Brazil's Tax Evolution: Understanding New Opportunities for U.S. Businesses

The introduction of Bill nº 68/2024 to the Brazilian Congress marks a significant step forward in the long-awaited tax reform in Brazil. This bill, together with other legislative proposals and an impending proposal from the Executive Branch, seeks to simplify Brazil's intricate tax system for consumption taxes.

The Brazil-U.S. Business Council has been diligently tracking these developments and engaging in discussions with the Brazilian Executive and Congressional branches to offer crucial insights for the U.S. business community.

Potential Impact on Businesses

The bill has the potential to simplify compliance for businesses operating across various sectors. However, concerns remain regarding the specific implementation details, particularly around ensuring fair treatment across industries and managing the transition period smoothly. Businesses also anticipate potential challenges in compliance and reporting, particularly for those with digital operations.  

What the Bill Entails 

The Bill nº 68/2024 introduces several significant elements: 

1. New Taxes: A dual VAT system (IBS and CBS) and a Selective Tax (IS) are established:

• Goods and Services Tax (IBS): Consolidates state and municipal taxes (ICMS and ISS). 
• Social Contribution on Goods and Services (CBS): Consolidates existing federal consumption taxes (PIS and Cofins). 
• Selective Tax (IS): Tax on specific goods and services that are considered harmful or luxury items, such as alcohol, tobacco, and luxury goods. This may impact sectors such as hospitality and tourism, potentially leading to shifts in pricing strategies or consumer behavior. 

2. Destination-Based Taxation: Taxes will be charged at their destination (place of consumption). This change aims to combat the so-called "fiscal war," where states compete to attract companies to establish business in their territories. This change might shift the competitive landscape for sectors like retail and consumer goods, where businesses that previously benefitted from favorable local tax policies may face new pricing structures.  

Moreover, the bill includes provisions for taxation related to digital goods and services, specifying that the local tax applied to digital services is based on the primary domicile of the recipient, allowing for a clearer geographic assignment of tax liability. 

3. Tax Neutrality: The bill emphasizes tax neutrality to avoid distorting economic activities or consumption decisions: 

• Non-Cumulative Taxation: The IBS and CBS only tax value added at each stage of the supply chain, preventing cascading taxes. This could particularly benefit manufacturing industries with long production processes, simplifying compliance and reducing overall tax burdens. 
• Tax Rate: While the bill does not set specific tax rates, the Ministry of Finance estimates an average rate of 27.5% for the new taxes, subject to potential changes during the legislative process. 

4. Tax Exemption: The bill also establishes tax exemptions, such as: 

• Export of Goods and Services: This exemption allows manufacturers and exporters to maintain competitiveness in global markets. 
• Charitable and Religious Organizations: Entities such as religious organizations, political parties, labor unions, and non-profit educational and social organizations are exempt. 
• Financial Transactions and Investment: Operations involving financial transactions, including investments in securities, financial products, and other assets.  This measure can foster a conducive environment for the financial sector, bolstering growth across industries, including banking, asset management, and financial services. 

5. Transition Period: A phased implementation designed to minimize abrupt disruptions: 

• CBS: The CBS will phase in between 2027 to 2035.  
• IBS: The IBS will phase in between 2029 and 2035.  
• Reference Rates: Established annually during the transition period to provide consistency and predictability. 
• Compensation Mechanisms: For eventual changes affecting CBS or IBS revenue during the transition period, ensuring a stable tax burden across sectors. 

Challenges in Congress 

The Brazilian Congress began its tax reform deliberations prior to the introduction of Bill nº 68/2024, establishing working groups that developed 13 bills related to the tax reform on consumption. 

The abundance of bills presented in Congress highlights the significant challenge the Brazilian Administration faces in working with lawmakers to approve a final cohesive text. This task is especially challenging due to the municipal elections scheduled for this year, which are likely to disrupt the work of Congress during the second semester. These circumstances create a critical, limited window for action and negotiation, not only for the Administration but also for the business community to address concerns and refine the proposed legislation.   

Chamber Perspective and Recommendations 

The Brazil-U.S. Business Council has consistently supported Brazil's tax reform, as discussed in the Council's meeting with Brazil’s Minister of Finance, Fernando Haddad, during Spring Meetings in Washington, D.C. The Council is advocating for the following: 

1. Double Taxation: Consolidating indirect taxes into a VAT-like structure is a positive step, simplifying tax compliance for businesses and reducing administrative burdens. However, the Chamber stresses the need for effective management of VAT credits to prevent double taxation. 
2. Tax Administration: The Council advocates for measures to reduce bureaucracy and increase transparency, fostering legal certainty and reducing tax litigation. 
3. Long-Term Contracts: Given the phased implementation of the new taxes, it is essential to provide clear guidelines on how existing long-term contracts will be treated to avoid disputes and ensure seamless transitions. The Council recommends that the Brazilian government establish transitional rules that respect the terms of current contracts while providing flexibility to renegotiate terms to accommodate the new tax structure. This approach will help mitigate risks for businesses and foster a predictable environment for long-term planning and investments. 
4. Tax Credits: The new tax regime emphasizes non-cumulative taxation, but complex provisions for credit appropriation may introduce administrative burdens. Simplifying the credit utilization process ensures businesses can effectively manage their tax obligations. 
5. Sector-Specific Treatment: Sector-specific tax regimes offer targeted relief for some industries. However, businesses in other sectors may face less favorable treatment, potentially impacting competitiveness and growth. 
6. Digital Sector Taxation: We recommend clear guidelines to define which and how platforms are subject to tax responsibilities, ensuring compliance. Additionally, the localization rules, which assign tax liability based on the recipient's domicile, could pose compliance challenges for U.S. companies, potentially affecting pricing strategies and competitiveness. We commend the tax exemptions for exports of digital goods and services to sustain the sector's global standing. Ongoing engagement with stakeholders is crucial to address these evolving challenges. 
7. Transition Period: The Council echoes the importance of the transition period to ensure stability and for careful monitoring to address unintended consequences. We commend the Government of Brazil for establishing compensation mechanisms to avoid drastic tax burdens across sectors. 

Engagement Continues

Brazil's tax reform is a pivotal move toward modernizing its tax framework, aligning it with international standards, and cultivating a favorable business climate. The Brazil-U.S. Business Council remains dedicated to representing the interests of the U.S. business community in discussions with the Brazilian Government.

By offering expertise gleaned from global tax reform experiences and advocating for policies that stimulate job creation, economic expansion, and investments, the Council supports initiatives that benefit both U.S. and Brazilian enterprises. 

About the authors

Leonardo Abranches