Originally published on the march 9 edition of World Tax Daily (Copyrights Tax Analysts www.taxanalysts.com)
Brazil’s president and 27 state governors on March 6 discussed an executive branch proposal to replace five existing taxes with two new valued added taxes — a federal VAT (VAT-F) and a state VAT (VAT- E).
Brazilian President Luiz Inácio Lula da Silva and all 27 state governors on March 6 discussed a tax reform proposal from the executive branch that would replace five existing taxes — state VAT (ICMS), federal excise tax (IPI), P.I.S. (Program for Social Integration contribution), COFINS (Contribution for the Financing of Social Security), and fuel tax (CIDE-Fuel) — with two new valued added taxes: a federal VAT (VAT-F) and a state VAT (VAT-E). In interstate transactions, the VAT-E would go to the state of destination of the goods or services, which is a complete change from the existing ICMS rules.
The overall reaction to the tax reform proposal was favorable. However, the states’ main concern in any tax reform effort is that they receive a share of certain federal contributions — namely the P.I.S., COFINS, and CPMF (bank transactions tax). Some governors warned that any attempt to resume tax reform negotiations will fail if the sharing of P.I.S., COFINS, and CPMF revenues with the states is not addressed.
The amount at stake for 2006 totals almost BRL 150 billion (approximately US $71 billion) — specifically BRL 32 billion in CPMF, BRL 92.5 billion in COFINS, and BRL 24.3 billion in P.I.S., according to official figures from the Federal Revenue Department. The states want 20 percent of that amount (BRL 30 billion). For 2007 the total may be even higher.
The states’ concern stems from the fact that they have a constitutional right to a share of the federal income tax and the federal excise tax (IPI), which have undergone virtually no increase in basis or rate during the past decade, but not to P.I.S., COFINS, and CPMF, which have undergone numerous rate increases.
Despite the governors’ warning, Finance Minister Guido Mantega said the sharing of P.I.S., COFINS, and CPMF revenues is out of the question for the time being because of cash problems at the federal level. However, he said the executive branch may consider sharing those contributions with the states as part of a broader tax reform.
As proposed, the two new taxes would be levied simultaneously in every taxable transaction. Within a predetermined range (probably established by the Senate), states would be free to set their own VAT-E rates. However, the change of interstate VAT from origin to destination would be viable only if exporting states such as São Paulo accept the change, because those states stand to lose tax revenues. Historically, São Paulo has opposed such a change, but São Paulo’s governor recently issued a statement announcing his support of the change as a way to improve the efficiency of Brazil’s tax system.
The change from origin to destination and from ICMS to VAT-F and VAT-E would not be immediate; there would be a transition period of five years. In interstate transactions, VAT-E initially would go to the state of origin, gradually transferring to the state of destination. VAT-F would be put into place two or three years after VAT-E.
Further negotiations will certainly take place in Congress during the review of the actual tax reform bill. Historically, state governors have had some influence over their states’ representatives in Congress, but not enough to ensure that an agreement among governors and the executive branch will be followed by lawmakers in both the House of Representatives and the Senate.
Meanwhile, a multiparty group of lawmakers in the House of Representatives is about to present a proposal (Constitutional Amendment Project No. 285/2004) that would amend an existing constitutional project, changing some taxes to simplify the tax system in the short term. One of the proposal’s virtues is that it would eliminate the P.I.S. and COFINS and replace them with a single tax that would also encompass IPI and ICMS. So far, the executive branch has made no response to this serious attempt to eliminate those important taxes.