At the end of 2018, President Bolsonaro was elected under campaign promises of implementing liberal policies and reducing the Brazilian government and its intervention in the economy.
With an aim to contain increases in public spending, Brazil approved a very important constitutional reform in its Social Security System, increasing social security retirement ages and implementing stricter controls for granting benefits, among others. Regardless of the approval of such reform, economists point out a high likelihood that the public spending limit will either be disrespected or reviewed in 2021 or 2022.
To avoid this, the new economic team has expressed its will to cut public spending, but not to increase taxes.
Public spending cuts involve reducing the number of civil servants and this will be a difficult challenge for the new President (involving the risk of strikes and protests), which, if not sufficiently successful, will result in the need for an effective tax increase. In fact, a constitutional administrative reform is expected in 2020 or 2021 to promote government efficiency and reduce costs. It is still doubtful whether Congress will approve such a reform.
The position of the new economic team not to increase taxes resulted in the exoneration of the new Secretary of the Brazilian Federal Revenue Service, who defended and proposed the reintroduction of the tax on bank transfers or financial resources transfers, the currently expired “CPMF”. Nonetheless, a constitutional tax reform is expected to make the Brazilian tax system simpler and fairer, without a tax increase. Alongside the recent reduction in interest rates and expected administrative reform, the tax reform is considered key for the recovery of the Brazilian economy.
Tax Reforms Key to Economic Recovery
The indication that taxes will not increase does not mean that changes in tax legislation will not be implemented or that tax incentives will not be revoked. In other words, although changes in legislation may not result in additional tax revenues, they may mean more taxes for certain economic sectors, with relief for others.
The constitutional tax reform is expected to be approved in 2020, but it is still unclear whether the unification of federal, state and municipal indirect taxes will really succeed and, even if only federal taxes are merged, there is a deep concern about the proposed transitional period, in which the current and future system would co-exist. There are two constitutional amendment proposals being discussed at the National Congress and the government still has to present its proposal.
The unification of social contributions on gross revenues (PIS/COFINS) in a single social contribution or value added tax (VAT) is the most realistic change that may be effectively implemented. It is also possible that other taxes be unified in such VAT, such as the Brazilian excise tax (IPI), the currency exchange, credit, insurance and securities transactions tax (IOF), and the contribution to intervene in economy (CIDE), which are all federal taxes. The National Congress will also discuss the possibility of concentrating in such new VAT even the state VAT (ICMS) and the municipal tax on services (ISS), a move that would need not only changes in the tax system at constitutional level, but also in the characteristics of the Brazilian federation and of sharing of tax revenues.
The proposals that aim to concentrate in a single national indirect tax all federal, state and municipal indirect taxes also seek to tax events currently not taxed by ICMS and/or ISS, such as rentals, operational leasing and royalties. One proposal aims at fixing a flat rate for all activities, which would increase the tax burden for certain activities, especially for the services sector.
Reduction of Corporate Income Tax at Forefront of Proposals
One of the main topics that continues to be discussed and may be presented to the National Congress by the government under a statute amendment is the reduction of corporate income taxes, with the reintroduction of withholding tax on dividends, which was revoked in the mid-1990s. The general idea being suggested to make Brazil more competitive is the reduction of the corporate income taxes combined rate to 21% or 22%, with dividends withholding tax set at a 15% rate. In Brazil, in contrast with other countries, income is subject to corporate income tax and to social contribution on profits, two different taxes, with a combined rate of 34%. Certain sectors, such as financial institutions and insurance companies, are currently subject to corporate income taxes of 40%.
If the current tax exemption of dividends is revoked, it will be possible, at least in the case of payment of dividends to beneficiaries resident in countries with which Brazil has entered into tax treaties, to apply the corresponding provisions that not only establish a maximum rate of withholding tax, but also set forth reduced maximum rates if certain conditions are met (like a minimal equity stake and/or a minimal holding period). In other words, certain foreign shareholders of Brazilian companies may benefit from a more favourable tax treatment, depending on the fulfilment of the conditions established in the relevant applicable tax treaty.
Connected with this theme is the possibility of deduction of interest on equity paid to shareholders being revoked, although some say that this feature of the Brazilian tax system is a result of the prohibition to adjust financial statements in light of local inflation, not being directly related to the current non-taxation of dividends at shareholder level.
Alongside all these potential changes, the Brazilian Federal Revenue Service is analysing the adoption of a fully new basis of calculation of corporate income taxes under the actual profit regime. Since the adoption of IFRS standards, aligning Brazilian accounting and financial statements to the international rules, the tax rules have also been changed to neutralise the positive and negative differences arising from the new accounting patterns. In this context, the dynamic updates of the accounting rules headed by IASB vis-à-vis the need of law enactment to adequate the tax system (which is a bureaucratic and time-consuming process) led tax authorities to conclude that a complete renewal of the actual profit regime should be implemented, avoiding the necessity of tax rules being revised every time the accounting ones are changed. A few public debates among the tax authorities and representatives of the private sector (companies and lawyers) have occurred in order to better understand the direction of such changes. It is likely that there will be news in 2020 or 2021 on this matter.
