The Government’s Fiscal Adjustment Package

As expected, the recent change in Brazil’s government has significantly impacted the tax area. In early January 2023,  the Federal Government unveiled a fiscal adjustment package designed to address public account imbalances. The goal is to increase revenue through taxes and end the year with a primary surplus.

There are several key fiscal recovery measures proposed.

Review of Tax Exemptions and Rules

Reinstating PIS and COFINS

One of the measures is to reinstate PIS (social integration plan contributions) and COFINS (social security financing contributions) on previously exempt fuels (gasoline and ethanol). From April to July, PIS/COFINS will be charged based on per cubic metre rates lower than those provided for the former legislation (before the exemption), with full rates applying from 30 July. Diesel and natural gas remain untaxed for now.

Reversing PIS/COFINS tax rate reduction on financial revenues

A second measure is to reverse the PIS/COFINS tax rate reduction on financial revenues. Decree 11,322/22, published on 30 December 2022 by the former Government, halved the PIS and COFINS rates applied to financial revenue earned by companies subject to the non-cumulative regime. The rates were reduced from 0.65% and 4% to 0.33% and 2%, respectively.

The rate reduction was due to take effect from 1 January 2023. However, on 2 January, Decree 11,374/23 (published when the new Government took office) revoked Decree 11,322/22, reinstating the original rates. Since Decree 11,374/23 is effective from the date of publication, taxpayers went to the courts to debate the immediate increase in social contribution rates. They aimed to ensure compliance with the constitutional principle of anteriority, which, for PIS and COFINS, prohibits tax collection before 90 days have passed since the provisions on the rate increase took effect.

This has led to intense litigation between taxpayers and the Federal Government. There are several pending lawsuits throughout the country, and the discussion has already reached the Supreme Federal Court (STF). There is a Direct Action of Constitutionality filed by the Federal Government itself asking the court to give the final answer on whether the principle of anteriority has been violated in the case.

Excluding ICMS from calculation basis for PIS and COFINS credits

A third measure involves excluding value-added sales tax (ICMS) from the calculation basis for PIS and COFINS credits. In a landmark case known as “the tax dispute of the century” (Extraordinary Appeal 574706 - Theme 69 of General Repercussion, concluded in 2021), the STF ruled that ICMS should not be included in the PIS and COFINS calculation basis as it does not constitute a part of the taxpayer’s revenue.

Following the STF’s decision to exclude ICMS from the PIS and COFINS taxable basis, a debate emerged on whether ICMS could be included in the calculation of contribution credits. The legislation allows for various credit deductions that reduce the calculated amount for these contributions.

In December 2022, the Federal Revenue published an infra-legal provision establishing the inclusion of ICMS in PIS and COFINS credits. However, in January 2023, the new government set forth a new provision, which took effect from 1 May, excluding the possibility of credits on the value of ICMS levied on purchase operations.

New Tax Amnesty Programme in the Federal Sphere: Incentives for Settlement of Tax Debts

The tax amnesty programme allows for the renegotiation of tax debts based on the taxpayer’s ability to pay, with the aim of reducing litigation in the tax field. Taxpayers must request the withdrawal of any judicial measure or administrative defence related to the discussion.

Individuals, micro and small businesses with debts below 60 minimum wages can obtain discounts of 40% to 50% on the total amount of debt (tax, interest, and fines) with a payment term of up to 12 months.

Legal entities with debts higher than 60 minimum wages can receive discounts of up to 100% on the value of interest and fines related to “unrecoverable and difficult to recover credits”. Companies with tax losses and negative calculation basis of income tax and social contribution can use these tax credits to offset the debts (52% to 70% of the debt).

The programme, known as “Zero Litigation”, has extended its enrolment deadline to 31 May.

Changes at CARF

According to the Federal Government, a couple of changes would be required at the Administrative Council for Tax Appeals (CARF), which is the administrative court responsible for judging disputes involving federal taxes before a lawsuit. The aim of the changes is to reduce the backlog of administrative proceedings pending trial (around 100,000 since 2018). The government has also reported that the value involved in these proceedings, around BRL600 billion between December 2015 and December 2019, jumped to over BRL1 trillion in October 2022.

The President of the Republic issued Provisional Measure No 1160/23 in January 2023 to provide for these changes, namely:

• the immediate reinstatement of the tie-breaking vote in favour of the Tax Administration; and
• an increase in the jurisdictional value for access to the Council, raised from 60 minimum wages (BRL78.1 thousand) to one thousand minimum wages (BRL1.3 million).

Contentious Issues at CARF

For the government, the above measures would increase revenue and solve the CARF’s low productivity in recent years.

However, the measures have been severely criticised, mainly because the alleged “delay” in receiving revenues by the National Treasury due to the backlog of pending cases at CARF results from various factors unrelated to the tie-breaking criteria. These factors include the CARF’s budgetary crisis, the impact of the COVID-19 pandemic, and the lengthy stoppages caused by the tax auditors’ strikes in 2021 and 2022.

