The cap for sales tax ICMS rates on certain items, as proposed by the Chambers of Deputies and approved on Wednesday, may reduce inflation projections in the short term by 1 to 1.5 percentage points, while generating revenue losses for states and municipalities of R$65 billion to R$70 billion per year, especially as of 2023, economists estimate.
The current measure goes against what is done in most parts of the world, say some specialists, especially when it comes to fossil fuels, which usually suffer higher taxation.
Deputies approved a bill defining fuel, electricity, natural gas, communications and public transportation as essential goods and services, implying that they would have a 17%-18% cap for ICMS collection. Today, states usually apply rates as high as 30% on these items, especially fuel and energy.
The eventual impact of the measure on prices will depend on the rate charged by each state, but the governing coalition expects a reduction in gasoline, gas cylinders and electricity bills before the October election. “It is the latest attempt by Brasília to ease inflation after another bill to reduce the ICMS tax on diesel prices did not yield the expected results,” said Roberto Secemski, Brazil economist at Barclays.
On Tuesday, even before the decision at the Chamber of Deputies, J.P. Morgan added the possibility of the bill’s approval to its scenario and reduced its projection for benchmark inflation index IPCA in 2022 to 8.7% from 9.1%. “Considering an 80% pass-through to final consumers, we estimate that the gasoline tax cut reduces this year’s IPCA by about 40 basis points [0.4 percentage point]. For energy, we assume a 100% pass-through, as this price is controlled at the consumer level, which would reduce this year’s IPCA by about 30 basis points,” wrote economists Vinicius Moreira and Cassiana Fernandez.
The justification for the project among politicians is that states and municipalities have fiscal space and “surplus” cash. Ítalo Franca, an economist at Santander, notes, however, that the revenue of the states has risen by cyclical factors, such as high oil prices and high inflation. “When the disinflation process comes, revenue tends to fall,” he said.
In addition, expenses are normalizing, increases for civil servants have already been granted, but if inflation remains high, the pressure for increases ahead is likely to continue. “This can cause problems for the states’ accounts. In the broader picture, this revenue tends to fall. If the government wants to reduce taxes, I think it is positive, the tax overhaul is one of the focal points, but they cannot let mandatory expenses grow,” the economist said. “We contract a problem for one, two years from now. We are postponing it.”
Felipe Salto — Foto: Wenderson Araujo/Valor
If the states get into a tight spot further down the road, however, the problem returns to the federal government, notes the economist, as they need to enter government support schemes. Felipe Salto, secretary of Finance of São Paulo, said that the bill may reduce by R$0.10 to R$0.12 fuel prices in the pump, but the reduction will be rapidly offset by the effect of high oil prices driven by the war in Ukraine. According to him, the state will lose R$8.6 billion a year with the measure.
Fuels, electric energy, and telecommunications represent 31.7% of the states’ total ICMS collection, according to data from the National Council of Finance Policy (Confaz) organized by economist Sergio Gobetti, a specialist in public accounts.
“There is a high chance of litigation of this issue,” Citi comments in a report. “As this is an election year, it is not yet clear whether states would raise taxes on other goods to offset the negative impact of this bill on tax revenues.”
Although, in theory, there is fiscal space for the measure, Gabriel Leal de Barros, chief economist at Ryo Asset, says the ICMS is a tax with many problems and the focus of Congress should be on more structural solutions, such as the approval of the dual value-added tax – a single value-added tax encompassing the federal collections and another for state and municipal collections. Mr. Gobetti says that with the creation of the Tax on Goods and Services (IBS) in the model of a VAT, the tax overhaul is the best solution to standardize the tax burden on goods and services and end some distortions that exist in the ICMS.
The alignment of Brazil to the transfer pricing standard of the Organization for Economic Cooperation and Development (OECD) will prevent the country from facing revenue losses totaling billions of reais per year, Pascal Saint-Amans, director of the Center for Tax Policy and Administration at the OECD, told Valor.
Brazilian authorities and Mr. Saint-Amans will detail the new Brazilian system on Tuesday in Brasília, the result of convergence between the OECD and the Secretariat of Federal Revenue. According to him, the final phase of the studies started in February 2018 found a surprising extent of losses for Brazil because of the current system.
