Historic Tax Reform Overhauls Brazil's Consumption Tax System

The reform is a constitutional amendment requiring subsequent implementing legislation and regulation. The administration must present these to Congress within 180 days. These discussions will establish the new tax system rates, scope, and exceptions.

While the reform primarily targets the consumption tax system, it also addresses property and financial operations taxes.

Brazil's Constitution outlines the principles, limits, and specific taxes at federal, state, and municipal levels, along with their revenue distribution. Consequently, any substantial tax system change mandates a constitutional amendment.

Over the decades, Brazil's consumption tax system has grown increasingly complex and costly, positioning the country as one of the most inefficient tax jurisdictions. The existing system, fraught with numerous tax norms and judicial interpretations, has led to legal uncertainty, capital misallocation, and a plethora of tax disputes, hindering investment and competitiveness.

The call for redesigning the consumption tax system dates back to the 1990s. Despite stabilizing the currency and curbing hyperinflation, structural issues affecting business competitiveness, encapsulated in the "Brazil Cost" concept, remained. The tax system was a significant component of these issues. Reform aims to simplify and bring transparency to the tax system, eliminating distortions like tax-on-tax and inter-state tax competition.

I. Dual VAT System (CBS and IBS)

At the heart of the reform is the introduction of a "dual" value-added tax (VAT), applied at the destination (a welcome change from the current origin basis of taxation).

Businesses will have the right to deduct taxes on their inputs, terminating most cascading of taxes. To offset the effects of the changed to the States, the reform introduces various funds and compensation mechanisms.

The initial proposal for a single VAT faced opposition from states and municipalities fearing loss of tax autonomy. The dual VAT emerged as a compromise, preserving federalism by maintaining separate national and subnational tax components.

Dual VAT would be consolidating five federal, state, and municipal indirect taxes into a national and subnational VAT, as follows: 

1. National VAT (CBS contribuição sobre bens e serviços):

• Contribution on Goods and Services (CBS) replaces:

• Federal tax on manufactured goods (IPI)

• Federal contribution for Social Security financing (COFINS)

• Federal contribution for the private sector Social Integration Program (PIS)

The CBS will fund Social Security and have a uniform national legislation with a single rate approved by the Senate. It will be non-cumulative, with limited exceptions, and enforced by the federal government.

2. Subnational VAT (IBS imposto sobre bens e serviços):

• Tax on Goods and Services (IBS) merges:

• State tax on goods and services movement (ICMS)

• Municipal tax on services (ISS)

The IBS will support state and local government programs. It will also have a single national legislation, with a reference rate set by the Senate. States and cities may set their own rates, complying with national legislation. The IBS will be managed by a national committee comprising state and municipal representatives, ensuring uniform implementation.

Reform includes several other amendments, such as: 

The reform introduces a Selective Tax (IS) on goods and services with significant negative health and environmental impacts. This tax, charged on production, extraction, sale, or importation, will not apply to exports, telecom operations, or electricity.

This new excise is replacing the existing federal IPI excise tax.

The reform makes the inheritance and donations tax (ITCMD) progressive and extends it to non-residents. It also expands the vehicle ownership tax (IPVA) to include aircraft and vessels, with specific exemptions.

The reform eliminates the tax on insurance-related financial operations, previously part of the broader financial operations tax (IOF).

To avoid increasing the overall tax burden or reducing tax revenue, the reform includes a mechanism capping the dual VAT rate based on a ten-year revenue average. This aims to balance fiscal responsibility with economic growth.

The new tax system will be phased in from 2024 to 2033, with five stages ensuring a gradual transition. Additional legislation will be required to detail the new tax structure and rates, maintain competitiveness, and ensure smooth implementation.

CBS at 8,8%, IBS at 17,7%, consolidated approximately 26,55%.

Details on some exemptions remain outstanding. It is expected cumulative tax rate may eventually rise to 27.5%- 28%.

The new consumption tax system in Brazil aims to standardize tax rates across sectors through a VAT-based system. This reform is not designed to increase the overall tax burden but will shift the burden between sectors. Manufacturing and capital-intensive sectors will benefit from reduced taxes, while labor-intensive sectors, like agribusiness and services, will face increased tax burdens.

Due to the anticipated impact on various sectors, Congress adopted exceptions to the general dual VAT rate. These exceptions come in the form of discounted rates or special tax rules:

• 30% Discount: Professional services in intellectual, scientific, literary, or artistic fields regulated by professional councils.

• 60% Discount: Agriculture, livestock, aquiculture, fishing, forestry, in natura products, education services, public transportation, health services, pharmaceuticals, and more.

• 100% Discount: University inclusion programs, fruits, vegetables, eggs, medical devices, services by non-profit institutions, and others.

