Originally published in the June 27 edition of World Tax Daily (Copyrights Tax Analysts – www.taxanalysts.com)
In an unprecedented decision, Brazil’s Federal Regional Appellate Court (TRF) for the Fourth Region (with jurisdiction over the southern states of Rio Grande do Sul, Santa Catarina, and Paraná) has ruled that a corporate taxpayer is entitled to change from the noncumulative P.I.S. (Program for Social Integration contribution) and COFINS (Contribution for the Financing of Social Security) regime to the cumulative regime, even though the company’s corporate income tax regime requires it to stay under the noncumulative regime. The decision was delivered March 20 in Appeal 2004.71.08.010633-8.
The decision is unprecedented not only because of the subject but also because of the court’s rationale in justifying the change of tax regimes. The court argued that the increase in the taxpayer’s overall tax burden as a result of calculating P.I.S. and COFINS under the noncumulative regime was unreasonable and violated the constitutional principle of equality.
Under the existing rules, taxpayers under the general income tax regime (lucro real) pay income tax in advance during the calendar year. At the end of the year, they are required to prepare a balance sheet in which all expenses and income, including the net operating losses of previous years, are computed, and the actual taxable income is determined and taxed. Taxpayers under lucro real are required to calculate P.I.S. and COFINS in accordance with the noncumulative regime, under which the rates are set at 1.65 percent and 7.6 percent of monthly gross income, respectively, and some tax credits are available. Certain activities and taxpayers with annual gross income in excess of BRL 48 million (approximately $24.7 million) are required to use lucro real and the noncumulative P.I.S./COFINS regime.
Taxpayers with annual gross revenues below BRL 48 million may elect to calculate income tax according to the presumed method (lucro presumido), on the basis of a percentage of its gross revenues. The applicable P.I.S. and COFINS rates are significantly lower for taxpayers under lucro presumido: 0.65 percent of monthly gross income for P.I.S. and 3 percent for COFINS.
In the case at issue, Top Service Serviços e Sistemas Ltda, a service provider with annual gross income in excess of BRL 48 million (and therefore under lucro real) claimed that the creation of the noncumulative P.I.S. and COFINS regime resulted in an unreasonable increase of more than 100 percent in the company’s tax burden. The increase resulted from the P.I.S./COFINS rate increases and the company’s inability to claim P.I.S. and COFINS credits. (As a service provider, its major cost was labor, which does not generate P.I.S. and COFINS credits.)
On reviewing the case, the TRF argued that the P.I.S./COFINS rate increase under the noncumulative regime was intended to be at least partially offset by the taxpayers’ ability to claim P.I.S. and COFINS credits. However, in the relevant case, the rate increases were not accompanied by the ability to claim credits because of the nature of the taxpayer’s activities. The result was a direct and unreasonable increase of the taxpayer’s tax burden caused by the income tax regime (lucro real) the taxpayer was required to use because of its annual gross revenues.
The court also accepted the taxpayer’s argument that the noncumulative regime was commercially harmful because the taxpayer’s competitors under lucro presumido were subject to lower P.I.S./COFINS rates. Finally, the court argued that a taxpayer’s income tax regime should not be a valid criterion to determine if a taxpayer should be under the noncumulative regime.
In the end, the appellate court ruled that the taxpayer should be allowed to calculate and pay P.I.S. and COFINS using the lower rates applicable under the cumulative regime, regardless of the fact that it pays income tax according to the lucro real.
The decision is not binding, but it is still important to companies — particularly service providers — that have faced significant increases in their P.I.S./COFINS tax burden since the entry into force of the noncumulative regime only because they calculate income tax under the lucro real.
David Roberto R. Soares da Silva