“If we say that Brazil loses revenue today, and that by changing the rules it will lose less, it means that companies will pay more tax,” Mr. Saint-Amans said. “Someone can argue that this is not good for investments. In reality, since the situation is complex, it is not incompatible with an improvement of the corporate tax regime in Brazil.”
Transfer pricing is an issue that all multinationals face. It can be used to move profits from one country to another. It concerns the amount charged when goods or services are sold between two companies in the same group in different countries. It can allow them to legally reduce their tax liability, for example, by accounting for low or overpriced transactions or by moving profits to low-tax jurisdictions such as tax havens. For some transactions, it may be relatively easy to set transfer prices and for tax authorities to control them. But there are more complex transactions, involving, for example, intangible assets and certain financial transactions, which are more challenging for tax authorities to control.
The Brazilian system, with a fixed margin, was originally designed to be simple and easy. But the OECD assessment is that it is detached from commercial reality and has resulted in multi-billion revenue losses and double taxation problems.
To join the OECD, Brazil will adopt a new system fully aligned to the organization’s standard, which seeks to determine the appropriate market price in the transaction. At the same time, simplification measures will be developed to achieve the objectives of the old system, but based on economic reality. Brazilian authorities are to determine when a bill will be presented to Congress and how the system will be gradually put into practice.
Mr. Saint-Amans is one of the world’s leading experts on taxation. He is at the center of the fight against tax evasion. And he was a key player in the creation of the global minimum tax of 15% on multinationals, the biggest overhaul of the international tax system in decades. Read below excerpts from the interview before his trip to Brasília:
Valor:Does the Brazilian transfer pricing system pose detrimental effects on Brazil?
Pascal Saint-Amans: Yes, it does. We identified quite a while ago that the Brazilian transfer pricing policy was atypical, very different and not in line with the OECD standard. To facilitate a change, we decided with the Ministry of Economy and the Secretariat of Federal Revenue to do an analysis. This work is now being finished and has led to some very surprising findings. We thought that the Brazilian system was quite different but a very robust one, which protected Brazil’s tax base. The reputation of Brazil was of a “tough guy,” very strict. The study showed that the Brazilian system had many flaws and led to many revenue losses. The main lesson of this work is that, in a constructive, relaxed way, we were able to make a common analysis of the situation between the OECD, on one hand, and the Federal Revenue, on the other, and realize the deficiencies and some advantages, but that are limited, in order to reach these common findings that will facilitate Brazil’s approximation and alignment to international standards.
Valor:How does this loss of revenue by Brazil happen, in practice?
Mr. Saint-Amans: Multinationals are currently able to legally transfer profits generated by operations in Brazil to low or no tax foreign jurisdictions by exploiting some of the divergences between the Brazilian transfer pricing structure compared to the international standard. A concrete example is the case of a company with high-value products that benefit from cheap production factors. Due to the Brazilian system of fixed margins, the company can legally leave only a small amount of profit in Brazil, say 15% of the production cost, while the real added value is close to 100%! The product will be sold to another company in the group in a low tax country and resold from there to other countries. Because of the fixed margin, the profit will have been transferred out of Brazil. This is just one example. Many other situations arise in relation to other transactions that affect all sectors of the Brazilian economy, including transfers of valuable assets, including intangible assets, as well as financial transactions.
Valor:How much tax revenue does Brazil lose per year in this case?
Mr. Saint-Amans: I don’t have precise figures, but we are talking about quite large amounts, billions of reais, no doubt. This study is based on the country-by-country reporting adopted in the BEPS (Base Erosion and Profit Shifting) case. Examining this study, Brazil realized that a good part of the tax base that should have remained in the country was transferred to countries that offered advantages. The Brazilian transfer pricing, which gave the impression of being solid, with a fixed price in the transaction depending on the activity, in practice was easily circumvented or even used to transfer profits abroad. The system favors transfer abroad, with loss of revenue, as it is also rigid in some fields, which is an obstacle to better integration of Brazil in the value chains.
Valor:How much would Brazil lose, then?
Mr. Saint-Amans: These are large amounts, not secondary values on a company.
