Brazil moves major VAT reform bill to Senate for consideration

A complementary bill (the Bill) on value-added tax (VAT) reform, which was approved by the Brazil Chamber of Deputies on 19 July 2024, has been finalized and forwarded to the Federal Senate for scrutiny. With an expedited process requested, it is anticipated that the Senators will pass the proposed text within next months.

The Bill reflects a major simplification of how indirect taxes are calculated but could also pose some challenges for taxpayers. Moreover, on 1 August 2024, the first technical notes were released aimed at adapting the layout of current invoices so they can be ready on 1 January 2026, when the transition period begins.

Background

The Brazilian Constitution underwent an amendment in December 2023, laying the groundwork for the indirect tax reform. Following this, debate began on the complementary bill that would be essential for advancing the reform. The resulting Bill requires review and approval of both the Chamber of Deputies and the Federal Senate before it can be promulgated. (For background, see EY Global Tax Alerts, Brazil Senate considers VAT reform plan, dated 10 August 2023, and Brazil: Special Committee of Lower House approves proposed indirect tax reform, dated 10 January 2019.)

New legislation

The Bill sanctioned by the Chamber, which remains subject to amendments by the Senate, specifies the taxable events for certain new levies, — specifically, the contribution on goods and services (Contribuição sobre bens e Serviços or CBS), the tax on goods and services (Imposto sobre Bens e Serviços or IBS) and the selective tax (IS — Imposto Seletivo) — outlines both the differentiated and specific tax regimes, and sets forth guidelines for a transitional phase. These new taxes will replace the state and federal VATs (ICMS — Imposto sobre a Circulação de Bens e Serviços and IPI — Imposto sobre Produtos Industrializados), the Tax on Services (ISS — Imposto sobre Serviços) and the federal social contributions known as the Program of Social Integration (PIS) and Contribution for the Financing of Social Security (COFINS).

One of the notable improvements made in the Bill is the stipulation that the list of products and services eligible for reduced rates will be revised if the CBS and IBS standard rates surpass the 26.5% threshold. This change is aimed at mitigating the impact on taxpayers who fall under the standard taxation system (as opposed to those who fall under the reduced rates).

Conversely, certain elements continue to raise concerns and warrant vigilant monitoring. For instance, the established timeframes for reimbursing the accumulated credits from the new taxes could extend to as long as 270 days. The prevailing expectation had been for immediate tax refund, or at the latest within 60 days, which would significantly alleviate the challenges encountered by taxpayers with accrued credits.

Moreover, the noncumulative aspect of the new tax (i.e., IBS tax on goods and services and CBS "contribution" on goods and services) remains a focal point of apprehension; for example, the buyer of a service or goods will only be entitled to a tax credit after the supplier pays the new taxes.

Implications

The Brazilian indirect tax could significantly affect the tax burden on businesses. A proper understanding of the reform's effects on businesses will be needed for taxpayers to plan and potentially mitigate any increase in the tax burden or more efficiently capture the benefits arising from the change.

Many current strategic and operational models will need to be reviewed, as certain structures may no longer provide benefits and are operationally complex (e.g., maintaining separate legal entities to manufacture and distribute products, a planning approach known as the dual structure).

Other examples of disruptive changes include the:

• Extinction of the monophasic PIS/COFINS regime (under which contributions are collected solely by the industrial legal entity, leaving the rest of the supply chain subject to a zero rate)
  
  
• End of the incentives for state VAT referred to as ICMS
  
  
• Adoption of the destination principle (i.e., the IBS, which will replace ICMS, will be due to the state/municipality where the consumer of the good or service is located, rather than where the supplier is located)
  
  
• Adoption of a broader noncumulative definition for the assessment of tax credits

It is vital to understand the effect that the changes proposed in the Bill could have on the current operating models adopted by taxpayers in Brazil, particularly considering the major milestones of the transition period:

• From 2027, when PIS/COFINS and the federal VAT known as IPI will no longer exist
  
  
• From 2029 to 2032, when ICMS incentives begin to be gradually reduced
  
  
• From 2033 when the transition is complete