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Brazil takes a leap towards consumption taxes reform

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Mauri Bornia and Gabriel Caldiron Rezende of Machado Associados discuss the status of the tax reform bill approved by the Chamber of Deputies, to be analysed by the Senate during the second half of 2023.

The Brazilian consumption tax is highly complex, especially because there are several taxing entities and different tax regimes – depending on the taxpayer’s profile, products, activities, and more. Additionally, it limits the booking of tax credits (thus distorting VAT neutrality) that, aside from the tax burden, results in an excessive cost for taxpayers to comply with many ancillary obligations.

Furthermore, tax law is open to a broad interpretation, leading to many conflicts between taxpayers and tax authorities, resulting in an insecure and litigious scenario.

In view of this, for years society has been debating the need to take a modern approach to Brazilian consumption tax, aligning it with an actual and simplified VAT model.

As previously discussed, after the presidential elections of 2018, the discussions around tax reform were sparked and seen with great optimism with the presentation of the Proposal for Amendment of the Brazilian Federal Constitution 45/2019 (PEC 45/19). However, debates were halted in view of the COVID-19 pandemic.

Nevertheless, in 2023, after new presidential elections, the debates were resumed and in July, PEC 45/19 was approved by the House of Deputies, with some substantial changes.

In summary, the approved proposal aims at:

  • Unifying the state and municipal taxes of goods and services, substituting the state VAT (ICMS) and municipal service tax (ISS) for a goods and service tax (IBS) to be shared between states and municipalities;

  • Substituting the Social Contributions on Revenues (PIS and COFINS) for a Contribution on Goods and Services (CBS), to be taxed by the federal government; and

  • Substituting the Federal excise tax (IPI) for a sin tax on goods and services (selective tax) considered as harmful for health and environment, to be taxed by the federal government.

The main aspects of the IBS and CBS are:

  • Same treatment, i.e., same triggering events, specific regimes, tax credits rules, etc.;

  • Levied on transactions with goods, services and rights, both local and imports, being exempt from exports tax;

  • Uniform tax rate for all transactions, composed by the sum of rates determined by the state and municipality of the transaction destination;

  • Fully non-cumulative taxes; thus, all taxed acquisitions will entitle the purchaser to the right to book credits to offset against the taxes levied on its transactions, except for goods and services for individual use and consumption;

  • Calculated on top of the net price. If the transaction is subject to the selective tax, it will be comprised in the IBS and CBS taxable basis;

  • As a rule, no tax benefit of differentiated treatment will be granted for CBS and IBS;

  • Law may establish mechanisms for reducing the impact on the acquisition of capital goods; and

  • Law will establish specific treatment for special customs regimes.

Although the original intention of PEC 45/19 was that no differentiated tax treatment be granted for IBS (and CBS, which was inserted as an amendment to the original project), the proposal currently approved provides for some tax reduction (in some cases even to zero) for:

  • Transactions with basic necessities - to be defined by law;

  • Education, health, and collective transportation services;

  • Medical devices, medication, agricultural products, human food and personal hygiene products;

  • Artistic, cultural, journalistic and audiovisual productions; and

  • Goods and services related to national sovereignty and security.

Furthermore, the approved version of PEC 45/19 also provides for, mainly:

  • The states authority to charge contribution on primary and semi-elaborated products, up to December 31, 2043;

  • Changes in the auto vehicle property tax (IPVA), which will also be levied on the property of water and air vehicles, aside from land vehicles. Furthermore, IPVA may have different tax rates in accordance with the value, use or environmental impact;

  • Changes in the real estate property tax, so that its taxable basis may be updated by the executive branch; and

  • Changes in the tax on donations and inheritance, so that it may be progressive in view of the amount donated or inherited.

PEC 45/19 provides for a long transition period, in which both systems will coexist, as follows:

  • 2024-2025: enactment of laws to impose the new taxes and creation of tax systems, define the new tax authority for IBS purposes, among other measures necessary to operationalise the new tax system. The selective tax may be charged as soon as the corresponding law is enacted. Goods subject to the selective tax will not be subject to the IPI;

  • 2026: IBS and CBS will begin to be charged at 0.1% and 0.9%, respectively;

  • 2027: CBS will be fully charged, extinguishing PIS and COFINS;

  • 2027: IPI rates will be reduced to zero. The levy will be maintained for products manufactured/imported in any point of Brazil other than the Manaus Free Trade Zone (subject to IPI exemption), but that are also manufactured in said zone, to keep the competitiveness of this region;

  • 2029 to 2032: gradual rate reduction of ICMS and ISS; and

  • 2033: extinction of IPI, ICMS and ISS.

Even though the approval of PEC 45/19 by the House of Deputies is a leap towards a modern taxation on consumption in Brazil, there are several matters to be addressed and further improved during the discussion at the Congress. Matters such as how the PIS, COFINS and IPI credit balance currently held by taxpayer will be dealt with, as it only addresses (and not very clearly) the ICMS credit balance.

Also, the IBS and CBS rates remain to be determined.

Brazil is taking efforts to improve its taxation on consumption, aligning it to international VAT standards. Nevertheless, the path that will be taken in the discussions at Congress remains unclear. The second half of 2023 will certainly be full of discussions to be closely followed.

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