We are sharing this article from Diario Financiero, in which our partner Rodrigo Albagli analyzes the effects that the gradual reduction in the First Category tax will have on companies.
It is undoubtedly one of the most eagerly awaited articles by companies and tax advisors ahead of the implementation of the Reconstruction Law. It involves the gradual reduction of the First Category tax on undistributed profits, which will drop from the current 27% to 25.5% next year, then reach 24% in 2028, and finally settle at 23% in 2029.
The reason? A positive impact on companies’ cash flows is anticipated, as this will free up resources for investments and hiring.
However, this scenario will not be the same for all companies, as some are carrying forward operating losses; in such cases, the concept of “deferred taxes” comes into play. This is because a company with no profits does not pay the corresponding corporate tax, but it must recognize it for accounting purposes and, therefore, it will affect its future financial statements.
Claudio Bustos, a partner at Bustos Tax & Legal, explains that the most common instance of deferred taxes relates to tax losses accumulated by companies, which are carried forward against future profits.
What does this mean? It means that “in the future, when a profit is generated, if that profit is offset by the accumulated loss, no First Category tax will be paid,” he says. In other words, an “asset” is created that can be used in the future at a rate of 27%.
What’s the catch? Javiera Céspedes, a partner at Mizon Abogados, explains that if deferred taxes were calculated using a rate higher than the one that will ultimately be in effect—for example, 27%, even though it will later decrease—companies reported profit or loss figures that were higher than they would have been had the new rate been approved at the time: “Those amounts will need to be adjusted,” she says.
Since these assets must be valued using the tax rate expected to apply in the future, a reduction in the rate requires them to be recalculated at a lower value, adds Sofía Orbegozo, a partner at Forvis Mazars’ Tax & Legal practice: “That could result in an immediate accounting loss for some companies, even if there is no actual deterioration in their business or impact on their cash flows,” she adds.
Companies with accumulated tax losses are in a net asset position, explains César Gárate, a partner at Asesorías Baker, which means that if the corporate tax rate is reduced, the asset value also decreases, resulting in a loss that is reflected in the financial statements.
“A loss of 1,000 today results in an asset of 270 at a 27% tax rate. Calculated at 23%, that same asset is worth 230. The decline is not 4 percentage points, but rather 14.8% of the asset’s book value. Hence the paradox worth highlighting: a measure that reduces future tax liability generates an accounting loss today,” he explains.
The effect can be particularly significant for companies that carry forward tax losses and have recognized deferred tax assets based on the current 27% rate, says az partner Rodrigo Albagli: “Although the reduction in First Category tax implies a lower future tax burden, it may initially have a negative impact on the accounting results of companies that hold significant deferred tax assets.”
Christian Bourke, a partner at Insignia Alternative Assets, notes that the tax cut is “positive going forward,” but may produce a one-time negative accounting effect for some companies that have significant accumulated tax losses: “That effect may reduce their earnings or book equity, even though it does not imply a cash loss for the company, and it applies to a group of companies that did not perform well in the past.”