Valor:Many multinationals use this practice, of avoiding paying taxes in Brazil?
Mr. Saint-Amans: The answer is yes. It is something that is systematically used, which is logical. There is a tax system with its advantages and its disadvantages, and companies deal with it. The advantage of this system, and this is why we wanted to build a common answer with the Federal Revenue, is that it is simple to handle. It doesn’t need many tax auditors or many controls, because there is a fixed margin determined beforehand and companies have no choice. With the OECD transfer pricing, on the other hand, you have to examine it transaction by transaction. We acknowledge that it is complicated, sophisticated and needs more resources in tax administration. That said, we try to understand how the OECD itself could simplify things. Brazil is going to align itself with the OECD rules, and in turn the OECD moves in the direction a little on the positive side of the Brazilian system.
Valor:For example?
Mr. Saint Amans: What we have done in recent years at the OECD is to modify the transfer pricing standard. In the BEPS project, we have three measures on transfer pricing. First, we say that if [the company] wants to locate intellectual property in a country it has to have substance. Second, we can simplify the benchmarks for the price of raw materials, such as oil, and look at the market price as Brazil and Argentina do. So we acknowledge that this so-called “sixth method” is not incompatible with the OECD standard. We also developed the global agreement announced in October 2021 with two pillars: Pillar 2 introduces a minimum global tax of 15% on multinationals – and Brazil should ask itself if it will put this tax in place; we will work closely with Brazil to see if it is possible. And Pillar 1 includes two things: the biggest multinationals – notably U.S. and European ones, with a combined profit of $700 billion a year – will leave a 25% share of profits in the countries of markets according to some criteria when this political agreement is legally in place, whether the company has a physical presence in the country or not. We will have $125 billion to $ 200 billion a year redirected to these markets. Brazil is a big market. Therefore, it is a fundamental change. In addition, when a company has distribution activity in a country, which is underpaid, we will also simplify rules, as Brazil does, for the company and the country to have more legal security. It will be an approach that respects the principle of full competition, only more simplified. Brazil has two reasons to align itself with the OECD rules: they are more robust, and the Brazilian rules are quite fragile.
Valor:What legal changes will Brazil have to make, then, to align itself with the OECD system?
Mr. Saint Amans: Brazil needs to pass a law that will call into question its fixed margin principles and acknowledge the relevance of a transactional approach. I understand that this bill is well advanced, but the political question now, which does not belong to us, is about the timing for this legislative change. We understand that Brazil will hold elections this year. But these are technical and bipartisan works. We are confident that this work will result in a possible majority in Brazil after the elections.
Valor:In other words, will Brazil need to join the Arm’s Length Principle at the heart of the OECD standard?
Mr. Saint Amans: Yes. This means we should transact as if we were not in a family. In family, we embrace each other. When we are foreigners, we are at arm’s length. The principle forces a company, when doing internal transactions, to put the market price, which would be as with an independent entity and not as with someone in the family. It is a rule that dates back to 1928. Every internal transaction must be done at market price. This system has its weaknesses, because in an open world, with tax havens, companies are interested in locating their profits in countries where there is little taxation. That is why we introduced the BEPS.
Valor:With the change in transfer pricing in Brazil, will the multinationals pay more taxes?
Mr. Saint Amans: Yes, If we say that Brazil loses revenue today, and that by changing the rules it will lose less, it means that companies will pay more tax. Someone can argue that this is not good for investments. In reality, since the situation is complex, it is not incompatible with an improvement of the corporate tax regime in Brazil. It is just that the current system has many drawbacks. I am not saying that Brazil was very bad and the rest of the world was very good, no. But the simplicity of the Brazilian system runs into the problem of double taxation.
Valor:The OECD says that the change will help Brazil in global value chains. How?
Mr. Saint Amans: It has to do with what we just talked about. Brazil has its own rules, which fundamentally integrate poorly with the rest of the world. We found that companies were not necessarily making all the investments that they could make in Brazil. We think that it is not only the fiscal obstacle, but there is a fiscal obstacle that is substantial. And if it is solved, it could facilitate better integration.
