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New tax developments and outlook in Brazil
Seeking fiscal balance
The focus of the Brazilian government of Jair Bolsonaro since its election in January 2019 has been initiatives to build up economic strength to the level experienced by the country before the 2014 crisis. In this context, Brazil has been adopting a number of measures to achieve fiscal balance and regain international reliability. These measures were initiated by the previous government back in 2016, with the approval of fiscal austerity measures and with the reform of Brazilian labor law, and have been continued by Jair Bolsonaro’s economic team.
Social security system
More specifically, Jair Bolsonaro’s government successfully achieved the approval of the much awaited Brazilian Social Security System reform in November 2019, in connection with the approval of the so called Law of Economic Freedom, aimed at bringing an environment of economic openness to Brazil. Now, the government’s target is to implement, under the liberal agenda of this government’s economic team, other reforms and changes considered essential to strengthen the Brazilian economic environment, especially with regard to the attraction of foreign direct investors through a reduction of bureaucracy, protection of free enterprise and a restriction on unnecessary government regulations.
Accordingly, having approved the Social Security reform in 2019, one of the Brazilian government’s top priorities has been the approval of two important reforms, namely, the public administration reform and the Brazilian tax reform, and other measures, such as the potential privatization of public companies and the autonomy of the Brazilian Central Bank.
A noticeable feature of the tax reform is that besides being a government priority, it is also a consensus: as a matter of fact, changes to Brazilian tax policy have been debated over many years, and the country has now entered the right political and economic context to finally try and take it from paper to reality.
Besides the awaited government tax reform proposal, which policymakers are saying is going to be submitted to the Brazilian Congress next March, there are essentially two proposals being discussed in parliament: Proposal 45/2019, an initiative of the Congress, and the 110/2019, an initiative of the Brazilian Senate.
These two proposals were submitted in 2019 and are still being discussed this year. Similarly to 2019, in 2020, among other matters, the attention of both proposals is on the potential consumption tax reform, which, due to its complexity and being at odds with the current business dynamics, is causing Brazilian industry to fall behind in competitiveness, compared with the top world economies. More specifically, Proposal 45/2019 only discusses consumption tax and Proposal 110/2019 comprises other matters, but is also directly mainly at consumption tax).
Other equally important matters are also under analysis, with the objectives of gradually – and as applicable– harmonizing Brazilian tax law to the best international practices, as well as reducing labor costs, with a view to maintaining and increasing the creation of formal jobs.
In a volatile environment with many proposals and an intense debate, it is not possible to make accurate predictions as to what the next steps will be. Furthermore, the legislative process that these projects must undergo is complex and quite often time-consuming.
Nonetheless, we highlight below some points that we consider important to continue monitoring in 2020:
Consumption tax reform
In general terms, this reform proposal consists in replacing the current consumption tax model, with a single value-added federal tax, referred to as a goods and services tax (in Portuguese, Imposto sobre Bens e Serviços – “IBS”).
In this context, various federal and local taxes, such as the ISS (municipal VAT), ICMS (state VAT), PIS and Cofins (contributions on revenues), IPI (excise tax) and a few other taxes would be replaced with the IBS, on certain transactions involving goods and services and until further notice, with few exception rules. Even so, implementation of the IBS would mean that the reference point for consumption tax would not be the “entry”, but the “destination”.
Another important matter associated with the IBS idea is the removal or reduction of certain tax benefits. According to its defenders, the provision of tax benefits as an instrument for local development is ineffective. Therefore, most benefits should be removed with the advent of the IBS, with a few exceptions, to be debated and voted during the legislative process. This matter is indeed likely to cause a lot of debate, since tax benefits are largely provided by local governments to attract investment and are difficult to remove under the principles adopted by the Brazilian Constitution.
The two proposals being discussed in the Brazilian Congress are centered on the idea of creating the IBS and have the same main ideas and principles as those explained above, but present many differences regarding the powers over the new IBS (whether it will be a federal or state tax), the transition period (politicians expect a transition period of 6 to 10 years), the sharing of the IBS revenue among federal government, states and municipalities, the rules applying to the provision of tax benefits by public entities, and others.
For this reason, it is very difficult at this point to predict the specific details of the consumption tax reform to be approved by the Brazilian Congress. However, political analysts seem to agree that it is most likely that a bill unifying both proposals will be presented with the political aid of the Government, since the IBS is also one of its priorities.
Also, as may be observed, many important practical issues would arise if this Reform is approved, which would have to be studied and addressed over time. Nevertheless, it is important to highlight that even though the final text of the proposal is uncertain, the chances that it will be proposed and voted in 2020 are very high.
Besides the consumption tax reform, similarly to 2019, the Brazilian government is still studying changes to the taxation of income and the payroll exemption:
A proposal - without a defined model - for a broad tax exemption on payroll is being debated by the current government, with the objective of lowering the cost of formal employment in Brazil and contributing to the generation of direct and indirect formal jobs.
Another proposal under discussion refers to the potential reduction of the corporate income tax rate, as opposed to the taxation of profits and dividends, with the existence of some special regimes. This change would be in line with actions being adopted by several OECD member countries and, in part, with the recent U.S. tax reform..
Finally, it is important to emphasize that Brazil continues to carry out actions to bring it closer to the OECD.
One of these is an initiative headed by the National Confederation of Industry (in Portuguese, Confederação Nacional da Indústria, CNI) and the Federal Government, a joint work project that was launched on transfer pricing in 2019, in which Brazil and the OECD analyzed the differences between the Brazilian legislation and the OECD approach. The study was published in mid-2019 in a joint declaration, by the Brazilian Federal Revenue Service and the OECD.
According to the declaration, the most viable way of approaching the Brazilian legislation to the OECD parameters would be the gradual amendment or replacement of specific rules that are critical in Brazilian legislation. Also, it is mentioned that resources of the Brazilian system known to ensure simplicity and predictability should be adapted and maintained. In this context, the study is expected to influence changes in Brazilian legislation to harmonize with the OECD Transfer Pricing standards.