Chambers Latin America Guide 2020: Online Overview
Brazil is a federative state, similar to the US, but with three constitutional levels of public administration, namely (i) municipalities, (ii) member states; and (iii) union. Brazil’s Federal Constitution is very detailed and in many aspects quite specific.
In particular, the right to impose taxes is divided among the three federal levels while at the same time the Brazilian Constitution allocates duties and tasks to be performed by each of the three administrative levels (thereby triggering heavy financial obligations/costs for each one).
The Brazilian tax system is often perceived as complex. This complexity has historically been driven by a combination of factors, the main ones being (i) the already mentioned different layers of taxing jurisdiction (i.e., Federal, State and Municipal), (ii) the intensive legislative activity, (iii) the significant time it usually takes for a view on the interpretation of tax legislation to be officially expressed by the tax authorities, and (iv) the often aggressive positions of the tax administration, with “dialogue channels” not well established with the business community.
This complexity, coupled with the fact that by law tax authorities are in general obliged to file a tax infringement notice whenever they disagree with a certain position taken by taxpayers (even if they acted in good faith and in view of a reasonable interpretation of the law), has historically created a highly litigious tax environment in Brazil.
The Brazilian Internal Revenue Service (“IRS”) issued several tax assessments in 2019 with values exceeding BRL1 billion. In addition to targeting tax evasion and general non-tax compliance, the IRS has been focusing its efforts on challenging tax planning structures that, according to its internal policies, are considered abusive - despite in several cases being arguably allowed by tax law.
Notwithstanding, in 2019 some important initial steps were taken by the new Brazilian government and National Congress to reduce the complexity of the tax system and the highly litigious tax environment.
In October a Provisional Measure was issued to establish the requirements and conditions under which the Federal Government and taxpayers may settle tax disputes. Although the tax settlement has been foreseen in theory since 1966 in the National Tax Code as a way to extinguish tax debts, until the issuance of this Provisional Measure there was no rule at the federal level to regulate it and, thus, in practice the tax authorities were not allowed to settle tax disputes with taxpayers.
Ambitious proposals for tax reform aimed at simplifying the tax system have started to be discussed in both houses of the Brazilian Congress in 2019.
While discussion on the proposals is expected to take a significant amount of time and run into 2020, it is anticipated that the reforms could involve, among others, the following measures:
(a) unification of a number of different municipal, state and federal indirect taxes into a single VAT;
(b) taxation of dividends and, on the other hand, reduction of corporate income taxes; and
(c) reduction or elimination of social security contributions applied over the payroll.
As regards measure (a) above, unlike European countries, Brazil currently imposes more than one tax (value-added tax or other) on transactions involving the sale of goods and/or the rendering of services. Upon approval of a constitutional amendment, all those taxes would be gradually substituted and unified into a single VAT. This measure alone could dramatically decrease the complexity of the Brazilian tax system, as it would (i) reduce or eliminate the currently existing “tax war” among member States and Municipalities to attract investments into their territories, (ii) create unified laws and regulations on how VAT should be calculated and paid, and (iii) reduce the time and resources currently spent by companies located in Brazil to comply with ancillary tax obligations (e.g. tax filings and returns, books, etc.).
Such measure (a) is the most challenging from a political perspective as it requires an amendment to the Brazilian Constitution which, in order to enter into force, must be approved in two turns by a super majority of the Federal Senate and the House of Representatives (approval by 3/5 of the members is required).
Measure (b) is simpler to be implemented as it requires simple majority approval by the Brazilian Congress. Since 1996 payment of dividends by Brazilian companies, regardless of the location and nature of the recipient, is fully exempt from income tax. On the other hand, currently the aggregate rates of corporate income taxes are 34% for companies in general and 40% for financial institutions. Following a world-wide trend of reduction in corporate income taxation, there are ongoing discussions in the Brazilian government to reduce corporate income tax. In order to avoid that this intended reduction increases the budget deficit and also to align Brazilian tax laws with those of most OECD countries, payments of dividends would be subject to withholding income tax at rates to be defined.
In relation to measure (c), in November a Provisional Measure was issued to grant exemption for social security contributions on salaries of up to 1.5 times the minimum wage which are paid by companies that comply with certain requirements to workers aged between 18 and 29 years old and who are in their first full-time position and are contracted until 2022. This seems to be just the first step of the declared intention of the federal government to reduce the heavy tax burden applicable to the hiring of employees in Brazil.
Although the final shape and form the reforms will take and how far the Brazilian Congress will go in simplifying the system are yet to be seen, for the first time in decades there seems to be political momentum for them to be approved.
Resident and non-resident investors and businesses will continue to spend time and consideration in properly structuring deals, documenting their position and handling tax litigation, but the approval of tax reforms could mean that in the medium term they could be doing this in a much friendlier tax environment.