With the approval of Brazil’s consumption tax reform in 2023 – currently undergoing regulatory implementation – the country has taken a major step towards simplifying its complex tax structure and aligning with the VAT model adopted by most economies worldwide.
Although Brazil’s dual VAT model has its peculiarities, with multiple taxable entities and a broad tax base, one of the reform’s main pillars is the adoption of full non-cumulative taxation as an effective instrument of neutrality and less regressive taxation, with a view to achieving greater fiscal equity.
However, there are many uncertainties about the effectiveness of this broad non-cumulative taxation. Although this system already applies to most of the current ‘indirect’ taxes, in practice there are many conditions and restrictions applied by the federal and state tax authorities that generate increased costs, price distortions, and persistent and growing tax litigation.
Summary of the Brazilian tax reform
- The tax on goods and services (imposto sobre bens e serviços, or IBS) replaces the tax on the circulation of goods and services (imposto sobre circulação de mercadorias e serviços, or ICMS) and the tax on services (imposto sobre serviços, or ISS); and
- The contribution on goods and services (contribuição sobre bens e serviços, or CBS) replaces the social contributions for the social integration programme and for the financing of social security (programa de integração social and contribuição para o financiamento da seguridade social, or PIS/COFINS).
How does non-cumulative taxation work in Brazil’s current tax system?
In the case of multiphase taxes, non-cumulative taxation allows the deduction of credits relating to taxes levied in previous stages, avoiding a cascading levy along the chain of production and commercialisation of goods and services.
This system is applied by Brazilian laws in the calculation of state taxes, such as ICMS, and federal taxes, such as PIS/COFINS. The credit must be supported by a valid tax document and be of a book-entry nature. The main issue is the tax authorities’ divergent interpretations in relation to the use of credits and, therefore, the effective scope of this non-cumulative taxation.
With regard to consumption taxes, there is no provision for the application of non-cumulative taxation in the calculation of ISS, which falls under municipal responsibility and, therefore, does not allow for the deduction of costs – resulting in tax layering along the service chain.
Although non-cumulative status is guaranteed for ICMS, the tax on manufactured products (imposto sobre produtos industrializados, or IPI), and PIS/COFINS, its effectiveness is currently compromised because this broad and unrestricted character is subject to strict conditions that make the regime far from uniform and fair.
Taking the ICMS – which is governed at state level by 27 laws – in general terms, the offsetting of credits is conditional on the immediate and full consumption of the input considered in the production process; thus, for example, necessary contact with the product being manufactured or incorporated into the product is not requested.
With regard to IPI, which is a federal tax, the offsetting of credits does not require the immediate and full consumption of the input in the production process, nor its incorporation into the product being manufactured, but it does require necessary contact with the product.
For PIS/COFINS, in the non-cumulative calculation system, the offsetting of credits is restricted to expenses considered essential and relevant to the production process or service provision.
In the acquisition of assets, only ICMS and PIS/COFINS authorise credits, requiring use in the production process or service provision and compliance with specific rules:
For ICMS, use in the production process and appropriation within 48 months; and
For PIS/COFINS, use in an amount corresponding to the depreciation or amortisation levels.
IPI legislation does not authorise the offsetting of this type of credit.
None of these taxes allow the use of credits with regard to use and consumption goods. In the case of ICMS, companies have been waiting almost 30 years for legislative authorisation to use these credits; currently, this credit is only authorised from the end of 2032. If ICMS is to be abolished and replaced by IBS from 2033, the right to use such credits is a hollow victory.
What will change with full non-cumulative taxation in relation to IBS and CBS?
Under the approved tax reform, the use of IBS and CBS credits, although still linked to proof of operation by means of an electronic tax document, is now financial in nature, no longer bookkeeping-related and linked to the respective highlight, but conditional on payment, with a view to reducing tax evasion.
Although ‘cross-compensation’ between IBS and CBS credits is forbidden, infra-constitutional legislation includes restrictions on full non-cumulative taxation; in particular, the non-utilisation of credits in transactions in which no IBS/CBS is paid – such as in cases of immunity (except for exports), exemption, and zero rate – and in relation to goods considered to be “for personal use and consumption”.
Following the legal provision regarding characterisation as “goods for personal use and consumption”, without the right to IBS/CBS credit, we have:
Assets listed in an exhaustive manner – such as jewellery, stones, precious metals, works of art, and alcoholic beverages – unless they are used ‘predominantly’ in the taxpayer's business;
Those acquired/produced and provided free of charge or at below market value to partners, employees, etc., such as residential property and vehicles, and, in the case of a family office, goods and services related to management; and
Those that depend on regulations to define the criteria for personal use and consumption or that are not related to the development of economic activity, in the case of individuals.
Although the constitutional architecture of the new tax system has pointed towards a more rational model in relation to non-cumulative taxation, infra-constitutional implementation could jeopardise this promise if it is not revised. This is because the wording of Article 57 of Supplementary Law 214/2025, which regulates the consumption tax reform approved by Constitutional Amendment 132/2023, raises fears that subjective criteria will once again be used to define the cases in which credits can be used, since it requires, for example, “preponderance”, a “direct link” to certain taxable income, and “efficient use” of resources.
By the letter of the law and despite the preponderance requirement, jewellery, precious metals, and works of art would only be eligible for credit if they were marketed or used to manufacture goods to be marketed.
Healthcare plans and the provision of transport vouchers, meal vouchers, or food vouchers would only entitle the use of IBS/CBS credits if they were granted to employees and their dependants because of collective agreements or conventions. Therefore, would only amounts of this nature be eligible for the respective credit? And if these services are incurred for the benefit of partners, would the credits be forbidden?
If other cases of IBS/CBS credit are subject to regulation when goods and services are supplied free of charge or below market value, does this not give a ‘blank cheque’ to impose limits on broad IBS/CBS credit?
Final thoughts: will Brazil’s tax reform be a mere façade?
The risk is real: taxpayers may continue to contend with the same complexity that has persisted with regard to non-cumulative taxation. All this, coupled with Brazil’s adoption of a dual VAT, raises further concerns that, although IBS and CBS share the same material scope, state and municipal tax authorities could adopt divergent and restrictive interpretations of credit entitlements – thereby undermining the system’s intended simplification and neutrality.
Lawmakers and regulatory bodies must therefore critically review the restrictions to IBS and CBS credits. For the new tax model to deliver its promise of efficiency in an environment of greater legal certainty, a uniformity of interpretation and respect for the logic of broad credit must be ensured. Otherwise, Brazil’s tax reform could be reduced to a façade reform: progressive in speech, but regressive in essence.
