After three decades of deliberation by Congress and various administrations, the tax reform proposal reached a significant milestone this Friday, December 15th, 2023 in the House of Representatives. The initial draft, which had been previously endorsed by the House, underwent amendments in the Senate and has now been returned for further scrutiny.

This initial phase targets consumption taxes—those levied at the point of sale. Plans are in place to also reevaluate the approach to income tax in the future.

The essence of the ongoing reform is the consolidation of consumption taxes into a dual-rate Value Added Tax (VAT) system, distinguishing between state and federal taxes. VAT in Portuguese: Imposto sobre Valor Agregado (IVA).

While the exact VAT rate is pending determination, it’s anticipated to hover around 25%, positioning it amongst the globe’s highest.

The reform’s intent is not to alter the nation’s existing tax load but to maintain it. The anticipated change lies in simplification: a streamlined, more effective tax collection process that aims to reduce corporate inefficiencies. Current Brazilian tax structures are often viewed as convoluted, creating economic irregularities.

The government projects that, as a result of these reforms, businesses will eventually be able to economize and lower product costs, a win for both manufacturers and consumers that could spur economic expansion.

Key aims of the reform include:

Streamlining Taxes:
The reform introduces VAT into the tax framework, replacing five existing taxes with two distinct VATs:

  • Federal taxes (PIS, Cofins, and IPI) will merge into the CBS (Contribution on Goods and Services, in Portuguese: Contribuição sobre Bens e Serviços).
  • State (ICMS) and municipal (ISS) taxes will combine into the IBS (Tax on Goods and Services, in Portuguese: Imposto sobre Bens e Serviços), managed collaboratively by state and local governments.

Under the VAT system, taxation occurs only on value increments along the production line. For instance, a retailer pays tax solely on the added value from the factory, not on the raw materials, for which the factory has already paid tax to the supplier.

The exact VAT percentage will be established in a PEC regulation, aiming to preserve the current tax burden without increase or decrease.

Moreover, taxation will shift to the consumption point rather than the production origin, mitigating interstate tax competition.

Eliminating Economic Inefficiencies:
Currently, some businesses benefit from tax incentives simply by routing products through certain states, known as “presumed credit,” leading to unnecessary transportation and environmental impact.

The reform proposes taxation at the product’s consumption point rather than its production origin, post-transition, which should address interstate tax competition.

Increased Efficiency:
The prevailing system involves taxes on taxes, complicating the final cost calculation. The reform ensures that such cascading taxation will cease, except for selective taxes on certain items to avoid market distortion.

Companies running SAP systems without an external tax engine will have to adapt to the changes. The transition period of the Tax Reform will begin in 2026 and is expected to come into full effect from 2033. It sounds a lot of time, but this is a meaty topic in Brazil. Stay alert!