Originally published in the July 13 edition of World Tax Daily (Copyrights Tax Analysts – www.taxanalysts.com)
Brazil’s Supreme Court has ruled that taxpayers are not legally entitled to take federal excise tax (IPI) credits on purchases of materials subject to IPI exemption, zero rating, or nontaxation.
Brazil’s Supreme Court on June 25 reversed its prior position in one of the most relevant tax issues in dispute before the Brazilian judiciary: the possibility for manufacturers to take federal excise tax (IPI) credits on purchases of materials that are zero rated, or exempt from or not taxed by IPI.
With a 6-5 vote, the Supreme Court ruled (extraordinary appeals 353,657 and 370,682) that taxpayers are not legally entitled to take IPI tax credits on purchases of materials subject to IPI exemption, zero-rating, or nontaxation. The court ruled that the legal limitation to those credits is legal and constitutional.
The decision is important because for almost a decade taxpayers have relied on prior Supreme Court precedents that allowed such IPI credits. (For related coverage, see Tax Notes Int’l, Sept. 6, 2004. The amount of tax contingencies at stake is estimated in the billions.
Brazil’s tax system makes a distinction among zero rating, exemption, and nontaxation: zero rating means taxation of a given product at the rate of zero; an exemption is the lack of taxation of a transaction or product because a legal provision so determines; nontaxation is lack of taxation because the taxable event or transaction falls outside the description of a taxable transaction. For instance, in natura (nonmanufactured) products such as vegetables and fish are not taxed by IPI because IPI applies only to manufactured products.
Historically, taxpayers have claimed that they should be entitled to IPI credits on purchases of materials that are IPI zero rated, exempt from IPI, or not taxed; otherwise the tax relief granted for those products would be canceled at the time the taxpayer sold a taxable final product.
To illustrate the situation, assume a product worth $1,000 is subject to a 10 percent IPI. Also, assume that to manufacture the product, the taxpayer purchases materials worth $500 that are IPI exempt. If no IPI credit is allowed on the exempt materials, the taxpayer will have to disburse $100 of IPI on a sale of $1,000. If, however, the taxpayer is entitled to take a 10 percent IPI credit on purchases of IPI-exempt materials ($50, or 10 percent of $500) on a taxable sale of $1,000, the taxpayer will disburse IPI of $50, after taking a tax credit of $50 to offset the $100 IPI liability. Because of the credit-debit nature of IPI, taxpayers have argued that without the IPI tax credit, the IPI exemption, zero rating, or nontaxation of a given material would be more burdensome than the actual levy of IPI on purchases of materials, as shown in the example.
Tax authorities have always rejected that approach based on lack of legal authorization for such tax credits.
Since the mid-1990s the Supreme Court has accepted the taxpayers’ arguments, which resulted in major tax savings to companies that purchase IPI-exempt materials. Following the Supreme Court precedents, lower courts have granted injunctions and delivered decisions favorable to thousands of companies.
Experts argue that the change to the Supreme Court’s rule may derive from changes to its composition in recent years.
In practical terms, the case is a major defeat to taxpayers that is worth billions. For years thousands of taxpayers have obtained injunctions to take IPI tax credits on purchases of materials subject to IPI exemption, zero rating, or nontaxation. Although the recent decision is not binding and applies only to the parties involved in the relevant cases, it will be used by the government and lower courts to revoke injunctions or reverse prior decisions at appellate courts.
Taxpayers disputing this issue in court should consult with their lawyers to assess the amounts at risk, contingent exposure, and possible alternatives to minimize the adverse impact of the decision.
David Roberto R. Soares da Silva