A decomposition algorithm for computing income taxes with pass-through entities and its application to the Chilean case

Javiera Barrera, Eduardo Moreno, Sebastián Varas K

Research output: Contribution to journalArticlepeer-review

Abstract

Income tax systems with “pass-through” entities transfer a firm’s income to shareholders, which are taxed individually. In 2014, a Chilean tax reform introduced this type of entity and changed to an accrual basis that distributes incomes (but not losses) to shareholders. A crucial step for the Chilean taxation authority is to compute the final income of each individual given the complex network of corporations and companies, usually including cycles between them. In this paper, we show the mathematical conceptualization and the solution to the problem, proving that there is only one way to distribute income to taxpayers. Using the theory of absorbing Markov chains, we define a mathematical model for computing the taxable income of each taxpayer, and we propose a decomposition algorithm for this problem. This approach allows us to compute the solution accurately and to efficiently use computational resources. Finally, we present some characteristics of Chilean taxpayers’ network and the computational results of the algorithm using this network.

Original languageEnglish
Pages (from-to)545-557
Number of pages13
JournalAnnals of Operations Research
Volume286
Issue number1-2
DOIs
StatePublished - 1 Mar 2020

Keywords

  • Algorithms
  • Income taxes
  • Markov processes
  • Networks

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