica Chile S.A. for ThCh$ 4 corresponding to its participation in that company. On April 19, 2006, Tecnonáutica S.A. changed its name to Telefónica Multimedia Chile S.A.

(2) On January 26, 2006, CTC Equipos y Servicios de Telecomunicaciones S.A. sold 16 shares of Telefónica Internet Empresas S.A. to Telefónica Chile S.A. for ThCh$ 132 (historical value) corresponding to its participation in that company.

On January 27, 2006, Telefónica Empresas CTC Chile S.A. sold 215,099 shares of Telefónica Internet Empresas S.A. to Telefónica Chile S.A. for ThCh$ 1,468,683 (historical) corresponding to its participation in that company.

(3) On October 3, 2006, the third party COASIN Chile S.A. sold to Telefónica Gestión de Servicios Compartidos de Chile S.A. its participation in Administradora de Telepeajes de Chile S.A. of 426,000 shares for a sum of ThCh$ 3,200 (historical value). On October 20, 2006, Telefónica Internet Empresas S.A. sold to Telefónica Gestión de Servicios Compartidos Chile S.A. 1,703,999 shares of Telepeajes de Chile S.A. for ThCh$ 12,800 (historical value). On that same date, Administradora de Telepeajes de Chile S.A. changed its name to Instituto Telefónica Chile S.A.

(4) On February 28, 2006, Telefónica Chile S.A. purchased one share of CTC Equipos y Servicios de Telecomunicaciones S.A. from third parties for ThCh$ 11 (historical value), and absorbed its subsidiary on March 1, 2006.

(5) On April 19, 2006, Telefónica Mundo S.A. changed its name to Telefónica Larga Distancia S.A. On May 1, 2006, Telefónica Larga Distancia S.A. absorbed Globus 120 S.A.

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Notes to the Consolidated Financial Statements – (continued)
__________

Note 2. Summary of Significant Accounting Policies, (continued):

(e) Price-level restatement:

The cumulative inflation rate in Chile as measured by the Chilean Consumer Price Index (“CPI”) for the three-year period ended December 31, 2006 was approximately 8.9% .

Chilean GAAP requires that the financial statements be restated to reflect the full effects of changes in the purchasing power of the Chilean peso on the financial position and results of operations of reporting entities. The method is based on a model that enables calculation of net inflation gains or losses caused by monetary assets and liabilities exposed to changes in the purchasing power of the local currency. The historical costs of such accounts, equity accounts and the statement of operations are restated for general price-level changes between the initial date of recognition of each item and the year-end (see also Note 27).

The purchasing power gain or loss included in net income or loss reflects the effects of Chilean inflation on the monetary assets and liabilities held by the Company.

The restatements were calculated using the official consumer price index of the National Institute of Statistics and based on the “prior month rule”, in which the inflation adjustments are based on the CPI at the close of the month preceding the close of the respective period or transaction. This index is considered by the business community, the accounting profession and the Chilean government to be the index that most closely complies with the technical requirement to reflect the variation in the general level of prices in Chile, and consequently it is widely used for financial reporting purposes.

The values of the Chilean consumer price index used to reflect the effects of the changes in the purchasing power of the Chilean peso (“price-level restatement”) are as follows:

        Change over Previous 
    CPI    November 30 
     
November 30, 2004    100.0    2.50% 
November 30, 2005    103.6    3.60% 
November 30, 2006    105.8    2.10% 

The actual values of the Chilean consumer price index as of the balance sheet dates are as follows:

        Change over Previous 
    CPI    December 31 
     
December 31, 2004    100.0    2.40% 
December 31, 2005    103.7    3.70% 
December 31, 2006    106.4    2.60% 

The above-mentioned price-level restatements do not purport to represent appraisal or replacement values and are only intended to restate all non-monetary financial statement components in terms of local currency of a single purchasing power and to include in net income or loss for each year the gain or loss in purchasing power arising from the holding of monetary assets and liabilities exposed to the effects of inflation.

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Notes to the Consolidated Financial Statements – (continued)
__________

Note 2. Summary of Significant Accounting Policies, (continued):

(f) Basis of conversion:

Assets and liabilities in US$ (United States dollars), Euros, Brazilian Real, UF (Unidad de Fomento) and JPY (Japanese Yen) have been converted to Chilean pesos at the observed exchange rates as of December 31 of each year-end as follows:

Year    US$    EURO    UF    JPY    Real (Brazil)
           
2004    557.40    760.13    17,317.05    5.41    210.18 
2005    512.50    606.08    17,974.81    4.34    219.35 
2006    532.39    702.08    18,336.38    4.47    249.28 

Foreign currency translation differences resulting from the application of this Standard are recognized in net income.

Convenience translation to US dollars

The financial statements are stated in Chilean pesos. The translations of Chilean pesos into US dollars are included solely for the convenience of the reader, using the observed exchange rate reported by the Chilean Central Bank as of December 31, 2006 of Ch$ 532.39 to US$ 1.00. The convenience translations should not be construed as representations that the Chilean peso amounts have been, could have been, or could in the future be, converted into US dollars at this or any other rate of exchange.

(g) Time deposits:

Time deposits are carried at cost plus UF indexation adjustments, where applicable, and accrued interest as of year end.

(h) Marketable securities:

Fixed income securities and shares are recorded at the lower of their price-level restated cost plus accrued interest at each year-end using the actual interest yield determined at the purchase date, or at their market value, whichever is less.

(i) Inventories:

Depending on the nature of respective items, equipment held for sale is carried at the lower of either its price-level restated acquisition or production cost or at its market value. Movements are considered on a first-in first-out basis.

Inventories are expected to be used during a period of twelve months after their acquisition and classified as current assets. Their cost is price-level restated. The obsolescence provision has been determined on the basis of an analysis of materials with slow turnover.

(j) Allowance for doubtful accounts:

The Allowance for doubtful accounts is estimated on the basis of the aging of such accounts, up to 100% of accounts outstanding for more than 120 days and 180 days in the case of large customers (corporations).

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Notes to the Consolidated Financial Statements – (continued)
__________

Note 2. Summary of Significant Accounting Policies, (continued):

(k) Property, plant and equipment:

Property, plant and equipment are carried at their price-level restated acquisition and/or construction cost.

Property, plant and equipment acquired up to December 31, 1979 are carried at their appraisal value, as stipulated in Article 140 of D.F.L. No. 4. Some assets subsequently acquired were subject to a technical revaluation to their appraisal value recorded as of September 30, 1986, as authorized in SVS Circular No. 550 (see Note 11). All these values have been price-level restated.

(l) Depreciation of property, plant and equipment:

Depreciation has been calculated and recorded on a straight-line basis over the estimated useful lives of the assets.

Depreciation on assets owned and assets acquired under capital leases are computed using the straight-line method over the related assets’ estimated useful lives. The depreciation periods reflect the respective estimated economic useful lives of such assets and have been approved by the Chilean Undersecretary of Telecommunications and are summarized as follows:

     Range 
    of years 
   
 
Buildings   
20 to 40    
Central exchange equipment   
10 to 12    
Subscriber’s equipment   
2 to 10    
External plant   
3 to 40    
Office furniture and equipment   
3 to 10    
Software   
4    
Other   
4 to 10    

(m) Leased assets:

Leased assets with a purchase option, whose contracts satisfy the characteristics of a financial lease, are recorded similarly to the acquisition of property, plant and equipment, recognizing the full obligation and interest on an accrual basis. These assets are not legally owned by the Company; therefore, until it exercises the purchase option, they cannot be freely disposed of. The depreciation of leased assets is included in the total depreciation of property, plant and equipment.

(n) Intangibles:

 

i) Rights to underwater cable:

Rights to underwater cable correspond to the rights acquired by the Company for the use of an underwater cable to transmit voice and data. These rights are amortized over the term of the respective contracts, with a maximum of 25 years.

ii) Software licenses:

Software licenses are valued at their price-level restated acquisition cost. Amortization is calculated using the straight-line method over their estimated useful life, which does not exceed 4 years.

 

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Notes to the Consolidated Financial Statements – (continued)
__________

Note 2. Summary of Significant Accounting Policies, (continued):

(o) Investments in related companies:

These investments are accounted for under the equity method, which recognizes the investor’s share of income on an accrual basis. For investments abroad, the valuation methodology as defined in Technical Bulletin No. 64 is applied. Investments in countries deemed to be unstable and whose activities are not an extension of the operations of the Parent Company are first measured in US dollars and translated to Chilean pesos for inclusion in these financial statements.

(p) Goodwill:

Goodwill recorded by the Company was determined according to SVS Circular No. 368 based on differences between the purchase price and the recorded book values of the company acquired at the effective acquisition date. Amortization is determined using the straight-line method, considering the nature and characteristic of each investment, foreseeable life of the business and investment return, and does not exceed 20 years. Future acquisitions will be recorded using Technical Bulletin No. 72 based on the fair values of the identifiable assets and liabilities acquired. Any excess of the purchase price over the value of assets acquired and liabilities assumed will be allocated to goodwill.

The Company has evaluated the recoverability of its recorded goodwill in accordance with Technical Bulletin No. 56 and No. 72. As of December 31, 2005 and 2006, there were no indicators of an impairment of goodwill.

(q) Transactions with repurchase agreements:

Purchases of financial instruments including repurchase agreements are recorded as fixed rate instruments and are classified as Other Current Assets (see Note 9).

(r) Commercial paper and Bonds:

Bonds payable are presented under liabilities at the par value of the issued bonds (see Note 18b). The difference between par and placement value, determined on the basis of the actual interest rate for the transaction, is deferred and amortized over the term of the respective bond (see Notes 9 and 15).

Commercial papers are presented under liabilities at placement value plus accrued interest (see Note 18a).

Costs directly related to the placement of these obligations are deferred and amortized over the term of the respective liability.

(s) Income tax and deferred income tax:

The Company records income taxes in accordance with Technical Bulletin No. 60 and complementary technical bulletins thereto issued by the Chilean Association of Accountants, and with SVS Circulars No. 1466 and No. 1560, recognizing, using the liability method, the deferred tax effects of temporary differences between the financial reporting basis and tax basis of assets and liabilities. As a transitional provision at the date of adoption, a contra asset or liability has been recorded offsetting the effects of the deferred tax assets and liabilities not recorded prior to January 1, 2000. Such complementary asset or liability is being amortized to income over the estimated average reversal periods corresponding to the underlying temporary differences to which the deferred tax asset or liability relates calculated using the tax rates that will be in effect at the time of reversal.

The valuation allowances reflect amounts, which relate to deferred tax assets that management believes will more likely than not expire without benefit. In future periods, management's estimate of the amount of the deferred tax assets considered realizable may change, and hence the valuation allowance may increase or decrease.

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Notes to the Consolidated Financial Statements – (continued)
__________

Note 2. Summary of Significant Accounting Policies, (continued):

(t) Staff severance indemnities:

The severance indemnity that the Company is obligated to pay under collective bargaining agreements is recorded based on the projected benefit obligation using an annual discount rate of 7% in 2005 and 6% in 2006 as detailed in Note 3, considering assumptions about the future service period of the employees, mortality rate of employees and salary increases used as the basis of actuarial calculations (see Note 22).

Costs for past services of employees resulting from changes in assumptions used as the actuarial bases, are deferred and amortized over the average of the estimated employees’ future service periods.

(u) Revenue recognition:

The Company’s revenues are recognized on an accrual basis in accordance with Chilean GAAP. A revenue is recorded when the title and the risk of the related goods and services is transferred, regardless of when the resulting monetary or financial flow arises. Services performed and not billed at each year-end are valued at selling prices using current rates and are recorded as Trade Accounts Receivable.

The revenues from wireline telephony and other services are recognized on an accrual basis, i.e. when the actual flow of the related goods and services occurs, regardless of when the resulting monetary or financial flow arises.

The revenues generated by the sale of the prepaid cards (fixed telephony and long-distance telephony) are recognized when the traffic is used or when the card expires, whichever occurs first.

The revenues from sales of telecommunications equipment are recognized upon delivery to the customer.

Revenues for the charges of installations of telephone lines are recognized when the installation is complete.

(v) Foreign currency forwards:

The Company has entered into short-term forward contracts to purchase foreign currency. These contracts are hedging liabilities in foreign currency against changes in exchange rates.

These instruments are recorded in accordance with Technical Bulletin No. 57. This standard requires all financial derivative instruments to be recorded at fair value. Changes in fair value are either deferred as unrealized gains/losses or recorded directly in income depending on what type of hedge designation is applied or if the instrument is considered a hedge or not. No adjustments to the hedged item’s carrying amount are performed.

These contracts are detailed in Note 30, reflecting in the balance sheet only the net right or obligation at year-end, classified according to the maturity of each contract under Other Current Assets or Other Payables, as applicable.

(w) Cross currency interest rate swaps:

The Company has entered into long term cross currency interest rate swaps to hedge long-term liabilities denominated in foreign currencies with variable interest rates. These contracts are hedging both, currency risk and interest rate risk.

These instruments are recorded in accordance with Technical Bulletin No. 57. This standard requires all financial derivative instruments to be recorded at fair value. Changes in fair value are either deferred as unrealized gains/losses or recorded directly in income depending on what type of hedge designation is applied or if the instrument is considered a hedge or not. No adjustments to the hedged item’s carrying amount are performed.

These contracts are detailed in Note 30, reflecting in the balance sheet only the net right or obligation at period end, classified according to the maturity of each contract under Other Current Assets or Other Payables, as applicable.

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Notes to the Consolidated Financial Statements – (continued)
__________

Note 2. Summary of Significant Accounting Policies, (continued):

(x) Computer software:

The cost of software purchased is deferred and amortized using the straight-line method over a maximum period of four years and are classified as other property, plant and equipment.

(y) Research and development expenses:

Research and development expenses are charged to income in the period in which they are incurred. Those expenses have not been significant in the years presented in the financial statements.

(z) Other reserves:

The Company recognizes in this equity account the effect of exchange rate fluctuations and the Consumer Price Index (C.P.I.) resulting from measuring those investments abroad that are controlled in United States dollars. The balance of this account is recognized in income in the same period in which the gain or loss is recognized on the total or partial disposal of these investments.

(aa) Statement of cash flows:

The consolidated Statements of Cash Flows have been prepared using the indirect method in accordance with Technical Bulletin No. 50 of the Chilean Accountants Association and SVS Circular No. 1,312. The Company defines securities under agreements to resell and time deposits with a remaining maturity of less than 90 days as cash equivalents; cash and cash equivalents are detailed as follows:

   
As of December 31, 
   
   
2004
   2005       2006 
       
   
ThCh$ 
   ThCh$    ThCh$ 
 
Cash    8,313,844    6,424,238    10,074,960 
Time deposits    56,207,781    86,753,294    27,543,715 
Other current assets    101,696,285    4,084,521    3,728,382 
       
 
                         Total    166,217,910    97,262,053    41,347,057 
       
       

Cash flows related to the Company’s operations and all those not defined as from investing or financing activities are included in “Cash Flows from Operating Activities”.

(ab) Correspondents:

The Company has agreements with foreign counterparties to set the conditions that regulate international traffic, determining the payments for each counterparty based on fixed rates for the net exchange of traffic.

This receivables/payables related to these agreements are recorded on an accrual basis, recognizing the costs and income for the period in which these are incurred, recording the net receivable or payable for each counterparty where the legal right of offset exists under “Accounts Receivable” or “Accounts Payable” as applicable.

(ac) Use of estimates

The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

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Notes to the Consolidated Financial Statements – (continued)
__________

Note 3. Accounting Changes:

Changes in estimates

i) Changes in actuarial hypotheses

As established in Technical Bulletin No. 8 issued by the Chilean Association of Accountants and with the new contractual conditions derived from the organizational change in Company, a series of studies were undertaken that allowed the modification of the calculation base for the staff severance indemnities provision. Initially, in December 2004, this resulted in recognizing deferred assets of ThCh$ 4,872,939 (historical). After concluding these studies in 2005, the Company decided to include actuarial estimates in the calculation methodology used for this provision. The additional variables modified were personnel turnover index, mortality rate and future salary increases. As a result of these modifications, the Company recorded deferred assets of ThCh$ 3,648,704 in 2005.

During the first quarter of 2006, an evaluation was performed of the market interest rate used to calculate the current value of staff severance indemnities. After completing this analysis, the Company decided to reduce the discount rate from 7% to 6%. As a result of these modifications, the Company recorded deferred assets of ThCh$ 2,797,402 (historical).

All effects will be amortized over the future service period of the employees that receive this benefit (see portion to be amortized in the short-term in Note 9 Footnote 2 and in the long-term in Note 15 Footnote 1).

ii) Change in estimation of international traffic

Due to the profound changes experienced by the telecommunications industry, the Company changed its focus from a product-oriented approach to a segment-oriented approach. In response to this change, the Company initiated the development of information systems, changes in the processes and advances to the applications in the different business areas, in order to implement an automated system to measure, value and determine international traffic with foreign counterparties. This work has allowed the Company to improve its process regarding the determination of quantities of international traffic pending collection and/or settlement.

This new methodology resulted in a change to the estimation of the provisions, settlement and recoverability of the net balances of accounts receivable and payable to counterparties, resulting in a net charge to income in the amount of ThCh$ 10,624,218 (US$ 20.7 million (historical)) during the second half of 2005.

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Notes to the Consolidated Financial Statements – (continued)
__________

Note 4. Time deposits:

The detail of the time deposits is as follows as of December 31, 2005:

                Yearly             
                interest    Maturity    Accrued     
Placement    Financial Institution    Currency    Principal    rate    date    interest    Total 
               
             ThCh$    %        ThCh$    ThCh$ 
 
Dec 30, 2005    ABN AMRO BANK    US$    86,380,697    4.03    Jan 03, 2006    -    86,380,697 
Dec 26, 2005    BANCO CREDITO E INVERSIONES    US$    76,344    4.30    Jan 25, 2006    46    76,390 
Dec 06, 2005    BANCO CREDITO E INVERSIONES    UF    292,973    6.20    Mar 07, 2006    1,266    294,239 
Dec 30, 2005    BANCO SANTANDER SANTIAGO    Ch$    1,968    -    Jan 30, 2006    -    1,968 
               
 
                                                                   Total        86,751,982            1,312    86,753,294 
               
               

The detail of time deposits is as follows as of December 31, 2006:

                Yearly             
                interest    Maturity    Accrued     
Placement    Financial Institution    Currency    Principal    rate    date    interest    Total 
               
             ThCh$    %        ThCh$    ThCh$ 
 
Sep 11, 2006    BCO. SANTANDER SANTIAGO    Ch$    1,000,000    5.76    Mar 12, 2007    17,760    1,017,760 
Sep 13, 2006    BCO. SANTANDER SANTIAGO    Ch$    1,800,000    5.82    Mar 12, 2007    31,719    1,831,719 
Sep 26, 2006    BCO. SANTANDER SANTIAGO    Ch$    1,000,000    5.76    Mar 12, 2007    15,360    1,015,360 
Sep 27, 2006    BCO. SANTANDER SANTIAGO    Ch$    1,000,000    5.76    Mar 12, 2007    15,200    1,015,200 
Oct 02, 2006    BCO.CHILE    Ch$    800,000    5.76    Mar 12, 2007    11,520    811,520 
Nov 30, 2006    BCO.ESTADO    Ch$    1,500,000    5.64    Feb 26, 2007    7,285    1,507,285 
Dec 04, 2006    CORPBANCA    Ch$    1,600,000    5.64    Feb 12, 2007    6,768    1,606,768 
Dec 20, 2006    BCO. CREDITO E INVERSIONES    Ch$    1,000,000    6.00    Jan 22, 2007    1,833    1,001,833 
Dec 20, 2006    CORPBANCA    Ch$    1,100,000    5.88    Jan 22, 2007    1,976    1,101,976 
Dec 20, 2006    CORPBANCA    Ch$    2,000,000    5.88    Jan 22, 2007    3,593    2,003,593 
Dec 21, 2006    BCO. CREDITO E INVERSIONES    Ch$    3,000,000    6.00    Jan 22, 2007    5,000    3,005,000 
Dec 26, 2006    BCO. CREDITO E INVERSIONES    Ch$    1,700,000    6.00    Feb 20, 2007    1,417    1,701,417 
Dec 27, 2006    BCO.CHILE    Ch$    2,800,000    6.00    Jan 31, 2007    1,867    2,801,867 
Dec 29, 2006    BCO.CHILE    Ch$    1,000,000    5.52    Jan 29, 2007    307    1,000,307 
Dec 29, 2006    BCO.CHILE    Ch$    1,500,000    4.92    Jan 29, 2007    410    1,500,410 
Dec 29, 2006    BCO. SANTANDER SANTIAGO    Ch$    1,928    -    Jan 31, 2007    -    1,928 
Dec 29, 2006    HSBC BANK    Ch$    1,500,000    5.64    Feb 1, 2007    470    1,500,470 
Dec 05, 2006    BCO. CREDITO E INVERSIONES    UF    302,368    5.90    Mar 06, 2007    1,284    303,652 
Dec 07, 2006    BCO. CREDITO E INVERSIONES    US$    71,494    5.25    Jan 08, 2007    250    71,744 
Dec 07, 2006    BCO. CREDITO E INVERSIONES    US$    80,126    5.25    Jan 08, 2007    280    80,406 
Dec 27, 2006    ABN AMRO BANK    US$    2,661,950    5.24    Jan 04, 2007    1,550    2,663,500 
               
 
    Total        27,417,866            125,849    27,543,715 
               
               

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Notes to the Consolidated Financial Statements – (continued)
__________

Note 5. Marketable Securities:

The balance of marketable securities is as follows:

    As of December 31, 
   
     2005     2006 
     
    ThCh$    ThCh$ 
 
Publicly traded governmental securities    16,078,005    16,263,602 
     
 
Total Marketable Securities    16,078,005    16,263,602 
     
     

The balance of publicly traded governmental securities as of December 31, 2005 is as follows:

    Date       Carrying Value 
       
Instrument    Purchase    Maturity    Par value    Amount    Interest 
Rate		   Market value    Provision 
               
             ThCh$    ThCh$    %    ThCh$     ThCh$ 
BCD0500907    December 2004    September 2007    2,616,313    2,659,744    5.00    2,659,744    (44,560)
BCD0500907    August 2005    September 2007    1,831,419    1,861,820    5.00    1,861,820    (12,458)
BCD0500907    September 2005    September 2007    2,093,050    2,127,795    5.00    2,127,795    (27,888)
BCD0500907    September 2005    September 2007    2,616,313    2,659,743    5.00    2,659,743    (32,662)
BCD0500907    September 2005    September 2007    2,616,313    2,659,743    5.00    2,659,743    (30,371)
BCD0500907    September 2005    September 2007    523,263    531,948    5.00    531,948    (6,012)
BCD0500907    September 2005    September 2007    523,263    531,948    5.00    531,948    (5,658)
BCD0500907    September 2005    September 2007    1,046,525    1,063,897    5.00    1,063,897    (10,297)
               
 
Sub-Total            13,866,459    14,096,638        14,096,638    (169,906)
               
 
BCU500909    November 2005    September 2009    1,835,228    1,981,367    5.00    1,984,528    - 
               
 
Sub-Total            1,835,228    1,981,367        1,984,528    - 
               
 
Total            15,701,687    16,078,005        16,081,166    (169,906)
               
               

The balance of publicly traded governmental securities as of December 31, 2006 is as follows:

    Date       Carrying Value 
       
Instrument    Purchase    Maturity    Par value    Amount    Interest 
Rate		   Market value    Provision 
               
             ThCh$    ThCh$    %    ThCh$     ThCh$ 
BCD0500907    December 2004    September 2007    2,661,950    2,700,997    5.00    2,700,997    (23,428)
BCD0500907    August 2005    September 2007    1,863,365    1,890,698    5.00    1,890,698    (8,812)
BCD0500907    September 2005    September 2007    2,129,560    2,160,798    5.00    2,160,798    (15,612)
BCD0500907    September 2005    September 2007    2,661,950    2,700,997    5.00    2,700,997    (19,309)
BCD0500907    September 2005    September 2007    2,661,950    2,700,997    5.00    2,700,997    (18,521)
BCD0500907    September 2005    September 2007    532,390    540,199    5.00    540,199    (3,837)
BCD0500907    September 2005    September 2007    532,390    540,199    5.00    540,199    (3,693)
BCD0500907    September 2005    September 2007    1,064,780    1,080,399    5.00    1,080,399    (7,160)
               
 
Sub-Total            14,108,335    14,315,284        14,315,284    (100,372)
               
 
BCU500909    November 2005    September 2009    1,833,638    1,948,318    5.00    1,963,051    - 
               
 
Sub-Total            1,833,638    1,948,318        1,963,051    - 
               
 
Total            15,941,973    16,263,602        16,278,335    (100,372)
               
               

F - 19

Table of Contents

COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

Note 6. Current and long-term receivables:

The detail of current and long-term receivables as of December 31, is as follows:

    Current    Long-term 
     
    Up to 90 days    Over 90 up to 1 year       Subtotal    Total Current (net)        
             
Description    2005    2006    2005     2006    2006     2005    2006     2005    2006 
                   
     ThCh$     ThCh$    ThCh$    ThCh$         ThCh$    ThCh$    %    ThCh$     %    ThCh$    ThCh$ 
 
Accounts receivable    206,386,671    235,563,333    5,324,584    3,171,776    238,735,109    151,965,200    100.00    176,310,318    100.00    1,086,836    - 
   Standard telephony service    158,807,008    187,372,685    1,680,374    283,755    187,656,440    111,732,638    73.53    135,199,724    76.68    1,086,836    - 
   Long distance    24,278,493    22,703,056    -    -    22,703,056    16,540,377    10.88    16,307,812    9.25    -    - 
   Communications companies    19,258,931    20,847,854    3,316,522    2,597,662    23,445,516    20,276,385    13.34    21,782,183    12.36    -    - 
   Others    4,042,239    4,639,738    327,688    290,359    4,930,097    3,415,800    2.25    3,020,599    1.71    -    - 
Allowance for doubtful accounts    (59,746,055)   (62,424,791)   -    -    (62,424,791)   -        -        -    - 
Notes receivable    8,189,387    8,325,856    105,348    221,157    8,547,013    3,433,457        4,125,379        -    - 
Allowance for doubtful notes    (4,861,278)   (4,421,634)   -    -    (4,421,634)   -        -        -    - 
Other receivables    8,944,237    7,551,599    3,327,536    2,972,805    10,524,404    12,271,773        10,524,404        14,620,144    13,607,076 
Allowance for doubtful accounts    -    -    -    -    -    -        -        -    - 
                       
 
Total long-term receivables                                        15,706,980    13,607,076 
                       

During 2004, 2005 and 2006, there were bad debt write-offs of ThCh$ 23,403,471, ThCh$ 43,669,583 and ThCh$ 14,471,923, respectively, which were charged against the allowance for doubtful accounts.

As of December 31, 2005 and 2006, current receivables from employees amounted to ThCh$ 1,911,908 and 1,108,572, respectively. Other long-term receivables include loans given to employees at the amount of ThCh$ 7,813,206 and ThCh$ 9,613,147, respectively. These loans bear an average variable interest rate that is equal to inflation rate and the value is changed each year to reflect the change in salaries (see Note 15 Footnote 2).

F - 20

COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

Note 7. Balances and transactions with related entities:

There have been charges and credits recorded to current accounts between these related parties for sales of materials, equipment and services. The intercompany balances do not bear any interest. As per Article No. 89 of the Corporations Law, all these transactions are carried out under conditions similar to those that normally prevail in the market.

a) Receivables from related parties are as follows:

        Short-term 
     
             As of December 31, 
     
Taxpayer No.   Company     2005    2006 
         
        ThCh$    ThCh$ 
87.845.500-2    Telefónica Móviles Chile S.A.    -    702,422 
96.672.150-2    Telefónica Móviles Chile Inversiones S.A.    -    53,353 
96.672.160-k    Telefónica Móviles Chile Larga Distancia S.A.    1,173,710    330,509 
96.834.230-4    Terra Networks Chile S.A.    1,137,399    1,893,796 
96.895.220-k    Atento Chile S.A.    418,619    477,989 
96.910.730-9    Telefónica International Wholesale Services Chile S.A. (formerly Emergia Chile S.A.)   106,387    489,650 
96.786.140-5    Telefónica Móviles de Chile S.A.    6,635,631    8,458,174 
59.083.900-0    Telefónica Ingeniería de Seguridad S.A.    1,926    10,980 
96.990.810-7    Telefónica Móviles Soluciones y Aplicaciones S.A.    184,992    136,888 
Foreign    Telefónica España    819,149    702,320 
Foreign    Telefónica LD Puerto Rico    -    212,383 
Foreign    Telefónica Data USA    27,237    36,035 
Foreign    Telefónica Data España    357,121    - 
Foreign    Telefónica Argentina    1,847,521    1,600,129 
Foreign    Telefónica Soluciones de Informática España S.A.    -    1,522,632 
Foreign    Telefónica International Wholesale Services    459,420    391,626 
Foreign    Telefónica Gestión de Servicios Compartidos España    11,437    11,204 
Foreign    Telefónica Perú    -    391,372 
Foreign    Telefónica Procesos Tec. de Información    1,366,279    - 
       
 
    Total    14,546,828    17,421,462 
       
       

b) Payables to related parties are as follows:

        Short-term 
     
             As of December 31, 
     
Taxpayer No.   Company     2005    2006 
         
        ThCh$    ThCh$ 
96.990.810-7    Telefónica Móviles Soluciones y Aplicaciones S.A.    1,301    - 
96.527.390-5    Telefónica Internacional Chile S.A.    286,296    286,048 
96.834.230-4    Terra Networks Chile S.A.    4,241,588    5,336,338 
96.895.220-k    Atento Chile S.A.    675,232    3,309,526 
96.910.730-9    Telefónica International Wholesale Services Chile S.A. (formerly Emergia Chile S.A.)   219,679    4,154,051 
96.786.140-5    Telefónica Móviles de Chile S.A.    14,979,040    14,591,511 
87.845.500-2    Telefónica Móviles Chile S.A.    -    2,525,323 
96.672.160-k    Telefónica Móviles Chile Larga Distancia S.A.    4,531,142    4,744 
59.083.900-0    Telefónica Ingeniería de Seguridad S.A.    -    1,163 
Foreign    Telefónica Gestión de Servicios Compartidos España S.A.    -    31,397 
Foreign    Telefónica Argentina    -    567,014 
Foreign    Telefónica España    -    35,344 
Foreign    Telefónica Perú    49,651    427,488 
Foreign    Telefónica Guatemala    100,575    25,274 
Foreign    Telefónica Móvil El Salvador S.A. de C.V.    57,307    29,856 
Foreign    Telefónica International Wholesale Services    692,229    954,266 
Foreign    Telefónica Puerto Rico    16,385    8,704 
Foreign    Telefónica Investigación y Desarrollo    522,310    577,993 
Foreign    Telecomunicaciones de Sao Paulo    35,726    27,932 
Foreign    Telefónica Data España    -    113,188 
       
 
    Total    26,408,461    33,007,160 
       
       

F - 21

Table of Contents

COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

Note 7. Balances and transactions with related entities for the years ended December 31, (continued):

c) Transactions:

        Nature 
of
 Relationship 		   Description 
of
 transaction 		                        
            2004     2005    2006 
Company    Tax No.        ThCh$     ThCh$    ThCh$ 
             
                    Effect on        Effect on        Effect on 
                Amount    income    Amount    income    Amount    income 
Telefónica España    Foreign    Ultimate Parent Co.    Sales    539,811    539,811    889,463    889,463    891,339    891,339 
            Purchases    (339,780)   (339,780)   (232,877)   (232,877)   (453,065)   (453,065)
Telefónica Internacional Chile S.A.    96.527.390-5    Direct Parent Co.    Purchases    (573,712)   (573,712)   (583,198)   (583,198)   (580,709)   (580,709)
            Financial Expenses (1)   (274,693)   (274,693)   -    -    -    - 
Telefónica Data USA    Foreign    Member of controlling group    Sales    -    -    9,580    9,580    35,182    35,182 
Terra Networks Chile S.A.    96.834.230-4    Member of controlling group    Sales    5,786,605    5,786,605    5,328,198    5,328,198    6,107,825    6,107,825 
            Purchases    (2,097,808)   (2,097,808)   (933,828)   (933,828)   (694,904)   (694,904)
Atento Chile S.A.    96.895.220-K    Member of controlling group    Sales    1,131,063    1,131,063    1,709,311    1,709,311    1,224,942    1,224,942 
            Purchases    (17,991,620)   (17,991,620)   (15,741,142)   (15,741,142)   (17,094,965)   (17,094,965)
Telefónica Argentina    Foreign    Member of controlling group    Sales    1,271,678    1,271,678    1,152,875    1,152,875    1,816,792    1,816,792 
            Purchases    (896,750)   (896,750)   (853,821)   (853,821)   (1,885,541)   (1,885,541)
Telefónica de Sao Paulo    Foreign    Member of controlling group    Sales    189,600    189,600    163,258    163,258    286,655    286,655 
            Purchases    (200,878)   (200,878)   (213,567)   (213,567)   (167,757)   (167,757)
Telefónica Guatemala S.A.    Foreign    Member of controlling group    Sales    8,285    8,285    9,031    9,031    23,505    23,505 
            Purchases    (18,217)   (18,217)   (38,541)   (38,541)   (53,472)   (53,472)
Telefónica del Perú    Foreign    Member of controlling group    Sales    579,592    579,592    525,857    525,857    1,028,126    1,028,126 
            Purchases    (649,851)   (649,851)   (552,147)   (552,147)   (745,448)   (745,448)
Telefónica LD Puerto Rico    Foreign    Member of controlling group    Sales    15,570    15,570    11,964    11,964    10,928    10,928 
            Purchases    (14,231)   (14,231)   (14,447)   (14,447)   (21,079)   (21,079)
Telefónica El Salvador    Foreign    Member of controlling group    Sales    -    -    5,130    5,130    9,395    9,395 
            Purchases    (34,377)   (34,377)   (29,614)   (29,614)   (42,627)   (42,627)
Telefónica Móviles de Chile S.A.    96.786.140-5    Member of controlling group    Sales    7,346,297    7,346,297    13,589,179    13,589,179    14,136,159    14,136,159 
            Purchases    (20,347,569)   (20,347,569)   (42,684,401)   (42,684,401)   (42,179,355)   (42,179,355)
            Financial Income    736,186    736,186    -    -    -    - 
Telefónica Móviles S.A.    Foreign    Member of controlling group    Sale of Telefónica Móvil Shares    715.206.764    321.071.436    -    -    -    - 
Telefónica Móviles Chile Larga Distancia S.A.    96.672.160-K    Member of controlling group    Sales    -    -    1,569,089    1,569,089    629,856    629,856 
            Purchases    -    -    (12,478,781)   (12,478,781)   (8,191,302)   (8,191,302)
Telefónica International Wholesale Services España    Foreign    Member of controlling group    Sales    -    -    304,153    304,153    -    - 
            Purchases    (979,311)   (979,311)   (2,624,571)   (2,624,571)   -    - 
Telefónica Móviles Chile Inversiones S.A.    96.672.150-2    Member of controlling group    Sales    -    -    793,708    793,708    -    - 
            Purchases    -    -    147,727    147,727    -    - 
Telefónica International Wholesale Services Uruguay    Foreign    Member of controlling group    Sales    225,289    225,289    -    -    -    - 
            Purchases    (1,407,508)   (1,407,508)   (1,328,185)   (1,328,185)   -    - 
Telefónica Gestión de Serv. Compartidos España S.A.    Foreign    Member of controlling group    Sales    -    -    11,437    11,437    -    - 
            Purchases    -    -    -    -    (8,590)   (8,590)
            Other Non-operating Income    -    -    -    -    137    137 
Telefónica Ingeniería de Seguridad S.A.    59.083.900-0    Member of controlling group    Sales    -    -    10,228    10,228    104,259    104,259 
            Purchases    -    -    -    -    (28,075)   (28,075)
Telefónica Móviles Soluciones y Aplicaciones S.A.    96.990.810-7    Member of controlling group    Sales    12,434    12,434    93,208    93,208    65,110    65,110 
Terra Networks Inc.    Foreign    Member of controlling group    Sales    -    -    -    -    82    82 
Telefónica International Wholesale Services Chile S.A. 
(formerly Emergia Chile S.A.)		   96.910.730-9    Member of controlling group    Sales    705,625    705,625    959,746    959,746    1,279,971    1,279,971 
            Purchases    (80,625)   (80,625)   (111,193)   (111,193)   (5,129,791)   (5,129,791)
Telefónica Soluciones de Informática y Comunicaciones de España    Foreign    Member of controlling group    Sales    -    -    -    -    22,730    22,730 

(1)
The current account of Telefónica Internacional Chile S.A. is denominated in US dollars, accruing interest at a variable rate adjusted to market rates (US$ + Market Spread).

 

F - 22

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COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

Note 8. Current and deferred income taxes:

a) General information:

For the years ended December 31, 2004, 2005 and 2006, the Parent Company recorded a first category income tax provision based on taxable income of ThCh$ 95,095,518, ThCh$ 112,443,624 and ThCh$ 142,024,686, respectively.

In addition, as of December 31, 2005 and 2006, a provision for first category income tax in subsidiaries was recorded based on the subsidiaries’ respective taxable income of ThCh$ 29,208,300 and ThCh$ 52,220,032, respectively.

As of December 31, 2005 and 2006, accumulated tax losses of subsidiaries amount to ThCh$ 7,495,647 and ThCh$ 6,344,235, respectively. According to Chilean legislation, tax loss carryforwards do not expire.

In the normal course of its operation, the Company is subject to the regulation and oversight of the Chilean Internal Revenue Service. Based on the information available to date, management believes that there are no additional significant liabilities other than those recorded in the financial statements. However, actual taxable results may differ from these estimations.

F - 23

Table of Contents

COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

Note 8. Current and deferred income taxes, (continued):

b) Deferred taxes:

As of December 31, 2005 and 2006, the net deferred tax liabilities amounted to ThCh$ 47,657,709 and ThCh$ 41,131,826, respectively and the detail is as follows:

    December 31, 2005    December 31, 2006 
     
    Deferred tax assets    Deferred tax liabilities    Deferred tax assets    Deferred tax liabilities 
         
Description    Short-term    Long-term    Short-term    Long-term    Short-term    Long-term    Short-term    Long-term 
                 
    ThCh$    ThCh$       ThCh$         ThCh$       ThCh$    ThCh$    ThCh$         ThCh$ 
Temporary differences                                 
Allowance for doubtful accounts    10,265,254    -    -    -    10,080,033    -    -    - 
Provision for vacations    834,088    -    -    -    732,497    -    -    - 
Benefits for tax losses    225,115    1,049,145    -    -    -    1,078,520    -    - 
Staff severance indemnities    -    -    -    6,351,092    -    -    -    3,901,638 
Leased assets and liabilities    -    61,465    -    124,007    -    20,504    -    210,814 
Property, plant and equipment    -    4,214,526    -    167,885,804    -    661,234    -    144,637,726 
Difference in amount of capitalized staff severance    -    546,158    -    -    -    374,552    -    385,800 
Deferred charge on sale of assets    -    -    -    988,059    -    4,102    -    260,834 
Software development    -    -    -    2,199,009    -    -    -    3,952,366 
Collective negotiation bonus    -    -    -    34,648    -    -    -    138,783 
Other    656,481    292,305    50,100    4,229,742    3,180,902    1,134,220    61,142    7,093,945 
                 
 
Sub-Total    11,980,938    6,163,599    50,100    181,812,361    13,993,432    3,273,132    61,142    160,581,906 
Complementary accounts net of accumulated amortization    -    (3,726,247)   -    (119,786,462)   -    (863,355)   -    (103,108,013)
                 
 
Sub-Total    11,980,938    2,437,352    50,100    62,025,899    13,993,432    2,409,777    61,142    57,473,893 
Reclassification for presentation purposes    (50,100)   (2,437,352)   (50,100)   (2,437,352)   (61,142)   (2,409,777)   (61,142)   (2,409,777)
                 
 
Total    11,930,838    -    -    59,588,547    13,932,290    -    -    55,064,116 
                 
                 

F - 24

Table of Contents

COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

Note 8. Current and deferred income taxes, (continued):

c) Income tax breakdown:

The current tax expenses recorded by the Company in 2004, 2005 and 2006 result from the following items :

    For the years ended December 31, 
   
    2004    2005    2006 
       
Description     ThCh$    ThCh$       ThCh$ 
 
Current tax expense before tax benefits (17%)   27,761,050    24,423,166    33,021,602 
Tax on disallowed expenses (Article 21 35%)   33,353    63,256    52,484 
Capital gains tax assessed on the proceeds of the sales of subsidiary             
       Telefónica Móvil and the Company's participation in Publiguías    38,374,487    -    - 
Tax expense adjustment (previous year)   (5,282,325)   74,698    (337,991)
       
Current income tax subtotal    60,886,565    24,561,120    32,736,095 
 
- Current year deferred tax charge (credit)   (9,796,497)   (4,363,371)   (16,932,280)
- Tax benefits from tax loss carry forwards    (1,117,979)   -    (19,475)
- Effect of amortization of complementary accounts    16,026,815    13,895,659    13,815,557 
       
 
Deferred tax expense subtotal    5,112,339    9,532,288    (3,136,198)
       
 
Total income tax expense    65,998,904    34,093,408    29,599,897 
       
       

F - 25

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COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

Note 9. Other Current Assets:

The detail of other current assets is as follows:

    As of December 31, 
   
     2005     2006 
     
    ThCh$    ThCh$ 
 
Financial instruments with fixed income and resale agreement (Note 10)   4,084,521    3,728,382 
Telephone directories for connection program    2,771,733    2,978,524 
Deferred union contract bonus (1)   1,270,488    1,410,404 
Deferred staff severance indemnities (2)   1,038,064    1,210,332 
Derivatives contracts (net of partial liquidations)   232,979    631,636 
Deferred issuance costs for foreign financing placements (3)   702,122    415,127 
Deferred bond discount (Note 29)   48,761    230,432 
Deferred issuance costs for placement of bonds (Note 29)   269,297    127,846 
Commercial paper issuance costs (Note 29)   102,983    - 
Deferred exchange insurance premiums    80,417    - 
Others    731,673    215,875 
     
 
                 Total    11,333,038    10,948,558 
     
     

(1) Between May and September 2006, the Company negotiated a 38-month and 48-month union contract with a number of its employees, granting them, among other benefits, a signing bonus. That bonus was paid between July and December 2006. The total benefit of ThCh$ 4,918,946 (historical), is amortized using the straight-line method over the term of the union agreement.

The long-term portion is incurred in “Others” under “Other non-current Assets” (Note 15).

(2) Corresponds to the short-term portion to be amortized due to changes in the actuarial hypothesis, as described in Note 3, and to the concept of loans to employees as indicated in Note 15 Footnote 2.