Furthermore, Provisional Measure No 1160/23 abruptly modified a law that the National Congress had democratically voted on three years prior (Law 13988/20). This law stipulated that in case of a tie, the cancellation of the tax debt should prevail, as Brazilian legislation does not allow for doubtful tax collection. The change was made without seeking prior public debate on the matter.

The measure also contradicts the majority view of the Supreme Court Justices in the trial of Direct Actions of Unconstitutionality 6399, 6403 and 6415, as well as Complementary Bill No 17/2022, which establishes the Taxpayer Defence Code. Both of these sources oppose maintaining the tie-breaking vote in favour of the Tax Authorities.

As a result, taxpayers have turned to the courts to prevent their CARF cases from being ruled on under this new tie-breaking vote system favouring the Tax Administration, at least until the Provisional Measure is converted into law by the National Congress.

The National Congress has 60 days (with a possible one-time extension for another 60 days) to approve or reject the Provisional Measure. If this deadline passes, the Measure loses its validity. Given recent history, Provisional Measure No 1.160/23 is expected to be rejected by the National Congress.

Reintroducing the tie-breaking vote through a provisional measure that, as the name suggests, is temporary, and which the Federal Government openly declared was motivated by tax voracity, undermines the impartiality and credibility of CARF.

Trials conducted during the precarious period of validity for the Provisional Measure (before its approval by the National Congress within 60 days, extendable for another 60 days) are subject to significant legal uncertainty. This situation is incompatible with numerous constitutional principles, including due process of law, isonomy, reasonableness, morality, protection of good faith, and cooperation between litigants.

Taxpayers also argue that (i) Provisional Measure No 1.160/23 does not meet the constitutional requirement of urgency, and (ii) the Brazilian Constitution explicitly prohibits the President from issuing such acts to modify procedural rules that critically impact the trial system.

The Judiciary has already granted some preliminary injunctions requested by taxpayers in their particular cases. Meanwhile, the Supreme Court has been mediating discussions between the Ministry of Finance, the National Congress and civil society.

The Case Law Reversal Wave: a New Chapter of Legal Uncertainty on Very Relevant Issues

Amid the legal uncertainty surrounding Provisional Measure No 1.160/23, CARF has included several cases of high legal and economic relevance in its trial agenda just days after the Measure came into force. Taxpayers have argued that the Tax Administration is attempting to capitalise on the temporary validity of the tie-breaking criterion, which could expire within weeks, in order to swiftly rule on a select group of handpicked issues in favour of the National Treasury and alter the case law already consolidated by CARF on these matters.

There has already been a reversal in the jurisprudence on the following issues due to the double vote of the chairperson as a tie-breaker:

• Amortisation of goodwill generated between companies within the same economic group for the calculation of Corporate Income Tax (IRPJ) and Social Contribution on Net Income (CSLL); and
• Incompatibility between the treaties for the avoidance of double taxation and the Brazilian law provision that determines the levy of IRPJ and CSLL, in Brazil, over the results obtained by affiliated foreign companies.

Reviving the Discussion on Tax Reform Proposals

Tax reform has become a priority for the new government, which has already garnered support in the National Congress to promote changes in the tax system in the first half of this year. Given the political framework and the lack of consensus in Congress, the former government failed to advance this discussion last year.

The new government is expected to try to combine two of the main proposals already presented to Congress – Proposals for Constitutional Amendments No 45 and 110 – to create a comprehensively revised draft for debate.

Tax reform is mainly focused on two areas: (i) corporate taxation, which involves changes to the rules for IRPJ, CSLL and dividend taxation; and (ii) consumption taxation, which involves changes to the rules for PIS and COFINS contributions, ICMS, service tax (ISS), tax on manufactured products (IPI), tax on financial transactions (IOF), and more.

In the corporate tax domain, the main proposals involve:

• taxation of dividends distributed by resident legal entities in Brazil, which currently benefit from exemption;
• new income tax exemption brackets for individuals;
• new rules for disguised profit distribution;
• new rules for taxation of investment funds, other investments and assets; and
• the possibility of eliminating the payment of interest on equity to shareholders as an addition or an alternative to dividends.

Regarding consumption taxation, the primary goal is to simplify the tax system by unifying consumption taxes. This ambitious and complex reform presents a significant challenge, as it faces significant hurdles. One key issue is the need to navigate the autonomy and revenue distribution among the various entities within the Brazilian Federation, since unification would impact taxes under the jurisdiction of the National Treasury, states and municipalities. Furthermore, there are conflicts of interest among the economic and social sectors and also a perception that the reform would increase the tax burden, especially for the service sector.

The 2023 Tax Agenda at the Higher Courts

At present, there are several significant tax debates at the STF (the highest appellate court for constitutional issues) and the Superior Court of Justice (the STJ, which is responsible for non-constitutional issues).

Termination of the effects of the final and unappealable decision on tax matters when contrary to the Supreme Court’s supervenient binding case law

In February 2023, the Federal Supreme Court’s full bench ruled on a highly anticipated discussion under the general repercussion regime (Extraordinary Appeals 949.297 and 955.227 – Themes 881 and 885, respectively).

