Brazil: Brazil approves the long-awaited consumption tax reform

Introduction

The Brazilian consumption taxation is world-famous for its high complexity, especially due to its many taxes, plurality of taxing entities and relevant laws, different tax regimes – depending on the taxpayer’s profile, products, activities, etc. –, and undue limitations to the booking of tax credits (thus distorting VAT neutrality). Aside from the tax burden, taxpayers incur in excessive costs to comply with the many ancillary obligations.

Furthermore, Brazil currently does not impose a single VAT/GST on goods and services, but rather shares the taxation of goods and services between the federal, states and municipal governments, which commonly results in different interpretations, by different taxing entities, of the same fact, resulting in several disputes with taxpayers. As an example of these difficulties, we highlight (among several other matters) the following conflicts:

• Competition between states to charge the State VAT (ICMS) levied on imports, when there are two or more establishments located in different states involved;
• Competition between states regarding the granting of ICMS tax benefits to attract investments, and between municipalities for the Municipal Service Tax (ISS) benefits;
• Competition between municipalities to charge the ISS when the service provider is in a municipality different from that where the service is carried out;
• Competition between states and municipalities regarding the determination of the legal nature of transactions, i.e. if a service subject to the ISS or a supply of goods subject to the ICMS. In many cases, the federal government may also have a different approach towards the same transaction, leading to different tax consequences; and
• As the taxation of goods and services is shared by the ICMS and ISS, several distortions regarding tax neutrality tend to arise, such as the lack of tax credits on the acquisition of goods subject to the ICMS for the provision of services subject to the ISS, and vice-versa.

Furthermore, tax law is open to a broad interpretation, leading to many conflicts between taxpayers and tax authorities, resulting in an insecure and litigious scenario. In view of this, Brazilians have been carrying out debates on the need to take a modern approach to the Brazilian consumption tax for years, aligning it with an actual and simplified VAT model.

In 2019, Deputy Baleia Rossi presented the Proposal for Amendment of the Brazilian Federal Constitution 45/2019 (PEC 45/19), aiming at unifying and reducing the number of taxes, simplifying tax laws, and providing for an actual VAT system, which was received with great optimism. In summary, the approved proposal aimed at:

• Unifying the state and municipal taxes on goods and services, replacing the ICMS and ISS for a Goods and Service Tax (IBS) to be shared between states and municipalities;
• Substituting the Federal Social Contributions on Revenues (PIS and COFINS) for a Contribution on Goods and Services (CBS), to be taxed by the Federal Government; and
• Substituting the Federal Excise Tax (IPI) for a Sin Tax on Goods and Services (Selective Tax) to be imposed on goods considered as harmful for the health and environment, to be taxed by the Federal Government.

In 2023, after a long pause in the discussion of the proposal in view of the Covid-19 pandemic, and after the presidential elections, the debates were resumed and in December 2023, PEC 45/19 was approved by both houses (Deputies and Senate) of the Brazilian Federal Congress, resulting in Constitutional Amendment 132/2023.

IBS and CBS: The new Brazilian VAT

The main aspects of the IBS and CBS are:

• Same treatment, i.e., same triggering events, specific regimes, tax credits rules, etc.;
• Levied on all transactions along the supply chain with goods, services and rights, both local and imports, being exempt from export tax;
• Uniform tax rate for all transactions (goods and services), composed by the sum of rates determined by the state and municipality of destination of the transaction. Each government will determine its own tax rate, which should be the same for all transactions;
• Fully non-cumulative taxes; thus, all taxed acquisitions will entitle the purchaser to the right to book credits to be offset against the taxes levied on its transactions, except for goods and services for individual use and consumption;
• Calculated on top of the net price, thus not being included in its own taxable basis. If the transaction is subject to the Selective Tax, this tax will be included in the IBS and CBS taxable basis. Also, during the transitional period, IBS and CBS may be included in the ICMS and ISS taxable basis;
• As a rule, no tax benefit with differentiated treatment will be granted for CBS and IBS;
• Mechanisms for reducing the impact on the acquisition of capital goods may be established by law; 
• Specific treatment for special customs regimes will be established by law; and
• A cashback system to refund taxes to low-income consumers will be provided for by law.

Although the original intention of PEC 45/19 was that no differentiated tax treatment should be granted for IBS and CBS, the end result provides for there will ultimately be some tax reductions on transactions with certain goods and services to be defined in the law, as follow:

• 60% rate reduction related to education; health; medical devices; accessibility devices for people with disabilities; medications; basic menstrual health care products; collective public passenger transportation services; food intended for human consumption; personal hygiene and cleaning products mostly consumed by low-income families; agricultural, aquacultural, fishing, forestry and plant extractive products in natura; agricultural and aquaculture inputs; national artistic and cultural events, journalistic and audiovisual productions and sporting activities and institutional communication; and goods and services related to sovereignty and national security, information security and cybersecurity; and
• 30% rate deduction for the provision of intellectual services, of a scientific, literary or artistic nature, provided that they are subject to supervision by a professional council.

