Brazil aims to reform complex tax system

The Brazilian tax system is globally known for its enormous complexity. Not only is the tax burden very high, but there are five different indirect taxes: ICMS (state tax), ISS (municipal tax), IPI (tax on industrialised goods), PIS (employees’ profit participation programme) and COFINS (federal taxes). This leads to innumerous ancillary obligations not to mention conflicts of jurisdiction between the federal government, states and municipalities on the tax levied on a great number of activities.

The intricacy of the tax system is one of the key hurdles for foreign capital attraction and economic growth. There have been several attempts during the last years to improve the Brazilian tax system, but they have all been unsuccessful. It is very hard to obtain consensus with so many parties and interests involved: federal government, states, municipalities and taxpayers. Furthermore, the reform requires a constitutional amendment, to which a supermajority vote (3/5 of congress) would apply. 

Nevertheless, the new administration, which took office in January 2019, has undertaken to approve several reforms to reduce public spending, bureaucracy and facilitate doing business in the country, and one of them is tax reform.

Different bills are being discussed but they all have one point in common: the simplification and combination of all current taxes imposed on consumption into one single tax.

The bill that is currently in the most advanced stage was originally conceived by a team of very influential Brazilian tax experts and has now been presented to congress as the Constitutional Amendment Bill No. 45/2019 (the bill).

According to this bill, consumption taxes would be replaced with one single tax on consumption of goods and services (IBS), following the international standards of VAT tax.

IBS tax would be originally set at a uniform reference rate for each federative entity, to be applied indistinctly to all transactions involving tangible or intangible assets. The final tax burden is expected to reach the initial rate of 25% after a 10-year term of transition.

Combined with the single flat rate applicable to all businesses, another significant improvement to the tax system brought by this proposal is the implementation of the taxation where the consumer is located, pursuant to which IBS shall be a destination-based tax. This measure will put an end to the so-called "tax war" between states that use unauthorised subsidies to attract investment, a huge problem in Brazil, finally levelling the playing field among taxpayers and states.

Two concerns related to the tax reform are being voiced by digital economy companies. The first one is that they would have to cope with a significant tax hike if the 25% is confirmed. In return, the reform seeks to increase security for investors and provide transparency to consumers, who will actually bear the tax burden. As a result, despite the rise in tax burden following implementation of IBS tax, companies are expected to benefit from simplification of the system, the possibility of fully using the credits arising from the tax paid in the previous stages, considerable reduction in the number of ancillary obligations and associated costs, and reduction in uncertainty and in litigation alike.

Another worry relates to the criteria and mechanisms for identifying the jurisdiction of consumption. Implementing the destination principle with respect to services and intangibles is difficult, because they cannot be subject to border controls in the same way as goods and the rules should ensure that clarity and certainty are provided for both business and tax administrations and that compliance is kept as simple as possible with minimal costs involved.

Ana Carolina Carpinetti and Luiz Roberto Peroba Barbosa 

This article was written by Ana Carolina Carpinetti (acarpinetti@pn.com.br) and Luiz Roberto Peroba Barbosa (lperoba@pn.com.br) of Pinheiro Neto.

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