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In Brazil, all kinds of rules (laws, provisional measures, decrees, regulations, ordinances, etc.) are enacted by the Federal District, state and municipal governments almost every day.
The main reason for this complexity is that the Brazilian tax system is based on, and structured in accordance with, rules and principles embedded in the Federal Constitution of 1988 and its amendments, which require a very formal procedure to be observed to effect any changes, including changes to the tax rules.
While it is the backbone of the principles and general rules of the tax system, the Federal Constitution was created to provide financial independence to the federal government, the states (of which there are 27, including the Federal District where the capital is located) and the municipalities (of which there are 5,570) in the establishment of their own sets of rules for specific taxes—94 are currently in force in Brazil, including taxes, social contributions, fees and duties—applying to each entity.
In addition, Brazilian taxation is set apart from the systems in developed countries as it has a heavy concentration on collection of indirect taxes, and taxation of income is regressive.
In this scenario, instead of providing financial independence to the different entities, and due to the size of the country, 31 years after the enactment of the Federal Constitution the Brazilian tax system is highly complex with:
- a tax war among the states arising out of the Brazilian value-added taxes (indirect taxes) (Tax on the Circulation of Goods and Services, ICMS) and among states and Federal District (Excise Tax, IPI) and municipalities (Tax on Services, ISS);
- an excessive number of ancillary tax obligations/compliance rules;
- sparse and subjective legislation in relation to the social contribution (PIS and COFINS) and several exception and special regimes, and a lack of clarity in relation to the practical concept of raw materials and inputs granting credits; and, as a consequence,
- a high volume of tax litigation at both the administrative and the judicial level; and
- an individual interpretation of, and position in relation to, international tax concepts and standards.
In this scenario of uncertainty, domestic and international pressure from investors and taxpayers has increased over the years for a simpler, more reliable and more efficient tax system in order to foster the development of the country.
Legal Framework for Reforms
Due to the current structure of the Brazilian tax system, reforms are being proposed on two levels: constitutional and legal. The difference is basically the legitimacy to propose, the approval process and the matters that can be regulated or changed by each legal act.
In sum, amendments to the Constitution (AC) may be submitted by the President of the Republic, by one third of the federal deputies or senators, or by more than half of the legislative assemblies, provided that each of these is manifested by a relative majority. ACs cannot be presented to suppress the so-called stone clauses of the Constitution (including the federative form of government in which each entity must have its own power to tax).
Ordinary laws deal with all matters of federal competence, with the sanction of the President of the Republic. An ordinary bill is passed by simple majority. It may be proposed by the President of the Republic, deputies, senators, the Supreme Federal Court (STF), superior courts and the attorney general of the Republic. In the case of taxes, ordinary laws can change taxes that are within the competence of the federal government including individual income tax, corporate income taxes, excise tax and social contributions.
Finally, complementary laws may be proposed by the President of the Republic, by deputies, senators, committees of the House, Senate and Congress, as well as by the STF, higher courts, the attorney general of the Republic and by ordinary citizens. The quorum for passing a supplementary bill is an absolute majority of the two Houses of Congress. The Senate vote is a single round, but the House vote is held in two rounds. In the case of taxes, complementary laws regulate the general rules for the state and municipal value-added taxes (VAT), as well as the creation of extraordinary taxes not currently regulated in the Constitution.
Current AC Proposals and Main Reforms Proposed
AC Proposal 45/2019
According to the proposed draft of AC Proposal 45/2019, five indirect taxes on consumption (ICMS, IPI, ISS, PIS and COFINS) would be consolidated into the Tax on Goods and Services (Imposto sobre Bens e Serviços—IBS) to be established by a complementary law.
In summary, the IBS would have the following characteristics:
- broad base of goods, services, rights (tangible and intangible) and any utilities intended for consumption, regardless of the current ICMS and IPI selective criteria;
- billing at all stages of commercialization and production;
- full non-cumulative regime;
- exemption for exports;
- national and uniform legislation;
- a single rate for all transactions carried out with goods, services and rights with the purpose of simplification and avoidance of the need to classify goods and services into several categories;
- taxation on the destination;
- no exemptions, tax benefits or special regimes; and
- no extra fiscal characteristics.
The IBS is intended to unify tax competences of different levels. The creation of a management committee is envisaged, via complementary law, which would be responsible for the collection and distribution of revenues among the federal government, states, Federal District and municipalities. The political and financial autonomy of the entities would be ensured by the possibility of modifying the rate regarding the federal, state or municipal portions of the IBS.
In this regard, the proposed constitutional amendment (PEC) foresees the creation of a national management committee that will include representatives of the federal government, states, Federal District and municipalities, and will regulate and establish the rules for collection and distribution of the IBS revenues among the different entities. A range of IBS rates from 20% to 25% is being discussed.
Finally, a transition period of 10 years for the full implementation of the IBS is established, and another period of 50 years for the consolidation of the new method of tax revenue sharing. Over the 10-year period, the two models will co-exist and taxpayers will have to continue to collect PIS, COFINS, IPI, ISS and ICMS alongside the IBS.
