Tax Reform advances with substitute text to PEC No. 45/2019

On June 22, 2023, Brazil’s National Congress released the draft preliminary opinion of the substitute text to PEC No. 45/2019, which aims to change the national tax system and implement a Tax Reform mainly focused, at first, on consumption taxes.

Find below a summary of the main points regarding this substitute text:

• Dual VAT system

As already published in the preliminary report, the substitute provides for the creation of a dual version of the VAT (Value-added Tax) on consumption taxes. The Federal VAT will be called Contribution on Goods and Services (“CBS”) and will replace the Tax on Industrialized Products (“IPI”), as well as the Social Integration Program (“PIS”) and the Contribution for the Financing of Social Security (“Cofins”).

In addition, a subnational VAT will also be created, with shared competence between states and municipalities, called Goods and Services Tax (“IBS”), bringing together the Tax on Circulation of Goods and Services (“ICMS”) and the Services Tax (“ISS”). The IBS will focus on transactions with tangible and intangible goods (including rights), or services, and will be charged by summing the rates of the state and municipality where the operation is going to take place. Also, there is a provision on the incidence on the import of goods, rights or services.

It is worth highlighting that both the CBS and the IBS will hold the same:

• taxable events, calculation bases, hypotheses for non-incidence and taxpayers;
• specific, special or favored taxation systems; and
• regulations on noncumulativeness and recording of credits.

• Rates

The reference rate of the IBS is expected to be established by resolution of the Brazilian Federal Senate for each federal sphere, under the terms of the supplementary law, and each federal entity will be able to adopt the reference rate or fix its own rate according to a specific law.

The rate fixed by the federal entity must be the same for all transactions involving goods or services, apart from the exceptions allowed for in the Brazilian Federal Constitution itself.

The substitution also allows for a 50% cut in the rate for (i) education services, (ii) health services, (iii) medical devices, (iv) medicines, (v) urban, semi-urban or metropolitan public transport services, (vi) agricultural, fishing, forestry and in natura plant extractive products; agricultural inputs, food intended for human consumption and personal hygiene products, and (viii) national artistic and cultural activities.

Urban, semi-urban or metropolitan public transport services may also be held exempt, by means of a provision in the supplementary law, as well as a 100% cut in the IBS and CBS rates on medicines, and a 100% cut in the CBS rates on:

• higher education services under the terms of the University for All Program (“Prouni”); and
• services supported by the Emergency Program for the Resumption of the Events Sector (“Perse”) until February 28, 2027.

• Noncumulative IBS

According to the text, the IBS will be noncumulative, thus compensating the tax due by the taxpayer through the amount charged on all transactions in which such taxpayer acquires tangible or intangible goods, or services, except for those considered exclusively for personal use or consumption, under the terms of the supplementary law and others, provided for in the Brazilian Federal Constitution.

Exceptions to the use of credits are also observed in cases of exemption and immunity, which should not imply credit for the following transactions and should result in the cancellation of the credit related to the previous transactions (except in the event of immunity, whenever established otherwise by supplementary law).

• Credit Recording and Compensation

The supplementary law will provide for the compensation system, and may establish hypotheses in which the use of credit will be subject to the verification of the effective payment of the tax or contribution regarding the transaction, provided that (a) the acquiror collects the tax on their goods or services purchased; or (b) the tax collection takes place at the financial settlement of the transaction.

• Cashback

The Supplementary Law will also provide for the hypotheses of return of both the IBS and CBS to individuals, including limits and beneficiaries.

• Specific special arrangements

According to the text, fuels and lubricants, financial services, real estate transactions, healthcare plans, forecasting competitions and operations contracted by the direct and indirect public administration may hold special payment arrangements for collecting the CBS and IBS.

These arrangements, depending on the case and according to the supplementary law, may establish changes in rates, credit regulations, calculation bases and collection on revenue or billing.

• Selective tax

The text provides for the creation of a selective tax on the production, trade or import of goods and services that are harmful to health or the environment, in accordance with the legislation in force.

• Manaus Free Trade Zone

The text preserves the existence of the Manaus Free Trade Zone until the constitutional deadline of 2073, with an extension to the Free Trade Areas.