(3) This amount corresponds to the disbursements incurred for foreign loans obtained by the Company to finance its investment plan.

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COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

Note 10. Information regarding purchase commitment and sales commitment transactions (agreements):

The detail for the year 2005 is as follows:

    Dates        Original
Currency 		   Subscription 
Value 		           Instrument
Identification 		   Book 
Value 
           
Code   Inception    End    Counterparty        Rate    Final Value     
                   
                                    ThCh$ 
CRV    December 30, 2005    January 05, 2006    Banco de Crédito e Inversiones    Ch$    1,000,000    4.44%    1,021,756    BCP0800708    1,021,126 
CRV   December 30, 2005    January 06, 2006    HSBC Bank    Ch$    2,000,000    4.68%    2,043,858    BCP0800708    2,042,266 
CRV    December 30, 2005    January 05, 2006    Banco de Estado de Chile    UF    993,270    4.56%    1,014,879    PRC-750501    1,014,257 
CRV    December 30, 2005    January 05, 2006    Banco de Estado de Chile    UF    6,730    4.56%    6,876    PRC-06B0695    6,872 
                   
                Total    4,000,000        4,087,369        4,084,521 
                   
                   

Code: CRV = Purchases under agreements to resell.

The detail for the year 2006 is as follows:

    Dates        Original
Currency 		   Subscription
Value 		           Instrument
Identification 		   Book 
Value 
           
Code   Inception    End    Counterparty        Rate    Final Value     
                   
                                    ThCh$ 
CRV   December 28, 2006    January 04, 2007    HSBC Bank    US$         3,726,730    5.32%         3,771,437     BCP0800708       3,728,382 
                                     
                     
                                     
                                     
                Total         3,726,730             3,771,437           3,728,382 
                     
                     

Code: CRV = Purchases under agreements to resell.

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COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

Note 11. Property, plant and equipment:

The detail of property, plant and equipment as of December 31, 2005 and 2006 is as follows:

    2005    2006 
     
    Accumulated    Gross property,    Accumulated    Gross roperty, 
Description    depreciation    plant and    depreciation    plant and 
        equipment        equipment 
         
         ThCh$           ThCh$         ThCh$           ThCh$ 
Land    -    27,852,723    -    27,858,064 
 
Building and improvements    334,195,911    791,790,968    355,383,167    785,112,256 
 
Machinery and equipment    1,989,388,441    2,723,729,586    2,120,375,386    2,762,527,493 
Central office telephone equipment    1,230,381,338    1,554,229,089    1,310,136,450    1,544,440,986 
External plant    575,640,139    927,068,791    598,561,543    931,830,518 
Subscribers’ equipment    146,407,442    204,413,834    175,157,240    249,126,821 
General equipment    36,959,522    38,017,872    36,520,153    37,129,168 
 
Other Property, Plant and Equipment    155,313,521    264,559,181    185,488,435    316,701,911 
Office furniture and equipment    82,748,400    107,872,923    97,934,870    113,042,579 
Projects, work in progress and related materials    -    63,072,289    -    92,962,795 
Leased assets (1)   56,364    503,026    64,748    503,026 
Assets temporarily out of service    5,549,445    6,635,785    7,004,509    7,004,509 
Software (2)   65,295,048    83,841,793    78,512,544    100,649,206 
Others    1,664,264    2,633,365    1,971,764    2,539,796 
 
Technical revaluation-Circular 550    11,174,705    9,948,548    10,825,085    9,463,656 
         
 
        Total    2,490,072,578    3,817,881,006    2,672,072,073    3,901,663,380 
         
         

(1) Leased assets relate to the category of buildings.

(2) The total amount of depreciation charged to income related to Software was ThCh$ 18,382,456, ThCh$ 14,222,534 and ThCh$ 15,057,694 for the years ended December 31, 2004, 2005 and 2006, respectively.

Up to December 31, 2002, work in progress included capitalization of finance costs of related loans according to Technical Bulletin No. 31 of the Chilean Association of Accountants. Therefore, gross property, plant and equipment includes interest in the amount of ThCh$ 197,476,462. Accumulated depreciation for this interest amounts to ThCh$ 126,825,076 and ThCh$ 137,959,179 for 2005 and 2006, respectively. The depreciation charge on capitalized financing expenses for the years ended December 31, 2004, 2005 and 2006 amounted to ThCh$ 14,238,222, ThCh$ 12,810,955 and ThCh$ 10,268,317, respectively.

Operating costs include a depreciation charge for the years ended December 31, 2004, 2005 and 2006 of ThCh$ 232,374,019, ThCh$ 191,077,905 and ThCh$ 198,515,815 and administration and selling expenses a depreciation charge of ThCh$ 8,706,605, ThCh$ 7,111,361 and ThCh$ 5,511,233 for 2004, 2005 and 2006, respectively. Assets temporarily out of service are made up mainly of telephone equipment under repair, and incurred depreciation amounting to ThCh$ 6,701,327, ThCh$ 2,724,767 and ThCh$ 879,772 in 2004, 2005 and 2006, respectively, which is classified as “Other non-operating expenses” (Note 26b).

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COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

Note 11. Property, plant and equipment, (Continued):

The detail by item of the technical revaluation as of December 31, 2005 and 2006 is as follows:

    Gross            Gross 
    property,            property, 
    plant and    Net    Accumulated    plant and 
    equipment    balance    Depreciation    equipment 
Description    2005    2006    2006    2006 
         
    ThCh$    ThCh$         ThCh$    ThCh$ 
Land    (517,192)   (517,192)   -    (517,192)
Building and improvements    (4,962,876)   (805,598)   (4,157,537)    (4,963,135)
Machinery and equipment       15,428,616    (38,639)   14,982,622    14,943,983 
         
 
             Total    9,948,548    (1,361,429)   10,825,085    9,463,656 
         
         

Amortization of the technical reappraisal surplus amounted to ThCh$ (30,613), ThCh$ (23,723) and ThCh$ (22,455) for the years ended December 31, 2004, 2005 and 2006, respectively.

Gross property, plant and equipment includes assets that have been fully depreciated in the amount of ThCh$ 1,102,827,648 in 2005 and ThCh$ 1,353,312,969 in 2006, which include ThCh$ 12,518,520 and ThCh$ 13,141,591, respectively, from the reappraisals mentioned in Circular No. 550.

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COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

Note 12. Investments in related companies:

Tax payer No.    Company    Country 
of 
origin 		   Currency
 controlling
the
 investment 		   Number of 
shares 		    Percentage 
participation 		   Equity of 
the companies 		   Net income (loss)
of the companies for the years 		   Equity in income (loss)
of the investment for the years 		   Investment
 book value 
       
         
2005    2006     2005    2006             2005    2006    2004    2005    2006    2005    2006 
                               
                     %    %    ThCh$    ThCh$    ThCh$    ThCh$    ThCh$    ThCh$    ThCh$    ThCh$    ThCh$ 
 
Foreign    TBS Celular Participación S.A. (1)   Brazil    Dollar    48,950,000     2.61    2.61    148,096,542    151,214,295    5,146,141    (1,288,424)   97,198    134,315    (33,628)   3,865,320    3,946,692 
96.895.220-K    Atento Chile S.A. (2)   Chile    Pesos    3,209,204    28.84    28.84    14,325,163    14,433,488    5,596,446    6,759,221    664,710    1,614,014    1,949,359    4,131,377    4,162,618 
96.922.950-1    Empresa de Tarjetas Inteligentes S.A. (3)   Chile    Pesos    -    20.00    -    -    -    (165,964)   -    (105,924)   (33,193)   -    -    - 
93.541.000-2    Impresora y Comercial Publiguías S.A. (4)   Chile    Pesos    -    -    -    -    -    -    -    (82,010)   -    -    -    - 
                               
                                            573,974    1,715,136    1,915,731    7,996,697    8,109,310 
                               
                               

(1) The Company records its investment in TBS Celular Participación S.A. using the equity method since it exercises significant influence through the Telefónica group to which it belongs, as established in paragraph No. 4 of Circular 1179 issued by the Superintendency of Securities and Insurance and ratified in Title II of Circular 1697. Although the Company only has a 2.61% direct participation in TBS Celular Participación S.A., its Parent Company, Telefónica S.A. Spain directly and indirectly has a percentage exceeding 20% ownership of the capital stock of that company.

(2) As of December 31, 2006, the value of the investment was recognized on the basis of unaudited financial statements.

(3) With an Extraordinary Shareholders’ Meeting the dissolution of Empresas de Tarjetas Inteligentes S.A. was agreed upon. In the month of September 2005 the Chilean Internal Revenue Services authorized the termination of operations of this company.

(4) On April 26, 2004, the Company sold its share of 9% in Impresora y Comercial Publiguías S.A., to Telefónica Publicidad e Información S.A. The selling price was US$ 14,760,000 (historical) equivalent to Ch$ 9,781 million, resulting in a gain on sale after taxes of Ch$ 5,358 million.

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COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

Note 13. Goodwill:

                As of December 31,     
       
            2005    2006
         
        Year    Amount    Net    Amount    Net 
Taxpayer No.    Company    of    amortized    Balance    amortized    Balance 
        Origin    for the    of    for the    of 
            year    goodwill    year    goodwill 
             
            ThCh$    ThCh$    ThCh$    ThCh$ 
 
Foreign    TBS Celular Participación S.A. (3)   2001    190,433    2,538,239    190,433    1,702,655 
    Telefónica Larga Distancia S.A.                     
96.551.670-0    (formerly Telefónica Mundo S.A.)   1998    1,174,896    15,043,133    1,174,896    13,868,237 
    Telefónica Multimedia Chile S.A. (1)                    
78.703.410-1    (formerly Tecnonáutica S.A.)   1998    155,466    777,329    761,341    - 
96.834.320-3    Telefónica Internet Empresas S.A. (2)   1999    96,021    480,106    96,021    384,085 
             
 
    Total        1,616,816    18,838,807    2,222,691    15,954,977 
             
             

Goodwill amortization periods have been determined taking into account aspects such as the nature and characteristics of the business and estimated period of return of investment.

(1) On January 26, 2006, Telefónica Internet Empresas S.A. sold 449,081 shares of Tecnonáutica S.A. to Telefónica Chile S.A. for ThCh$ 1,624,273 (historical) corresponding to its participation in that company. On that same date, CTC Equipos y Servicios de Telecomunicaciones S.A. sold 1 share to Telefónica Chile S.A. for ThCh$ 4 corresponding to its participation in that company. On April 19, 2006, Tecnonáutica S.A. changed its name to Telefónica Multimedia Chile S.A.

This sale was performed at book value, not taking into consideration the amount corresponding to goodwill in the ales price, which meant recognizing in results (in an extraordinary manner) the amortization of the balance of goodwill of ThCh$ 761,341 as of that date (see Note 2d Footnote 1).

(2) On January 26, 2006, CTC Equipos y Servicios de Telecomunicaciones sold to Telefónica Chile S.A. 16 shares at ThCh$ 132, which corresponded to its participation in Telefónica Internet Empresas S.A. On January 27, 2006, Telefónica Empresas CTC Chile sold to Telefónica Chile S.A. 215,099 shares at ThCh$ 1,468,683, which corresponded to its participation in this company (see Note 2d Footnote 2).

(3) The goodwill related to TBS Celular Participación S.A. is controlled in US dollars.

Note 14. Intangibles:

The detail of Intangibles is as follows:

    As of December 31, 
   
    2005    2006 
     
    ThCh$    ThCh$ 
Underwater cable rights (gross)   37,827,844    37,817,759 
    Accumulated amortization    (7,529,868)   (9,298,808)
Licenses (Software) (gross)   12,075,031    15,414,682 
    Accumulated amortization    (4,563,295)   (8,660,969)
     
 
Total Net Intangibles    37,809,712    35,272,664 
     
     

The amortization for the years ended December 31, 2004, 2005 and 2006 amounted to ThCh$ 1,759,387, ThCh$ 2,251,951 and ThCh$ 1,768,940 for the underwater cable rights, respectively. The amortization for the years ended December 31, 2004, 2005 and 2006 amounted to ThCh$ 965,474, ThCh$ 2,595,384 and ThCh$ 3,255,187 for licenses respectively.

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COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

Note 15. Other non-current Assets:

The account detail is as follows:

    As of December 31, 
   
     2005     2006 
     
    ThCh$    ThCh$ 
Deferred actuarial indemnity difference (1)   7,416,719    8,017,844 
Deferred staff severance indemnities (2)   4,752,041    4,208,788 
Deferred union contract bonus (see Note 9 Footnote 1)   69,714    3,076,244 
Bond discount (see Note 29)   183,916    1,120,213 
Deferred issuance costs for obtaining external financing (3)   1,291,171    721,033 
Bond issuance expenses (see Note 29)   27,208    684,423 
Security deposits    140,421    116,806 
Others    16,280    - 
     
 
                 Total    13,897,470    17,945,351 
     
     

(1) With the implementation of new contractual conditions derived from the organizational change in the Company, there have been a series of studies that allowed, with primary effect in 2004, the modification in the calculation basis for staff severance indemnities of the variable for future service life of employees. After concluding these studies in 2005, other changes in estimates were incorporated, such as personnel fluctuation rate, mortality of employees and future salary increases, and includes the rate change mentioned in Note 3b (i) for 2006, all determined on the basis of actuarial calculations, as established in Technical Bulletin No. 8 of the Chilean Association of Accountants.

The difference at the beginning of the year as a result of changes in the actuarial estimates constitute actuarial gains or losses, which are deferred and amortized over the estimated average remaining future service life of the employees that will receive the benefit (see Note 2t).

(2) In conformity with the union agreements between the Company and its employees, loans were granted to employees, the amounts and conditions of which were based, among other aspects, on the accrued balances of staff severance indemnities at the date of the grant.

The staff severance indemnities provision has been recorded in part at its current value, deferring and amortizing this effect over the years of average remaining future service life of employees that subscribe to the benefit. The loan is presented under “Other Long-term Receivables”.

(3) This amount corresponds to the disbursements incurred for foreign loans obtained by the Company, to finance its investment plan (see Note 9 Footnote 3).

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COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

Note 16. Short-term debt with banks and financial institutions:

The breakdown of short-term obligations with banks and financial institutions as of December 31 is as follows:

    Bank or Financial Institution                         
        US$   UF   TOTAL 
         
   Taxp. No.    Current portion of long-term debt     2005     2006    2005    2006     2005     2006 
               
        ThCh$    ThCh$    ThCh$    ThCh$    ThCh$    ThCh$ 
97.015.000-5    Santander Santiago    -    -    327,951    446,305    327,951    446,305 
Foreign    Calyon New York Branch (Syndicated Loan)   128,200    169,034    -    -    128,200    169,034 
97.008.000-7    Citibank N.A.    315,130    655,812    -    -    315,130    655,812 
Foreign    BBVA Bancomer (Syndicated Loan)   576,013    -    -    -    576,013    - 
Foreign    ABN AMRO BANK    -    733,963    -    -    -    733,963 
               
 
    Total    1,019,343    1,558,809    327,951    446,305    1,347,294    2,005,114 
               
               
 
 
    Average annual interest rate    4.68%    5.70%    2.32%    3.16%    4.10%    5.20% 

     As of December 31, 
   
     2005     2006 
     
    %    % 
 
Percentage of short-term debt in foreign currency     75.66%    77.74% 
Percentage of short-term debt in local currency     24.34%    22.26% 
     
Total    100.00%    100.00% 
     
     

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COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

Note 17. Long-term obligations with banks and financial institutions:

The breakdown of long-term obligations with banks and financial institutions as of December 31, 2005 and 2006 is as follows:

            Long-term
portion
as of
December 31,
2005		               Long-term
portion
as of
December 31,
2006		   Average
 annual 
Interest 
              Years to maturity     
              for long-term portion     
       
    Bank or Financial    Currency                   
Taxp. No.    Institution    Index      1 to 2    2 to 3    3 to 5      rate 
                 
            ThCh$   ThCh$    ThCh$     ThCh$       ThCh$   % 
 
    Loans In US$                             
                                 
Foreign    Calyon New York Branch And Others (1)   US$    104,652,502    -    106,478,000    -       106,478,000   Libor + 0.35% 
Foreign    BBVA Bancomer and Others (3)   US$    78,489,374    -    -    79,858,500         79,858,500   Libor + 0.334% 
97.008.000-7    Citibank N.A. (2)   US$    78,489,374    79,858,500    -    -         79,858,500   Libor + 0.31% 
               
 
    Subtotal        261,631,250    79,858,500    106,478,000    79,858,500       266,195,000    5.70% 
               
 
    Loans In UF                             
 
97.015.000-5    Banco Santander Santiago (4)   UF    65,242,359    -    -    65,185,831         65,185,831   TAB 360 + 0.45% 
               
 
    Subtotal        65,242,359    -    -    65,185,831         65,185,831    3.16% 
               
 
    Total        326,873,609    79,858,500    106,478,000    145,044,331       331,380,831    5.20% 
               
               

     As of December 31,
   
     2005     2006 
     
    %    % 
 
Percentage of long-term debt in foreign currency     80.04%    80.33% 
Percentage of long-term debt in local currency     19.96%    19.67% 
     
Total    100.00%    100.00% 
     

(1) In December 2004, the Company renegotiated this loan, extending its due date from February and August 2005 to December 2009, in addition to changing the agent bank, that until then was the BilbaoVizcaya Argentaria Bank.

(2) In May 2005, the Company renegotiated this loan, extending its due date from April 2006 and April 2007 to December 2008, in addition to changing the agent bank, that until then was the ABN Amro Bank.

(3) In November 2005, the Company renegotiated this loan, extending its due date from April 2006, April 2007 and April 2008 to June 2011, in addition to changing the agent bank, that until then was the ABN Amro Bank.

(4) In April 2005, the Company renegotiated this loan, extending its maturity date from April 2008 to April 2010 and reducing the interest rate to TAB 360 + 0.45%. The Tasa Activa Bancaria (TAB), published by the Association of banks and financial institutions, was 3.78% as of December 31, 2006.

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Notes to the Consolidated Financial Statements – (continued)
__________

Note 18. Commercial paper and Bonds:

a) Commercial paper:

On January 27, 2003 and May 12, 2004, the Company registered a series of commercial paper in the securities registry, the inspection numbers of which are 5 and 15, respectively. The maximum amount of the line is ThCh$ 35,000,000, and placements charged to this line may not exceed that amount. The term of this line will be 10 years from the date of registration with the Superintendency of Securities and Insurance. The interest rate will be defined upon each issuance of these commercial papers.

On April 27, 2005, there was a placement in series F for ThCh$ 23,000,000 of the same type of instrument. The placement agent was Scotiabank Sudamericano Corredores de Bolsa.

On October 25, 2005, there was a placement in series G and H for ThCh$ 35,000,000 of the same type of instrument. The placement agent was Scotiabank Sudamericano Corredores de Bolsa.

On March 21, 2006, a Series I placement of the same type of instrument was made for ThCh$ 12,000,000, maturing on December 6, 2006. The placement agent was Inversiones Boston Corredores de Bolsa.

On July 11, 2006, the Company placed a fourth issuance of its line of Commercial Paper with a charge to line No. 015. This issuance was performed in three series (J1 - J2 - J3) for a total of ThCh$ 7,000,000, maturing on September 27, 2006. The placement agent was Inversiones Boston.

The details of commercial paper are described below:

        Current 
nominal
 amount
 placed 		                        
          Bond    Monthly        Carrying value    Placement 
in Chile 
or abroad 
Registration or identification          readjustment    interest    Final     as of December 31,   
number of the instrument    Series      unit    rate    maturity     2005    2006   
                 
        ThCh$    ThCh$    %        ThCh$    ThCh$     
Short-term commercial paper                                 
015    F    23,000,000    Ch$ non-adjustable    0.4100    Mar 28, 2006    23,217,737    -    Chile 
005    G    17,500,000    Ch$ non-adjustable    0.5100    Apr 20, 2006    17,544,574    -    Chile 
005    H    17,500,000    Ch$ non-adjustable    0.5100    Apr 27, 2006    17,523,515    -    Chile 
 
                 
Total                        58,285,826    -     
                 
                 

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COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

Note 18. Commercial paper and Bonds, (continued):

b) Bonds:

The detail of bonds issued as of December 31, classified as short and long-term is as follows:

        Nominal
Amount
of
Issue		       Nominal 
annual
 interest
 rate 		                        
Registration number 
or identification of
 the instrument 		         Readjustment
unit
for
bond 		         Frequency    Par value    Location 
of bond placement 
       
            Final 
maturity 		   Interest 
payment 		        2005 
ThCh$ 		    2006 
ThCh$ 		  
  Series              Pay down       
                     
                %                        
Short-term portion of long-term bonds                                         
 
 143.27.06.91    F    71,429    UF    6.000    April 2016    Semi-annual    Semi-annual    1,483,495    1,465,059    Chile 
 281.20.12.01    L (a)   -    UF    3.750    October 2012    Semi-annual    At maturity    -    374,699    Chile 
 
 Issued in New York    Yankee Bonds    -    US$    7.625    July 2006    Semi-annual    At maturity    26,884,467    -    USA 
 Issued in New York    Yankee Bonds    -    US$    8.375    January 2006    Semi-annual    At maturity    85,344,169    -    USA 
                     
                            Total    113,712,131    1,839,758     
                     
                     
Long-term bonds                                         
 
 143.27.06.91    F    607,143    UF    6.000    April 2016    Semi-annual    Semi-annual    12,453,342    11,132,803    Chile 
 281.20.12.01    L (a)   3,000,000    UF    3.750    October 2012    Semi-annual    At maturity    -    55,009,140    Chile 
                     
                            Total    12,453,342    66,141,943     
                     
                     

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COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

Note 18. Commercial paper and Bonds, (continued):

b) Bonds, (continued):

a) On March 29, 2006, the Company placed bonds in the local market for a nominal amount of UF 3,000,000 equivalent to US$ 102.1 million (historical) of a series denominated L, which is composed of 6,000 bonds with a value of UF 500 each. These bonds mature in one installment on October 25, 2012. The annual interest rate amounts to UF + 3.75% and interest is paid semi-annually. There is a redemption option as of October 25, 2007.