AC Proposal 110/2019
In turn, AC Proposal 110/2019 also aims to create an IBS with the characteristics of a VAT, differing from AC 45/2019 in relation to the current taxes that would be the object of unification. AC Proposal 110/2019 would include the following taxes: IPI, PIS and COFINS, tax on exchange transactions (IOF), salary education contribution, ICMS and ISS. The IBS would be regulated by a complementary law.
In summary, the IBS would have the following characteristics:
- flat rate;
- transfer among taxpayers, financial transactions, free broadcasting of sound and images would not be taxable events;
- (the proceeds from the collection would belong to the state of destination;
- lower taxation for a restricted list of products;
- end of tax benefits and maintenance of the Manaus Free Trade Zone by granting deemed credits to cover the differences in logistics and transportation costs of projects located in the region.
In addition, AC Proposal 110/2019 intends to create a “selective tax” (IS), which would focus on energy, telecommunications, vehicles and oil and tobacco derivatives, with the following characteristics:
- levy on imports;
- possibility of differentiated rates;
- non-levy on exports;
- should not have a higher rate than the IBS, except for cigarettes, tobacco products and alcoholic beverages;
- single phase incidence; and
- excluded from the taxable base of the IBS.
AC Proposal 110/2019 is intended to incorporate the social contribution on net profit (CSLL) into the corporate income tax (IRPJ). In addition, it provides for the possibility of an additional rate of IBS to replace the employer’s social security contribution. AC Proposal 45/2019 is silent on these subjects.
AC Proposal 128/2019
Although relying on the main features of AC Proposal 45/2019 and PEC 128/2019, AC 128/2019 does have some differences.
The first relates to the possible creation of a “dual IBS”:
- a federal IBS, encompassing PIS/COFINS and the IOF; and
- a combined IBS within the competence of states and municipalities, encompassing ICMS and ISS.
IPI will be adjusted to become an exclusive extra and selective tax, aiming at discouraging the consumption of certain goods or services due to risks to public health and public safety, or to give effect to preferential treatment to the Manaus Free Trade Zone.
Regarding the state and municipal IBS, AC Proposal 128/2019 provides:
- collection will belong to the state and municipality of destination;
- there will be a reference rate and the final rate will be the sum of the rates of the states, Federal District and the municipalities;
- state and municipal rates will be formed by the sum of the individual rates linked to certain destinations (i.e. health, education), while part of the rate may be set in a non-binding destination;
- it will not be subject to tax or financial exemptions, incentives or benefits;
- it will be a full non-cumulative regime.
At the federal level, AC Proposal 128/2019 provides for the extinction of the IOF and creates a tax on the movement or transfer of amounts and credits and financial rights (Imposto sobre Movimentação e Transmissão—IMT). The IMT rate would be calculated with the purpose of offsetting, together with the IBS, the proceeds from the collection of the IOF, IPI, PIS/COFINS and PIS/COFINS on imports.
With regard to the transition period, it determines that the rate of IBS-Federal and IBS-state/municipal would increase gradually over six years, with a decrease in the replaced taxes.
In relation to income tax, AC Proposal 128/2019 establishes the taxation, exclusively at source, of profits or dividends paid or credited by legal entities at the rate of 4%. On the other hand, it also determines that the IRPJ rate will be reduced proportionally, so that the income collected is equivalent to the estimated tax collection on profits and dividends.
Finally, it establishes which type of law may define the economic segments for which it would be possible to replace the social security contribution on payroll (CPP) with the contribution on revenue or invoicing.
Current Bills of Laws and Main Reforms Proposed
In addition to the PECs described above, there are still some bills related to income tax (Bills of Laws 3,129/19; 2,015/19 and 604/19) that could implement reforms in the Brazilian tax system without the legal requirements of an AC Proposal.
In summary, they are intended to:
- update the progressive income tax table for individuals to increase the exemption limit;
- establish withholding income tax on the distribution of dividends (currently exempt);
- reduce or extinguish the deductibility of interest on equity; and
- proportionally reduce the IRPJ rate due to such changes (currently the rate is 34%, and there is an intention to reduce it to 20%).
What to expect for 2020?
Discussions arise almost on a daily basis, since the tax reform is government and Congress’s priority for 2020. It is expected that the primary changes will come from AC Proposals since this involves eventual changes of tax competence and may impact the current constitutional federative principle of independence of the Federal District, states and municipalities.
A committee formed of 15 deputies and 15 senators has been created in order to consolidate the AC Proposals. The final draft should be based on AC Proposals 45/2019 (proposed by the House of Representatives) and 110/2019 (proposed by the Senate), and is expected to be issued in the first quarter of 2020.
It is expected that the final draft will be approved by the House of Representatives and the Senate and promulgated in the first half of 2020.
Henrique Erbolato is a Partner with Santos Neto Advogados, Brazil.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Read the full archive of the Bloomberg Tax International Forum articles here.