Valor:Is the transfer pricing change key for Brazil to join the OECD?
Mr. Saint Amans: Of course. To join the OECD, Brazil needs to be in compliance with OECD standards.
Valor:In other words, the country must do this in two, three years?
Mr. Saint Amans: It has to do this before it can join the OECD. There is a tight schedule. It depends on how fast Brazil wants to get in, but clearly it is one of the important points of the country’s accession to the OECD. But, I insist, it is not a pressure imposed by the OECD, we built this together.
Valor:Economy Minister Paulo Guedes recently went to the OECD and talked to you about a tax overhaul in Brazil. Is this a factor for accession?
Mr. Saint Amans: The question of tax policy in general is not a matter of accession. We have standards like tax information exchange with Brazil, the country applies BEPS and has engaged in providing reliable information for our statistics. In contrast, the OECD has recommendations in this field, which countries are not obliged to apply. What we see from Brazil is that its tax burden is high (33.9% of GDP in 2021) and with a VAT (value-added tax) system that is not good, because of the federal structure and the way it is shared between the federal government and the states. The work that has begun on simplifying and improving the effectiveness of VAT is very important, and ensures revenue without economic distortion. VAT is a very good tax that can be a little regressive, and we need to pay attention to this. And in Brazil it is not so effective.
Valor:In Brazil, do you pay a lot of tax?
Mr. Saint Amans: The VAT in Brazil is not effective, it generates income but also causes obstacles to the fluidity of exchanges, it makes life more complicated. In corporate tax, the revenue could be even higher while making life easier for companies. An OECD recommendation could make tax overhaul to be more effective, less penalizing for the fluidity of business. Today, the Brazilian system compared to other Latin American countries has a level of mandatory taxation that is higher, but it goes with a level of state development that is higher than other countries in the region.
The political wing of the government acted on Thursday to approve a Proposed Amendment to the Constitution (PEC) that would allow President Jair Bolsonaro (Liberal Party, PL) to zero taxes on all fuels, including gasoline, without having to compensate for the increase in other taxes. In addition, it authorizes a reduction in the Tax on Industrialized Products (IPI) and Tax on Financial Transactions (IOF) on any products without counterparts. The project contradicts the position of Economy minister Paulo Guedes, who is concerned about the impact of this measure on public accounts and who defended a tax exemption restricted to diesel oil, with a lower fiscal cost.
Deputy Christino Áureo (Progressive Party, PP- Rio de Janeiro) filed the PEC on Thursday at the request of a part of the government. The text, as revealed by Valor, was formulated in the Chief of Staff Office, controlled by minister Ciro Nogueira (Progressive Party, PP), and allows for a partial reduction or even zero taxes in 2022 and 2023 to counter one of the main criticisms of voters to the current administration: the high price of gasoline, cooking gas and diesel oil, because of Petrobras’ pricing policy.
The cost, according to economic sources, will be around R$54 billion per year, higher than the total investments planned for 2022. The exemption on gasoline alone would bring a loss of almost R$27 billion to the taxpayer: R$23.8 billion from social taxes PIS/Cofins and another R$3 billion from federal tax Cide. Diesel, on the other hand, would cost another R$18 billion. If Congress resumes the idea, already defended by President Bolsonaro, of cutting taxes on electricity, the impact would rise to up to R$75 billion. In addition, the PEC authorizes a cut in IPI and IOF, among other taxes that had not entered the waiver calculation.
Tax laws require that the reduction of one tax be offset by the increase of others, but a wing of the government decided to propose the PEC to circumvent this rule temporarily. The country has been living with a primary fiscal deficit for seven years and in 2021 it recorded a deficit of R$35 billion in the central government. For 2022, the estimate is a deficit of R$79.3 billion – and that is before the idea to exempt fuel.
The Ministry of Economy did not participate in the elaboration of the PEC, says a source. On the contrary, the ministry considers it bad and. In the opinion of the technicians, it would not even be necessary to change the Constitution. The cut could be authorized by a supplementary law (which would amend the Fiscal Responsibility Law to allow it to happen without the need to create other sources of revenue to compensate for the loss) and adjustments to the Budgetary Guidelines Law (LDO).