Note 19. Trade accounts payable:

The detail of other trade accounts payable is as follows:

    As of December 31, 
   
     2005       2006 
     
    ThCh$     ThCh$ 
Suppliers         
     Domestic    62,726,184    78,616,641 
     Foreign    5,116,358    23,397,546 
Provision for work in progress    10,245,219    5,202,071 
     
 
                     Total    78,087,761    107,216,258 
     
     

Note 20. Other payables:

The detail of other payables is as follows:

    As of December 31, 
   
     2005     2006 
     
    ThCh$    ThCh$ 
 
Carrier service    8,583,010    6,371,448 
Billing on behalf of third parties    6,254,068    6,172,602 
Accrued supports    1,026,799    1,258,297 
Exchange insurance contract payables    3,158,496    71,930 
Material received not yet invoiced    1,321,534    - 
Accounts payable to retired employees    383,014    - 
Others    212,851    52,690 
     
 
                     Total    20,939,772    13,926,967 
     
     

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COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

Note 21. Accruals:

The detail of accruals shown in liabilities is as follows:

    As of December 31, 
   
     2005       2006 
     
    ThCh$    ThCh$ 
Current         
Staff severance indemnities    486,528    462,785 
Vacation    4,947,831    4,307,527 
Other employee benefits (1)   5,938,839    5,095,643 
Employee benefits advances    (1,073,889)   (1,484,258)
     
    10,299,309    8,381,697 
Long-term         
Staff severance indemnities    36,078,910    35,525,488 
     
 
                 Total    46,378,219    43,907,185 
     
     

(1) Includes provisions for bonuses agreed under the current as per current union agreement and miscellaneous.

Note 22. Staff severance indemnities:

The detail of the charge to income for staff severance indemnities is as follows:

     2004    2005    2006 
       
    ThCh$    ThCh$    ThCh$ 
Operating costs and administration and selling expenses     4,450,191    4,472,409    3,898,771 
Other non-operating expenses     3,424,356    1,345,883    9,470,747 
       
 
                     Total     7,874,547    5,818,292    13,369,518 
       
       
 
Payments and other changes for the years (1)    2,272,785    1,737,323    (19,645)
       
       

(1) For the years ending December 31, 2004, 2005 and 2006, this amount includes increases of ThCh$ 10,562,511, ThCh$ 3,725,327 and ThCh$ 6,078,197 in the provision due to changes in actuarial estimations (see Note 3) and total payments of ThCh$ 8,289,726, ThCh$ 1,988,004 and ThCh$ 6,097,842, respectively.

Note 23. Other accounts payable:

Other accounts payable contain the obligations related to the foreign currency forward contracts and the cross currency interest rate swaps.

F - 38

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COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

Note 24. Minority interest:

Minority interest recognizes the portion of equity and net income of subsidiaries owned by third parties. The breakdown for the years ended December 31, 2004, 2005 and 2006, respectively, is as follows:

    Percentage                     
    Minority    Participation    Participation 
Subsidiaries    Interest    in equity    in net income (loss)
       
    2004    2005    2006    2005    2006    2004    2005    2006 
                 
    %    %     %    ThCh$    ThCh$    ThCh$    ThCh$    ThCh$ 
Instituto Telefónica Chile S.A. (formerly Telepeajes de Chile S.A.)   20.00    20.00    -    251,764    -    158,013    (6,716)   (47,226)
Telefónica Larga Distancia S.A. (formerly Telefónica Mundo S.A.)   0.84    0.84    0.69    1,142,716    1,053,959    85,880    8,583    104,884 
Fundación Telefónica    50.00    50.00    50.00    275,590    176,314    55,486    28,852    (99,276)
Telefónica Gestión de Servicios Compartidos Chile S.A.    -    -    0.001    -    14    -    -    (1)
CTC Equipos y Servicios S.A.    0.0001    0.0001    -    11    -    6    5    - 
                 
 
Total                1,670,081    1,230,287    299,385    30,724    (41,619)
                 
                 

Note 25. Shareholders’ Equity

(a) Paid-in capital:

Number of shares:

    No. of subscribed    No. of paid    No. of shares with 
Series    shares    shares    voting right 
       
 
A    873,995,447    873,995,447    873,995,447 
B    83,161,638    83,161,638    83,161,638 
       
    957,157,085    957,157,085    957,157,085 
       
       

The Company’s bylaws authorize two classes of common shares Series A and Series B. The rights of both series of common shares are identical, except that the Board of Directors shall consist of seven directors, six to be elected by the holders of Series A Common Stock and one to be elected by the holders of Series B Common Stock, and that in case of a possible dissolution of the company of three liquidators two shall be elected by the holders of Series A Common Stock and one by the holders of Series B Common Stock.

Paid-in capital:

    Subscribed    Paid-in 
Series    Capital    Capital 
     
    ThCh$    ThCh$ 
 
A    813,490,434    813,490,434 
B    77,404,519    77,404,519 
     
    890,894,953    890,894,953 
     
     

On April 20, 2006, the Extraordinary Shareholders’ Meeting approved the modification of the Company’s bylaws to decrease capital by ThCh$ 40,200,514, in order to distribute additional cash to the shareholders in 2006. Capital distribution No. 1 was equivalent to Ch$ 42 per share and Ch$ 168 per ADR.

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COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

Note 25. Shareholders’ Equity, (continued):

(b) Shareholder stratification:

As indicated in Circular No. 792 of the Chilean Superintendency of Securities and Insurance, the stratification of shareholders by percentage of ownership in the Company as of December 31, 2006 is as follows:

    Percentage of    Number of 
Type of shareholder    total holdings    shareholders 
     
    %     
10% holding or more    55.90    2 
Less than 10% holding:         
 Investment equal to or exceeding UF 200    43.35    1,584 
 Investment under UF 200    0.75    10,999 
     
 
                                 Total    100.00    12,585 
     
     
 
Telefónica Internacional Chile    44.90    1 
     
     


(c) Dividends:

 
i) Dividend policy:

In accordance with Law No. 18,046, unless otherwise decided at a Shareholders Meeting by unanimous vote of the outstanding shares, when there is net income, at least 30% must be allocated as dividend payments.

Considering the cash flow situation, the levels of projected investment and the solid financial indicators for 2005 and future years, on April 14, 2005, the Ordinary Shareholders’ Meeting modified the dividend distribution policy reported at the Ordinary Shareholders’ Meeting of April 2004, and agreed to distribute 100% of net income generated during the respective year, by means of an interim dividend in November of each year and a final dividend in May of the following year.

ii) Dividend distributed in the year:


On April 14, 2005, at the Extraordinary Shareholders’ Meeting, the payment of a final dividend (No. 168) of Ch$ 58.84591 per share on net income for 2004 equivalent to ThCh$ 56,324,775 was approved. Likewise, the payment of a provisional dividend (No. 169) of Ch$ 50.99095 pesos per share was approved, with a charge to retained earnings as of December 2004 equivalent to ThCh$ 48,806,351 (historical). Both dividends were paid on May 30, 2005.

On October 27, 2005, the Board approved payment of an interim dividend (No. 170) of Ch$ 11.00 per share, on 2005 net income, equivalent to ThCh$ 10,528,728 (historical).

On April 20, 2006, at the Extraordinary Shareholders’ Meeting, the payment of a final dividend (No. 171) of Ch$ 15.31 per share with a charge to net income for 2005 of ThCh$ 14,654,592 was approved. The dividend was paid on June 22, 2006.

F - 40

COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

Note 25. Shareholders’ Equity, (continued):

On October 26, 2006, the Board of Directors approved payment of interim dividend No. 172, in the amount of ThCh$ 10,528,728, equivalent to Ch$ 11 per share.

(d) Other reserves:

Other Reserves include the participation of the reserve established by Telefónica Larga Distancia S.A. (formerly Telefónica Mundo S.A.) for the acquisition of the shares of dissident minority shareholders and the net effect of the adjustment for conversion differences as established in Technical Bulletin No. 64 of the Chilean Association of Accountants, the detail of which is as follows:

    Amount        
                 
Company    Balance as of 
December 31,
2005 		   Price-level 
restatement 		   Net 
movement 		   Balance as of 
December 31,
2006 
       
         
    ThCh$    ThCh$    ThCh$    ThCh$ 
 
Telefónica Larga Distancia S.A.                 
(formerly Telefónica Mundo S.A.)   -    (8,092)          (674,254)   (682,346)
TBS Participación S.A.    (1,751,241)   (36,775)          (530,149)   (2,318,165)
         
 
     Total               (1,751,241)   (44,867)   (1,204,403)   (3,000,511)
         
         

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COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

Note 26. Other Non-Operating Income and Expenses:

(a) Other non-operating income:

The detail of other non-operating income is as follows:

    For the years ended December 31, 
   
       2004     2005     2006 
       
     ThCh$    ThCh$    ThCh$ 
 
Gain on sale of used equipment    2,808,910    1,956,018    606,183 
Administrative services    63,004    130,522    445,709 
Real estate rental    204,501    276,691    349,404 
Penalties on suppliers and indemnities    195,338    32,563    125,864 
Sales of promotional material    107,983    -    - 
Gain on sale Publiguías S.A. (1)   6,878,034    -    - 
Gain on sale Telefónica Móvil de Chile S.A. (2)   491,695,142    -    - 
Provision for investment in New Skies Satellites    235,259    -    - 
Gain on sale of shares Intelsat    -    646,887    - 
Others    763,182    128,152    89,707 
       
 
     Total    502,951,353    3,170,833    1,616,867 
       
       

(1) See Note 12 “Investment in related companies” Footnote 4.

(2) On July 23, 2004, the Company sold 100% of its participation in Telefónica Móvil de Chile S.A. The sales price for Telefónica Móviles S.A. (purchaser) was US$ 1,058 million, which was paid on July 28, 2004. With this transaction Compañía de Telecomunicaciónes de Chile S.A. recognized an effect on income (gain), after extraordinary amortization of goodwill as of June 2004 associated to this investment and net of taxes, in the amount of ThCh$ 321,071,436 as of December 2004 (equivalent to approximately US$ 470 million as of the transaction date).

(b) Other non-operating expenses:

The detail of other non-operating expenses is as follows:

    For the years ended December 31, 
   
       2004     2005     2006 
       
     ThCh$    ThCh$    ThCh$ 
 
Restructuring costs (1)   6,584,690    2,070,590    9,528,970 
Lawsuit indemnities and other provisions    722,402    1,189,410    2,859,891 
Provision for obsolete assets    10,118,315    2,885,547    2,534,000 
Depreciation and retirement of out of service property, plant and equipment (2)   8,465,982    4,471,460    1,516,086 
Provision for decrease in market value    -    169,905    26,213 
Non-recoverable tax    -    1,495,319    - 
Donations    183,606    416,345    - 
Others    20,865    653,004    179,522 
       
 
                 Total    26,095,860    13,351,580    16,644,682 
       
       

(1) Corresponds mainly to payments made to employees on the basis of the Early Retirement Plans.

(2) As of December 2005 and 2006, this item is mainly composed of depreciation of telephone equipment maintained in stock for replacement of lines in service. In 2004 this item includes ThCh$ 1,764,655 corresponding to depreciation of the La Serena Cable TV network (assets temporarily out of service) not transferred in the sale of the subsidiary Multimedia to Cordillera Comunicaciones.

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COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

Note 27. Price-level restatement:

The detail of price-level restatement is as follows:

             For the years ended December 31, 
     
Assets (Charges) Credits    Indexation     2004     2005     2006 
         
        ThCh$    ThCh$    ThCh$ 
 
Inventories    CPI    222,500    181,845    25,622 
Prepaid expenses    CPI    4,515    5,264    (1,255)
Prepaid expenses    UF    (76,871)   (14,014)   22,242 
Other current assets    CPI    (161,050)   54,659    118,016 
Other current assets    UF    (4,275,017)   145,178    78,956 
Short and long-term deferred taxes    CPI    3,522,136    4,515,842    2,387,135 
Property, plant and equipment    CPI    42,093,409    51,304,830    27,844,681 
Investments in related companies    CPI    148,822    215,088    132,539 
Goodwill    CPI    1,704,958    710,813    371,584 
Long-term debtors    UF    (187,007)   (1,909,445)   (328,733)
Long-term debtors    CPI    241,467    304,103    144,527 
Other long-term assets    CPI    1,011,975    1,713,663    789,282 
Other long-term assets    UF    37,395    12,119    (103,584)
Expense accounts    CPI    8,969,124    11,103,245    4,508,838 
         
 
     Total Credits        53,256,356    68,343,190    35,989,850 
         
         

Liabilities and Shareholders’ Equity        For the years ended December 31, 
     
       (Charges) Credits    Indexation     2004     2005       2006 
         
        ThCh$    ThCh$     ThCh$ 
 
Short-term obligations    CPI    15,137    -    (23,572)
Short-term obligations    UF    (6,066,394)   (6,865,444)   (125,877)
Long-term obligations    CPI    (13,255)   (18,718)   (26,908)
Long-term obligations    UF    (4,297,440)   (9,240,066)   (9,991,243)
Shareholders’ equity    CPI    (26,624,845)   (32,314,220)   (18,421,044)
Revenue accounts    CPI    (20,676,820)   (17,919,074)   (6,900,277)
         
 
                 Total Charges        (57,663,617)   (66,357,522)   (35,488,921)
         
         
 
                 Gain (Loss) from price-level restatement, net    (4,407,261)   1,985,668    500,929 
         
         

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COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

Note 28. Foreign currency translation:

The detail of foreign exchange gain (loss) is as follows:

        For the years ended December 31, 
     
Assets (Charges) Credits    Currency     2004     2005     2006 
         
        ThCh$    ThCh$    ThCh$ 
 
Current assets    US$    20,860,196    5,290,076    3,694,819 
Current assets    EURO    4,044,191    (10,006)   2,096 
Current assets    REAL    -    (32,263)   142,064 
Long-term receivables    US$    5,507,627    6,007,972    1,411,885 
Other long-term assets    US$    62,186    5,931    (850)
Other long-term assets    EURO    76    -    - 
         
 
                 Total Credits/ ( Charges)       30,474,276    11,261,710    5,250,014 
         
         
 
Liabilities (Charges) Credits    Currency     2004     2005     2006 
         
        ThCh$    ThCh$    ThCh$ 
 
Short-term obligations    US$    (28,837,284)   (1,489,006)   (2,024,503)
Short-term obligations    EURO    (3,880,669)   5,422    (52,254)
Short-term obligations    REAL    -    21,950    82,030 
Long-term obligations    US$    16,151,714    (8,823,947)   (3,090,398)
         
 
                 Total (Charges)/ Credit        (16,566,239)   (10,285,581)   (5,085,125)
         
         
 
                 Foreign exchange gain, net        13,908,037    976,129    164,889 
         
         

Note 29. Issuance and placement of shares and debt expense:

The detail of this item as of December 31 is as follows:

    Short-term    Long-term 
     
    2005     2006     2005     2006 
         
    ThCh$    ThCh$    ThCh$    ThCh$ 
 
Bond issuance expenses    269,297    127,846    27,208    684,423 
Discount on debt    48,761    230,432    183,916    1,120,213 
Commercial paper issuance expense    102,983    -    -    - 
         
 
                         Total    421,041    358,278    211,124    1,804,636 
         
         

The corresponding items are classified as “Other Current Assets” and “Other Long-term Assets”, as applicable and are amortized over the term of the respective obligations, as described in Note 18 “Commercial Paper and Bonds”.

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COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

Note 30. Derivative contracts:

Type of 
Derivative  		   Type of 
contract		   Contract  
value 		   Maturity 
or 
Expiration 		   Specific 
item 		               Value 
of 
hedged 
item 
ThCh$ 		                
                                   Affected accounts     
     
          Purchase
/ Sale 
position 		   Hedged item
or
transaction 		   Amount      Asset/Liability    Effect on income 
   
                  Name         Amount      ThCh$    Realized    Unrealized
ThCh$ 
                       
                         
 
S    CCPE    150,000,000    III Quarter 2008    Exchange rate    P    Oblig. in US$    150,000,000    79,858,500    asset    80,191,646    4,084,417    - 
                                    liabilities    (90,137,930)        
S    CCPE    200,000,000    II Quarter 2009    Exchange rate    P    Oblig. in US$    200,000,000    106,478,000    asset    106,533,546    2,754,923    - 
                                    liabilities    (120,358,491)        
S    CCPE    150,000,000    II Quarter 2011    Exchange rate    P    Oblig. in US$    150,000,000    79,858,500    asset    80,047,989    (1,185,064)   - 
                                    liabilities    (83,908,400)        
FR    CI    26,400,000    I Quarter 2007    Exchange rate    S    -    -    -    asset    14,063,458    5,656    - 
                                    liabilities    (14,057,502)        
FR    CI    13,105,140    I Quarter 2007    Exchange rate    P    -    -    -    asset    6,977,047    (63,046)   - 
                                    liabilities    (7,040,093)        
FR    CI    391,416    I Quarter 2007    Exchange rate    P    -    -    -    asset    96,891    19,272    - 
                                    liabilities    (71,372)        
 
Amortization of premium for exchange forward contracts                        liabilities    -    317,621    - 
Amortization of costs for exchange insurance                        asset    -    (206,190)   - 
Exchange forward contracts expensed during the year ( net )                               2,049,135     
                   
                                        Total    7,776,724    - 
                   
                   

Types of derivatives:    Type of Contract: 
   
FR: Forward    CCPE: Hedge contract for existing transactions 
S: Swap    CI: Investment hedge contract 

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Notes to the Consolidated Financial Statements – (continued)
__________

Note 31. Contingencies and commitments:

Management and their internal and external legal counsel periodically monitor the evolution of the lawsuits and contingencies affecting the Company in the normal course of its operations, analyzing in each case the possible effect on the financial statements. Based on this analysis and on the information available to date, Management and their legal counsel believe that it is unlikely that the Company’s income and equity will be significantly affected by a loss contingency eventually represented by significant liabilities in excess of those already recorded in the financial statements.

a) Lawsuits against the Republic of Chile:

 
• On October 31, 2001, Telefónica Chile S.A. filed an administrative motion before the Ministry of Transport and Telecommunications and the Ministry of Economy, requesting correction of the errors and illegalities in Rate Decree No. 187 of 1999. On January 29, 2002, the Ministries issued a joint response rejecting the administrative recourse, after having “carefully evaluated, only the viability and timeliness of the petition made, considering the set of circumstances that concur in the problem stated and the prudence that must orient public actions”, adding that such rejection “has had no other motivation than to protect the general interest and progress of the telecommunications services”.

Upon extinguishing the administrative instances to correct the errors and illegalities involved in the tariff setting process of 1999, in March 2002, Telefónica Chile S.A. filed a lawsuit for damages against the State of Chile for the sum of ThCh$ 181,038,411, plus readjustments and interest, which covers past and future damages until May 2004. A decision is still pending in this case.

• Telefónica Chile S.A. and Telefónica Larga Distancia S.A. (formerly Telefónica Mundo S.A.) filed a plenary damage indemnity lawsuit against the Government of Chile, claiming damages due to modification of telecommunications networks related to work performed by highway concessionaries from 1996 to 2000.

The Government of Chile forced both companies to pay for the transfer of their communications networks due to the construction of public works on concession under the Concessions Law and the related damages amount to:

a.- Compañía de Telecomunicaciones de Chile S.A.: ThCh$ 1,929,207.
b.- Telefónica Larga Distancia S.A. (formerly Telefónica Mundo S.A.): ThCh$ 2,865,209.

The process is currently at the final judgment stage.

b) Lawsuits:

 
(i) Voissnet Accusation:

On January 20, 2005, Telefónica Chile S.A. responded to a claim made by Voissnet filed before the National Economic Attorney General’s Office based on alleged anti-competitive practices with respect to the development and growth of Internet technology, mainly of broadband telephony, and access to broadband, since Telefónica S.A. prohibits carrying voice using the Company’s Internet broadband access. Voissnet wants the Antitrust Commission to compel Telefónica Chile S.A. to allow third parties to provide IP Telephony through the ADSL Internet owned by Telefónica Chile S.A.

On October 26, 2006, the Company was notified of the Antitrust Commission’s decision, which, in part, accepted Voissnet S.A.’s claim, as well as the requirement of the National Economic Attorney General’s Office. Telefónica Chile S.A. was fined ThCh$ 581,454 (historical).

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Notes to the Consolidated Financial Statements – (continued)
__________

Note 31. Contingencies and commitments, (continued):

 
On November 8, 2006, Telefónica Chile S.A. filed an appeal before the Supreme Court asking that the judgment be revoked and the Company be exonerated from any sanction. The appeal was accepted for processing and, at this time, the Supreme Court has not set a date to hear the allegations of the parties.

