Originally published in the February 14 edition of World Tax Daily (Copyrights Tax Analysts – www.taxanalysts.com)
Brazil’s executive branch is finalizing the review and draft of the new tax reform bill that is expected to reach Congress by the end of February. It was initially announced in November 2007 that the tax reform would change many existing taxes, but because of Senate opposition to those changes, the new bill will likely focus on ending the so-called tax war, the harmful tax competition among Brazilian states.
The government gave up on the idea of merging the 9 percent social contribution on net income (CSL) into corporate income tax. The proposed merger of both taxes had been announced by Finance Minister Guido Mantega in late 2007, but after having considered many tax policy factors, the government decided not to include the merger in the tax reform, mainly because it would affect the sharing of corporate income tax revenues with states and municipalities.
Under existing constitutional rules, states and municipalities are entitled to receive a percentage of all revenue generated by corporate income tax and the federal excise tax (IPI). The percentage of corporate income tax and IPI revenue that the federal government is required to share with states is 21.5 percent, while it is 23.5 percent (after a few deductions) for municipalities. The sharing requirement, though, does not apply to CSL revenue. A merger between CSL and corporate income tax would require additional constitutional changes and negotiations with states and municipalities to adapt the revenue sharing to the tax resulting from the tax merger.
For a similar reason, the government decided not to merge IPI with other gross revenue taxes, namely P.I.S. (Program for Social Integration contribution) and COFINS (Contribution for the Financing of Social Security). This is because 10 percent of IPI revenue, after the sharing described in the preceding paragraph, is transferred to states as a compensation for tax revenue losses resulting from exemption of the state value added tax (ICMS) on exports of manufactured products.
By excluding from the tax reform some points that could directly affect transfers of federal funds to states and municipalities, the government believes the reform could focus on eliminating the tax war among Brazilian states and on making ICMS a tax with uniform rules and rates throughout the country. Today, each of Brazil’s 27 states has autonomy to issue its own ICMS rules, ICMS code, and rates.
In addition to establishing a more uniform set of rules and rates, the tax reform will likely consider eliminating ICMS on interstate transactions. Currently, the state of origin of some goods taxes interstate sales (with ICMS) at the rates of 7 percent, 12 percent, 17 percent or 18 percent, depending on the state of destination or the nature of the purchaser (if purchaser is an ICMS taxpayer, the 7 percent or 12 percent rates apply; if purchaser is not a taxpayer, the applicable rate is 17 percent or 18 percent, depending on the state of origin). By eliminating interstate ICMS, the tax on interstate sales shifts ICMS to the state of destination, as subsequent sales of a product within the same state are taxed by that same state.
The elimination of interstate ICMS will also reduce, if not eliminate, the tax war among Brazilian states, as companies will have no ICMS tax incentives for interstate sales. With tax-exempt interstate sales, ICMS tax incentives will make sense only where a large market exists (intrastate sales). The elimination of interstate ICMS, however, would not come immediately. A transition period (six years) most likely will be granted for states to adapt to the new system.
In addition to making ICMS more uniform and putting an end to the tax war, the tax reform will create a new tax, the federal value added tax (imposto sobre valor adicionado federal, or IVA-F), resulting from the merger of the fuel tax (CIDE-fuel), P.I.S., and COFINS. The government originally considered merging IPI into the new IVA-F, but eventually decided to leave it outside IVA-F in order to keep IPI as an instrument of industrial policy.
Although no specific deadline has been reported, members of the executive branch believe that the tax reform bill, in the form of a constitutional amendment project, will reach Congress before the end of the month.
David Roberto R. Soares da Silva