A special commission of Brazilian lawmakers will soon present consolidated legislation to the National Congress that aims to modernize and simplify the country’s byzantine indirect tax system and open the door to direct tax reforms.
A joint tax reform commission comprising 25 members of the Chamber of Deputies (the lower house) and 25 members of the Senate (the upper house) kicked off its work March 4, according to a Chamber of Deputies release. Its goal is to bring together two indirect tax reform proposals already presented in the two houses, as well as the government’s own forthcoming proposals, to produce a single legislative text.
The draft legislation will be sent to lawmakers for consideration in the next 45 days, Deputy Alexis Fonteyne of the New Party, a commission member, told Tax Notes. The goal is to get both houses to approve the proposed tax reform package in the next four months, with a likely implementation date of January 1, 2021, according to Fonteyne. “But there is a long transition period of at least five years,” he said. “The transition is necessary due to the amount of distortions in the current system.”
The two proposals on which the commission will base its text are amendments to the constitution to allow a complete overhaul of the country’s indirect tax system.
One proposal is PEC 45/19, which was introduced in the Chamber of Deputies in December 2019. It calls for a single tax on goods and services (Imposto Único sobre Bens e Serviços, or IBS) to replace all five existing indirect taxes: the social contribution tax (PIS), the federal contribution tax (COFINS), the federal excise tax (IPI), the state VAT (ICMS), and the municipal tax on services (ISS).
The IBS would have federal, state, and municipal components with separate tax rates that apply to sales of goods and services. Federal, state, and municipal bodies would be able to set their own rates based on an IBS reference rate, which the Federal Audit Court would calculate and the Senate would approve. The rate will become clearer during the transition, but it is expected to be 25 percent, according to Fonteyne.
PEC 45/19 is based on a proposal from the Fiscal Citizenship Center, an independent think tank, and would be modeled on a simple, local, and modern (SLIM) VAT system, according to University of Leeds tax law professor Rita de la Feria, who is assisting the center and will speak during a public hearing on March 10 in Brasilia . De la Feria told Tax Notes that that the hope is the commission’s proposed text will largely follow PEC 45/19 .
De la Feria developed the SLIM VAT model in 2015. The proposed IBS regime fits into the SLIM VAT model because it calls for a simple, broad-based VAT with minimal exceptions, limited exemptions, and a single rate that applies to all products to ensure neutrality, she said.
It would also address local concerns, in particular Brazil’s status as a federal state, according to de la Feria. To that end, the IBS regime would comprise features that would take into account how revenue is distributed among Brazil’s states, and how interstate transactions would occur, she added.
The proposed regime could be easily adopted by the Receita Federal with its sophisticated IT and software systems, which have been handling Brazil’s complex tax system, de la Feria said.
Tackling 'the Tax Wars'
Brazilian tax reform efforts have zeroed in on the indirect tax system because it’s considered a major impediment to attracting foreign investment, de la Feria said. “What they have now is one of the worst indirect tax systems in the world,” she said.
At the heart of the problem is that the indirect tax system was not implemented using the destination principle, meaning Brazil imposes tax where goods and services are produced, not consumed.
That has led to a phenomenon de la Feria said she has never seen before: indirect tax competition among Brazilian states and municipalities, which offer tax breaks, lower rates, and other incentives to attract companies. As a result, Brazil has five consumption taxes that tax different parts of the system and a multitude of incentives. “The system is absolutely fully contaminated by distortions,” she said. “You put this all together and it’s an unbelievable nightmare.” According to de la Feria, the situation is so dire that the Brazilians have a nickname for it: the tax wars.
Past governments have tried to patch up the indirect tax system, but those fixes never addressed the underlying problems. Some had even called for the adoption of the destination principle, but those efforts always failed because of political resistance against change, de la Feria said.
However, attitudes are changing because there is a growing recognition that the tax system is becoming too complex for foreign investors. “The tax system is actually contaminating their whole economy,” de la Feria said. “There is momentum to push this through because Brazil is at a critical time when it needs more than ever to have a functioning economy so they can create employment and attract investment.”
According to the World Bank's "Doing Business 2019" report, Brazil is trailing behind other world economies when it comes to ease of paying taxes, ranking 184 out of 190 countries covered. The survey also found that it takes a corporate taxpayer 1,958 hours per year to comply with all Brazilian tax regulations.
“The Brazilian tax system is sick,” Fonteyne said, citing the World Bank's figures and adding that legal uncertainty is high, leading to more than 50 percent of GDP tied up in tax disputes. “The reform is urgent and the complexity and legal uncertainty of the current system is a death sentence for the small entrepreneur and [leads to] loss of competitiveness for the big entrepreneur,” he added.
Brazil’s desire to become a member of the OECD is also driving the debate to some extent, according to de la Feria. “Brazil is now aware it has to fit into international patterns of taxation, and that includes having a functioning indirect tax system,” she said.
Brazil’s efforts are welcome, according to Grace Perez-Navarro, deputy director of the OECD’s Centre for Tax Policy and Administration. “It’s a huge task they have because of the complexity of their VAT system,” she said. “But it’s good they’re trying to do it because it’s really needed.”
The United States recently notified the OECD that it would support Brazilian OECD membership and that it wants accession efforts to focus mainly on Brazil, according to Perez-Navarro. The country is already in a good position because it did a lot of foundational work during a joint Brazil-OECD transfer pricing project, she added.
Adoption of OECD transfer pricing standards is a benchmark for OECD member countries. Brazil in December 2019 had made the political decision to gradually align its transfer pricing system with the OECD’s standards, following a 15-month review of the country’s unorthodox transfer pricing regime, so it is well on its way on that part of its tax reform plans, according to Perez-Navarro. “For VAT, they are looking to do this reform and move to the OECD standard, [so] that’s also very positive,” she said.
Once indirect tax reform is rolled out, lawmakers will look at other ways to improve Brazil’s tax system, according to Fonteyne. Brazil has many consumption taxes and few on income and property, so they will examine other ways to decrease regression in the tax system, he added. “The reform of the Brazilian tax system, regardless of the OECD recommendation, is an urgency,” Fonteyne said.
Brazil is a big country with huge potential, so it’s a pity that the tax system is in such need of reform, according to de la Feria. But if indirect tax reform is approved, it will eliminate distortions, raise more revenue over time, bring costs down, and introduce more efficiency in the tax system, she added. “And if it’s more efficient, that means one more hospital or one more school,” she said. “That makes a big difference in people’s lives.”