Originally published in the January 4 edition of World Tax Daily (Copyrights Tax Analysts – www.taxanalysts.com)
From a tax standpoint, Brazil ushered in 2007 with great expectations, as President Luiz Inácio Lula da Silva announced a long-awaited economic and tax package (Programa de Aceleração do Crescimento, or PAC). The year ended with the entire country looking at another major tax issue: the extension of the 0.38 percent bank transactions tax (CPMF), which expires December 31, 2007.
At press time, the extension of CPMF through 2011 was still pending, as the government measure faced fierce opposition in the Senate (after its quite smooth approval in the House of Representatives). Even senators from allied parties threatened to vote against the extension. At stake was BRL 40 billion (approximately $22.1 billion) in annual tax revenue.
Although opposition parties in principle are against the extension, a new element promises to play an important role in determining whether the extension is approved: the presidential elections in 2010. Regardless of rumors about an attempt from allied parties to ‘‘grant’’ a third term in office to president Lula da Silva (which would be constitutionally questionable), the fact is that under current constitutional rules, Lula da Silva has to step down on December 31, 2010. With no clear viable successor from the president’s side, opposition parties may vote to extend CPMF in the hope that if they prevail in the 2010 elections, they will be able to count on a significant source of tax revenue if CPMF is approved.
PAC
The year began with the formal announcement of PAC. While the tax package focuses mainly on economic issues, such as public investments in key sectors of the economy, official credit lines, and the
creation of a fund to invest in infrastructure projects, it also includes a number of tax cuts designed to stimulate investment in some key sectors.
For many, the tax portion of the PAC was a disappointing mix of new measures combined with others already in place or in progress, such as the adjustment of the personal income tax brackets and the introduction of the General Small Business Act.
PAC tax measures also included the creation of the Special Incentive Regime for Infrastructure Development, which suspended the P.I.S. (Program for Social Integration contribution) and COFINS (Contribution for the Financing of Social Security) on local purchases and imports of new machinery, instruments, equipment, construction materials, and services for use in infrastructure works, if they are to be included in the taxpayer’s fixed assets.
Similar special regimes were created to promote research, development, and production in the semiconductor and digital TV sectors. The PAC also included P.I.S. and COFINS exemptions for sales of personal computers and excise tax (IPI) zero rates for some iron products.
International Taxation and Treaties
Besides the Brazil-Mexico income tax treaty’s entry into force during the last days of 2006, the major tax treaty news was the entry into force of the Belgium-Brazil treaty protocol signed in 2002 and held up since then in Congress. The Belgium protocol updates many provisions of the 1972 tax treaty to follow current OECD recommendations.
Another treaty-related issue was the reduction of Brazil’s withholding tax rate from 15 percent to 10 percent on royalties paid to beneficiaries in Mexico. The reduction was triggered by the Brazil-South
Africa treaty, which took effect in Brazil in 2006. The protocol to the Brazil-Mexico treaty provided that if Brazil granted a lower tax rate to any other country with which it signs a tax treaty, that lower rate would be extended to royalties paid to Mexico.
Following meetings between Lula da Silva and U.S. President George Bush in March in São Paulo, the two countries signed a tax information exchange agreement. This should be a first step in negotiating a long-awaited comprehensive tax treaty between Brazil and the United States.
Brazil, India, and South Africa in October signed a technical cooperation agreement regarding taxation and customs during the second annual India-Brazil-South Africa Dialogue Forum in Pretoria. The agreement covers initiatives on exchange of information, risk management by tax and customs administrations, development of human resources, tax control, review of the business units of large taxpayers, transfer pricing, and customs valuation.
In another treaty-related matter, the Taxpayers’ Council, an administrative federal tax court, rejected an earlier ruling by the Federal Revenue Department and held that profits and dividends distributed by special Spanish holding companies are not taxable in Brazil.
Major Tax Changes
One of the most important tax-related developments in 2007 was the merger of the Social Security Revenue Department with the Federal Revenue Department, which created a super tax collecting agency with broad audit and investigative powers.