Desire to Join OECD Drives Increase in Tax Treaties
Regardless of the above, Brazil has finally acknowledged the importance of becoming a member of the Organisation for Economic Co-operation and Development (OECD). Brazil is well known for adopting pre-determined profit margins for transfer pricing control as well as for not accepting the so-called fourth method (transactional net margin method), among other differences from the OECD standards. The movement towards alignment with the OECD transfer pricing rules has already been initiated and it seems that there is no turning back. A joint report launched last December by the Brazilian Federal Revenue Service and the OECD indicates the options for such alignment. It is under discussion as to whether such changes would occur gradually or immediately, provided that taxpayers’ constitutional rights are observed (such as strict legality, ability to pay and equality principles). The implementation of such changes will bring more legal certainty to multinational enterprises doing business in Brazil, and will make the environment more attractive to new investors.
Concerned with its proper and most effective insertion in the international market, Brazil expanded its treaty network in 2019 and this trend is expected to continue in the coming years. Since the first treaty to avoid income double taxation was signed with Japan in the mid-1960s, Brazil has concluded 34 double tax treaties, among which 33 are in force. Although it is an inexpressive treaty network when compared with those built up by countries such as China, India and Russia, it has not prevented companies of the main developed countries (capital export jurisdictions) from investing in Brazil. Recently, some changes were negotiated to amend the treaties with Sweden and Argentina, in order to comply with certain recommendations of the BEPS Project. New treaties with the United Arab Emirates, Switzerland, Singapore and Uruguay were also negotiated and signed in light of the BEPS recommendations, but they are still awaiting approval from the Brazilian National Congress. Brazil did not join the Multilateral Instrument (MLI) but the intention to become an OECD member may lead to an increase in the number of tax treaties.
Clarification on the Tax Exemption of Foreign Investors of Private Equity Funds (FIP)
Specifically for cross-border private equity investments in 2019, tax authorities challenged the application of withholding tax exemption on income paid to foreign investors by FIPs – Brazilian investment funds in private equity. Provided that legislation requirements are complied with (eg, the beneficiary not being resident in a tax haven), income paid by a FIP to non-resident investors is exempt, and not subject to the ordinary 15% rate. Although fund administrators believed that non-resident investors of FIPs administered by them complied with the applicable conditions, tax authorities claimed that they should have sought to identify the ultimate beneficiary of the investors, regardless of the number of levels, under the penalty of being subject to the 15% withholding tax plus interest and a fine in tax assessments. This resulted in turmoil in the financial market and uncertainty on the procedures adopted and to be adopted by such administrators. In December 2019, the tax authorities enacted an interpretative act in which they stated that FIP administrators should look at the non-resident direct investors level only (their jurisdiction of residence), with an exception made for cases of simulation, fraud or wrongful conduct. It is expected that this recent act will bring more certainty for the financial market in 2020, but this will depend on how the tax authorities will apply such act in audits.
Goodwill Amortisation a Hot Topic for 2020
Another aspect that deserves comment is that M&A transactions in Brazil increased in 2019 after the election of President Bolsonaro, even with the approval of the Social Security Reform pending up to October. Private equity firms, family offices, distressed assets and technology companies have been the most recurring players involved in the past year's deals. In spite of no significant trends being expected to change the tax aspects of the Brazilian M&A environment in the near future, the amortisation of goodwill has not yet become an uncontroversial topic in Brazil as a subject of attention of said players. Case law has not made clear cases in which goodwill amortisation should be considered valid, and the results of cases vary depending on the existing facts. Therefore, this is certainly an important topic to be followed up in 2020.
Attention to Corruption and Tax-Related Matters in M&A
Still connected with M&A, in cases in which tax reductions or tax exemptions allegedly result from administrative dishonesty, including corruption, public prosecutors have pursued indemnifications corresponding to non-paid taxes for the relevant government for periods longer than six years, which is the maximum term under the Brazilian statute of limitations applicable to tax frauds, simulation or wrongful conduct. Negotiations and tax discussions with public prosecutors have occurred. In the event of a settlement not being reached, public prosecutors file actions in court, which are defended by tax, administrative law and anti-corruption lawyers. This strengthens the importance of proper representations and warranties to address tax and anti-corruption issues in share purchase agreements as well as of the need for companies to maintain effective anti-bribery and anti-corruption programmes that include training, procedures and controls relating to tax matters.
Introduction of Tax Settlements Addresses Several Dispute Issues
Regarding tax disputes in general, in the context of the Brazilian economy struggling to grow, it is fair to expect tax authorities to intensify tax audits and the issuing of tax assessments, with the subsequent filing of tax enforcement actions. It seems that tax planning will continue to be intensively challenged by tax authorities and without a clear perspective of having the courts, both administrative and judicial, being capable of – in the lack of proper rules – drawing the line to separate legitimate tax avoidance from tax evasion.