Furthermore, the law may also determine further tax reductions as follow:

• Tax exemption for the provision of collective public passenger transportation services, in addition to the 60% rate reduction;
• 100% tax rate reduction for medical devices; accessibility devices for people with disabilities; medicines; basic menstrual health care products; vegetables, fruits and eggs; services provided by non-profit innovation, science and technology entities; and purchase of cars by people with disabilities or autism spectrum disorder, as well as by taxi drivers; and
• Tax exemption for urban rehabilitation activities in historic areas and critical areas for recovery and urban reconversion.

Furthermore, Constitutional Amendment 132/2023 also provides that certain activities will be subject to differentiated tax regimes, to be defined by law, among which we highlight:

• Fuels and lubricants: single-phase levy, with uniform ad rem rates (specific by unit of measurement), differentiated by product, and the possibility of granting credit to the taxpayer, as long as the fuel is not intended for resale;
• Financial services, real estate transactions, health care plans and prognosis competitions: different rates, specific taxable basis and tax credits rules, and taxation based on revenues;
• Hotels, amusement parks and theme parks, travel and tourism agencies, bars and restaurants, sporting activities developed by Anonymous Football Societies (SAF) and regional aviation: differentiated rates and credit rules;
• Public passenger transportation services by intercity and interstate roads, rail and waterway: differentiated rates and credit rules; and
• Government acquisitions of goods and services.

Other provisions of the tax reform

Constitutional Amendment 132/2023 provided for a single-phased Federal Selective Tax levied on transactions with goods and services harmful for the health and environment, to be defined by law. This tax will not be levied on exports, electricity, and telecommunications.

The Selective Tax is calculated on top of the net price and will not be included in its own taxable basis. It should be noted that this tax will be included in the taxable basis of the IBS and CBS and, during the transitional period, in the ICMS and ISS taxable basis.

Although the IPI was due to be extinguished with the tax reform, its levy was maintained for products manufactured/imported in any point of Brazil other than the Manaus Free Trade Zone (subject to IPI exemption), but which are also manufactured in that zone, to maintain the competitiveness of this region. Other products will no longer be subject to the IPI.

Furthermore, Constitutional Amendment 132/2023 also provides for, mainly:

• Changes to the auto vehicle property tax (IPVA), which will also be levied on the property of water and air vehicles, in addition to land vehicles. Furthermore, the IPVA may have different tax rates in accordance with the value, use or environmental impact;
• Changes to the real estate property tax (IPTU), so that its taxable basis may be updated by the Executive Branch; and
• Changes to the tax on donations and inheritance (ITCMD), so that it may be progressive in view of the amount donated or inherited.

The implementation of the new consumption tax system will be subject to a long-term transitional period, as follows:

• 2024-2025: enactment of laws to impose the new taxes and creation of tax systems and definition of the new tax authority for IBS purposes, among other measures necessary to operationalize the new tax system. The Selective Tax may be charged as soon as the corresponding law is enacted;
• 2026: IBS and CBS will begin to be charged at 0.1% and 0.9%, respectively;
• 2027: CBS will be fully charged, extinguishing PIS and COFINS;
• 2027: IPI rates will be reduced to zero, except for products manufactured/imported in any point of Brazil other than the Manaus Free Trade Zone, but that are also manufactured in such zone;
• 2029 to 2032: gradual rate reduction of ICMS and ISS and gradual increase of IBS and CBS rates; and
• 2033: extinction of ICMS and ISS.

During this period, the law will provide for measures for the refund of accumulated ICMS, PIS, COFINS and IPI credit balance, as well as the possibility to offset them against other taxes.

Conclusions

Even though the final wording of Constitutional Amendment 132/2023 might not be the most wished-for regarding the consumption tax reform, it is most definitely a major improvement for the Brazilian tax system, and a leap towards a modern and international VAT standard.

The next steps of the consumption tax reform, especially the debate around the new tax laws, must be closely followed in order to avoid implementations that result in controversies and flaws. In addition, the IBS and CBS rates remain to be determined, as well as the effective scope of the Selective Tax.

In any case, companies should be prepared to quickly implement changes for the calculation and compliance of the new taxes, especially in view of the short timeframe between the enactment of the laws and charge of IBS and CBS. Furthermore, they should be prepared for a long transitional period with the coexistence of both tax systems.