Originally published at the Feb 16 edition of World Tax Daily (Copyrights Tax Analysts – www.taxanalysts.com)
São Paulo, Brazil’s most developed state, recently issued a controversial decree revoking more than 20 state VAT (ICMS) incentives, some of which had been in force for many years. Surprisingly, a few days later, the state government restored some of the tax incentives, acknowledging that a tax break created by law cannot be revoked by decree.
According to sources at the state Treasury Department, the revocations established in Decree 51,520 (published in the state official gazette on January 30, 2006) applied to tax breaks that were granted unilaterally by the state of São Paulo — without the agreement of the other states, as required by federal law — and that could be challenged by other states as harmful fiscal competition. The revocations became effective on February 1.
Surprisingly, a few days ago, the state Treasury issued the first of a series of notices clarifying that some tax breaks affected by Decree 51,520 have not actually been revoked. The reason given is that the legal basis for the tax breaks is not the ICMS code per se, but rather, legislation approved by the state assembly, which cannot be revoked by a mere decree.
Further, the state Treasury has issued ordinances that provide for special tax regimes for some sectors affected by the revocations, which means that those taxpayers may continue to enjoy some of the tax breaks that existed before Decree 51,520. Not all taxpayers have been so fortunate, however, as some important tax breaks have not been restored or absorbed into the new special regimes.
Following is a summary of the main changes made by Decree 51,520 and the tax breaks that have been restored in the state of São Paulo.
Presumed ICMS tax credits: ICMS is a true VAT, as taxpayers can take tax credits on inputs to offset the tax due on outputs. Decree 51,520 revoked the state Treasury’s power to replace the credit/debit system with a presumed ICMS credit. That revocation is controversial because, although the presumed credit is contained in the ICMS code, its legal basis is the ICMS statute (Law 6,374/89), which cannot be revoked by a mere decree.
Credits from fixed assets: Fixed assets generate ICMS credits on their acquisition, although they follow a special credit system — instead of immediate credit, taxpayers are required to book ICMS credits from fixed assets at a rate of 1/24 per month. On the sale or transfer of those assets, taxpayers usually are required to cancel the ICMS credits. Decree 51,520 revoked taxpayers’ ability under the ICMS code to maintain the ICMS credits if the relevant asset is transferred within the state of São Paulo. However, Notice 06/07 of February 8 clarified that the revocation is not applicable because the legal basis for the rule is the ICMS statute.
Tax base for software: One of the most important revocations was of the reduced tax basis for software. The ICMS code provided for a reduced ICMS tax basis for software that was equal to twice the sales value of the media (CDs, disks, and so on), disregarding the intangible value. For example, a computer disk containing a specific operating program (the intangible) might sell for US $500 while a blank computer disk has a sales value of only US $1. Before the revocation, the reduced ICMS tax basis for both products would have been US $2 (twice the sales value of the disk, disregarding the intangible value). The revocation means that off-the-shelf software now is subject to ICMS based on both its tangible and intangible value. In the aforementioned example, that would increase the ICMS tax basis for the disk containing the operating program to its full sales value of US $500.
The 7 percent rate for basic food products and some computer equipment and preservatives: The decree revoked the 7 percent ICMS rate applicable to some basic food products and some computer products and preservatives. With the revocation, the rate could reach as high as 12 percent or 18 percent. However, Notice 04/07 of February 7 clarified that because the grounds for the reduced rate are in the ICMS statute, as opposed to the ICMS code, the rate continues to be 7 percent.
Special regime for bars, restaurants, and similar establishments: The ICMS code provided for special ICMS regime under which companies in those businesses could pay a 3.2 percent ICMS on monthly revenues instead of being subject to the credit/debit system. That special regime has now been revoked and taxpayers are required to pay ICMS according to the general basis and rate (at a rate of either 12 percent or 18 percent).
Intrastate sales of goods to be used in the manufacturing of tractors, trucks, buses, computer items, beverages, and other items: Some articles in the ICMS code provided for ICMS deferrals for eligible materials and components up to the moment when the final product left the manufacturer. Although Decree 51,520 revoked those deferrals, Treasury ordinances 10, 13, 14, and 15 have restored them by establishing special tax regimes with tax deferrals.
Agribusiness machinery and equipment: The ICMS deferral applicable to those items has been revoked and has not been restored.
Steel wool sponges: Decree 51,520 revoked the ICMS deferral for these products, but the deferral was restored by means of a special regime granted through Ordinance 12/07;
ICMS for outsourced manufacturing services: Products remitted to a contract manufacturer that are to be returned to the taxpayer were subject to an ICMS deferral on the manufacturing services. That was an important benefit that deferred ICMS to when the final product was ready to be marketed. Decree 51,520 revoked the deferral, but Ordinance 11/07 of February 12 restored it by means of a special regime.
Microcompanies and small businesses: The decree revoked the ICMS exemption applicable to very small businesses (microcompanies) and the special ICMS regime for small businesses. However, Notice 05/07 clarified that because those tax breaks were based on the ICMS statute, rather than on the ICMS code, both continue to apply.
Penalty discount: The decree revoked discounts to assessed penalties when the taxpayer pays the tax debt. However, Notice 07/07 of February 8 clarified that because those tax breaks are based on the ICMS statute rather than the ICMS code, both continue to apply.
Others: The decree revoked other tax breaks applicable to some items, such as artworks (reduced tax base), and some computer, food, ceramic, and beef products (tax credit). Those tax breaks have not, as yet, been restored.
Since Decree 51,520 was issued, the São Paulo Treasury Department has been issuing ordinances and notices almost daily to neutralize the effects of the decree. It is entirely possible that within a few weeks, all the affected tax breaks will be restored. However, taxpayers should carefully monitor further developments to determine any potentially adverse tax consequences for their activities.
David Roberto R. Soares da Silva