The Brazilian Tax Reform

Why does Brazil need a tax reform?

In a nutshell, the Brazilian Tax System has suffered from the following symptoms:

  • High tax burden on the wealth produced (33,5% of the GDP);
  • Multiple tax authorities (Federal Government, States and Municipalities);
  • Excessive number of taxes, rules and regulations;
  • Several exceptions, regimes and specific benefits;
  • High tax compliance costs;
  • Uncertainty in the proper calculation and collection of taxes;
  • Difficulty in consulting with tax authorities;
  • High level of tax controversy and litigation;
  • Substantial delays in dispute resolution; and
  • Recurrent tax recovery and amnesty programs.

Brazilian tax experts have sometimes questioned such diagnosis based on the lack of trustworthy information, worsening the resolution of the problem. Hence, below you will find a list of some reliable sources used for the purposes of our analysis:

According to the available data, Brazil has a level of taxation equal to the average of the OECD countries (approximately 34% of GDP). However, the country offers its taxpayers the lowest Human Development Index (HDI) within the top 30 countries with the highest percentage of GDP taxation. Note that the HDI is prepared by the United Nations Development Program (UNDP) and measures basically three things: life expectancy, level of education and net income per capita. In addition, Brazil is probably the most challenging tax environment in the world.

For instance, Brazil has 26 States, one Federal District and 5570 Municipalities. All of them are competent to perform tax audits and legislate on tax matters. Considering the Federal Government, States, the Federal District and the Municipalities, Brazil has approximately 5600 different competent tax authorities, performing active legislative and auditing roles.

Pursuant to some researches, this system has produced more than 500 new tax rules per day, involving a vast number of different taxes, which some argue that may reach 92 different taxes. On top of such complexity, the Brazilian Federal Constitution is a very detailed document, with more than 25 different articles dealing solely with taxes.

Since 2002, the World Bank has performed a study involving 190 countries, called “Paying Taxes”. Such study involves several global and local partners and aims at comparing the tax systems around the globe, by pushing the same business and legal model through the specific tax systems. In this study, Brazil has always been the highest tax compliance cost in all 190 countries analyzed, with approximately 2 thousand hours spent per year to comply with local tax rules and obligations. This number is twice the amount of the second country ranked (Bolivia) and 8 times the average of all 190 countries. In summary, Brazil ranks number 184 in this study, with  only 6 countries ranked below.

Furthermore, according to the study performed by National Justice Council (CNJ), there are more than 4 million new judicial proceedings involving solely tax related matters, which adds up to approximately 11 thousand new judicial tax litigation cases per day. According to the CNJ study, tax enforcement claims represent 39% of all on going judicial proceedings in Brazil, and they represent 73% of all enforcement claims being pushed by the Brazilian Judiciary Branch.

If we only consider the Federal Tax level, according to the Federal Treasury Attorney’s Office and the Brazilian Federal Tax Authorities:

  • The amount involved in judicial proceedings and enrolled as Federal Tax Debts represents approximately 23% of the total Brazilian GDP (approximately 400 billion dollars);
  • In the first level Administrative Federal Tax Courts alone, there are more than 226 thousand on going cases, with an average time of approximately 3 years for a final ruling;
  • In the second level Administrative Federal Tax Courts (Courts of Appeals), the number of decisions ruled in favor of the taxpayers has dropped from 54% to 0.05%, during the period between 2004 and 2018, in cases involving over 50 million dollars; and
  • Considering the past 10 years and 4 different Federal Tax Amnesty programs, the amount of Federal Tax Debt forgiven adds up to 44 billion dollars and 68% of the taxpayers benefiting from such programs have recurrently requested tax amnesty (more than 3 times over the past 4 programs)

Considering the above, it seems very clear that the Brazilian tax system must be reformed. This conclusion has also been reached by most of the taxpayers in Brazil, a good part of the Brazilian Congress and all levels of the Brazilian Government. In this regard, please find below a brief comparison of the main Tax Reform proposals being currently discussed in Brazil.

Which are the current tax reform proposals?

The current proposals mainly focus on  changing the indirect taxation in Brazil, by creating a single value-added tax (VAT), which would replace 6 to 9 different taxes on goods and services.

Some propose to achieve such goal via changing specific legislation, without major changes in the Federal Constitution, the so-called “Mini-reform”. Two of them are already being discussed in the Brazilian Congress, via different Constitution Amendment Proposals, called PECs. The other is a very disruptive idea, which would substitute part of the revenues derived by such existing taxes by a tax on financial transactions (ITF).

PROPOSAL PROS CONS
“Mini-reform” ·   Upholds the Federation; and
·   Greater agility to approve.
·   Recent negative experiences; and
·   Very limited effects.
VAT
PEC 110/2019
·   Reduces the number of taxes and rules;
·   Shifts some of the tax auditing and legislative powers; and
·   Simplifies the taxation of goods and services.
·   Potential discussion involving the Federation;
·   Maintains the current model with local tax benefits;
·   Long transition period; and
·   Does not address some of the major issues.
VAT
PEC 45/2019
·   Reduces the number of taxes and rules;
·   Prevents local benefits;
·   Shifts the tax auditing and legislative powers; and
·   Simplifies the taxation of goods and services.
·   Potential discussion involving the Federation;
·   Long transition period; and
·   Does not address some of the major issues.
Dual VAT ·   Mitigates the discussion on the Federation;
·   Smooth transition helps Congress approval;
·   Phase 1 (Federal VAT) substitutes three Federal taxes on goods and services;
·   The following phases could lead to a single harmonized VAT on goods and services.
·   Complexity of the system could continue;
·   Potential maintenance of State and Municipal taxes on goods and services may generate several discussions;
·   Maintenance of multiple competent tax authorities.
ITF
Imposto sobre Transações Financeiras
·   Reduced level of tax avoidance;
·   Practical auditing and collection;
·   Wider tax base;
·   Universally applied.
·   Unpopular;
·   Regressive;
·   Cumulative; e
·   Stimulates a decentralized financial system.

 

What should we expect from these proposals?

The first impression is that the current proposals do not address all the symptoms diagnosed in the beginning of this analysis, as their primary focus is on to simplify the taxes on goods and services, apart from minor changes in Income Tax, Gift Tax and other taxes.

Should the simplification of the taxes on goods and services be achieved, there is no doubt that it would substantially improve some of the symptoms described herein, specially the number of taxes, the vast legislation, the tax compliance costs and potentially reduce tax litigation in Brazil.

Nevertheless, the current proposals do not address some of the other symptoms, such as the level of GDP taxation, the difficulty in consulting tax authorities, the lack of an agile dispute resolution system and the need for recurrent tax amnesty programs.

As most of the taxpayers in Brazil, a good part of the Brazilian Congress and all levels of the Brazilian Government have concluded, it is crystal clear that the Brazilian tax system must be reformed. It is an opportunity to be bold and achieve the tax reform that Brazil needs.

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