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. Attribution to impose taxes on Brazilian taxpayers follows the same division mentioned above, which results in each of the three administrative levels being able to issue tax laws and collect taxes which sometimes are conflicting.
This is generally one of the reasons why the Brazilian tax system is often perceived as complex. The other three factors that are added to complete the chaotic scenario are (i) the intensive legislative activity of the Government bodies, (ii) the significant time it usually takes for a view on the interpretation of tax legislation to be officially expressed by the tax authorities, and (iii) the often aggressive positions of the tax administration, with “dialogue channels” not well established with the business community.
A substantial tax reform aiming at simplifying the tax system is being discussed at the National Congress since 2019. Some important items of this tax reform will require an amendment to the Brazilian Constitution which, in order to enter into force, must be approved in two turns by absolute majority in both the Federal Senate and the House of Representatives before being approved by the Brazilian President. Nevertheless, and in spite of the COVID-19 crisis, it is expected that at least part of this tax reform is going to be approved in 2020.
In that regard, the Federal Government has recently sent to the National Congress a bill of law to eliminate the two existing social contributions on gross revenues (“PIS” and “COFINS”) and create instead a single social contribution on revenues (“CBS”), which should in principle apply only on a value-added basis. Indeed, although the wording of the bill of law might still need certain adjustments to make it clearer, the Federal Government has made many public statements affirming that tax credits will be allowed over all expenses and costs incurred by taxpayers over which the CBS will apply. Further, except for specific cases (one of which is the taxation of financial institutions), CBS will be levied at the same rate (12%) and have the same calculation basis for all taxpayers.
Unlike European countries, Brazil currently imposes more than one tax (value-added tax or not) on transactions involving the sale of goods and/or the rendering of services. The creation of CBS should be part of a first step for the future unification of a number of different municipal, state and federal taxes into a single VAT. The other part of this first step should be the unification into a single state tax of the currently existing state VAT tax (“ICMS”) and municipal services tax (“ISS”). This other part is still awaiting a bill of amendment to the Federal Constitution, which should be sent by the Federal Government to Congress this year.
The expected future unification in one tax due on transactions involving the sale of goods and/or the rendering of services could alone dramatically decrease the complexity of the Brazilian tax system, as it would (i) terminate the current “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 to comply with ancillary tax obligations (e.g. tax filings and returns, books, etc.).
Another measure that is expected to be proposed by federal government and approved by Congress in 2020 is the taxation of dividends coupled with the reduction of corporate income tax rates. Since 1996 payment of dividends by Brazilian companies, regardless of the location of the recipient, are fully income tax exempt. On the other hand, currently the tax rates of corporate income taxes are 34% for companies in general and 45% for financial institutions. Following a world-wide trend of reduction in corporate income taxation, there are ongoing discussions in the Brazilian government to decrease to 20% the rate of corporate income taxes. In order to avoid that this intended reduction increases governmental budget deficit and also to align Brazilian tax laws with those of most of the OECD countries, payments of dividends would be subject to withholding income tax at a rate of 15% or 20%.
Finally, the federal government also declared its intention to submit to Congress this year a proposal to eliminate or at least reduce the high social security contributions currently applied in Brazil over the payroll. In turn, some members of the federal government, specially the Ministry of Economy, publicly declared that this reduction would be accompanied by a proposal to create a new tax on financial transactions (e.g. transfers of funds/cash) made online. This potential new tax could be very simple in terms of tax compliance and collection efficiency but, on the other hand, its actual creation may face strong resistance in the National Congress because many see it as unfair (since it would apply at a flat rate regardless of the economic/financial status of each taxpayer) and potentially harmful to the economy (among other reasons, because it would have a cumulative effect and, thus, create a heavier burden to longer production chains).
Although the intended tax reform will not produce immediate effects, we believe in the medium term it should create a far more business-friendly tax environment in the country.