Originally published in the October 17 edition of World Tax Daily (Copyrights Tax Analysts – www.taxanalysts.com)
In a desperate attempt to avoid refunding billions in P.I.S. (Program for Social Integration contribution) and COFINS (Contribution for the Financing of Social Security) to corporate taxpayers, Brazil’s executive branch on October 15 filed a direct action of constitutionality (Ação Direta de Constitutionalidade, or ADC) before Brazil’s Supreme Court. The action, ADC 18, aims to force the Supreme Court to finally rule on the constitutionality of the inclusion of the state value added tax (ICMS) into P.I.S. and COFINS tax basis.
In a court session on August 24, 2006, five Supreme Court justices delivered their opinions that ICMS should not be included in the COFINS tax base. With one vote delivered years ago favorable to taxpayers, 6 of the 11 Supreme Court justices have decided in favor of taxpayers. Since then, the judgment has been suspended by request of one justice who has not yet delivered his opinion. Extraordinary Appeal 240,785 is the leading case in the country on the subject.
The existing score should confirm taxpayers’ victory. However, because the judgment is still open, any justice could — at least theoretically — change his vote in favor of the government. As this is unlikely, the executive branch has decided to file an ADC to force the Supreme Court to issue a rule applicable to all taxpayers at once.
While a decision in Appeal 240,785 applies only to the relevant taxpayer (albeit it serves as a very strong precedent to other cases), a rule issued in an ADC binds all taxpayers and the tax administration, which could end all tax disputes on the topic if the Supreme Court ruled favorably to the government. The government still hopes to reverse at least a few of the votes for the exclusion of ICMS from P.I.S. and COFINS basis.
The government’s hopes lay in the fact that one justice, Sepúlveda Pertence, who voted in favor of the taxpayers, retired just after the August 24, 2006, session, and that a new justice, Carlos Menezes Direito, appointed by president Luiz Inácio Lula da Silva, has taken his place. The government’s strategy is that Justice Direito could vote in favor of the government upon reviewing ADC 18, which could lead to a 6-5 vote for the government if all remaining justices who have not yet cast a vote voted for the government as well.
The strategy has one major obstacle and at least one major risk. The obstacle is whether the Supreme Court will accept the ADC at this point while the judgment of Appeal 240,785 is still open. The Supreme Court could reject in limine ADC 18 on the grounds that the issue is already under discussion before the court.
The risk with the ADC, if accepted by the court, is to anticipate payment of billions in P.I.S. and COFINS tax refunds, if the Supreme Court confirms the exclusion of ICMS from P.I.S. and COFINS tax basis. Because a decision in ADC is binding, an unfavorable decision would be binding to the administration, put an end to all existing disputes on the subject before lower courts, and require the government to refund taxpayers or entitle them to take billions in P.I.S. and COFINS tax credits. The government estimates the amount of tax revenue it may lose per year to be BRL 12 billion (approximately $6.67 billion) if ICMS is excluded from P.I.S. and COFINS base.
David Roberto R. Soares da Silva