The option for a complementary law would also allow Mr. Guedes to pressure President Bolsonaro to veto “exaggerations” approved by lawmakers. On the other hand, a constitutional amendment, although it requires greater support to be approved, is enacted by Congress itself, without this alternative. “PEC is very bad,” said a member of the ministry. The so-called “PEC dos Precatórios” — regarding writs that represent federal debts from loss of court disputes, voted on in December — had the space for spending doubled by congressmen.
The content was also far from what was advocated by the economic area. Until the day before, the perception in the ministry was that the proposal would be expensive to the taxpayer to generate relief in prices that could quickly disappear when faced with a depreciation of the Real against the dollar or the price of oil. Mr. Guedes even publicly criticized the removal of taxes on gasoline at a time of transition to a low-carbon economy. Diesel tax release, on the other hand, was seen as acceptable, given the importance of the fuel in the country’s logistics, not to mention that it pleases one of the president’s bases of support, the truck drivers.
The version filed by Mr. Áureo allows the full release of fuel taxes in 2022 and 2023 without the need for compensation – it would be enough to present financial estimates and adjust the budget laws to the new rates. The endorsement would be for the federal government and also the states and municipalities, giving strength to Mr. Bolsonaro’s strategy of pushing the burden of the gasoline price to the governors who refuse to accept the reduction of ICMS.
On Thursday, the governors declared support for the bill proposed by Senator Jean Paul Prates (PT-RN) to change Petrobras’ fuel price policy, creating a tax on crude oil exports and a fund to stabilize prices in the domestic market. “The bill is born from the problem itself, from the extraordinary profit from the increase in fuel prices,” said the governor of Piauí, Wellington Dias (Workers Party, PT), who coordinates the Governors Forum. The discussion about the ICMS on fuels would be left only for the tax reform.
According to the bill, the reduction of taxes will only have to respect the requirements of presenting an estimate of the budget and fiscal impact of the measures adopted, to comply with the annual goals of fiscal result (which can be changed by law), and to be part of the budget laws (such as the annual budget and the multi-annual plan).
Mr. Áureo told Valor that the text is of his authorship, negotiated with the federal government and that he will wait to discuss the project. “I will continue my dialogue with the government and with productive sectors and society”, he said. The document data, however, show that it was written in the computer of a government technician, the assistant sub-secretary of Public Finance of the Chief of Staff’s Office, Oliveira Alves Pereira Filho, and sent to the deputy to officially present it.
Initially, the idea of the federal government was that Senator Alexandre Silveira (Social Democratic Party, PSD of Minas Gerais) would file the PEC in the Senate if he accepted to be the government’s leader. But he has signalized that he will refuse the leadership after pressure from colleagues and the changing of government’s strategy, with the process starting in the House, where the government’s base is stronger. Mr. Silveira, in turn, is preparing an alternative PEC for the Senate that would contemplate the fuel tax release, and also the use of Petrobras dividends to finance a social fund to balance prices.
The text needs the support of 171 deputies to start being processed. As the Constitution and Justice Commission (CCJ) is not expected to be opened until after Carnaval [March 1], it is most likely that the speaker of the Chamber of Deputies, Arthur Lira (Progressive Party, PP of Alagoas), will decide on admissibility on a floor vote. After that, a special commission would be created and a rapporteur appointed to discuss an updated version of the PEC, within a period of 11 to 40 sessions.
For the economist and consultant Adriano Pires, president of the Brazilian Center for Infrastructure (CBIE), the PEC will have almost no impact on consumers, the same way that occurred with the exoneration of the PIS and Cofins on cooking gas, in effect since March, and diesel, which was valid for three months in 2021. “The government zeroed the PIS and Cofins on diesel, but as the barrel kept rising and the exchange rate kept depreciating against the dollar, the price went up,” he said. He believes that the PEC will also face opposition from the rural caucus and the states that produce hydrous ethanol, which today has a lower PIS and Cofins than gasoline. “If the tax is reduced for both, ethanol will lose a lot of competitiveness,” he said.
(Edna Simão and Estevão Taiar, from Brasília, and Marta Watanabe, from São Paulo, contributed to this story)
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