The challenges of tax compliance in Brazil
Clarissa Machado and Ana Carolina Utimati of Trench Rossi e Watanabe, in cooperation with Baker McKenzie, analyse Brazil’s fiendishly complex tax system and how the government is looking to simplify it.
Brazil is known for having one of the most complex tax systems in the world. There are three levels of tax authorities: federal, state and municipal. Although the federal constitution and laws set forth general rules for all taxes, each state and municipality has powers to enact their own laws and regulations for the collection of the state and municipal taxes, respectively.
This scenario results in more than 10 federal taxes collected by the central government, two state taxes collected by each of the 26 states (and one federal district) and two municipal taxes collected by each of the 5,570 municipalities.
According to the World Bank's Doing Business report the total tax burden in Brazil can reach 68% of a company's total income (including profit tax, labour taxes and others).
This is not the only challenge for Brazilian taxpayers. In fact, complying with all the other tax ancillary obligations created by federal, state and municipal governments can be more challenging than paying taxes. The non-compliance of tax ancillary obligations may result in extraordinary penalties (in certain cases, the penalties are greater than the related taxes).
At the federal level, there are currently multiple tax returns, including for corporate income taxes (ECF), turnover tax (PIS and COFINS) (EFD Contribuições), value added taxes (EFD ICMS/IPI), social security contributions (GFIP), withholding income taxes (DIRF), credits and debts (DCTF), services (SISCOSERV) and offsetting (DCOMP), amongst others.
At the level of the states and municipalities, the tax returns are usually simpler, especially considering that states mostly collect the so-called "state VAT" (ICMS) and the municipalities mostly collect the municipal services tax (ISS). The other state and municipal taxes do not usually apply to day to day transactions of legal entities, but only in specific events (e.g., upon the sale of real estate, the municipal real estate transfer tax should apply).
However, the real complexities in the state and municipal taxes are the number of different compliance rules that the taxpayer may be subject to. This is because there is no standard ICMS or ISS tax return. Each state and municipality may potentially create its own system, with different forms, periods and other requirements for the declaration of such taxes. In this context, companies that have presence in more than one state and municipality (which is very common) must be very cautious upon applying the different rules applicable in each place.
Compliance with all such tax returns (i.e., ancillary obligations) is a great challenge to companies in Brazil, which are often required to have entire tax departments focused on this matter or even hire specialised accounting firms to prepare the list of tax returns applicable in each case.
According to the World Bank report mentioned above, Brazilian companies spend an average of 2,038 hours to comply with the tax system and tax rules, which puts Brazil in the 181st position of the 190 countries ranked by the World Bank in the matter of paying taxes (which also encompasses other criteria such as number of taxes and tax rates).
For reference, note that Brazil is only ahead of Nigeria, the Republic of Congo, Guinea, Venezuela, Bolivia, the Central African Republic, Mauritania, Chad and Somalia, while our neighbours Mexico and Chile are in 114th and 120th place, respectively.
In terms of the number of hours spent on compliance with the tax rules, Brazil comes out worst, followed by Bolivia with an average of 1,025 hours, i.e. roughly half of the hours spent by Brazilian companies. Using Mexico and Chile as references once more, the World Bank estimates that taxpayers in these countries spend an average of 291 and 286 hours, respectively, on tax compliance.
As a direct consequence, Brazil is ranked in 123rd place for doing business around the world, while Chile is in 57th place and Mexico is 47th.
Although not mentioned in the World Bank reports, experience shows that Brazilian companies not only spend many hours in tax compliance but also spend a relevant amount of money in payment of penalties and/or endless tax litigation cases linked to tax compliance as further discussed below.
The facts above are certainly not good signs in terms of inviting new investment to Brazil. And under this scenario, there has been increasing concern for the Brazilian government, which is seeking ways to recover the economy from a very difficult period.
From a Brazilian tax standpoint, discussions about the tax reform are in the daily news once again. However, such important reform – a topic in the top list of political discussions for the last 20 years – would demand a political investment and power that may not be within the reach of the current government, which is in a severely weakened position.
Meanwhile, the Ministry of Finance (Federal Revenue Department) and the Federal Confederation of Industry are holding a joint committee to discuss an initiative to simplify tax compliance procedures. In August 2017, the two entities hosted the Forum for Tax Simplification and Integration.
During this forum, representatives presented several initiatives to integrate the three taxation levels (federal, state and municipal), to enhance the efficiency in the tax administration and to simplify ancillary tax obligations for taxpayers.
Also during the forum, the Chief of the Federal Revenue Department presented four measures for the simplification of the tax system, with primary goals of reducing the costs to companies, making the business environment in the country better, and ultimately increasing the competitive capacity and production. These measures may be summarised as follows:
The first measure: In 2007, the federal government created the Public System of Digital Bookkeeping (SPED), a platform that unifies the presentation and retention of tax and accounting information. In this context, the first measure is to enlarge the reach of the system, allowing different levels of tax authorities to access and share information using this system.
The second measure: This deals with the simplification of the tax ancillary obligations with the states. The objective is to eliminate the requirement to present the same information twice in SPED and in the state tax returns. According to the Federal Revenue Department, this is because approximately 87% of information requested in state returns is already reported in SPED.