• Collective passenger transportation

• Cooperatives

• Financial services, real estate, private healthcare insurance

• Fuel and lubricants

• Government procurement

• Hospitality industry

• International treaty-related operations

Additional special tax rules apply to biofuels, green hydrogen, capital goods, and export processing zones. Existing special tax rules for small businesses, the Amazon Free Zone, and free trade zones will be preserved.

Despite opposition, the Senate version includes tax incentives for auto companies in less developed regions until 2032. This decision faced strong resistance from companies in more developed regions.

To secure approval, Congress established four new funds aimed at promoting regional development and compensating companies affected by the loss of state-level tax incentives:

1. Regional Development National Fund: Up to BRL 60 billion annually for infrastructure, job creation, and sustainability projects.

2. Financial and Tax Benefits Compensation Fund: BRL 160 billion total for compensating companies from 2029 to 2032.

3. Western Amazon and Amapá States Sustainable Development Fund: Funding for development and economic diversification in the Amazon region.

4. Amazonas State Economic Diversification and Sustainability Fund: Funding for economic activities in Amazonas.

These funds are not limited by the new fiscal framework rules, potentially increasing fiscal pressure on the federal government.

The dual VAT and Selective Tax (IS) will be phased in over five phases from 2024 to 2033:

1. 2024-2025: No changes.

2. 2026: CBS and IBS introduced at minimal rates for testing. CBS at a rate of 0.9%, and IBS at a rate of 0.1%, which will be increased gradually. 

3. 2027-2028: Full implementation of CBS, IS, and zeroing of IPI. Termination of the PIS and COFINS and IPI from 2027. 

4. 2029-2032: Gradual increase of IBS, reduction of ICMS and ISS. The CBS and IBS rates will be gradually increased. 

5. 2033 onwards: Full implementation of IBS, extinction of ICMS and ISS. Final rates of around 26,5%- 28%.

The proposed tax reform in Brazil introduces extensive new obligations for nonresident sellers engaged in taxable transactions sourced to Brazil. These obligations include:

1. Registration, Collection, and Remittance of Taxes:

• Nonresident sellers must register for the new VAT-based taxes (IBS/CBS), collect the taxes on sales, and remit them to the Brazilian tax authorities.

2. Sourcing Rule:

• The tax liability is based on the domicile of the recipient of goods or services, which can differ from the buyer.

• The recipient's domicile is determined by their registered address, with specific rules for unregistered recipients using criteria like declared address, commercially relevant information, payment method register, or IP address.

3. Broad Application:

• Nonresident sellers could be liable for IBS/CBS for most transactions with Brazilian recipients, regardless of the buyer's location.

4. B2C and B2B Transactions:

• The new tax liability applies to both business-to-consumer (B2C) and business-to-business (B2B) transactions.

• Buyers may be jointly liable for IBS/CBS on acquisitions of immaterial goods, rights, and services from nonresident sellers, indicating possible compliance responsibilities for Brazilian purchasers in B2B transactions.

5. Tangible Property Imports:

• The importer of record holds the primary liability for import IBS/CBS, not the nonresident seller.

The proposed tax reform also imposes new tax liabilities on digital platforms facilitating transactions involving Brazilian recipients:

1. Platform Liability:

   • Sales by nonresident sellers not registered for IBS/CBS.

   • Sales by Brazilian sellers not registered for IBS/CBS or not recorded through an electronic invoice (e-invoice).

• Digital platforms, whether Brazilian or nonresident, are liable for IBS/CBS on specific transactions, including:

2. Definition of Digital Platforms:

   • Collection

   • Payment

   • Setting terms and conditions

   • Delivery

• A digital platform is an entity that intermediates transactions electronically and controls one or more key elements such as:

3. Exclusions:

• Entities only providing internet access, processing payments, advertising, or searching/comparing suppliers, and not handling service expenses, do not qualify as digital platforms.

4. Scope of Transactions:

• Unlike other jurisdictions where VAT platform liability is limited to digital services and certain goods sales, the Brazilian proposal includes all in-scope transactions facilitated by digital platforms if the sellers meet the defined qualifications.

Nonresident sellers and digital platforms must prepare for significant compliance challenges under the new Brazilian tax regime. Key steps include:

1. Registration and Reporting:

• Nonresident sellers must register for IBS/CBS and ensure accurate tax collection and remittance for transactions involving Brazilian recipients.

• Digital platforms must implement systems to manage tax liabilities for transactions involving unregistered sellers.

2. Joint Liability in B2B Transactions:

• Brazilian purchasers in B2B transactions may need to ensure compliance with IBS/CBS obligations when dealing with nonresident sellers, potentially requiring additional due diligence and contractual clauses.

3. Import Duties:

• Importers of record must be aware of their primary liability for import IBS/CBS and ensure proper documentation and payment processes.