(ii) Complaint filed by VTR Telefónica S.A.:

On June 30, 2000, VTR Telefónica S.A. (“VTR”) filed a plenary suit, charged in Chilean pesos, requesting payment of Ch$ 2,204 million, plus sums accrued during the suit, to cover access charges for the use of its networks. VTR bases its complaint on the differences that occurred as a result of the reduction of access charge tariffs after Tariff Decree No. 187 came into effect. Telefónica Chile S.A. responded to the complaint by arguing that the tariffs for access charges that both parties must pay for the reciprocal use of their networks is regulated under a contract signed between Telefónica Chile S.A. and VTR. VTR, however, does not recognize this contract. VTR’s complaint has been accepted and the requested compensation has been ordered. The Company filed an appeal for annulment before the Court of Appeals of Santiago, which is currently pending.

In connection to the above proceeding, two additional judicial proceedings are underway. The first was filed before Subtel in 2002 by VTR for alleged non-payment of invoices for access charges set by D.S. 26. VTR has requested that Telefónica Chile S.A. be forced to pay such invoices and pay the fines imposed by the General Telecommunications Laws. This case has been suspended by order of the Minister until a judgment is provided in the judicial proceeding filed by VTR in 2000. The second proceeding underway was filed by Telefónica Chile S.A. on June 6, 2003, for VTR’s non-payment of access charges in accordance with the contract signed between the parties. This case has been suspended until a judgment is provided in the 2002 suit.

In turn, on December 21, 2005 Telefónica Chile S.A. sued VTR for non-payment of automatic reversal of charges service (800 service) in the amount of Ch$ 1,500 million, plus sums accrued during the course of the trial. Based on the same argument, VTR filed a countersuit in the amount of Ch$ 1,200 million. This judicial process is in the first stage of processing.

(iii) Manquehue Net

On June 24, 2003, Telefónica Chile S.A. filed a forced contract compliance with damage indemnity complaint against Manquehue Net in the amount of ThCh$ 3,647,689 (historical) in addition to the sums accrued during substantiation of the proceeding, before the mixed arbitration court of Mr. Víctor Vial del Río. Likewise, and on the same date, Manquehue Net filed a complaint regarding compliance with discounts (in the amount of UF 107,000), in addition to a complaint regarding the obligation to perform (signing of 700 service contract). On June 5, 2004, following the evidence presentation stage, the arbitrator summoned the parties to pronounce judgment.

On April 11, 2005, the Court notified the first instance judgment that accepted the complaint filed by Telefónica Chile S.A., condemning Manquehue Net to pay approximately Ch$ 452 million (historical), and at the same time accepted the complaint filed by Manquehue Net condemning Telefónica Chile to pay UF 47,600.

Telefónica Chile S.A. filed an appeal for annulment, which is currently pending before the Court of Appeals of Santiago.

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Notes to the Consolidated Financial Statements – (continued)
__________

Note 31. Contingencies and commitments, (continued):

 
(iv) Chilectra and CGE:

In June 2006, Telefónica Chile S.A. filed complaints against Chilectra S.A. and Río Maipo (currently CGE Distribución) in which it requests a readjusted refund of the Reimbursable Financial Contributions (AFR) (“Aportes Financieros Reembolsables”) made by the Company between 1992 and 1998 in relation to the Electrical Law. The restitution amounts claimed are ThCh$ 899,658 and ThCh$ 117,350, respectively. The lawsuits are currently in the discussion stage.

(v) Protection Motion:

On June 28, 2006, television channels UCTV and TVN filed a petition for protection against Telefónica Chile S.A., requesting suspension of the inclusion of such signals in the Digital Television Plan. On June 30th, the Court of Appeals declared the petition inadmissible. The decision was confirmed on July 4, 2006, when the motion to set aside was rejected.

(vi) Labor lawsuits:

In the course of normal operations, labor lawsuits have been filed against the Company.

To date, among others, there are labor proceedings involving former employees, who claim wrongful dismissal. These employees did not sign termination releases or receive staff severance indemnities. On various occasions, the Supreme Court has reviewed the judgments handed down on the matter, accepting the argument of the Company and ratifying the validity of the terminations.

There are, in addition, other lawsuits involving former employees, whose staff severance indemnities have been paid and their termination releases signed, and who in spite of having chosen voluntary retirement plans or having been terminated due to company needs, intend to have the terminations voided. Of these lawsuits, to date, two have received a judgment favorable to the Company, rejecting the annulments.

Certain unions have filed complaints before the Santiago Labor Courts, requesting damage payments for various concepts.

(c) Financial restrictions

In order to develop its investment plans, the Company has obtained financing both in the domestic market and abroad (Notes 16, 17and 18), which establish among other things: clauses on the Company’s maximum debt. The maximum debt to equity ratio for these is 1.60, whereas the interest coverage ratio cannot be less than 4.00.

Non-compliance with these clauses implies that all the obligations assumed in these financing contracts would be considered due and payable.

As of December 31, 2006, the Company complies with all financial restrictions.

Note 32. Third party guarantees:

The Company has not received any guarantees from third parties.

 

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Notes to the Consolidated Financial Statements – (continued)
__________

Note 33. Local and Foreign Currency:

A summary of the assets in local and foreign currency is as follows:

          As of December 31, 
     
 
Description      Currency     2005    2006 
       
          ThCh$    ThCh$ 
 
Total current assets:               
     Cash      Non-indexed Ch$    6,326,771    6,222,818 
      US$    54,330    3,807,548 
      Euros    43,137    44,594 
     Time deposits      Indexed Ch$    294,239    303,652 
      Non-indexed Ch$    1,968    24,424,413 
      US$    86,457,087    2,815,650 
     Marketable securities      Indexed Ch$    1,981,366    1,948,318 
      US$    14,096,639    14,315,284 
     Notes and accounts receivable  (1)   Indexed Ch$    -    39,493 
      Non-indexed Ch$    163,657,874    189,017,503 
      US$    4,012,556    1,773,251 
      Euros    -    129,854 
     Due from related companies      Non-indexed Ch$    12,053,601    12,995,478 
      US$    2,493,227    4,425,984 
     Other current assets  (2)   Indexed Ch$    2,827,190    8,538,175 
      Non-indexed Ch$    30,143,564    21,169,688 
      US$    540,175    4,306,562 
      Reales    8,232    13,120 
       
          324,991,956    296,291,385 
Total property, plant and equipment:               
     Property, plant and equipment and accumulated             
     depreciation      Indexed Ch$    1,327,808,428    1,229,591,307 
       
          1,327,808,428    1,229,591,307 
 
Total other long-term assets:               
     Investment in related companies      Indexed Ch$    7,996,697    8,109,310 
     Investment in other companies      Indexed Ch$    4,179    4,179 
     Goodwill      Indexed Ch$    18,838,807    15,954,977 
     Other long-term assets  (3)   Indexed Ch$    51,531,024    43,849,330 
      Non-indexed Ch$    4,973,547    22,920,979 
      US$    10,909,591    54,782 
       
          94,253,845    90,893,557 
       
Total assets:          1,747,054,229    1,616,776,249 
       
       
               
      Indexed Ch$    1,411,281,930    1,308,338,741 
      Non-indexed Ch$    217,157,325    276,750,879 
      US$    118,563,605    31,499,061 
      Euros    43,137    174,448 
      Reales    8,232    13,120 

(1) Includes the following balance sheet accounts: Accounts Receivable, Notes Receivable and Other Receivables.
(2) Includes the following balance sheet accounts: Inventories, Recoverable Taxes, Prepaid Expenses, Deferred Taxes and Other Current Assets.
(3) Includes the following balance sheet accounts: Long term Receivables, Intangibles, Accumulated Amortization and Others.

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Notes to the Consolidated Financial Statements – (continued)
__________

Note 33. Local and Foreign Currency, (continued):

A summary of the current liabilities in local and foreign currency is as follows:

               Up to 90 days    90 days to 1 year 
       
      As of December 31,    As of December 31, 
       
 Description  Currency    2005    2006    2005    2006 
           
          Average        Average        Average        Average 
          annual        annual        annual        annual 
       Amount    interest     Amount    interest    Amount    interest    Amount    interest 
                   
      ThCh$    %       ThCh$    %    ThCh$    %    ThCh$    % 
Short-term portion of obligations with                                   
     banks and financial institutions  Indexed Ch$    -    -    446,306    3.16    327,951    -    -    - 
  US$    1,019,343    4.46    1,558,808    5.70    -    -    -    - 
Commercial paper  Non-indexed Ch$    23,217,737    3.10    -    -    35,068,089    3.60    -    - 
Bonds  Indexed Ch$    -    -    1,839,758    5.54    1,483,494    6.00    -    - 
  US$    85,344,170    8.40    -    -    26,884,467    7.60    -    - 
Long-term obligations maturing                              -    - 
     within a year  Indexed Ch$    2,747    9.06    2,930    8.10    14,115    9.06    8,792    8.10 
Due to related parties  Indexed Ch$    -    -    -    -    286,295    -    -    - 
  Non-indexed Ch$    25,642,842    -    30,502,075    -    -    -    -    - 
  US$    479,324    -    2,505,085    -    -    -    -    - 
Other short-term liabilities      (4) Indexed Ch$    2,026,114    -    555,372    -    821,280    -    -    - 
  Non-indexed Ch$    121,927,299    -    115,765,844    -    5,221,218    -    24,154,050    - 
  US$    5,133,496    -    16,952,763    -    367,928    -    -    - 
  Euros        -    380,743    -    -    -    -    - 
  Yen    -    -    785    -    -    -    -    - 
 
Total Current Liabilities      264,793,072    -    170,510,469    -    70,474,837    -    24,162,842    - 
                   
                   
 
Subtotal by currency  Indexed Ch$    2,028,861    -    2,844,366    -    2,933,135    -    8,792    - 
  Non-indexed Ch$    170,787,878    -    146,267,919    -    40,289,307    -    24,154,050    - 
  US$    91,976,333    -    21,016,656    -    27,252,395    -    -    - 
  Euros    -    -    380,743    -    -    -    -    - 
  Yen    -    -    785    -    -    -    -    - 

(4) Includes the following balance sheet accounts: Dividends payable, Trade accounts payable, Other payables, Accruals, Withholdings, Unearned income and Other current liabilities.

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Notes to the Consolidated Financial Statements – (continued)
__________

Note 33. Local and Foreign Currency, (continued):

A summary of the long-term liabilities in local and foreign currency is as follows:

             1 to 3 years    3 to 5 years    5 to 10 years    over 10 years 
           
        2005    2005    2005    2005 
           
Description    Currency        Average 
annual
 interest
 rate 		       Average
 annual
 interest
 rate 		       Average 
annual
 interest
 rate 		       Average 
annual
 interest
 rate 
           
                             
                             
        Amount      Amount      Amount           Amount   
                   
        ThCh$    %    ThCh$    %    ThCh$    %    ThCh$    % 
    Long-Term Liabilities                                     
 
   Obligation with banks and                                     
        financial institutions    Indexed Ch$    -    -    65,242,359    2.32    -    -    -    - 
    US$    78,489,375    4.69    104,652,500    4.90    78,489,375    4.64    -    - 
   Bonds payable    Indexed Ch$    -    -    -    -    -    -    12,453,342    - 
    US$    -    -    -    -    -    -    -    - 
   Other long-term liabilities      (5)   Indexed Ch$    16,310,859    -    17,362,297    -    6,131,252    -    78,141,088    - 
    Non-indexed Ch$    771,896    -    492,396    -    1,230,989    -    5,336,412    - 
                   
 
Total Long-Term Liabilities        95,572,130    -    187,749,552    -    85,851,616    -    95,930,842    - 
                   
                   
 
Subtotal by currency    Indexed Ch$    16,310,859    -    82,604,656    -    6,131,252    -    90,594,430    - 
    Non-indexed Ch$    771,896    -    492,396    -    1,230,989    -    5,336,412    - 
    US$    78,489,375    -    104,652,500    -    78,489,375    -    -    - 

        1 to 3 years         3 to 5 years    5 to 10 years    over 10 years 
           
        2006    2006    2006    2006 
           
Description    Currency        Average 
annual
 interest
 rate 		       Average 
annual
 interest
 rate
       Average 
annual
 interest
 rate 
       Average 
annual
 interest 
rate 
           
                             
                             
                             
        Amount      Amount     Amount     Amount  
                   
        ThCh$    %    ThCh$    %    ThCh$    %    ThCh$     %
 Long-Term Liabilities                                     
 
   Obligation with banks and                                     
     financial institutions    Indexed Ch$    -    -    79,858,500    5.70    -    -    -    - 
    US$    186,336,500    5.70    65,185,831    3.16    -    -    -    - 
   Bonds payable    Indexed Ch$    -    -    55,009,140    3.75    11,132,803    6.00    -    - 
   Other long-term liabilities       (5)   Indexed Ch$    34,280,242    -    4,300,302    -    3,883,407    -    67,127,739    - 
    Non-indexed Ch$    437,714    -    452,161    -    4,585,421    -    7,522,016    - 
                   
 
 
Total Long-Term Liabilities        221,054,456    -    204,805,934    -    19,601,631    -    74,649,755    - 
                   
                   
 
Subtotal by currency    Indexed Ch$    34,280,242    -    139,167,942    -    15,016,210    -    67,127,739    - 
    Non-indexed Ch$    437,714    -    452,161    -    4,585,421    -    7,522,016    - 
    US$    186,336,500    -    65,185,831    -    -    -    -    - 

(5) Includes the following balance sheet accounts: Other accounts payable, Accruals, Deferred long-term taxes, Other long-term liabilities.

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Notes to the Consolidated Financial Statements – (continued)
__________

Note 34. Sanctions:

Neither the Company, nor its Directors and Managers have been sanctioned by the Superintendency of Securities and Insurance or any other administrative authority during 2006, 2005 or 2004.

Note 35. Subsequent events:

On January 24, 2007, the Board of Directors agreed to propose in the Shareholders Meeting payment of final dividend (No. 173), with a charge to 2006 net income, in the total amount of ThCh$ 12,866,433 equivalent to Ch$ 13.44234 per share.

On February 26, 2007, the Board of Directors of Compañía de Telecomunicaciones de Chile S.A. agreed to do the following:

1) Call an Extraordinary Shareholders’ Meeting for Friday, April 13, 2007, in order to decide on the following matters:
     i) Capital decrease in the amount of Ch$48,815,011,335 (Ch$51 per share).
     ii) Modification of Article Five of the Company’s bylaws regarding changes to paid-in capital.
     iii) Implement the aforementioned modifications by formal agreement.

2) Modify the Company’s outstanding dividend distribution policy of distributing 100% of net income of the respective year, by adding the following: “In addition to paying dividends equivalent to 100% of net income, in the following fiscal year, to the extent that there is a surplus in positive cash flows and the Company complies with cash requirements for business-related obligations, the Board’s intention is to distribute a portion of this cash surplus to shareholders. The amount of the additional distribution will be proposed at a shareholders’ meeting to be called for this purpose each year.”

Management is unaware of any other significant subsequent events that have occurred in the period from January 1, 2007, to the date of issuance of the financial statements that may affect the Company’s financial position or the interpretation of the financial statements.

Note 36. Environment:

In the opinion of Management and their in-house legal counsel and because the nature of the Company’s operations do not directly or indirectly affect the environment, as of the closing date of the financial statements, no resources have been set aside nor have any payments been made for non-compliance with municipal ordinances or to other supervising organizations.

The Company reviewed its real property lease agreements with private parties and government agencies involving locations where certain Company’s assets are installed, such as digital exchanges, radio stations, antennas and other equipment, regarding potential obligations upon termination or expiration of the lease agreements considering the duration of the agreements and the terms for renewal. There are no significant obligations identified based on these contracts because:

• The Telecommunication Law in Chile provides that the Company, as a provider of public service, has the right to maintain its assets on third party property and can not be forced to remove its assets without its consent.

• Based on historical evidence, the majority of lease agreements are renewed. Those leases that were not renewed did not incur significant retirement costs.

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Notes to the Consolidated Financial Statements – (continued)
__________

Note 37. Differences Between Chilean And United States Generally Accepted Accounting Principles

The Company prepared its consolidated balance sheets as of December 31, 2005 and 2006, respectively, and its consolidated statements of income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2006, included in its 20-F filing for the year ended December 31, 2006, in conformity with accounting principles generally accepted in Chile (“Chilean GAAP”) with a reconciliation to net income for each of the three years in the period ended December 31, 2006, and a reconciliation to shareholders' equity as of December 31, 2005 and 2006, respectively, derived from applying accounting principles generally accepted in the United States of America (“US GAAP”). This presentation is in accordance with Item 18 of Form 20-F.

I. Differences in measuring methods

The Company’s consolidated financial statements are prepared in accordance with generally accepted accounting principles (“GAAP”) in Chile, which differ in certain respects from US GAAP.

Under Chilean GAAP, financial statements are restated to reflect the full effects of the gain (loss) in the purchasing power of the Chilean peso on the financial position and results of operations of reporting entities. The method is based on a model that enables calculation of net inflation gains or losses caused by monetary assets and liabilities exposed to changes in the purchasing power. The model prescribes that the historical cost of such accounts be restated for general price-level changes between the date of origin of each item and the year-end. As allowed pursuant to the rules and regulations for Form 20-F, the reconciliation included herein of consolidated net income, other comprehensive income and shareholders´ equity does not include adjustments to eliminate the effect of inflation accounting under Chilean GAAP.

Under Chilean GAAP, in accordance with Technical Bulletin 64 (BT 64), the financial statements of foreign subsidiaries that operate in countries exposed to significant risks ("unstable countries"), and that are not considered to be an extension of the parent Company’s operations, must be remeasured into US dollars. The Company has an equity method investment in the Brazilian TBS Celular Participación S.A., the Company remeasured this foreign equity-investee into US dollars under this requirement as follows:

• Monetary assets and liabilities are translated at year-end rates of exchange between the US dollar and the local currency.

• All non-monetary assets and liabilities and shareholders equity are translated at historical rates of exchange between the US dollar and the local currency.

• Income and expense accounts are translated at average rates of exchange between the US dollar and local currency.

• The effects of any exchange rate fluctuations are included in the results of operations for the period.

Under BT 64, the investment in a foreign subsidiary is price-level restated, the effects of which are reflected in income, while the effects of the foreign exchange gain or loss between the Chilean Peso and the US dollar are reflected in equity in the account “Cumulative Translation Adjustment”, as the foreign investment itself is measured in US dollars.

In the opinion of the Company and under the exemption allowed for Technical Bulletin 64 by the AICPA International Task Force, the Chilean GAAP procedures described above are part of the comprehensive basis of preparation of price-level adjusted financial statements required by Chilean GAAP. Inclusion of inflation and translation effects in the financial statements is permitted for Form 20-F and considered appropriate under the inflationary conditions that have historically affected the Chilean economy and accordingly, are not eliminated in the reconciliation to US GAAP.

a) Technical revaluation of Property, Plant and Equipment

As mentioned in Note 2(k) to the Chilean GAAP financial statements, in accordance with standards issued by the SVS in 1986, the property, plant and equipment of the Company subject to such regulation are allowed to be revalued pursuant to a technical appraisal. The difference between the book value prior to revaluation and the revalued amount is included

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Notes to the Consolidated Financial Statements – (continued)
__________

in equity as a surplus on account of such technical appraisal, and is subject to Chilean inflation adjustment and depreciation. Under US GAAP, such revaluations are not permitted. The effects of the reversal of this revaluation net of the accumulated depreciation, as well as of the related depreciation expense for the years are shown under paragraph (q) below.

b) Investments in Debt and Equity Securities

Under Chilean GAAP, investments in securities are accounted for at the lower of cost or market value. Under US GAAP, securities are classified as trading, held-to-maturity or available-for-sale. Those securities classified as trading are carried at their fair value, with realized and unrealized gains and losses recognized currently in earnings. Available-for-sale securities are also carried at fair value, with unrealized gains and losses recorded in shareholders’ equity. Securities classified as held-to-maturity are carried at amortized cost. The effects of the reversal of the unrealized losses that were considered to be temporary and the recording of the unrealized gains on available- for-sale securities which are recorded in equity in US GAAP for each year are included in paragraph (q) below.

c) Deferred Income Taxes

(i) Complementary Accounts

Starting January 1, 2000, the Company recorded income taxes in accordance with Technical Bulletin No. 60 of the Chilean Association of Accountants and its related amendments. Recognizing, using the liability method, the deferred tax effects of temporary differences between the financial reporting basis and the tax basis of assets and liabilities. As a transitional provision, a contra asset or liability had been recorded for the effects of the deferred tax assets and liabilities not recorded prior to January 1, 2000. Such complementary asset or liability is being amortized to income over the estimated average reversal periods corresponding to the underlying temporary differences to which the deferred tax asset or liability relates. The effects of the differences, primarily related to the amortization of the complementary account are included under paragraph (q) below.

(ii) Deferred tax effects of US GAAP adjustments

Under US GAAP, companies must account for deferred taxes in accordance with Statements of Financial Accounting Standards (“SFAS”) No. 109 “Accounting for Income Taxes”, which requires an asset and liability approach for financial accounting and reporting of income taxes, under the following basic principles: (a) A deferred tax liability or asset is recognized for the estimated future tax effects attributable to temporary differences and tax loss carry forwards; (b) the measurement of deferred tax liabilities and assets is based on the provisions of the enacted tax law and the effects of future changes in tax laws or rates are not anticipated; and (c) the measurement of deferred tax assets is reduced by a valuation allowance, if based on the weight of available evidence, it is more likely than not that some portion of the deferred tax assets will not be realized.

Temporary differences are defined as any difference between the financial reporting basis and the tax basis of an asset and liability that at some future date will reverse, thereby resulting in taxable income or expense. Temporary differences ordinarily become taxable or deductible when the related asset is recovered or the related liability is settled. A deferred tax liability or asset represents the amount of taxes payable or refundable in future years under currently enacted tax rates as a result of temporary differences at the end of the current year.