The STF decided that decisions rendered by the Court in concentrated and abstract control of constitutionality (direct actions of unconstitutionality and general repercussion regime, respectively) automatically cease the temporal effectiveness of res judicata previously obtained by the taxpayer or by the Public Treasury in the opposite direction.

In other words, according to the thesis defined by the STF, it is no longer necessary to file a rescissory action to interrupt the effects of the previously formed res judicata. However, it is essential to respect the rules of non-retroactivity and anteriority applicable to each tax.

Unconstitutionality of the 50% isolated penalty charged by the Brazilian Internal Revenue Service on the denial of tax credit offset requests

In March 2023, the Supreme Court concluded the trial of Theme 736 of the General Repercussion (Extraordinary Appeal 796.939 and Direct Action of Unconstitutionality 4905). The Justices defined the following thesis: “The isolated fine is unconstitutional when levied against the mere denial of tax offsetting request, as it does not consist of an illegal act to be automatically penalised”. It is a significant victory for taxpayers.

The STF accepted the taxpayers’ legal grounds that the penalty should only be applied if there is an illegal act by the taxpayer, characterised by fraud or sham, aimed at delaying tax payments or taking advantage of the Administrative Authorities’ delay in reviewing these requests. Charging the penalty would hinder companies’ right to petition for the recovery of unduly paid taxes.

PIS/COFINS on banks’ financial revenues

At the end of 2022, the STF started the analysis of General Repercussion Theme 372 (Extraordinary Appeal 609096), which discusses the levy of PIS and COFINS on the financial revenues of banks and equivalent companies defined by law (insurance companies, securities brokers and private supplementary pension entities).

The taxpayers argue that PIS and COFINS cannot be charged on financial revenues before Constitutional Amendment 20/1998 since the calculation basis of PIS and COFINS initially provided by the Federal Constitution corresponded exclusively to the gross income derived from the sale of products and provision of services, not including revenues derived from financial return on investments.

So far, the reporting justice has accepted the banks’ defence in part, holding that certain financial revenues do not fall under the concept of revenues, namely: the intermediation value in the securities market, the value of bank deposits, the principal, interest and late payment accruals relating to credit transactions carried out by financial institutions. On the other hand, it held that “the concept of revenues as the taxable basis for the collection of PIS and COFINS from financial institutions is the revenue from banking, financial and credit activities arising from the sale of products, services or products and services, until the advent of Constitutional Amendment 20/1998”. The Court suspended the trial and will probably resume it in 2023.

If the National Treasury’s appeal is dismissed, the impact on the public coffers would be BRL19 billion annually, reaching BRL94.5 billion in five years.

Determining the commencement date for collection of ICMS rate differences

The STF will resume the trial of Direct Actions of Unconstitutionality No 7066, 7070 and 7078 to determine the specific commencement date for collecting rate of ICMS on purchases intended for final consumers from another state (as in the case of e-commerce).

The state treasuries argue for collections to begin in January 2022, while taxpayers assert the application of the anteriority principle, proposing that collections should start in January 2023. This is because the Supplementary Law regulating the collection of rate differences of ICMS was published in January 2022.

The state governments have already estimated revenue losses at BRL11.9 billion if the taxpayers’ position prevails. The decision will primarily impact online retailers.

PIS/COFINS on imports of services

In Extraordinary Appeal No 565886, the STF shall decide, under the General Repercussion Regime (Theme 79), whether the Brazilian Constitution requires the enactment of a Supplementary Law to collect PIS and COFINS on imports of services. Taxpayers have defended that Ordinary Law No 10864/2004 could not create an alleged “customs value” as the basis for calculating PIS and COFINS on service imports.

Limitation of the calculation basis of contributions intended to third entities

This year, the Superior Court of Justice may define, under the system of repetitive appeals (Special Appeals No 1.898.532 and REsp 1.905.870 – Theme 1079), whether the contributions intended for third entities (such as the National Service for Industrial Training (SENAI), the Brazilian Service to Support Micro and Small Enterprises (SEBRAE) and the National Commercial Apprenticeship Service (SENAC)), currently calculated on the payroll, should have their calculation basis limited to 20 minimum wages.

The discussion revolves around the absence of revocation of the legal provision that established this limitation. There are decisions favourable to taxpayers already rendered by the STJ, and now the 1st Section of the Court will analyse the matter to set a binding precedent. All ongoing lawsuits will remain on hold until the trial’s conclusion.

Exclusion of ICMS-related tax benefits from the IRPJ and CSLL calculation bases

The 1st Section of the STJ has recently assigned the following issue to the system of repetitive appeals (Special Appeals Nos 1.945.110 and 1.987.158) to define whether it is possible to exclude ICMS-related tax benefits – such as reduction of rate or calculation basis, exemption, immunity and deferral – from the IRPJ and CSLL calculation bases.

Taxpayers are optimistic as the court has previously ruled in favour of excluding ICMS presumptive credit from the IRPJ and CSLL calculation bases.