Tax Reform

Vanessa Ferreira Lukaisus, Tax Director, GM Financial

The Brazilian tax system has evolved over time, influenced by historical, economic, and political factors. Since the Colonial Era and Independence (1500s-1822), period in which Brazil was subject to Portuguese rules, taxes were levied on trade, mining, and agricultural products. After the independence from Portugal in 1822, Brazil continued to rely on trade-related taxes and customs duties, and throughout the 19th century and into the early 20th century, Brazil's tax system was characterized by regional disparities and heavy reliance on customs duties. The federal government and provinces imposed their own taxes, leading to complexity and inefficiencies. Brazilian government centralized tax administration and introduced new taxes to fund industrialization – excise tax (IPI) - and social programs becoming a significant source of revenue.

Several years later, the Brazilian tax system remained complex and burdensome, with a multitude of federal, state, and municipal taxes. New taxes were launched within the last 20 years and others were expanded increasing the complexity of the tax system that led to high compliance costs and a barrier to economic growth, investment, and business development.

For the same period there have been ongoing discussions about tax reform in Brazil, that aims to simplify the tax structure, reduce tax evasion and improve the business environment resulting in several proposals presented by the Deputies. In this regard, as of September 2021, Brazil was considering various tax reform proposals.

July 2023 was a decisive month for the Brazilian Tax Reform, because, after long years of discussion inside Government Houses, the Bill of Amendment to the Constitution number 45, was finally approved in Congress and now is at the Senate to be voted. Despite the definitions included in the third substitute text presented it was maintained the consumption retention system based on a dual Value Added Tax (“VAT”) with the creation of the Contribution on Goods and Services (“CBS”), under the jurisdiction of the Federal Union, and the Tax on Goods and Services (“IBS”), by the states and counties.

A new Tax on Selective Products (“IS”) – an excise tax - was created and will be due on the production, commercialization or import of products harmful to health and environment to be defined by Complementary Law and will be a federal tax.

The proposal defines that CBS will replace two Social Contributions called PIS, COFINS and the actual excise tax called IPI (partially). IBS will replace local VAT called ICMS and the tax on services called ISS and the new tax will replace the remaining portion of IPI.

In the current proposed model, those changes still foresee the possibility of appropriation of credits, taxation at destination, reimbursement of credits from IBS and CBS, non-levy on exports, incidence on local operations and imports involving material goods or not, services and rights and standard rates for the three taxes: CBS / IBS and IS.

Although the expectation is that the change will bring major simplifications when compared to the current system, the fact is that the new proposed tax system will promote a wide range of changes in the market, co-mingled with changes in tax burden and products pricing with a potential decrease in the “weight” of tax factors on allocation decisions and productive investments.

Given the complexity that will involve changing the system, the proposed text foresees the transition in 7 years, with a faster change for the PIS and COFINS, and a more gradual one for the ICMS and ISS, according to the timeline below.

Even though it still depends on the approval by the Federal Senate and, after publication, depends on the publication of regulatory norms through a Complementary Law, there are many doubts, uncertainties, and controversial points, when comparing the current system with the new model of payment that is being proposed.

It is worth highlighting some of them, such as the potential increase in taxation in the services sector, how to use accumulated ICMS credits until 2032 and their destination after the implementation / full validity of the new system. Additionally, there is controversy involving the gradual reduction of tax incentives of ICMS and ISS as well as the effectiveness of new benefits through the creation of a fund,as well as the creation of different tax regimes for some sectors and activities (Transactions with Real Estate, Tourism, Health Plans, Biofuels, Financial services and insurance.

Other challenges and potential concerns associated with the tax reform could be listed and will be the most important part of the battle that Government and Taxpayers will fight for the next few months as the approval of this reform has become a priority for the new government.

In this regard, some of that could be listed such as: political and institutional challenges due to the diverse interests and stakeholders involved, short-term revenue impact for not incur in short-term losses, complexity of designing a new tax system that should be simple and effective, but a complex task when balancing different tax bases/rates and a careful consideration when speaking about incentives, among others.

Ultimately, the success of Brazil's tax reform would depend on a combination of sound economic principles, effective political collaboration, and the ability to strike a balance between competing interests. It's important to follow updates from reputable sources to understand the current state of the reform and its potential impact on the Brazilian economy and society.

Any tax reform is a complex and multifaceted issue for any country, and Brazil is no exception. The Brazilian tax system has long been criticized but now is being designing a new tax model which, if approved, will require a lot of work to be implemented, but with the aim of simplifying tax structures for all taxpayers.

Whether it will succeed or not, we will only know after approval and compliance with the implementation deadline... Much still to be discussed. 

Financial