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What a Unified Tax System in Brazil Could Mean for Your Organization

by Lucas Manuel Machado, FiscalNote Professional Services

Understanding what the proposed Brazilian tax reform is about and the implications it could have for industries and larger global trade.

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The Brazilian Tax Reform is approaching a crucial vote in the Chamber of Deputies, expected before the parliamentary recess on July 18. Although the text is not final and may undergo minor adjustments, it is anticipated that the bill will be approved and progress to the Senate, where it is also expected to receive support.

MP Aguinaldo Ribeiro from the centre-right Progressives (Progressistas - PP) presented a Preliminary Report for the proposal of constitutional amendment (PEC) 45/2019 on June 22, which aims to reform the country’s tax system.

The report suggests replacing the current value-added tax (VAT) regime with a centralized model aligned with international frameworks, while still preserving the Free Economic Zone of Manaus (Zona Franca de Manaus - ZFM), a strategic industrial zone based on reduced tax rates.

If approved in the Chamber, the bill would then proceed to the Senate, where it is likely to gain broader support.

This reform signifies a significant shift in the Brazilian tax system, aiming to simplify its complexity and align it with international standards.

A Reform Years in the Making

MP Baleia Rossi of the centrist Brazilian Democratic Party (Movimento Democrático Brasileiro - MDB) introduced PEC 45/2019, building upon the initial tax reform proposal put forth by economist Bernard Appy, who currently serves as the Special Secretary for the Tax Reform under Minister of Finance, Fernando Haddad. Appy had previously presented a tax reform plan during Luiz Inácio Lula da Silva’s presidency in 2007, which did not gain approval. However, ongoing discussions led to the development of Rossi's proposal, which underwent further modifications in a dedicated parliamentary working group.

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Understanding the Proposal

The key focus of the reform is the consolidation of the VAT system into a “dual VAT” structure with a unified rate across the entire country. This involves the creation of two new taxes: the Contribution over Goods and Services (CBS) and the Tax on Goods and Services (IBS).

Going From Five Value-Added Tax Systems to Two

Currently, Brazil has five different types of VAT imposed by three levels of government. The CBS will replace the Tax on Industrialized Products (IPI), the Social Integration Program (PIS), and the Contribution for the Financing of Social Security (Cofins) after a 10-year transition period with rates starting to change as early as the first year.

Similarly, the IBS will replace the Tax on the Circulation of Goods and Services (ICMS) and the Tax on Services (ISS) over a transition period of 50 years. Gradually moving rates and when to apply them in the supply chain as early as 2029.

While the federal government will have complete control over the CBS, the states and municipalities will determine the unified rate for the IBS. Although no official rate has been specified in the reform, it is anticipated that a total rate of 25 percent may be implemented to ensure continuity of the existing tax burden. However, this rate could be subject to adjustments during a trial period.

Eliminating Internal Competition and System Overlap

The introduction of the dual VAT regime would bring about two significant changes compared to the current model.

First, it would eliminate the competition between states and municipalities to attract businesses by offering lower tax rates, as there would be an agreement on a single rate. To offset the potential economic drawbacks for less attractive locations, a development fund would be established to prioritize the growth of underdeveloped territories.

Second, although VAT would still be divided into two taxes, they would no longer overlap with each other. This would put an end to the current accumulation of VAT at various stages within the supply chains in Brazil.

Impacts on the Digital Economy

The reform would also have significant implications for the digital economy. With concerns about tax revenue loss, the new tax system would shift the responsibility of paying consumption-related taxes from the origin of the product or service to its destination — the consumer. While it may be challenging to identify foreign providers of digital services, identifying the consumer is feasible and could lead to increased taxation in this sector.

Additionally, the reform eliminates the distinction between goods and services. The current system with multiple taxes and varying classifications is becoming increasingly complex, especially for digital services. This reform would address this issue and have an impact on the taxation of digital service providers within and outside the country if they serve the Brazilian public.

Safeguarding the Free-Trade Zone, Health, Environment, and Inflation

To ensure the preservation of the ZFM, exports would be tax-exempt under the new tax regime. The government would have the authority to adjust tax rates in a way that promotes operations originating from the ZFM or any free trade areas established before May 31, 2023. Furthermore, the administration would also have the ability to increase tax rates on goods and services that have negative impacts on the environment or health, as long as they are not intended for export.

Specifically on the environmental front, the reform favours the growth of the green economy by providing both general incentives and targeted support to the biofuel industry — particularly the need for a complementary law to regulate biofuel taxation, ensuring a more favorable treatment for biofuels compared to fossil fuels.

The reform also proposes that new tax incentives should incorporate environmental preservation criteria whenever feasible. Even local governments are encouraged to prioritize projects that contribute to environmental preservation when allocating resources from the development fund.

Finally, while the reform calls for a single tax rate, certain sectors may receive exemptions or be subject to different tax rules. These exemptions would apply to sectors with short supply chains, those that directly affect inflation, or industries related to education and healthcare.

On the healthcare front, half of the upcoming single VAT rate could be assigned to medical devices, services, and medicines. Some medicines could even be fully exempted depending on a complementary law regulating these reduced rates.

It's important to note that while tax rates can be adjusted as per the constitution, any decrease would need to be offset by increases to maintain tax revenue and avoid creating imbalances.

What Comes Next

PEC 45/2019 is expected to be approved, despite facing challenges related to the amount available in the development fund and concerns from service sector representatives regarding potential tax increases under the unified rate. However, there is a growing consensus on the necessity of the new tax regime and the simplification it offers.

While adjustments to the text may be made in response to these challenges, the overall proposal is unlikely to be abandoned. If approved, the government will have 180 days to present a proposal to Congress for modifying the current income tax regime for both companies and individuals.

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