On June 15 2005 the Brazilian government issued Medida Provisória 252 that, among other things, intends to enhance exports, boost the software industry and encourage technology innovation in the country, by providing certain tax incentives. It seems that Medida Provisória 252 was issued because of political and social pressure against the successive tax burden increases that took place in recent years, which culminated in the rejection by the Congress of certain proposed law changes at the end of 2004. This new legislation "package" is somewhat beneficial for taxpayers. Although the conversion is expected, there have been some debates around the wording of the legislation and therefore some changes may still be introduced. Discussions around exports-related benefits in the WTO context may also arise. These provisions have been in place since June 15 2005 (unless otherwise mentioned below) but they are in general pending on other terms and conditions to be issued by the Brazilian Revenue Service.

Software developers (REPES)

According to Medida Provisória 252/05, companies engaged exclusively in the development of software applications and information technology services may apply for the REPES (Regime Especial de Tributação para a Plataforma de Exportação de Serviços de Tecnologia da Informação). The REPES regime provides for a tax exemption with respect to the amount of PIS and COFINS levied on the direct imports and local acquisitions of goods and services associated with the activities above. The benefit comprises goods and services to be listed by the Brazilian Revenue Service (Secretaria da Receita Federal).

Certain restrictions and conditions apply for a company to elect the REPES regime. First, companies under the SIMPLES tax regime (normally available for small size companies) are not eligible. The legislation also prevents companies with a poor record of federal tax compliance to enrol in the REPES programme. This provision is still pending on more clear regulations and therefore it is not possible to determine its extension.

Most controversially however, is that, according to the law, companies with the totality or part of its revenue subject to PIS and COFINS under the so-called cumulative regime are not eligible for the programme either. This would exclude, for example, those that compute corporate taxes according to deemed profit (lucro presumido-available for companies with annual revenue not exceeding R$48 million ($20 million)), but also those with revenue from the provision of IT services, including software development, technical support, consulting, software updates, among others, which should be in principle the only potential beneficiaries of the REPES.

Companies under the non-cumulative regime (those that could in principle benefit from the REPES) may compute tax credits, corresponding to the PIS and COFINS, paid on imports and local purchases of goods and services to be directly applied in the manufacturing of goods or in the development of services. In these cases, the PIS and COFINS on acquisitions represent a mere prepayment of the taxes due on sales. In this sense, the REPES programme may represent only a temporary cash flow benefit for some companies. However, because export revenue is generally tax exempt, some export companies have to either offset the tax credits against other federal taxes or apply for a refund (which may take a long time to be approved). For them and with respect to fixed assets, which credits are recognized over their useful life or a minimum two-year period, the REPES may be more valuable. The significant benefit therefore would be to allow the REPES election by the software and IT service companies subject to the PIS and COFINS cumulative regime-that under current law may not recognize any credits on their acquisitions.

At the time of the REPES election, the company must commit itself to a minimum level of exports greater than 80% of its annual sales. To control production and demonstrate exports, the REPES beneficiary must also use open-code software approved by the Brazilian Revenue Service, which would provide the tax authorities with online access to certain company data for audit purposes with digital certification. More detailed information on this software is also expected, especially to measure the extension of the information to be provided and associated costs for the taxpayers.

Other restrictions and penalties may apply for companies that subsequently transfer the ownership or assign the utilization of the goods acquired with the REPES benefits and for those that are excluded from the REPES, for instance, for the lack of compliance with the minimum 80% level of exports. Such penalties may include payment of interest and penalties on the PIS and COFINS due on the acquisition of the goods and services and even the payment of the principal.

The REPES may increase Brazil export revenues of software applications and IT services from $100 million, in 2001 to $2 billion, in 2007, placing the country in a more competitive position. However, actual benefits for the taxpayers should be evaluated taking into account the fact that this may present only a temporary cash flow benefit for some companies while on the other hand there would be operational costs associated with the homologated software and other controls, future events may eventually prevent the company achieving the minimum required volume of exports and there would be restrictions to the disposal of the goods within the short term. Further discussions are also expected on the restrictions imposed to companies under the cumulative PIS and COFINS regime.

Marienne Shiota Munhoz (mmunhoz@kpmg.com.br) and Murilo Mello (murilomello@kpmg.com.br) of KPMG Tax Advisers in São Paulo