Certain US GAAP adjustments generate temporary differences and related tax effects which are included in paragraph (q) below.

d) Capitalization of finance costs

(i) Capitalization of interest

Under Chilean GAAP, all interest on debt directly associated with construction projects is capitalized, including interest, price-level restatement and, with respect to foreign currency borrowings, foreign currency translation gains and losses.

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Notes to the Consolidated Financial Statements – (continued)
__________

Until the end of 2002, all debt of the Company was considered directly associated with construction projects. The capitalization of interest costs associated with projects under construction is optional when incurred on debt that is not directly related to such projects. In 2003 under Chilean GAAP, the Company has discontinued capitalizing interest on its construction in progress due to the lack of incurrence of new debt which could be associated with such construction and the short-term nature of the items currently being included in the construction in progress category. Under US GAAP, capitalization of interest is required for the interest which could be avoided should expenditures for the associated assets have not been made. Since 2003 the Company continues to capitalize interest under US GAAP only.

The effects of the differences, including those related to the depreciation, described above are included under paragraph (q) below.

(ii) Foreign currency exchange differences

Under US GAAP, the Company reverses those amounts previously capitalized related to foreign currency exchange gains and losses on foreign currency borrowings related to construction for purposes of reconciling to US GAAP.

The effects of the differences, including those related to the depreciation, described above are included under paragraph (q) below.

e) Staff Severance Indemnities

(i) Prior Service Cost

Under Chilean GAAP, prior service cost resulting from the adoption of new severance indemnity plans created in year 1987 were charged to income upon adoption.

Under US GAAP, the prior service cost, under Statement of Financial Accounting Standards 87 is deferred and is amortized into income over the expected working life of the employee. With the adoption of Statement of Financial Accounting Standards No. 158 (SFAS 158), "Employer’s Accounting for Defined Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106 and 132(R)" as describe in part II of Note 37 under paragraph (l), the Company recorded the unamortized amount as a component of the ending balance of accumulated other comprehensive income, net of tax.

The effects of the deferral and the corresponding amortization for the years shown, as well as the adoption of SFAS 158, are included under paragraph (q) below.

(ii) Staff Severance Indemnities under Chilean GAAP

Under the Company's employment contracts and collective bargaining agreements, it has committed to provide a lump sum payment to each employee at the end of their employment, whether due to death, termination, resignation or retirement. Until November 30, 2004 the Company determined those obligations using the present value method, based on the current salaries and estimated average service life of each employee at year-end, and applying a discount rate of 7%.

Starting December 2004, the Company changed its estimation for staff severance indemnities by incorporating certain additional variables through an actuarial valuation. Variables such as workforce rotation, average salary increases, workforce mortality and average service life as underlying assumptions. Costs for past services of employees, resulting from these changes in assumptions, are deferred and amortized over the employees’ estimated average remaining service periods.

During 2006, the Company change the discount rate from 7% to 6% as describe in Note 3 (i) to the financial statements. The cost for past services of employees, resulting from this additional change in assumption, is deferred and amortized over the employees’ estimated average remaining service periods.

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Notes to the Consolidated Financial Statements – (continued)
__________

(iii) Staff Severance Indemnities under US GAAP

Under US GAAP, staff severance indemnities have always been recorded in accordance with SFAS No. 87, “Employer’s Accounting for Pensions” using the projected benefit obligation method. The assumptions used correspond to the valuation under Chilean GAAP, with the difference that until December 31, 2005, a discount factor of 5.5% was applied. As of December 31, 2006, under US GAAP a discount factor of 6% is applied, equal to the treatment under Chilean GAAP. The Company has elected to recognize its actuarial gains and losses immediately under US GAAP. The effects of the elimination of the transitional assets and the differences in the discount rate for the year ended December 31, 2005, and of the elimination of the transitional assets for the year ended December 31, 2006, are included under paragraph (q) below.

f) Derivatives

As described in Note 30 to the financial statements, the Company uses derivative instruments to manage exposures to foreign currency and interest rate risk. The Company’s objectives for holding derivatives are to minimize these risks using the most effective methods to eliminate or reduce the impact of these exposures.

The effects of the adjustments for financial derivatives are mainly related to cross currency interest rate swap contracts for the three years in the period ended December 31, 2006. The embedded derivatives are quantified as a separate adjustment in the reconciliation. Both adjustments are included in paragraph (q) below. As of December 31, 2006, there are no deferred gains or losses under Chilean GAAP, and no reconciling item is included.

(i) Forward exchange contracts:

The Company has forward exchange contracts between the US dollar and Chilean peso and US dollar and the UF. Under Chilean GAAP, these forward exchange contracts are recorded at fair value with mark to market adjustments recorded as unrealized gains on the balance sheet with no income statement effect and any unrealized loss in the income statements. These derivatives are considered fair value hedges of existing transactions. Under US GAAP, these forward exchange contracts are valued at fair value with changes in fair value recognized in income, whether they represent unrealized gains or unrealized losses.

(ii) Cross currency interest rate swaps:

The Company entered into cross-currency interest rate swaps as hedges of its debt denominated in US dollars. These swaps hedge both, currency risk and interest rate risk. Under Chilean GAAP, the unrealized gain and loss associated with these contracts was deferred. Under US GAAP, these contracts do not qualify for hedge accounting because they do not meet hedge requirements under SFAS No. 133, therefore mark to market adjustments are also charged to income.

(iii) Embedded derivatives:

Current Chilean accounting rules do not consider the existence of derivative instruments embedded in other contracts and therefore they are not analyzed and accounted for in the Company’s Chilean GAAP financial statements. For US GAAP purposes, certain implicit or explicit terms included in host contracts that affect some or all of the cash flow or the value of other exchanges required by the contract in a manner similar to a derivative instrument are required to be bifurcated from the host contract and accounted for at fair value.

g) Accommodation Equipment

From April 1, 2001 until the sale of Telefónica Móvil de Chile S.A. in July 2004, this segment loaned out phones under certain accompanying service contracts; ownership of the phones remained with the Company. The Company, under Chilean GAAP, writes off the equipment on a straight-line basis over the average life of the service contract, capitalizing any unamortized cost in fixed assets.

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Notes to the Consolidated Financial Statements – (continued)
__________

Under US GAAP, the subsidies on these types of phone (their cost) are recognized as losses in the income statement on the contract date due to, among other things, Telefónica Móvil’s lack of a sufficient history of recovery of the phones upon termination of the contracts and their lack of control procedures to track the phones during their customer service period. The effects are included under paragraph (q) below.

h) Goodwill

Under Chilean GAAP up through December 31, 2003, the Company recorded goodwill or negative goodwill for the difference between the purchase price and the carrying value of assets acquired and liabilities assumed. As of January 1, 2004 Technical Bulletin No. 72 (“BT 72”) of the Chilean Institute of Accountants became effective. The bulletin requires the assets acquired and liabilities assumed to be recorded at fair value and the excess of the purchase price of the investment over the fair value of assets acquired and liabilities assumed to be recorded as goodwill. Under BT 72 goodwill resulting from business combinations is amortized on a straight-line basis over a maximum period of 20 years.

Under US GAAP, assets acquired and liabilities assumed are recorded at their fair values. Any excess of the cost of an investment over the fair values of assets acquired and liabilities assumed is recorded as goodwill. In the opinion of the Company, the book value of any assets acquired or liabilities assumed has not materially differed from their fair values in any transaction recorded under purchase accounting in previous periods.

In accordance with SFAS No. 142, “Goodwill and other Intangible Assets” (SFAS No. 142) the Company no longer amortizes goodwill, instead goodwill is tested for impairment on an annual basis and whenever indicators of impairment arise. The goodwill impairment test, which is based on fair value, is performed on a reporting unit level annually. The Company has performed the annual impairment tests of goodwill required by the standards, which did not result in any impairment adjustment during the periods presented. The adjustment presented in paragraph (q) below reverses the effects of the amortization of goodwill recorded under Chilean GAAP.

During the year 2006, as explained in Note 13 Footnote 1, the Company recorded an impairment loss related to the goodwill of its subsidiary Tecnonáutica S.A. Under US GAAP, due to the higher unamortized book value, the Company recorded a higher charge to income, which is also reflected in the adjustment presented in paragraph (q) below.

i) Minimum dividend

As required by Law No. 18.046, the Company must distribute a minimum cash dividend equivalent to 30% of net income. Considering the cash situation, levels of projected investment and the solid financial indicators for 2005 and following years, on April 14, 2005, the Ordinary Shareholders’ Meeting modified the dividend distribution policy reported at the Ordinary Shareholders’ Meeting of April 2004, and agreed to distribute 100% of net income under Chilean GAAP generated during the respective year. Since the payment of these dividends is a legal requirement in Chile, an accrual for US GAAP purposes should be made to recognize the corresponding decrease in shareholders’ equity at each balance sheet date. Under Chilean GAAP, the Company records these dividends when they have received the approval of the shareholders during a shareholders’ meeting usually held in April of the following year. The effects as of December 31, 2005 and 2006 on consolidated shareholders’ equity are shown in the reconciliation in paragraph (q) below.

j) Transactions under common control entities and discontinued operations

In April 2004, Compañía de Telecomunicaciónes de Chile S.A sold its ownership in Sociedad Comercial e Impresora Publiguías S.A. to Telefónica Publicidad e Información S.A., a subsidiary of Telefonica S.A., Spain with a 59.90% ownership. The selling price was US$ 14,760,000 (historical), which resulted in a gain, net of taxes, of ThCh$ 5,358,482.

In July 2004, the Company sold 100% of its stock in its subsidiary, Telefónica Móvil de Chile S.A. to Telefónica Móviles S.A., a different subsidiary consolidated within the group’s 20-F of Telefónica S.A., Spain with a 92.46% ownership. The sales price for Telefónica Móviles S.A. (purchaser) was US$ 1,058 million (Ch$ 702,188 million), which was paid on July 28, 2004. For Compañía de Telecomunicaciónes de Chile S.A., this transaction meant recognizing a net of tax gain of

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Notes to the Consolidated Financial Statements – (continued)
__________

US$ 470 million (Ch$ 321,071 million) after inclusion of the balance of goodwill on this investment as of June 2004 as well as the balance of its investment in the Company.

Under US GAAP, sales of entities and interests between companies within a commonly controlled group transfer their assets and liabilities at historical cost. Any difference between such values and the amount paid for the transaction is considered a capital transaction and is recorded in shareholders’ equity.

The effects of reversing the gains associated with the sale of the stock in the subsidiary Telefónica Móvil de Chile S.A. and the Company’s participation in Sociedad Comercial e Impresora Publiguías S.A. and recording the sales as capital transactions under US GAAP in the equity reconciliation are included in (q) below.

The gain recorded under Chilean GAAP differs from the contribution of capital under US GAAP by approximately ThCh$ 23,719,819 which consists of assets and liabilities of Telefónica Móvil S.A. whose book values differ between Chilean GAAP and US GAAP on June 30, 2004, the date of deconsolidation of Telefónica Móvil S.A. This difference primarily relates to basis differences in goodwill. The reconciliation includes a reclassification to contribution of capital from retained earnings for the above transactions.

Additionally, under Chilean GAAP, no revision to the financial statement information presented in previous years is required after a divestiture has occurred. Under US GAAP, in accordance with SFAS No. 144, the discontinued operations of a component must be retroactively separated from the continuing operations of an entity. As Telefónica Móvil de Chile S.A. met the criteria to be considered as a “component” which would be presented under “Discontinued Operations” in accordance with Statement of Accounting Standards No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”), the Company has presented under US GAAP its operations through the sale date as discontinued under US GAAP, net of the tax effect, and retroactively for all periods presented.

k) Revenue Arrangements with Multiple Deliverables

Under Chilean GAAP, revenue is generally recognized as services are performed or products are delivered based on the specified contractual price. Under US GAAP, the Company adopted EITF 00-21 “Revenue Arrangements with Multiple Deliverables” on January 1, 2004. Certain of the contracts of the Company contain “multiple elements” as defined in the literature. These contracts primarily comprise those of the subsidiary Telefónica Empresas S.A., which is in the business of providing voice and internet data service to corporate customers. Contracts in this business may include equipment sales, equipment rentals, set-up/installation fees, and/or service and maintenance fees. As there is objective and reliable evidence of fair value of all delivered and undelivered items in an arrangement, the total consideration is allocated to the separate units of accounting based on their relative fair values (“relative fair value method”), which approximate the contractually stated prices. The services specified in the arrangement are performed continuously over the term of the contract (and any subsequent renewals). The Company therefore defers and recognizes the set-up fees over the life of the estimated customer relationship in accordance with US GAAP.

Additionally, the Company recorded adjustments to the revenue of its subsidiary, Telefónica Móvil S.A., for multiple deliverables as defined under Staff Accounting Bulletin 104 for the six months of operations included in the consolidated results for 2004. The Company determined that the sale of cellular handsets combined with “free” prepaid minutes constitutes a revenue arrangement with multiple deliverables. The Company began to allocate the arrangement consideration on a fair value basis resulting in the income for the free minutes being deferred and recognized over their actual usage period. Additionally, the Company deferred activation fees charged over the estimated life of the customer relationship.

The adjustments to income are included in paragraph (q) below.

l) Cost adjustment for certain property, plant and equipment

The Company, as part of its real estate construction-in-progress projects, enters into subcontracting agreements. As part of those agreements, certain cost adjustments may be charged back to the subcontractor. Under Chilean GAAP, back charges are recognized in non operating income in the period they are collected.

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Notes to the Consolidated Financial Statements – (continued)
__________

Under US GAAP, back charges to subcontractors are included in the determination of acquisition costs and should be applied to reduce contract costs to the extent collectible.

The effect of the adjustment arising from accounting under US GAAP for back charges and the reduction in depreciation related to the reduction of the fixed asset bases is presented in paragraph (q) below.

m) Connection Fees and Installation Cost:

Under Chilean GAAP, connection fees are recognized as revenues with its origination, and installation costs for fixed line services are capitalized in fixed assets.

Under US GAAP, until December 31, 2005, connection fees were recognized with its origination equal to the treatment under Chilean GAAP, and installation costs were expensed as incurred. Starting in 2006, these connection fees are deferred and taken to the income statement during the average estimated customer relationship period of 33 to 48 months, whereas installation costs are capitalized in fixed assets equal to Chilean GAAP.

As of December 31, 2005, the cumulative effect of the non-deferral of connection fees and installation costs was deemed immaterial, and no change was made to the Company’s prior period presentation. In accordance with Staff Accounting Bulletin 108 “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements”, the cumulative effect as of the beginning of 2006 was corrected in the current year financial statements.

As of December 31, 2005, the reversal of the capitalization of installation costs and their associated depreciation, and as of December 31, 2006, the deferral of connection fees received, are included in paragraph (q) below.

n) Write-off of deferred financing costs

The Company redeemed a UF 3,992,424 series K bond on February 15, 2005. For Chilean GAAP purposes, the majority of the associated deferred financing costs and discount were written off during the year ended December 31, 2004 in the amount of ThCh$ 3,423,519. The amount written off was calculated assuming a remaining amortization period ending on the redemption date of February 15, 2005. This write off of the deferred financing costs and discount during 2004 is not permitted under US GAAP, as the related debt issuance costs and discount must be charged to expense in the period in which the early extinguishment takes place under Accounting Principles Board Opinion No. 26 “Early Extinguishment of Debt”. Accordingly, this generated a difference of ThCh$ 3,423,519 in net income and shareholders’ equity between Chilean GAAP and US GAAP, as shown in the reconciliations in paragraph (q) below.

o) Restructuring costs

Compañía de Telecomunicaciónes de Chile S.A. made an offer to some employees to voluntarily terminate their working contracts with the Company. Related to this planned reduction of personnel, the Company made a provision of ThCh$ 2,070,590 as of December 31, 2005.

Under US GAAP, in accordance with SFAS 88, the recognition of a liability and a loss requires the acceptance of the offer by employees for a reliable estimation of the obligation. There was no acceptance of the offer by employees prior to January 1, 2006, therefore no provision was recognized.

p) Amortization of Bond Discount

Under Chilean GAAP, the Company is deferring and amortizing the difference between par and placement value of bonds on a straight-line basis over the respective term of the instrument. According to US GAAP, the Company should apply the effective interest rate method to determine the amortization of the bond discount. The impact of not applying the effective interest rate method was deemed not significant, the Company did not record an adjustment related to this concept.

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Notes to the Consolidated Financial Statements – (continued)
__________

q) Effects of conforming to US GAAP

The adjustments to reported net income required to conform to accounting principles generally accepted in the United States are as follows:

  For the years ending December 31. 
   
     2004     2005     2006 
       
     ThCh$    ThCh$    ThCh$ 
 
Net income in accordance with Chilean GAAP  329,627,099    25,712,170    23,353,046 
 
Technical revaluation of property, plant and equipment (a) (57,081)   (48,007)   110,377 
Deferred income taxes (c)          
 Complementary accounts  15,320,502    13,895,659    13,815,557 
 Deferred tax effects of US GAAP adjustments  853,765    (1,194,748)   (586,850)
Capitalization of finance costs (d)          
 Capitalization of interest  (684,134)   3,407,710    3,632,966 
 Capitalization of foreign currency exchange differences  403,939    403,939    403,939 
Staff severance indemnities (e)          
 Prior service cost  (397,003)   (778,711)   (397,003)
 Staff severance indemnities  (4,130,638)   1,663,008    4,115,398 
Derivatives (f)          
 Financial derivatives  (2,931,220)   3,463,384    (3,744,165)
 Embedded derivatives  (219,618)   (8,640)   - 
Accommodation equipment (g) 53,815    -    - 
Goodwill (h) 6,868,386    1,616,816    660,748 
Transactions under common control entities and discontinued operations (j)          
 Gain on sale of Telefónica Móvil de Chile S.A.  (321,071,436)   -    - 
 Gain on sale of Publiguías  (5,358,482)   -    - 
Revenue arrangements with multiple deliverables (k) 528,729    208,272    341,407 
Cost adjustment for certain property, plant and equipment (l) (180,614)   47,735    (40,354)
Connection Fees and Installation cost (m) (831,844)   (441,480)   1,100,082 
Write-off of deferred financing costs (n) 3,423,519    (3,423,519)   - 
Restructuring costs (o) -    2,070,590    (2,070,590)
           
       
 
 
Net income in accordance with US GAAP  21,217,684    46,594,178    40,694,558 
 
Net income from continuing operations in accordance with US GAAP  22,540,962    46,594,178    40,694,558 
Net income (loss) from discontinued operations           
 in accordance with US GAAP (see Note 37 II paragraph (d)) (1,323,278)   -    - 
 
Other comprehensive income, net of tax:           
Unrealized gain (loss) from debt and equity securities (b) 468,475    (720,777)   9,605 
Prior service cost (e) -    -    (240,390)
Cumulative translation adjustment on foreign investment  (449,801)   (478,884)   (530,149)
       
 
Comprehensive income in accordance with US GAAP  21,236,358    45,394,517    39,933,624 
       
       

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Notes to the Consolidated Financial Statements – (continued)
__________

The adjustments required to conform shareholders’ equity amounts to US GAAP are as follows:

    As of December 31, 
   
     2005     2006 
     
    ThCh$    ThCh$ 
 
Shareholders’ equity in accordance with Chilean GAAP    945,012,098    900,760,875 
 
Technical revaluation of property, plant and equipment (a)        
   Positive adjustment to Fixed Assets    (15,428,616)   (16,675,110)
   Accumulated Depreciation    15,252,425    16,538,373 
   Negative adjustment to Fixed Assets    8,240,289    9,973,181 
   Accumulated Depreciation    (4,658,575)   (6,320,544)
Investment in debt and equity securities (b)   3,161    14,733 
Deferred income taxes (c)        
 Complementary accounts    (116,060,215)   (102,244,658)
 Deferred tax effects of US GAAP adjustments    (291,500)   (831,619)
Capitalization of finance costs (d)        
 Capitalization of interest         
       Gross effect on Fixed Assets    14,363,357    19,528,225 
       Accumulated Depreciation    (3,004,401)   (4,536,303)
 Capitalization of foreign currency exchange differences         
       Gross effect on Fixed Assets    (5,618,072)   (5,618,072)
       Accumulated Depreciation    2,402,579    2,806,518 
Staff severance indemnities (e)        
 Prior service cost    686,629    - 
 Staff severance indemnities under US GAAP    (12,493,590)   (8,378,192)
Derivatives (f)        
 Financial derivatives    3,744,165    - 
 Embedded derivatives    -    - 
Goodwill (h)   6,600,248    7,260,996 
Minimum dividend (i)   (14,962,338)   (12,824,318)
Revenue arrangements with multiple deliverables (k)   (341,407)   - 
Cost adjustment for certain property, plant and equipment (l)        
   Gross effect on Fixed Assets    (817,705)   (930,231)
   Accumulated Depreciation    95,021    167,193 
Connection Fees and Installation cost (m)        
   Gross effect on Fixed Assets    (3,517,944)   - 
   Accumulated Depreciation    739,959    - 
   Connection Fees    -    (1,677,903)
Restructuring cost (o)   2,070,590    - 
     
 
Shareholders' equity in accordance with US GAAP    822,016,158    797,013,144 
     
     

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Notes to the Consolidated Financial Statements – (continued)
__________

The following summarizes the changes in shareholders’ equity under US GAAP during the years ended December 31, 2005 and 2006:

    As of December 31, 
   
     2005     2006 
     
    ThCh$    ThCh$ 
 
Balance as of January 1    913,557,854    822,016,158 
Minimum dividend (i)   (14,962,338)   (12,824,318)
Capital decrease    -    (40,200,514)
Other reserves decrease    -    (674,254)
Dividend declared and paid    (118,088,711)   (10,528,728)
Price-level restatement    (3,885,164)   (708,824)
Other comprehensive income, net of tax:         
   Cumulative translation adjustment    (478,884)   (530,149)
   Unrealized gain on marketable securities, net of taxes (b)   (720,777)   9,605 
   Prior Service Cost (e)   -    (240,390)
Net income in accordance with US GAAP for the year    46,594,178    40,694,558 
     
 
Balance at December 31    822,016,158    797,013,144 
     
     

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Notes to the Consolidated Financial Statements – (continued)
__________

q) Comprehensive Income

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 130, “Reporting Comprehensive Income” the Company reports a measure of all changes in shareholder’s equity that result from transactions and other economic events of the period other than transactions with owners (“comprehensive income”). Comprehensive income is the total of net income (loss) and other non-owner equity transactions that result in changes in net equity. The components of other comprehensive income are reported net of the related tax effects.

