Originally published in the September 17 edition of World Tax Daily (Copyrights Tax Analysts – www.taxanalysts.com)
Brazil’s Federal Revenue Department (FRD) is considering shifting from a payroll tax to a tax on gross income, FRD Coordination-General for Tax Policy Ronaldo Medina announced on September 11.
The tax on gross income would gradually replace the 20 percent payroll tax on employers, most likely over three years, Medina said. The new tax could be levied at a rate of 4 percent, he said, although calculations have not been concluded. The tax would be implemented in stages; the rate would be increased at the same time the payroll tax rate would be reduced. The payroll tax probably would be reduced to 10 percent initially, Medina said.
He acknowledged that the department’s calculations are only the first step in creating the tax and that a lot still needs to be done, such as drafting proposed legislation, scheduling debate within the various ministries, and negotiating with Congress.
The goal is to collect BRL 60 billion (approximately $30 billion) annually in tax revenue, the same amount that is currently collected through the payroll tax.
The FRD still has to work on some controversial issues, such as how to collect the tax from banks and other financial institutions. For years, those institutions have challenged gross income taxes — including the P.I.S. (Program for Social Integration contribution) and COFINS (Contribution for the Financing of Social Security) — in courts based on the argument that the definition of gross income, under applicable laws, applies to income from sales of goods and services, which exclude interest and other financial income earned by those institutions.
Although a Supreme Court decision on that issue is still pending, the government does not want to create a tax that will be immediately challenged in court. Nor does the FRD want to simply increase the existing P.I.S. and COFINS rates, which under the noncumulative regime can reach as high as 9.25 percent of a taxpayer’s monthly gross income. The legislation of those two taxes has become complex, and many different situations and exceptions exist, such as exemptions for exports, reduced rates for basic food products, and higher, one-time rates for certain products. Also, the P.I.S. and COFINS debit/credit system (under the noncumulative regime) might not guarantee the amount of tax revenues desired by the government.
Another reason not to simply increase the P.I.S. and COFINS rates is the possibility that both of those taxes will be absorbed, in a future tax reform, into a federal VAT, which would make revenue control of the tax virtually impossible.
However, the tax on gross income would not apply to all taxpayers, some of which would continue to be subject to the 20 percent payroll tax (for example, nonprofit organizations, associations, unions, sport clubs, and the government). Those entities do not have gross income over which the tax could be levied.
Although consultations about the tax have just started, critics already have indicated that it would increase taxpayers’ tax burden. Practitioners says that a 4 percent gross income tax — with a reduction from 20 percent to 10 percent of the employers’ payroll tax — would be advantageous only to taxpayers whose payroll represents more than 40 percent of their monthly gross income.
To illustrate the calculations, assume that Taxpayer A has gross income of $100,000 and a payroll of $50,000 (50 percent of gross income); Taxpayer B also has gross income of $100,000, but has a payroll of $30,000. Taxpayer A currently pays $10,000 in payroll tax (20 percent of $50,000), and with the new tax, it would pay $5,000 as payroll tax (10 percent of payroll) plus $4,000 in tax on gross income (at a rate of 4 percent). For Taxpayer A, the new tax would result in a $1,000 reduction of its tax burden. As for Taxpayer B, it currently pays $6,000 in payroll tax. But with the new tax, it would pay $3,000 in payroll tax plus $4,000 in tax on gross income, an increase of $1,000. Those figures indicate that the tax, as proposed by the FRD, would benefit only companies with a significant labor force as compared with gross income.
However, recent data from the Brazilian Institute of Geography and Statistics (IBGE), Brazil’s federal data collection and research agency, show that the corporate reality is significantly different. IBGE’s data show that payroll in Brazilian industries does not exceed, on average, 12 percent of gross income. Even for some manufacturing sectors with a large labor force, such as textiles, payroll expenses do not exceed 25 percent of gross income. In the service sector, the average ratio of payroll costs to gross income is 18.3 percent, according to IBGE’s 2005 data.
Therefore, based on the IBGE data, unless the FRD reduces the gross tax rate or reduces the remaining payroll tax by more than 10 percent, the new tax would increase taxpayers’ overall tax burden.
A dangerous precedent exists: When the new noncumulative P.I.S. and COFINS regimes entered into force in 2003 and 2004, respectively, most taxpayers experienced an increase, not a decrease, in their taxes.
David Roberto R. Soares da Silva