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Brazil’s Congress takes an important step towards approval of Tax Reform

June 12th, 2023

On June 06, 2023, Brazil’s National Congress released the Tax Reform Working Group report, which contains the proposals and guidelines for the substitute bill to be presented within the scope of Proposed Constitutional Amendment (PEC) No. 45/2019.

Below is a breakdown of the main proposals of the PEC, by category:

Dual Value Added Tax (VAT) Model

Adoption of a dual version of taxes on consumption, to be called “IBS” (Tax on Goods and Services, in English). The proposal is for two IBS taxes: one IBS under the jurisdiction of the Federal Government, comprising IPI, PIS and Cofins; and another whose jurisdiction is shared between states and municipalities, bringing together ICMS and ISS taxes. The idea is for this tax to be broad-based, to be levied as tax on tax-exclusive (that is, a model that does not include its own calculation base, in Portuguese referred to as “por fora”) and levied at the destination, with full non-cumulative effect. The use of a standard rate (as a rule) is suggested, allowing for a few different rates for certain sectors.

Selective Tax

In addition to the creation of the IBS, the report proposes the creation of a selective tax to discourage the consumption of goods and services that are harmful to health or the environment. The guideline is to leave a broad text in place, for later definition of the sectors affected by the tax. The idea is also that this new tax offsets, at least in part, the decrease in revenue generated by the termination of the IPI tax.

Rates

Creation of a single rate applicable to all goods and services, allowing other rates only for specific goods and services. The differentiated rates would be applied only to certain cases involving goods and services related to health, education, urban, semi-urban or metropolitan public transport and regional aviation, as well as rural production. In addition to these, there is the recommendation to evaluate the possibility of maintaining the differentiated treatment of products that comprise the basic food basket.

Cashback

The guideline is to provide for a system of returning part of the tax (named “cashback”) to low-income families.

Continuation of the Manaus Free Trade Zone

Continuation of the Manaus Free Trade Zone is included as a guideline, due to its essentiality for the socioeconomic development of the country’s North Region, which would ensure its maintenance until the constitutional deadline of 2073.

Continuation of the “Simples Nacional” regime

The report also provides guidelines on the simplified taxation system, named “Simples Nacional”, in which so-called “micro” or “small” companies may pay several federal, state and municipal taxes at once and in a single monthly payment form. In this line, the recommendation is to maintain the tax regime that facilitates micro and small companies opting for such system.

For the purpose of adapting the regime to the intended new indirect taxation model, a taxpayer included in Simples Nacional will be able to choose between two IBS collection models:

a) In the first, taxpayers can pay the IBS in a unified manner, as is currently the case with Simples Nacional, with the recommendation that, in this case, legal entities that acquire goods and services from operations included in this regime can appropriate credits in the same amount that was charged on such operations.

b) The second alternative is for the taxpayer opting for Simples Nacional to collect the IBS according to the normal calculation regime, without prejudice to continuing in the simplified regime in relation to other taxes.

Specific tax regimes

The guideline is that specific tax regimes be granted in the IBS for certain services and products whose particularities make it difficult or do not recommend the traditional calculation based on the comparison of debits and credits. In the report, the case of operations with real estate, financial services, insurance, cooperatives, fuels and lubricants, all of which require their own calculation systems, was highlighted.

Regional Development Fund

The creation of a Regional Development Fund is advocated to reduce regional inequalities and encourage the continuation of enterprises in less developed regions, which will no longer enjoy tax benefits as a result of terminated taxes.

It is expected that the adoption of the IBS destination principle – charging the tax at the place where the service is provided or the good is consumed – will put an end to the so-called tax wars advanced by states and municipalities, a practice that should be replaced by other more efficient public policies.

It is recommended that the Regional Development Fund be financed primarily with Federal Union resources.

Validated ICMS benefits

The report recommends that the ICMS tax benefits validated until 2032 by Complementary Law No. 160/2017 be respected, and that the substitute text should define the necessary formatting to comply with this guideline.

Transition to the new model

A specific transition period for the new model has not been established. Regardless, the report suggests that the transition between the current model and the new taxation model should comprise a faster change regarding PIS and Cofins and a gradual change for ICMS and ISS.

Federal transition

With the implementation of the destination principle, taxes will no longer come from production, but will rather start to effectively focus on consumption, which should directly impact the country’s economic environment.

In view of this, a long-term period was proposed as a guideline for the federative transition to accommodate states and municipalities in the change to the new model, offering the necessary resources for the continuation of activities to those entities that would lose out with the new model.

Management of IBS by the Federative Council

Proposal to create a Federative Council, led by states and municipalities, to work together with the Federal Government in the shared administration of IBS, so that federal and state/municipal taxes work in an efficient and integrated way.

Suggested changes to income and property taxation

Despite the focus of the Working Group being on the presentation of guidelines for the reform of taxation on consumption, suggestions were made at the end of the report for changes to the taxation of income and wealth, such as:

Taxation of water and air vehicles through the IPVA (vehicle tax), as a measure of fiscal justice, as well as the possibility of the tax being progressive due to the environmental impact of the vehicle.
With regard to ITCMD (inheritance tax), it is suggested that the tax be progressive due to the value of the transfer, with the taxation of high-value inheritances and donations applied more fairly, as has already been done in relation to the progressiveness of the IPTU (municipal property tax) carried out through Constitutional Amendment 29/2000.
As for the IPTU, it is suggested that the Executive Branch be able to update the tax calculation base by means of a decree, based on general criteria provided for in municipal law, in order to facilitate municipal administrations in reaching the collection potential of properties with high valuation.

Demarest’s Tax team is available to provide any additional information or clarifications that may be necessary.