In October 2019, the President enacted Provisional Measure 899, which introduced tax settlements in Brazil. The development represents an evolution and acknowledgment by the Brazilian Public Administration that the collection of tax and other governmental debts should be performed in an efficient and realistic way, with optimisation of public resources applied to this end under the economic and financial context involving the debtor. The adoption of tax settlements implements a new collection tax policy, similar to the US Offer in Compromise, with the aim of abandoning successive special tax instalment agreements at federal level, which benefit not only taxpayers under financial distress, but also those that do not need favourable conditions to fulfil their tax liabilities.
For tax credits classified as non-recoverable or of difficult collection – which exceeded BRL1 trillion at the end of 2018 – MP 899/2019 provides the possibility of debtors entering into tax settlements, the conditions of which involve the grant of discounts (50% of the total in reduction of ordinary fines and interest), longer terms for payment and/or substitution of collaterals. In this scenario, the tax debt may be equalised to the economic and financial reality of the debtor, which, in the event of non-compliance with the tax settlement, will be subject to a liquidation request by the Federal Union in a bankruptcy proceeding.
Moreover, the initiative to allow tax settlements for cases of relevant and multiplied tax controversies is a positive that may reduce the current heavy workload of judicial courts.
It should be noted that there are a few aspects of MP 899/2019 that may violate the Federal Constitution and legislation, such as the requirement of waiver of rights for settling, the possibility of tax authorities requesting liquidation of a company since they are not subject to judicial restructurings and/or termination cases that are not provided by law. MP 899/2019 should be voted and converted into law by the National Congress, and it may make clear the possibility of payment in kind with real estate, including in cases of tax settlements with discounts, avoiding conflicts with Law No 13.259/2016.
Special Tax Instalment Agreements Still a Reality
Despite academic discussions on the introduction of tax arbitration, the trend still is that tax disputes continue to be subject to a judgment at either administrative or judicial level, without possibility of a settlement. From time to time, it is possible that special tax instalment programmes with significant discounts become available, but such trend may be reversed. At the end of 2019, special instalment programmes for paying ICMS debts with discounts were open in certain states, such as São Paulo. Technicians of tax authorities correctly say that non-payment of taxes is used as a cheaper funding alternative, in contrast with bank finance, and the possibility of paying them under said programmes is an incentive for non-payment of taxes.
Important Tax Developments at the Supreme Court
Taxpayers have been successful in excluding ICMS from the PIS/COFINS basis in Brazilian courts. The Brazilian Supreme Court decided that ICMS is not a portion of gross revenues taxable by PIS/COFINS, generating an important credit for taxpayers. The Brazilian Supreme Court will revisit this topic in 2020 and taxpayers expect that it will maintain its previous understanding and confirm that the ICMS invoiced is the one to be excluded from the PIS/COFINS basis, and not the ICMS effectively paid in a given month as defended by the tax authorities. Additionally, it is possible that the Supreme Court establish that such understanding is only applicable to certain situations upon the fulfilment of certain conditions by taxpayers within a given period, which may limit the benefits of said decision.
Following the Superior Court of Justice, the Supreme Court has recently decided that non-payment of ICMS due on sales characterises a misappropriation crime, but only in cases in which such non-payment is recurrent and results from a wrongful conduct.
New Bill Set to Have Impact on Judicial Reorganisation
Finally, some developments on the collection of taxes in bankruptcy proceedings may occur in 2020. Tax-related credits are not subject to judicial reorganisation proceedings (JR) in Brazil, which means that tax creditors do not participate in acts of JR proceedings, such as the voting of the debtor’s JR Plan, and, as a rule, can be enforced in individual tax enforcement actions, even during the stay period.
Even though the bankruptcy legislation expressly authorises tax-related credits to be enforced against debtors under JR, there are a number of decisions issued by different Brazilian State Courts of Appeals ordering the prohibition of the collection of the debtor’s assets during the JR, since such collection could potentially impair the success of the JR. Since there are also court decisions authorising the collection of assets in such context, this issue has been recently submitted to the Brazilian Superior Court of Justice and this matter will be finally settled in the future. Upon a decision rendered by the Superior Court of Justice, the lower courts will be bound to the guidelines set.
On the other hand, there is a new bill of law pending at the National Congress that aims at introducing a more favourable special tax instalment programme for companies in judicial restructuring. The new programme would allow said companies not to tax cancellation of debt income, to use tax losses carry-forwards to pay taxes and pay existing balances in extended terms. This bill is still being discussed by the National Congress and may be subject to changes until it is finally approved.
The fact is that companies under JR owe billions to the tax authorities and the current legislation does not address their situation properly, with this matter needing to be settled in court or by new legislation.