Brazilian consumption taxes are known for their complexity, with multiple layers of taxation imposed by different levels of government. The federal government can levy a tax on manufactured products, while states can collect taxes on tangible goods and selected services. Municipalities, on the other hand, have the authority to tax services not covered by state taxes. This division of taxation responsibilities has led to various challenges, including tax competition between states and conflicts of jurisdiction among different tiers of government. Despite years of discussions and failed attempts, Brazil has finally enacted a reform to simplify its tax system.
The existing consumption tax system in Brazil includes the tax on manufactured goods (IPI), social contributions (PIS/COFINS), state tax (ICMS), and municipal services tax (ISS). The IPI, levied at each stage of industrial production and on imports, can range from 5% to 30% and even higher for certain products like tobacco. PIS/COFINS, which is highly complex due to multiple regimes, is a significant source of litigation in Brazilian courts. ICMS, imposed by states on goods and services, varies among states and follows the origin principle, leading to economic distortions and complexities. ISS applies to services not covered by ICMS and does not allow for input tax credits, increasing compliance burdens.
The enactment of a dual VAT system in Brazil, comprising a federal VAT (CBS) and a subnational VAT (IBS), aims to simplify taxation and enhance compliance. Each level of government will have the authority to set its own VAT rates, with the general rate estimated to be around 27%. The transition to the new system will occur over a seven-year period, with CBS starting at 0.9% and IBS at 0.1% in 2026. The reform establishes the Federal Revenue Agency to administer the federal VAT and creates the IBS Federative Council to oversee the subnational VAT, streamlining tax collection and administration processes.
Foreign remote sellers currently have no tax compliance obligations in Brazil, but under the new dual VAT system, they may face challenges in determining their tax obligations for digital services provided to Brazilian customers. While the specific tax collection mechanism for foreign sellers has yet to be determined, the application of the destination principle to both domestic and cross-border transactions suggests that foreign sellers could be subject to taxation in Brazil. It remains to be seen how Brazil will align with OECD recommendations on tax collection mechanisms for foreign sellers.
The Brazilian tax reform is expected to simplify taxation, enhance tax administration and compliance, and align with international tax principles. Clarity is still needed regarding the application of tax collection responsibilities for foreign remote sellers. The reform is also anticipated to stimulate foreign investments in Brazil by reducing the complexity and costs associated with the current tax system. With the implementation of the dual VAT system, it is hoped that more companies will be encouraged to establish a local presence in Brazil, boosting economic growth and development in the country.