The following represents accumulated other comprehensive income balances as of December 31, 2004, 2005 and 2006 (in thousands of constant Chilean pesos as of December 31, 2006):

    2004 
        Effect of US GAAP     
   
    Chilean GAAP    Unrealized        Accumulated 
    cumulative    (losses)   Deferred    other 
     translation    on marketable    Income    comprehensive 
    adjustment    securities       Tax    income (loss)
         
 
Beginning balance    (857,818)   307,138    (52,212)   (602,892)
Credit (charge) for the year    (451,314)   564,428    (95,954)   17,160 
Ending balance    (1,309,132)   871,566    (148,166)   (585,732)

    2005 
        Effect of US GAAP     
   
    Chilean GAAP    Unrealized        Accumulated 
    cumulative    (losses) gains    Deferred    other 
    translation    on marketable    Income    Comprehensive 
    adjustment    securities    Tax    (loss)
         
 
Beginning balance    (1,309,132)   871,566    (148,166)   (585,732)
Credit (charge) for the year    (478,885)   (868,405)   147,629               (1,199,661)
Ending balance    (1,788,017)   3,161    (537)              (1,785,393)

  2006 
  Effect of US GAAP 
   
  Chilean GAAP    Unrealized            Accumulated 
  cumulative    gains     Prior    Deferred    other 
     translation    on marketable    Service    Income    Comprehensive 
  adjustment    securities     Cost    Tax    income (loss)
           
 
Beginning balance  (1,788,017)   3,161                       -    (537)   (1,785,393)
Credit (charge) for the year  (538,240)   11,572     (289,626)   47,269    (769,025)
Ending balance  (2,326,257)   14,733     (289,626)   46,732    (2,554,418)

For the year ended December 31, 2005 the charge to unrealized gains on marketable securities is shown net of reclassifications into net income of ThCh$ 871,566.

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Notes to the Consolidated Financial Statements – (continued)
__________

r) Discontinued Operations

In July 2004, the Compañía de Telecomunicaciónes de Chile S.A. sold 100% of shares held in its consolidated subsidiary, Telefónica Móvil de Chile S.A. It was accounted for as discontinued operations in accordance with SFAS No. 144 and. accordingly, amounts in the reconciliation of net income to US GAAP and the additional disclosure notes required under US GAAP for all periods shown, reflect that component as a discontinued operation.

The results of operations of the discontinued operations detailed above in each period presented are as follows:

    For the six 
    months ended 
    June 30, 2004 
   
Amounts as reported under Chilean GAAP    ThCh$ 
     
Net Revenues    142,348,673 
     
Income (loss) before taxes    (9,855,935)
Income tax benefits    1,416,827 
   
Net income (loss) on discontinued operations    (8,439,108)
     
US GAAP adjustments :     
Deferred income taxes    (4,432)
Deferred taxes effects of US GAAP adjustments    (384,393)
Capitalization of interest    1,330,384 
Staff severance indemnities    (201,474)
Accommodation equipment    53,814 
Goodwill amortization    5,243,523 
Deferred income multiple element arrangements    1,078,408 
   
     
Net loss on discontinued operations as reported under US GAAP    (1,323,278)
   
   

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Notes to the Consolidated Financial Statements – (continued)
__________

II. Additional Disclosure Requirements:

a) Earnings per share

The following earnings per share information, presented in thousands of Chilean pesos per share, is not required to be presented in the financial statements under Chilean GAAP but is a required disclosure under US GAAP:

    For the years ended December 31, 
   
    2004    2005    2006 
       
 
Chilean GAAP earnings per share    0.3444    0.0269    0.0244 
US GAAP earnings per share, basic and diluted:             
US GAAP earnings per share continuing operations    0.0236    0.0487    0.0425 
Discontinued operations. net of tax    (0.0014)   -    - 
US GAAP earnings per share    0.0222    0.0487    0.0425 
Weighted average number of shares outstanding   957,157,085    957,157,085    957,157,085 

The earnings per share figures for both US GAAP and Chilean GAAP purposes have been calculated by dividing the respective earnings (loss) amounts in accordance with US GAAP and Chilean GAAP, respectively, by the weighted average number of common shares outstanding during the year. The Company has not issued convertible debt or other equity securities. Consequently, there are no potentially dilutive effects on the earnings per share of the Company.

b) Income taxes:

The provision (benefit) for income taxes differs under Chilean GAAP from the charge calculated in accordance with US GAAP, as a result of the following differences:

    For the years ended December 31, 
   
    2004    2005    2006 
       
       ThCh$       ThCh$     ThCh$ 
 
Current income taxes as determined under Chilean GAAP    60,886,565    24,561,120    32,736,095 
Deferred income taxes as determined under Chilean GAAP    5,112,339    9,532,288    (3,136,198)
       
 
Sub –Total    65,998,904    34,093,408    29,599,897 
 
US GAAP adjustments:             
Deferred tax effect applying SFAS No. 109    (15,320,502)   (13,895,659)   (13,815,557)
Deferred tax effect of US GAAP Adjustments    (853,765)   1,194,748    586,850 
Reclassification of taxes on the sale of Telefónica Móvil             
     de Chile S.A. and Publiguías to equity (capital contribution)   (38,374,487)   -    - 
       
 
Charge for the period under US GAAP Total    11,450,150    21,392,497    16,371,190 
       
       
 
 
Income tax expense from continuing operations    12,478,152    21,392,497    16,371,190 
 
Income tax expense (benefit) included in discontinued operations    (1,028,002)   -    - 

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COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

Deferred tax assets (liabilities) as of balance sheet dates are summarized as follows:

    2005    2006 
     
    SFAS No. 109    SFAS No. 109           Total    SFAS No. 109    SFAS No. 109    Total 
    Applied to    Applied to    Deferred Taxes    Applied to    Applied to    deferred Taxes 
    Chilean GAAP    US GAAP         Under    Chilean GAAP    US GAAP    Under 
    Balances    Adjustments    SFAS No. 109    Balances    Adjustments    SFAS No. 109 
             
    ThCh$    ThCh$         ThCh$    ThCh$    ThCh$         ThCh$ 
 
Allowance for doubtful accounts    10,265,255    -    10,265,255    10,080,033    -    10,080,033 
Vacation provision    834,088    -    834,088    732,497    -    732,497 
Accumulated Tax losses (1)   1,274,260    -    1,274,260    1,078,520    -    1,078,520 
Capitalized staff severance indemnities    546,158    (93,436)   452,722    374,552    (49,236)   325,316 
Reappraised property. plant and                         
     equipment depreciation    4,214,525    (578,940)   3,635,585    661,234    (597,704)   63,530 
             
 
Total Assets    17,134,286    (672,376)   16,461,910    12,926,836    (646,940)   12,279,896 
             
 
Property, plant and equipment    (167,885,804)   354,627    (167,531,177)   (144,637,726)   129,716    (144,508,010)
Staff severance indemnities    (6,351,092)   1,748,598    (4,602,494)   (4,287,438)   1,473,529    (2,813,909)
Software development    (2,199,009)   -    (2,199,009)   (3,952,366)   -    (3,952,366)
Capitalized interest included in fixed assets    -    (1,401,199)   (1,401,199    -    (2,070,663)   (2,070,663)
Assets and liabilities for leasing    (62,542)   -    (62,542)   (190,310)   -    (190,310)
Deferred charges    (988,059)   -    (988,059)   (256,732)   -    (256,732)
Other    (3,365,704)   (321,150)   (3,686,854)   (2,978,748)   282,739    (2,696,009)
             
 
Total Liabilities    (180,852,210)   380,876    (180,471,334)   (156,303,320)   (184,679)   (156,487,999)
             
 
Net deferred tax liabilities from application of SFAS No.109    (163,717,924)   (291,500)   (164,009,424)   (143,376,484)   (831,619)   (144,208,103)
             
             

(1) Under the current Chilean law, tax losses can be carried forward indefinitely.

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Notes to the Consolidated Financial Statements – (continued)
__________

The provision for income taxes differs from the amount of income tax determined by applying the applicable local statutory income tax rate to pretax income. calculated in accordance with US GAAP, as a result of the following differences:

    For the years ended December 31, 
   
     2004       2005       2006 
       
    ThCh$    ThCh$    ThCh$ 
 
Tax provision (benefit) at statutory Chilean tax rates of 17%    5,553,532    11,562,958    9,694,102 
 
Differences between accounting and tax bases:             
Price-level restatement not accepted for tax purposes    2,404,189    4,219,618    2,621,461 
Provision for lawsuits    -    130,673    3,388,418 
Non-deductible write-offs    1,308,433    4,605,599    172,522 
Other – non deductible items    2,183,996    873,647    494,687 
       
 
Income tax expense    11,450,150    21,392,495    16,371,190 
       
       

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Notes to the Consolidated Financial Statements – (continued)
__________

(c) Segment information:

Information by Business Segments:

Compañía de Telecomunicaciónes de Chile S.A. discloses segment information in accordance with SFAS No. 131 “Disclosures about Segments of an Enterprise and Related Information”, which establishes standards for reporting information about operating segments and related disclosures for products and services and geographic areas. Operating segments are defined as components of an enterprise for which separate financial information is available that is regularly used by the chief operating decision maker in deciding how to allocate resources and in assessing performance. The Company presents segment information in accordance with Chilean GAAP, which is used by management for internal reporting and decision-making purposes.

The Company manages and measures the performance of its operations by business segment. The internally reported operating segments are as follows:

Fixed Telecommunication

Fixed Telecommunication services include primary service, line connections and installations, value-added services, terminal equipment marketing and dedicated lines. Consistent with the financial statements, revenue is recognized as services are rendered.

Long Distance

The Company provides domestic and international long distance services. The long distance business segment also rents its long distance network to other telecom operators, such as long distance carriers, mobile telephony operators and Internet service providers. Consistent with the financial statements, revenue is recognized as services are rendered.

Mobile Communications

Total mobile communications revenues include revenues from outgoing mobile traffic mobile equipment sales, CPP interconnection revenues and revenues from other mobile services, such as paging, trucking and mobile data transmission. Handset and activation fee revenue is recognized at time of sale. Fees for cellular service are recognized monthly as services are provided, which includes a month-end estimate for cut-off purposes for contract services provided but not yet billed. Prepaid card revenues are recognized upon the customers’ usage of the cards.
This segment was sold on July 2004 as described in Note 37 I paragraph (j), and, therefore the segment information includes only the six months ended June 30, 2004.

Corporate Customer Communications and Data

Corporate customer communications service includes revenues from the sale and rental of telecommunications equipment and the sale of networks to corporate customers, the rental of networks associated with private network projects of corporate customers, and data transmission services. Revenue is recognized as the service is rendered or at the point of sale.

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Notes to the Consolidated Financial Statements – (continued)
__________

Other

Other services principally include public telephone services and interconnection services provided to other local networks. Revenue is recognized as services are rendered.

Relevant information concerning Compañía de Telecomunicaciónes de Chile S.A. and its principal subsidiaries, which represent different segments, together with information regarding other subsidiaries is as follows:

            Mobile Communications    Corporate Customer
 Communication and
Data 		            
                         
As of and for the year ended       Fixed     Long        Other         
December 31, 2004    Telephony    Distance        Subsidiaries   Eliminations    Total 
             
     ThCh$     ThCh$    ThCh$    ThCh$    ThCh$    ThCh$    ThCh$ 
 
Operating revenues    518,097,801    92,554,200    144,729,036    107,347,661    19,756,847    (139,015,079)   743,470,466 
Revenues    446,608,728    65,146,059    139,850,181    87,694,039    4,171,459    -    743,470,466 
Intercompany transactions    71,489,073    27,408,141    4,878,855    19,653,622    15,585,388    (139,015,079)   - 
 
Operating expenses    (456,045,576)   (72,182,871)   (148,422,013)   (85,871,253)   (18,510,365)   142,421,346    (638,610,732)
Salaries    (62,072,183)   (3,136,697)   (9,072,413)   (9,643,322)   (5,773,855)   -    (89,698,470)
Services    (139,991,418)   (39,667,934)   (95,212,244)   (21,781,801)   (10,349,970)   (828,272)   (307,831,639)
Depreciation    (178,857,079)   (12,710,383)   (37,957,389)   (12,204,695)   (179,349)   828,272    (241,080,623)
Intercompany transactions    (75,124,896)   (16,667,857)   (6,179,967)   (42,241,435)   (2,207,191)   142,421,346    - 
 
Operating income, net    62,052,225    20,371,329    (3,692,977)   21,476,408    1,246,482    3,406,267    104,859,734 
 
Non-operating income    512,380,877    615,533    342,383    184,955    11,333    381    513,535,462 
Financial income    9,241,811    337,871    153,831    77,233    11,074    381    9,822,201 
Other non-operating income    503,139,066    277,662    188,552    107,722    259    -    503,713,261 
Non-operating expenses    (222,415,968)   (3,319,003)   (5,753,244)   (407,552)   (74,436)   (381)   (231,970,584)
Financial expenses    (56,634,829)   (637)   (495,542)   (41,924)   (2,065)   (381)   (57,175,378)
Other non-operating expenses    (165,781,139)   (3,318,366)   (5,257,702)   (365,628)   (72,371)   -    (174,795,206)
Price-level restatement    12,264,571    (1,835,135)   (687,540)   (188,582)   (52,538)   -    9,500,776 
 
Intercompany transactions    9,339,744    (833,023)   (5,308,079)   202,228    5,397    (3,406,267)   - 
 
Non-operating income, net    311,569,224    (5,371,628)   (11,406,480)   (208,951)   (110,244)   (3,406,267)   291,065,654 
 
Income (loss) before income taxes    373,621,449    14,999,701    (15,099,457)   21,267,457    1,136,238    -    395,925,388 
 
Income taxes    (58,682,707)   (4,071,020)   1,416,827    (4,532,183)   (129,821)   -    (65,998,904)
Minority interest    -    -    -    -    (299,385)   -    (299,385)
 
Net (loss) income    314,938,742    10,928,681    (13,682,630)   16,735,274    707,032    -    329,627,099 
 
TOTAL ASSETS    2,001,441,596    197,246,802    -    117,296,316    86,399,149    (398,337,193)   2,004,046,670 
 
CAPITAL EXPENDITURES    52,443,716    1,333,122    22,835,607    6,993,967    8,957,799    731,368    93,295,579 
 
DEPRECIATION AND                             
     AMORTIZATION    169,634,029    12,697,391    37,957,389    11,666,479    17,820,156    731,368    250,506,812 
 
GOODWILL    -    16,218,031    -    1,508,923    2,728,669    -    20,455,623 

As a consequence of the sale of Telefónica Móvil de Chile S.A. in July 2004, the segment Mobile Communications reflects 6 months of operations. Revenues have been reclassified to present the continuing operations.

Revenues related to the fixed line services are included within Fixed Telephony as well as revenues of Telemergencia, pay phones and interior installations previously recorded as Other Business. For comparisons purposes, this change is reflected accordingly in the prior years.

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Notes to the Consolidated Financial Statements – (continued)
__________

            Corporate 
Customer Communication 
and Data 		            
                       
As of and for the year ended       Fixed     Long      Other         
December 31, 2005    Telephony    Distance      Subsidiaries    Eliminations    Total 
             
     ThCh$    ThCh$    ThCh$       ThCh$    ThCh$     ThCh$ 
 
Operating revenues    511,721,486    80,750,914    89,829,340    18,153,043    (107,550,509)   592,904,274 
Revenues    450,746,537    59,189,616    79,856,550    3,111,571    -    592,904,274 
Intercompany transactions    60,974,949    21,561,298    9,972,790    15,041,472    (107,550,509)   - 
 
Operating expenses    (448,239,604)   (74,694,847)   (75,019,842)   (17,325,807)   111,301,052    (503,979,048)
Salaries    (60,931,254)   (2,675,524)   (10,796,872)   (6,333,882)   -    (80,737,532)
Services    (147,441,599)   (45,694,556)   (19,984,819)   (9,335,892)   -    (222,456,866)
Depreciation    (179,867,033)   (10,847,691)   (9,895,477)   (174,449)   -    (200,784,650)
Intercompany transactions    (59,999,718)   (15,477,076)   (34,342,674)   (1,481,584)   111,301,052    - 
 
Operating income, net    63,481,882    6,056,067    14,809,498    827,236    3,750,543    88,925,226 
 
Non-operating income    11,990,016    958,515    113,759    9,330    -    13,071,620 
Financial income    7,800,697    290,289    52,759    8,713    -    8,152,458 
Other non-operating income    4,189,319    668,226    61,000    617    -    4,919,162 
Non-operating expenses    (43,503,117)   (968,610)   (623,496)   (27,118)   -    (45,122,341)
Financial expenses    (30,102,839)   (4,180)   (7,281)   (6,452)   -    (30,120,752)
Other non-operating expenses    (13,400,278)   (964,430)   (616,215)   (20,666)   -    (15,001,589)
Price-level restatement    5,619,977    (1,770,810)   (752,803)   (134,567)   -    2,961,797 
 
Intercompany transactions    1,640,875    1,137,897    871,620    100,151    (3,750,543)   - 
 
Non-operating income, net    (24,252,249)   (643,008)   (390,920)   (52,204)   (3,750,543)   (29,088,924)
 
Income (loss) before income taxes    39,229,633    5,413,059    14,418,578    775,032    -    59,836,302 
 
Income taxes    (26,928,495)   (3,818,762)   (3,414,173)   68,022    -    (34,093,408)
Minority interest    -    -    -    (30,724)   -    (30,724)
 
Net income    12,301,138    1,594,297    11,004,405    812,330    -    25,712,170 
 
TOTAL ASSETS    1,786,995,874    177,638,574    113,597,205    11,580,982    (342,758,406)   1,747,054,229 
 
CAPITAL EXPENDITURES    64,619,729    3,160,599    5,305,132    3,326    490,560    73,579,346 
 
DEPRECIATION AND                         
     AMORTIZATION    182,107,401    13,099,642    9,895,477    174,448    490,560    205,767,528 
 
GOODWILL    -    15,043,133    1,257,435    2,538,239    -    18,838,807 

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Notes to the Consolidated Financial Statements – (continued)
__________

            Corporate             
            Customer             
As of and for the year ended       Fixed     Long    Communication       Other         
December 31, 2006    Telephony    Distance    and Data    Subsidiaries    Eliminations    Total 
             
     ThCh$    ThCh$    ThCh$       ThCh$    ThCh$     ThCh$ 
 
Operating revenues    463,492,297    84,510,548    87,637,963    37,695,834    (96,133,108)   577,203,534 
Revenues    416,981,903    58,922,267    76,114,435    25,184,929    -    577,203,534 
Intercompany transactions    46,510,394    25,588,281    11,523,528    12,510,905    (96,133,108)   - 
 
Operating expenses    (420,806,067)   (66,334,953)   (70,852,562)   (34,606,121)   98,019,980    (494,579,723)
Salaries    (54,362,614)   (1,613,228)   (10,286,763)   (4,264,779)   -    (70,527,384)
Services    (150,341,126)   (33,188,999)   (16,379,869)   (16,860,591)   -    (216,770,585)
Depreciation    (176,111,093)   (14,638,551)   (13,682,079)   (2,850,031)   -    (207,281,754)
Intercompany transactions    (39,991,234)   (16,894,175)   (30,503,851)   (10,630,720)   98,019,980    - 
 
Operating income, net    42,686,230    18,175,595    16,785,401    3,089,713    1,886,872    82,623,811 
 
Non-operating income    7,004,114    608,754    241,483    148,434    -    8,002,785 
Financial income    3,740,107    537,074    49,386    109,992    -    4,436,559 
Other non-operating income    3,264,007    71,680    192,097    38,442    -    3,566,226 
Non-operating expenses    (35,764,733)   (724,574)   (540,480)   (1,351,303)   -    (38,381,090)
Financial expenses    (19,313,086)   (37,012)   (25,973)   (104,018)   -    (19,480,089)
Other non-operating expenses    (16,451,647)   (687,562)   (514,507)   (1,247,285)   -    (18,901,001)
Price-level restatement    1,925,850    (166,958)   (619,926)   (473,148)   -    665,818 
 
Intercompany transactions    (598,329)   1,257,940    1,350,223    (122,962)   (1,886,872)   - 
 
Non-operating income, net    (27,433,098)   975,162    431,300    (1,798,979)   (1,886,872)   (29,712,487)
 
Income (loss) before income taxes    15,253,132    19,150,757    17,216,701    1,290,734    -    52,911,324 
 
Income taxes    (21,084,259)   (4,028,693)   (3,919,257)   (567,688)   -    (29,599,897)
Minority interest    41,619    -    -    -    -    41,619 
 
Net income    (5,789,508)   15,122,064    13,297,444    723,046    -    23,353,046 
 
TOTAL ASSETS    1,663,078,932    184,158,501    136,043,930    66,321,914    (432,827,028)   1,616,776,249 
 
CAPITAL EXPENDITURES    74,136,754    2,618,638    10,117,993    22,295,198    355,208    109,523,791 
 
DEPRECIATION AND                         
     AMORTIZATION    176,618,239    15,207,973    13,682,079    4,067,448    355,208    209,930,947 
 
GOODWILL    -    13,868,237    -    2,086,740    -    15,954,977 

F-70

 

COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

d) Reclassifications to US GAAP

(i) Income Statement

Certain reclassifications would be made to the Chilean GAAP income statement in order to present US GAAP amounts. Certain other non-operating income and expense, such as restructuring cost, account receivable bad debt expenses, depreciation and write- off of out of service property, lawsuit indemnities and provisions, indemnities and supplier fines would be included in operating income. Equity participation in income or losses of related companies included in non-operating income and the income from discontinued operation related to Telefónica Móvil de Chile S.A. in accordance with US GAAP is presented net.