The tax portion of the Small Business Act (SUPER SIMPLES) also entered into force during 2007. Although the government claimed that the new simplified tax regime would reduce small businesses’ tax burdens, that was not necessarily the case for many taxpayers. The SUPER SIMPLES regulations turned out to be confusing, complex, and sometimes even conflicting, which made the situation even worse for small businesses. Other changes included:
• the suspension of P.I.S. and COFINS on imports of fixed assets by companies located in the Manaus Free Trade Zone (in the Amazon);
• elimination of the 10 percent royalty tax (CIDE) for imported software, retroactive to January 1, 2006;
• several states’ decisions to grant tax amnesties and special tax payment schedules related to the state value added tax (ICMS), with discounts of up to 75 percent for delay or assessed penalties and up to 60 percent for interest;
• the signing of an agreement between the Federal Revenue Department and National Council of Justice, allowing magistrates to have access to the revenue department’s database, including information protected by fiscal secrecy, taxpayers’ identity, location, assets, income tax, and tax returns;
• large taxpayers’ ability to take P.I.S. and COFINS tax credits on purchases from small businesses under the new SUPER SIMPLES tax regime (a measure that the revenue department originally prohibited);
• permission for companies in the auto parts, machinery, vehicles, textiles, footwear, furniture, and some appliance sectors to take full P.I.S. and COFINS tax credits on purchases of fixed assets (machinery and equipment) destined for production; and
• reduction of the export requirement from 80 percent to 70 percent (60 percent in some cases) for exporters in general to enjoy P.I.S. and COFINS suspension on purchases of new capital goods.
Court Cases
Brazilian courts had a busy year with respect to tax issues. The year 2007 started with a Brazilian taxpayer suing tax consultant Deloitte Touche Tohmatsu and two other tax consultants for ICMS fraud. The taxpayer asked for moral and material damages of BRL 5.1 million as a result of an assessment that alleged fictitious exports of soy and improper use of the resulting ICMS credits.
In March the Supreme Court ruled unconstitutional the requirement that taxpayers make a cash deposit, or asset pledge, to secure an administrative tax appeal. In separate decisions, the Court banned the cash deposit requirement for social security administrative appeals and the 30 percent asset pledge requirement for federal administrative tax appeals.
Another important decision, although still provisional, came from the Federal Regional Appellate Court for the First Region, which granted an injunction allowing a taxpayer to exclude municipal service tax (ISS) receipts from its P.I.S. and COFINS tax bases. The decision mirrors a similar dispute before the Supreme Court involving the exclusion of ICMS from the COFINS basis, and it was the first one dealing specifically with the exclusion of ISS.
The most important judicial issue was delivered in mid-2007, when the Supreme Court reversed its prior position in one of the most relevant tax issues currently being disputed before the Brazilian judiciary: the possibility for manufacturers to take IPI credits on purchases of materials that are zero rated, or are exempt from or not taxed by IPI. With a 6-5 vote, the court ruled that taxpayers are not entitled to take IPI tax credits on purchases of materials subject to IPI exemption, zero rating, or nontaxation. The decision was important because for almost a decade, taxpayers have relied on prior Supreme Court precedents that allowed such IPI credits. Other important Brazilian court developments include:
• a Superior Court of Justice decision to reduce the statute of limitations for unpaid social security taxes from 10 years to 5 years. The court ruled that the 10-year statute of limitations, provided by article 45 of Law 8,212/ 91, is unconstitutional;
• a ruling that assets of one company cannot be frozen to secure the tax debts of another company, even if both are owned by the same shareholders (21st Civil Chamber of the Court of Appeals of the state of Rio Grande do Sul); and
• a Supreme Court injunction to prevent the Federal Revenue Department from assessing a taxpayer for excluding its export income when calculating the 9 percent Social Contribution on Net Income.
What to Expect in 2008
More than 5,000 Brazilian municipalities will hold mayoral elections in 2008, a preparatory test for the 2010 general elections. Playing to the voters, the federal government may be tempted to grant tax cuts to gain popular support during the upcoming elections.
However, it appears the most important tax issue of 2008 will be the debate over a new tax reform proposal, which at press time was expected to reach Congress before the end of 2007. The debate will become more serious if the Senate rejects the extension of CPMF through 2011, in which case the government will have to review its budget as it will not be able to count on more than BRL 40 billion of annual CPMF tax revenue.
David Roberto R. Soares da Silva