To this end, the text provides for:

• changes to the IBS and CBS credit regulations and rates; and
• increase in the incidence of the selective tax, so that it reaches the manufacturing, trade or import of goods that are industrialized within the Manaus Free Trade Zone, thus ensuring a favored treatment as regards the operations originally carried out in this region.

• Transitional regulations

The transition from the current taxes to the new ones is expected to take place within eight years, as follows:

• 2026: initial term for CBS charge at a 1% rate, which may be compensated with the PIS/Cofins due by the taxpayer;
• 2027: initial term for CBS full charge, annulment of PIS/Cofins and zero IPI cut on products that are not industrialized within the Manaus Free Trade Zone (according to the supplementary law);
• between 2029 and 2032: gradual cut of both the ICMS and ISS, and introduction of the IBS;
• 2033: extinction of the ICMS, ISS and IPI.

• ICMS Tax benefits

Through the extinction of the ICMS by 2032, the use of the ICMS tax benefits will be ensured until 2032, as addressed by Supplementary Law No. 160/2017. However, the substitute text provides for the pro-rata cut on benefits while the ICMS is reduced, from 2029 to 2032.

The substitute text also prohibits extensions to the deadline for using the ICMS benefits.

• ICMS benefit compensation fund

Regardless of preserving the benefits, the establishment of the ICMS Benefit Compensation Fund is expected, with the purpose of compensating, until December 31, 2032, the legal entities that receive exemptions, incentives and fiscal or financial-tax benefits, granted for a given time frame and under conditions.

• Credit balances

The ICMS creditor balances existing at the end of 2032 may be used by taxpayers, under the terms of the supplementary law, provided that they are allowed for by the legislation in force and approved by the corresponding federal entities.

For this purpose, the application for approval of the credit balances must be examined by the entity within the deadline set by the supplementary law, and, in the absence of a response within the deadline, the respective creditor balances will be considered as ratified.

The balance of the approved credits must be submitted by the states and the Federal District before the IBS Federal Council, in order to be compensated with the IBS (a) for the remaining period of time, in the case of permanent asset credits; and (b) in 240 monthly installments, equal and successive, in other cases, under the terms of the supplementary law.

As of 2033, the creditor balances will be updated according to the Broad Consumer Price Index (“IPCA-E”) or another index that may replace it in the future.

The supplementary law will also regulate the way in which credit holders may transfer credits to third parties, as well as the way in which those credits may be reimbursed to the taxpayer by the IBS Federal Council, in the event that it is not possible to compensate the installment amount through the debts of the new tax.

There is no provision for compensating or refunding PIS/Cofins and IPI creditor balances.

• National Fund for Regional Development

The idea suggested in the report about the creation of a Fund for Regional Development was preserved, with the aim of reducing regional and social inequalities, through the delivery of resources, by the Brazilian Federal Government, so that the states and the Federal District can invest in:

• carrying out studies, projects and infrastructure works;
• fostering manufacturing activities with high potential for generating employment and income, including the granting of economic and financial subsidies; and
• encouraging actions that seek scientific and technological development and innovation.

• IBS Federal Council

The substitute text provides for the creation of the IBS Federal Council, operated by states and municipalities, without the participation of the Federal Government, as to collect tax and assist in the efficient and integrated application of federal and state/municipal taxes.

• Collection of Property Tax on boats and aircrafts

An extension to the Property Tax (“IPVA”) on boats and aircrafts is expected, as well as potential special rates due to the environmental impact caused by these specific crafts.

• Progressive Inheritance and Gift Tax

As for the Inheritance and Gift Tax (“ITCMD”), taxation is expected to be progressive due to the amount of the transmission or donation, similarly to the progressive taxation of the Urban Real Estate Tax (“IPTU”), established through Constitutional Amendment No. 29/2000.

• Update of Urban Real Estate Tax by the Executive Branch

The calculation basis for the IPTU can be updated by the Executive Branch, based on general criteria provided by municipal law, so that municipal governments can reach the potential tax collection for high-value buildings more easily.

Demarest’s Tax Team is monitoring all the proposed changes and is available to clarify any doubts.