    Year ended December 31, 2004 
   
            US GAAP     US GAAP 
    Chilean GAAP    Reclassification    Adjustment    Presentation 
         
    ThCh$    ThCh$    ThCh$    ThCh$ 
Operating income    104,859,734    (19,653,891)   (4,320,522)   80,885,321 
Non-operating expenses    291,065,654    28,935,852    (366,142,304)   (46,140,798)
Income tax expense for continuing operations    (65,998,904)   (1,416,827)   54,937,581    (12,478,150)
Minority interest    (299,385)   -    -    (299,385)
Participation in income of related companies, net    -    573,974    -    573,974 
         
Net income from continuing operations    329,627,099    8,439,108    (315,525,245)   22,540,962 
Income from discontinued operations                 
       net of taxes and minority interest (See Note 37 I paragraph (t))   -    (8,439,108)   7,115,830    (1,323,278)
         
 
Net income    329,627,099    -    (308,409,415)   21,217,684 
         
         

        Year ended December 31, 2005     
   
            US GAAP     US GAAP 
    Chilean GAAP    Reclassification    Adjustment    Presentation 
         
    ThCh$    ThCh$     ThCh$    ThCh$ 
Operating income    88,925,226    (7,809,028)   982,597    82,098,795 
Non-operating expenses, net    (29,088,924)   6,093,892    7,198,498    (15,796,534)
Income tax expense for continuing operations    (34,093,408)   -    12,700,913    (21,392,495)
Minority interest    (30,724)   -    -    (30,724)
Participation in income of related companies, net    -    1,715,136    -    1,715,136 
         
Net income from continuing operations:    25,712,170    -    20,882,008    46,594,178 
         
 
Net income    25,712,170    -    20,882,008    46,594,178 
         
         

        Year ended December 31, 2006     
   
            US GAAP     US GAAP 
    Chilean GAAP    Reclassification    Adjustment    Presentation 
         
    ThCh$    ThCh$    ThCh$    ThCh$ 
Operating income, net    82,623,811    (15,269,832)   4,289,516    71,643,495 
Non-operating expenses, net    (29,712,487)   13,354,101    (176,711)   (16,535,097)
Income tax expense    (29,599,897)   -    13,228,707    (16,371,190)
Minority interest    41,619    -    -    41,619 
Participation in income of related companies, net    -    1,915,731    -    1,915,731 
         
Net income from continuing operations:    23,353,046    -    17,341,512    40,694,558 
         
 
 
Net income    23,353,046    -    17,341,512    40,694,558 
         
         

F-71

 

COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

The 2004 reclassification amounts have been revised to reclassify all items which relate to the categories mentioned above to discontinued operations when Telefónica Móvil de Chile S.A. amounts had been included in that years.

(ii) Balance sheet

Consolidated condensed balance sheet prepared in accordance with US GAAP:

    As of December 31, 
   
    2005    2006 
     
    ThCh$    ThCh$ 
 
Current assets    321,539,221    294,865,354 
Property, plant, and equipment    3,815,102,316    3,907,939,607 
Accumulated depreciation of property, plant and equipment    (2,479,245,571)   (2,663,415,070)
     
Property, plant, and equipment, net    1,335,856,745    1,244,524,537 
Goodwill, net    25,439,055    23,215,973 
Other assets    63,932,907    61,882,361 
     
Total assets    1,746,767,928    1,624,487,225 
     
     
 
Current liabilities    342,387,828    208,564,823 
Long-term liabilities    580,693,861    617,678,971 
Minority interest    1,670,081    1,230,287 
Shareholders’ equity    822,016,158    797,013,144 
     
Total Liabilities and Shareholders’ equity    1,746,767,928    1,624,487,225 
     
     

The Company has the following unused lines of credit outstanding as of December 31, 2006:

    Million 
    Ch$ 
Bank Chile    500 
Bank Crédito e Inversiones    500 

F-72

 

COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

e) Cash flows:

(i) Information for inclusion in the statement of cash flows required by US GAAP is as follows:

    For the years ended December 31, 
   
    2004    2005       2006 
       
     ThCh$       ThCh$     ThCh$ 
OPERATING ACTIVITIES             
 
Cash provided by operating activities under Chilean GAAP    234,736,659    226,266,713    234,630,831 
Adjustment for sale Telefónica Móvil de Chile S.A.    (958,644)   -    - 
       
Cash provided by operating activities under US GAAP    233,778,015    226,266,713    234,630,831 
 
INVESTING ACTIVITIES:             
 
Cash provided by investing activities under Chilean GAAP    803,272,671    (88,253,741)   (108,020,842)
Purchase time deposits    -    -    (5,691,559)
Adjustment for sale Telefónica Móvil de Chile S.A.    1,293,038    -    - 
       
Cash used in investing activities under US GAAP    804,565,709    (88,253,741)   (113,712,401)
 
FINANCING ACTIVITIES:             
 
Cash used in financing activities under US GAAP    (901,214,853)   (205,394,443)   (181,661,451)

    As of December 31, 
   
       2004     2005     2006 
       
     ThCh$    ThCh$    ThCh$ 
 
Cash    8,313,844    6,424,238    10,074,960 
Time deposits    56,207,781    86,753,294    21,852,156 
Other deposit instruments (*)   101,696,285    4,084,521    3,728,382 
       
 
Total cash and cash equivalents    166,217,910    97,262,053    35,655,498 
       
       
 
Effect of inflation on cash and cash equivalents (**)   (6,713,663)   (1,574,386)   (863,534)

(*) These items consist of investments made for cash management purposes with original maturities of less than three months.
(**) These balances represent the net impact on cash and cash equivalents for the year resulting from the application of price level restatement.

(ii) Supplementary Cash Flow information:

    For the years ended December 31, 
   
    2004    2005    2006 
       
    ThCh$    ThCh$    ThCh$ 
 
Interest paid    64,725,246    32,151,295    24,035,002 
Income taxes paid    15,349,372    15,615,259    20,547,536 
Plant and equipment acquired by assuming directly             
   long-term debt or entering into capital leases    63,918    58,421    42,478 
       
       

F-73

 

COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

(iii) Maturities of debt:

The following payments of bank borrowings (short term obligations and short-term portion of long-term obligation) and long-term debt, including capital leases and current maturities, are scheduled to be paid during each of the years indicated:

    As of December 31, 2006 
   
    Capital         Other     Total 
    Leases    Obligations     
       
    ThCh$       ThCh$    ThCh$ 
 
2006 including accrued interest    45,292    3,811,302    3,856,594 
2007    45,292    81,168,242    81,213,534 
2008    45,292    107,787,742    107,833,034 
2009    45,292    66,495,573    66,540,865 
2010    45,292    81,168,242    81,213,534 
2011 and thereafter    192,492    60,902,975    61,095,467 
       
 
Total    418,952    401,334,076    401,753,028 
       
       

The present value of net long-term minimum lease payments totaled ThCh$ 222,018 as of December 31, 2006. The imputed interest totals ThCh$ 196,934.

(iv) Revenues from operating leases:

The Company records leasing operations in the fixed telephony and corporate communications and data transmission businesses. Revenues from leasing operations mainly consist of (i) fixed telephony equipment rental, (ii) PABX equipment rental and (iii) equipment rental to corporate clients. The contractually agreed expected lease revenue for the next 5 years is the following:

2007    2008    2009    2010    2011 
         
ThCh$    ThCh$    ThCh$    ThCh$    ThCh$ 
 
36,873,636    16,658,612    6,887,263    2,566,998    400,176 

F-74

Table of Contents

COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

f) Disclosure regarding the fair value of financial instruments and derivative financial instruments:

In accordance with SFAS No. 107, “Disclosures about Fair Value of Financial Instruments”, information is provided about the fair value of certain financial instruments for which it is practical to estimate that value.

For the purpose of SFAS No. 107, the estimated fair value of financial instruments is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation.

There are certain limitations inherent in the fair value data since while the data represents management’s best estimate, the data is subjective, involving significant estimates regarding current economic and market conditions. The methods and assumptions used to estimate the fair values are as follows:

For cash, short-term deposits and investments, and current receivables and payables, the carrying amounts approximate the fair value due to the short-term maturity of these instruments.

For interest earning assets and interest bearing liabilities, which are contracted at variable interest rates, the book value is considered to be equivalent to the fair value.

For financial instruments where an active secondary market does not exist, the fair value was calculated by discounting contractual cash flows at the current market origination rates for financial instruments with similar terms.

For the Company’s long-term fixed rate debt, the contractual cash flows were discounted at prevailing interest rates at the balance sheet dates.

The estimated fair values of the Company’s financial instruments compared to the carrying values under US GAAP are as follows:

    As of December 31, 
   
    2005    2006 
     
    Carrying     Fair    Carrying     Fair 
    Amount    Value    Amount    Value 
         
     ThCh$    ThCh$     ThCh$    ThCh$ 
Assets:                 
Cash and cash equivalents    97,262,053    97,262,053    35,655,498    35,655,498 
Marketable securities    16,081,166    16,081,166    16,278,335    16,278,335 
Accounts and notes receivable (net) and other    161,442,143    161,442,143    190,960,101    190,960,101 
Other current assets    47,840,685    47,840,685    48,236,916    48,236,916 
Liabilities:                 
Current maturities of long-term debt    173,362,113    173,051,524    3,856,594    3,856,435 
Accounts payable and accrued liabilities    119,627,216    119,627,216    147,710,299    147,710,299 
Bank borrowings (long-term) and long-term debt    339,508,187    339,473,536    397,744,792    397,715,307 
Derivatives    29,023,301    29,023,301    27,663,211    27,663,211 

The Company is exposed to credit related losses in the event of non-performance by counterparties to these financial instruments, but does not expect any counterparties to fail to meet their obligations given their high credit ratings. The credit exposure of foreign exchange contracts is represented by the fair value of contracts with a positive fair value at the reporting date.

F-75

 

COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

Disclosure regarding interest capitalization:

    For the years ended December 31, 
   
     2004     2005    2006 
       
    ThCh$    ThCh$    ThCh$ 
 
Interest cost incurred (1)   67,539,211    46,226,262    29,597,209 
Interest capitalized under US GAAP    3,783,178    3,512,431     5,103,160 

(1) The Interest cost incurred contains the implicit interest from debt denominated in UF of ThCh$ 10,363,834, ThCh$ 16,105,510 and ThCh$ 10,117,120 for the years 2004, 2005 and 2006, respectively, that is included in price-level restatement under Chilean GAAP.

g) Marketable Securities

Under US GAAP, marketable securities are accounted for under SFAS 115 “Accounting for Certain Investments in Debt and Equity Securities”. This standard requires investments to be accounted for as follows: (1) Held-to-maturity securities, which are defined as debt securities that a Company has a positive intent and ability to hold to maturity, are reported at amortized cost, (2) Trading securities, which are defined as those that are bought and held principally for the purpose of selling them in the near term, are reported at fair value with unrealized gains and losses included in earnings, and (3) Available-for-sale securities, which include securities not classified in either of the other two categories, are reported at fair value with unrealized gains and losses excluded from earnings and included as a separate component of shareholders’ equity.

Under Chilean GAAP, the Company presents marketable securities at the lower of cost plus indexation adjustment or market. Under US GAAP, these investments would be considered available-for-sale and be presented at fair value with unrealized gains and losses included as a separate component in shareholders’ equity.

Marketable securities as of each year-end are as follows:

    As of December 31, 
   
     2005     2006 
     
    ThCh$    ThCh$ 
 
Cost plus accrued indexation and interest    16,078,005    16,263,602 
Unrealized gain on marketable securities    3,161    14,733 
     
Fair value    16,081,166    16,278,335 
     
     

h) Employee Benefit Plans

 
(i) Employee Benefits:

Employee pension and health insurance benefits are provided by independent pension funds and health-insurance companies, which are funded by employees’ contributions, The Company has no responsibility as an employer to make payments under these plans, other than to withhold amounts from employees’ salaries.

Until December 2003, most of the employees of the Company had a right to receive staff severance indemnity pay in case of voluntary or involuntary severance. This severance indemnity is generally equal to 40 days of remuneration for every year of service, based on the last salary paid for all employees. During 2003 and 2004, the Company and the employee syndicates negotiated a change in the plan. According to the agreement entered between both parties, the previous plan is “frozen” and accrual of staff severance indemnities does not continue after December 31, 2003. Employees will have a right to payment of severance indemnity similar to that regulated by the Chilean Labor Code, which restricts voluntary termination and is equal to 30 days remuneration for each year of service, based on the last salary paid, with a limit of 11 years of service, with the exception that his regulatory limit does not exist for employees that were hired prior to December 31, 2003.

F-76

 

COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

Termination indemnity employee benefits have been accounted for in accordance with SFAS No. 87 consistent with that of a defined benefit pension plan, measuring the liability by projecting the future expected severance payments using a salary progression rate net of inflation adjustments, mortality and turnover assumptions, which are then discounted to their present value using actual interest rates. Actuarial gains and losses are recognized immediately.

An analysis of the changes in the accrued amounts for staff severance indemnities during the year ended December 31, 2005 and 2006 is as follows:

    Pension Benefits 
    as of and for the years ended 
    December 31, 
   
       2005     2006 
     
     ThCh$    ThCh$ 
Change in Benefit Obligation         
Benefit obligations at January 1 at restated values    (34,758,896)   (35,852,204)
Price-level adjustment    1,207,839    737,410 
Benefit obligation at January 1 at historic value    (33,551,057)   (35,114,794)
Service cost    (4,154,006)   (3,339,824)
Interest cost    (1,845,308)   (2,106,888)
Actuarial (gain) loss    1,846,664    3,728,723 
Benefits paid    1,851,503    5,903,282 
 
Benefit obligations as of December 31,    (35,852,204)   (30,929,501)
 
Amounts recognized in the statement of financial position consist of:         
Accrued benefit cost    (35,852,204)   (30,929,501)
Intangible assets    686,629    - 
     
 
Net liability recorded under US GAAP    (35,165,575)   (30,929,501)
 
Assumptions used in actuarial calculation         
Discount rate    5.5%    6.0% 
Rate of compensation increase    1.5%    1.5% 
Mortality (as per table)   RV-85    RV-85 
Turnover    2.34%    2.34% 

    For the years ended December 31, 
   
     2004    2005    2006 
       
    ThCh$    ThCh$    ThCh$ 
 
Components of net periodic benefit cost             
Interest cost    (2,208,675)   (1,845,308)   (2,106,888)
Service cost    (4,721,900)   (4,154,006)   (3,339,824)
Amortization of prior service cost    (397,003)   (778,711)   (397,003)
Actuarial (gain) loss    (4,872,293)   1,846,664    3,728,723 
 
Net periodic benefit cost    (12,199,871)   (4,931,361)   (2,114,992)

The accumulated benefit obligation as of December 31, 2005 and 2006, amount to ThCh$ 34,909,200 and ThCh$ 29,939,208, respectively.

F-77

 

COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

Following is a schedule of estimated pay-out of indemnities benefits in each of the next five years:

    As of December 
    31, 2006 
   
    ThCh$ 
 
2007    2,733,340 
2008    2,600,767 
2009    2,509,056 
2010    2,573,780 
2011    2,877,542 
Thereafter    48,690,070 

(ii) Corporate Restructuring and Activity Value Analysis Project:

During the months of May and November 2004, the Company carried out a headcount reduction process which involved employees of Compañía de Telecomunicaciónes de Chile S.A. and its subsidiaries. This process, originated charges to income from severance payments and other costs for a total amount of ThCh$ 6,584,690.

i) Early extinguishments of debt

As of January 1, 2002, the Company adopted SFAS No. 145, “Rescission of FASB Statements No. 4, 44 and 64. Amendment of FASB Statement No. 13, and Technical Corrections”. Among other items, this Statement rescinds FASB Statement No. 4, “Reporting Gains and Losses from Extinguishments of Debt”. As a result, early extinguishments of debt are no longer reported as extraordinary items but are included in income from continuing operations. For the year ended December 31, 2004, the Company extinguished bank loans, repurchased bonds in the national and international markets and the renegotiated of loans, obtaining reduced interest rates and extended maturities. This resulted in losses of approximately ThCh$ 7,064,722 for the year ended December 31, 2004.

j) Advertising Cost

The Company expenses advertising costs as incurred, Consolidated advertising costs for the years ended December 31, 2004, 2005 and 2006 were ThCh$ 18,597,806, ThCh$ 9,917,166 and ThCh$ 7,556,125, respectively.

k) Intangibles

The annual amortization expense expected for the years 2007 through 2011 is as follows:

Amortization expense    ThCh$ 
2007    5,359,275 
2008    3,696,126 
2009    1,332,295 
2010    1,226,780 
2011    1,210,826 

F-78

Table of Contents

COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

l) Recent accounting pronouncements

(i) In February 2006, the FASB issued SFAS 155, “Accounting for Certain Hybrid Financial Instruments - an amendment of FASB Statements No. 133 and 140”. The new statement:

a) permits fair value re-measurement of any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation;
b) clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS 133, “Accounting for Derivative Instruments and Hedging Activities”;
c) establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation;
d) clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives; and
e) amends SFAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”, to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument.

SFAS 155 generally is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Company does not anticipate that the adoption of this statement will have a material effect on its financial position, results of operations or cash flows.

(ii) In June 2006, the FASB issued FASB Interpretation 48 (FIN 48), "Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109". This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation also provides guidance on derecognition, classification and other matters, FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company has not determined the effect, if any, the adoption of FIN 48 will have on the Company’s financial position and results of operations.

(iii) In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, "Fair Value Measurements". This statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements, SFAS 157 is effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact that will result from the adoption of SFAS 157.

(iv) In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158 (SFAS 158), "Employer’s Accounting for Defined Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106 and 132(R)". This statement requires the recognition of the funded status of a benefit plan in the statement of financial position. It also requires the recognition as a component of other comprehensive income (OCI), net of tax, of the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost pursuant to statements 87 or 106. The statement also has new provisions regarding the measurement date as well as certain disclosure requirements. The statement was effective at fiscal year end 2006 and the Company adopted the statement at that time. With the adoption of SFAS 158, the Company recorded ThCh$ 240,390 as a component of the ending balance of accumulated other comprehensive income, net of tax.

(v) In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities". SFAS No. 159 permits measurement of recognized financial assets and liabilities at fair value with some exceptions. Changes in the fair value of items for which the fair value option is elected should be recognized in income or loss. The election to measure eligible items at fair value is irrevocable and can only be made at defined election dates or events, generally on an instrument by instrument basis. Items for which the fair value option is elected should be separately presented or be parenthetically disclosed in the statement of financial position. SFAS No. 159 also requires significant new disclosures that apply for interim and annual financial statements. SFAS No. 159 will be effective for fiscal years beginning after November 15, 2007 with earlier adoption permitted, if certain conditions are met. The Company is currently determining the policy of adoption as well as the resulting effect of SFAS No. 159 on the consolidated financial statements.

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Table of Contents

COMPAÑÍA DE TELECOMUNICACIONES DE CHILE S.A. AND SUBSIDIARIES
 

Notes to the Consolidated Financial Statements – (continued)
__________

2006
Schedule II - Valuation and Qualifying Accounts
(in thousands of constant Chilean pesos of December 31, 2006)
 
    Balance at    Charged to            Balance at 
    beginning of    costs            end of 
       period    and expenses    Deductions    Other (1)   period 
           
    ThCh$     ThCh$    ThCh$     ThCh$    ThCh$ 
 
December 31, 2004    102,621,569    30,601,399    24,341,374    15,769,094    93,112,500 
Allowance for doubtful accounts    99,637,095    29,291,132    23,403,472    13,163,864    92,360,891 
Allowance for obsolescence    2,984,474    1,310,267    937,902    2,605,230    751,609 
 
December 31, 2005    93,112,499    16,662,286    44,039,571    -    65,735,214 
Allowance for doubtful accounts    92,360,890    15,916,026    43,669,583    -    64,607,333 
Allowance for obsolescence    751,609    746,260    369,988    -    1,127,881 
 
December 31, 2006    65,735,214    17,120,723    14,719,991    -    68,135,946 
Allowance for doubtful accounts    64,607,333    16,711,015    14,471,923    -    66,846,425 
Allowance for obsolescence    1,127,881    409,708    248,068    -    1,289,521 

(1) This amount represents the allowances for doubtful accounts and inventory obsolescence transferred in the sale of Telefónica Móvil de Chile S.A.

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