Design flaw in the mega-reform?

There are many expectations about the impact that the tax measures of the national reconstruction law will have on economic growth. Beyond the discussion about whether those expectations are justified, it is worth pausing to consider an internal problem of what will soon become law. One of its central objectives is to gradually return to a fully integrated income tax system, with a phased reduction of the First Category Tax (IDPC) from 27% to 23% (in 2029). However, it is worth stopping to note a flaw in the design of the law that, if not corrected, will prevent the changes from applying during 2027 and 2028 to those who pay taxes in the highest bracket of the Global Complementary Tax (IGC), contradicting the logic of the system that is intended to be reinstated. The mechanics are well known to specialists, but it is worth explaining them to see the problem. When a company that pays taxes under the general IDPC regime distributes profits, its owners pay IGC on those profits, crediting the 27% IDPC paid by the company, and must then "restitute," as fiscal debit, 35% of that credit (Article 56 No. 3 of the Income Tax Law, LIR). When this system was designed in 2014, the maximum IGC rate was 35%, which resulted in a total burden of 44.45%. The 2020 tax reform, however, created a new maximum IGC bracket of 40%, which brought the total burden (rate plus the restitution of the credit) to 49.45%. Since that result was considered excessive, the final paragraph of Article 52 of the LIR set a cap: the rate ultimately applied "may reach a maximum of 44.45%," maintaining the 2014 maximum. The reconstruction law reduces the restitution to 30% of the credit in 2027 and to 20% in 2028 (while also reducing the IDPC rate to 25.5% and 24%, respectively), and eliminates it as of 2029, to arrive at a fully integrated system. The problem is that the law did not amend the final paragraph of Article 52 of the LIR. The consequence is arithmetic. For a person in the 35% IGC bracket, the total burden decreases each year: 44.45% in 2026, 42.65% in 2027, 39.8% in 2028, and 35% in 2029. For a person in the 40% IGC bracket, however, the sum of the rate and restitution remains above the cap in 2027 (47.65%) and 2028 (44.8%), so their burden remains fixed at 44.45% until the restitution disappears and jumps, only in 2029, to 40%. The gradual reduction that the legislator designed simply does not operate for that person. An example illustrates how strange the result is. Two partners in the same company receive the same dividend of 100 in 2028. The first pays taxes in the 35% bracket and, with the lower rate and the restitution reduced to 20%, pays a fiscal debit of 4.8 points. The second pays taxes in the 40% bracket and, due to the cap, pays a debit of 4.45 points. The higher-income taxpayer restitutes less than the lower-income one. And if compared with someone who receives those same 100 as remuneration, without going through a company, the difference is even harder to explain: that taxpayer pays 40%, while the partner continues paying 44.45% for two more years. One of the arguments given for making these tax changes was that the aim was to ensure the principle of horizontal equity in tax matters, which, as the example shows, will not be achieved in 2027 and 2028. It is also a significant problem in the design of the incentive that was intended, since the 40% IGC bracket concentrates a large share of the people whom the tax reduction seeks to incentivize to reinvest and distribute with a lower burden. The solution cannot be dogmatic, but rather requires a legal amendment. The final paragraph of Article 52 of the LIR needs to be amended so that it reflects the progressive reduction implied by moving to the fully integrated system. One alternative could be to set new maximum caps for 2027 and 2028 and repeal them as of 2029, when the restitution ceases to exist; another alternative is to reduce the restitution even further for those years. Everything will depend on the tax policy one wishes to apply. What matters for those who designed the reform is to find a solution that becomes law before the April 2028 tax filing operation. By Francisco Saffie, lawyer, partner at Saffie Torres Abogados NEWSLETTER Opinion Saturday, AM Tensions, opposing views, and clear analysis: elements to reveal the issues that divide opinions and will set the agenda. By subscribing, you accept the Terms and Conditions and Privacy Policies of La Tercera.