BRAZIL: An Introduction to Tax: Non-contentious

Brazil is a federative state with three constitutional levels of public administration, namely (i) municipalities, (ii) member states and (iii) the union. Brazil’s federal constitution is very detailed and, in many aspects, quite specific. Attribution to impose taxes on Brazilian taxpayers follows the same divisions mentioned above, which results in each of the three administrative levels being able to issue tax laws and collect taxes, which are sometimes conflicting.

This is generally one of the reasons why the Brazilian tax system is often perceived as complex. The other three factors which add to the complexity are (i) the intensive legislative activity of 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 reform in the tax system is long awaited by companies and investors in general. 2023 has witnessed the efforts of the federal government to implement the awaited tax reform that promises to have a significant impact on businesses and individuals. The economic staff of President Lula, who (re)assumed the office on 1 January 2023, have adopted a strategic approach towards breaking down the tax reform on multiple fronts.

The agenda of the federal government prioritised the reform of indirect taxes, which moved at a fast pace in the first semester of the year. On the other hand, although the reform of Brazilian corporate income tax (CIT) did not make much progress in 2023, the federal government put forward some relevant pieces of legislation that should still be voted by the Brazilian congress, such as a bill aimed at prohibiting the deduction of the so-called interest on net equity (JCP) and a provisional measure dealing with the taxation of investment subsidies granted by the federal, state and municipal governments.

Other aspects of tax reform have also undergone noteworthy developments throughout 2023. The federal government has changed certain aspects of the tax regime in relation to investment funds, and new Brazilian transfer pricing (TP) rules have been introduced to align Brazilian legislation with OECD standards. Finally, 2023 has been marked by another chapter in the attempt of the federal government to introduce anti-deferral rules to tax offshore assets held by Brazilian resident individuals.

Constitutional Reform of Taxes on Consumption of Goods and Services

Unlike European countries, Brazil currently imposes several taxes (whether value-added tax or not) on transactions involving the sale of goods and/or the rendering of services, namely state tax on the sale of goods and certain services (ICMS), municipal services tax (ISS), as well as social contributions on gross revenues (PIS and COFINS) and the tax on industrialised products (IPI), both charged by the federal union.

Several reforms have been proposed to simplify the consumption tax regime over the last decades, but all of them have failed to be approved in view of the lack of political support.

In two rounds of voting on 7 July 2023, the Brazilian house of representatives finally approved the Proposal of Constitutional Amendment No 45 (PEC 45), which had been awaiting a vote since 2019.

PEC 45 aims to substantially change the current framework for taxation of goods and services in Brazil by eliminating several of the “indirect” taxes (ICMS, IPI, ISS and PIS/Cofins) and replacing them with three new taxes: the tax on goods and services (IBS), the contribution on goods and services (CBS), and the excise tax (IS).

IBS and CBS will have single rates, applicable to all types of goods and services, subject to certain exceptions expressly provided for in PEC 45. The CBS rate will be established by federal law and the IBS rate will be the sum of the rates established by the state and municipality of destination of the operation.

Although certain aspects of the indirect taxes reform have yet to be thrashed out, such as how many sectors will have a reduced rate or exemption, PEC 45 undoubtedly represents a step forward in the enhancement of the Brazilian investment environment.

PEC 45 is now ready to be voted by the federal senate. If it is amended by the federal senate, it will have to be approved again by the house of representatives before going to presidential sanction.

CIT Reform 

Bill 2,337, which proposed the implementation of substantial changes to CIT and the (re)creation of dividend tax, was approved by the house of representatives at the end of 2021. It has yet to be voted on by the federal senate. No further developments in relation to this bill have been seen in 2023, and it is unlikely that it will be put to vote this year.

One of the changes proposed by Bill 2,337 is the abolition of the so-called JCP that can currently be paid by Brazilian companies in substitution for, or in addition to, dividends. This form of shareholder remuneration appears to remain under federal government scrutiny, because on 31 August 2023, a bill to prohibit the deduction of JCP with effect from 1 January 2024, was proposed. The bill still needs to be voted by both the house of representatives and the federal senate before being sent to presidential sanction.

Taxation of Investment Funds 

On 28 August 2023, the federal government published Provisional Measure 1,184 introducing several changes to the tax regime applicable to investment funds. The following day, the federal government published Bill 4,173 which essentially reproduced the provisions of Provisional Measure 1,184 and Provisional Measure 1,172 (the latter has introduced anti-deferral rules to tax offshore investments held by Brazilian individuals). Although Provisional Measure 1,184 (now absorbed by Bill 4,173) has been initially portrayed as a reform that would affect only wealthy familys’ funds, its implications extend far beyond that and impact a wide range of investment funds.

Bill 4,173 has introduced periodic taxation (the so-called come-quotas regime) for closed-end funds seeking the equalisation of the tax treatment currently applicable to open-end funds. The bill excludes from periodic taxation certain investment funds subject to specific regulation – private equity funds (FIPs), stock funds (FIAs), exchange-traded funds (ETFs) and receivables funds (FIDCs) – if they meet the requirements to be classified as an investment entity (which includes having a professional management with discretionary powers). Other types of funds subject to specific regulation – such as FII, FIP-IE, FIP-PD&I and others – were excluded from the periodic taxation regime.

Bill 4,173 also aligns the tax legislation with the new regulatory framework for investment funds in Brazil introduced by CVM Resolution 175. Other provisions address the tax treatment applicable to corporate reorganisation of funds, exemption rules on distribution of earnings by FII, among others. The bill is expected to be voted on by the Brazil congress in the near future.

While Bill 4,173 maintains the tax regime applicable to non-Brazilian residents investing in investment funds, Bill 4,188, which was submitted to national congress in 2021, but was only approved in 2023, and is currently awaiting presidential sanction, brings significant change in relation to this type of investor.

Among other proposed changes, Bil 4,188 revokes the requirement that non-resident investors cannot hold more than 40% of the FIP quotas to benefit from a 0% withholding income tax rate on income or gains arising from investments in FIPs. On the other hand, the bill provides for a new requirement, providing that the non-resident investors will be eligible to benefit from the 0% withholding income tax rate only if the FIP is classified as an investment entity.

New Brazilian TP Rules 

Another remarkable change in 2023 was the enactment of new Brazilian TP Rules as part of the accession procedure, with Brazil working towards an OECD membership. The new Brazilian TP Rules, which take effect from 1 January 2024 (with an option for early adoption with effect from 1 January 2023), aim to align with the standards of the OECD Transfer Pricing Guidelines and completely depart from the old Brazilian formulary approach (which made Brazil an outlier from a global tax perspective). Given the significance of the changes, existing structures will be impacted and Brazilian companies will need to adapt their cross-border intercompany transactions.

In view of all the above, consistent tax advice and planning should continue to be crucial for companies and investors in general to be able to navigate the Brazilian system and understand the practical implications of the decisions they take. This is true for a broad range of aspects of their businesses in Brazil, which involve, among others, deciding on the most tax-efficient way to structure and finance a new business or the acquisition of an existing one, accessing and exiting the local capital markets, putting in place a company’s logistics structure and location, creating remuneration plans for directors and employees, developing infrastructure or real estate projects, and implementing local and international corporate restructurings.