In accordance with this project, the taxpayer would present all relevant information for state taxes within SPED and the state tax authorities would have access to such information without the necessity of another specific state return.
There are reports of a pilot of this project in the states of Goias, Alagoas and Mato Grosso, with the objective of having all states using SPED for state purposes within six months. In a certain way, it may be viewed as a new mechanism for automatic exchange of information between the states and the federal government, but with a fair goal of simplifying ancillary obligations and mitigating the risk of mismatch of information.
The third measure: This measure deals with the municipalities. As previously mentioned, each municipality is currently allowed to create its own system to control municipal taxes, such as the municipal services tax. Accordingly, several municipalities created systems for the issuance of electronic invoices. In this scenario, the third measure to simplify the tax system aims at defining a national standard electronic services invoice and creating a data basis to control the electronic invoices issued.
For this project, São Paulo, Brasilia, Belo Horizonte, Rio de Janeiro and other four cities are testing the pilot, which should be implemented nationally by the end of the year.
The fourth measure: The objective of this measure is to simplify the customs procedures for importation and exportation of goods. This project has two phases. The first is the creation of a joint federal and state system to control the payment of federal and state taxes upon importation. Currently, only the federal taxes are controlled electronically by the foreign exchange system and the taxpayer has to carry out the payment of state taxes separately. According to the Federal Revenue Department, this project would reduce the time to import in 41% and the time to export in 38%.
The pilot project is scheduled to start in São Paulo, Rio de Janeiro and Pernambuco at the end of the year, but the application for the rest of the country is still not defined.
The second phase is to create a 'customs clearance on water', which would allow certain companies (authorised economic operators) to have their goods cleared from customs even before arriving in Brazil. The system is still in development for this phase, thus this phase is not expected to be in place until 2018.
The fact that the Ministry of Finance and the Confederation of Industries held the forum is a clear indication that the burden of tax compliance in Brazil is a problem widely acknowledged not only by taxpayers but also by the authorities. Besides, the projects presented at the forum seem to address some of the problems with tax compliance in Brazil. However, we will only be able to truly affirm that such projects will be effective in simplifying the tax system after they are fully operating.
If you fail
The compliance with tax ancillary obligations in Brazil is not simple, which makes Brazil one of the least inviting countries in which to do business in the world. However, if complying with the tax system is burdensome, not to do so is even worse, considering the penalties that can applied by federal, state and municipal tax authorities. Different relevant penalties may apply in case a company lacks compliance with tax obligations, even in the case it has adopted – in good faith – a different interpretation of the rules in place.
At the federal level, the standard penalty for lack of payment of taxes is 75% and can easily be increased to 115%, 150% or 225%, if the tax authorities conclude that there is any evidence of fraud or lack of cooperation of the taxpayer with the investigation.
Specifically in connection with ancillary obligations, the presentation of tax returns with incorrect information can result in penalties of up to 3% of the total amount of the commercial and financial transactions of the taxpayer.
In the state of São Paulo, the standard penalty for lack of tax payment is 80% of the unpaid taxes, and penalties for the non-compliance with tax ancillary obligations can reach up to 50% of the amount of the transactions.
In the municipality of São Paulo, the penalties for the lack of payment of taxes and for the lack of compliance with ancillary obligations are 50% of each tax due.
Although it may be difficult to comply with all tax obligations in Brazil, this means that the company should put relevant efforts to do its best and accordingly to try to mitigate the risks of assessment for lack of compliance.
We believe that if the measures described above are seriously implemented, there will be a relevant improvement in the tax system as a whole, and both taxpayers and authorities will win.
Trench Rossi e Watanabe, in cooperation with Baker McKenzie São Paulo
Clarissa Giannetti Machado has extensive experience advising clients on tax planning. Partner since 2007, she has worked in Baker McKenzie Chicago office in 2002 and in Baker McKenzie Amsterdam office in 2006. Clarissa has co-written articles on tax issues for several publications. She has been nominated as a leading tax lawyer by Chambers Latin America (since 2010) and as a pre-eminent figure in global transfer pricing deals by Euromoney's Guide to the World's Leading Transfer Pricing Advisers. Clarissa advises companies with business operations in Brazil on transfer pricing, real estate transactions and general tax planning. She helps clients develop and implement tax-efficient structures for financial transactions, acquisitions and sales of business operations, real estate operations and related transactions. She also counsels clients on the economic valuation of Brazilian companies. Clarissa graduated in 1997 from the Law School of the University of São Paulo and in business administration from Fundação Getúlio Vargas. She gained a master of laws (LL.M.) in 2002 from Columbia University School of Law of New York and was admitted to practice law in the State of New York (approved by the New York Bar in 2002).
Ana Carolina Utimati
Trench Rossi e Watanabe, in cooperation with Baker McKenzie São Paulo
Ana Carolina Utimati joined the firm in 2003 and became partner in 2015. Her practice includes administrative law, tax consultancy and tax litigation. She is an expert in tax administrative proceedings, experienced in drafting defences, appeals and requests for rulings with sectors of the federal, state and municipal tax public administration, as well as with social security sectors. She graduated in 2002 from the Law School of the University of São Paulo.