The Brazilian tax challenges in the Covid-19 era

It is already common sense that 2020 is the year that will change the world’s view of itself. Even when the Covid-19 pandemic passes – which is certain to happen – there is no doubt that it will leave its mark on relations between countries, between countries and their citizens and even on those between companies and their customers.

This statement may at first sound dramatic considering the evidence that the world has already experienced pandemics. This, however, is the first mobilization on an effectively global scale in a fully integrated world: in the past, a disease like the Spanish Flu was extremely aggressive but in a less connected world, and diseases like SARS and MERS, although more recent, had a more restricted spread. It can be said, therefore, that it is in this era that governments are learning to deal with an issue that touches everyone at the same time – not even wars have done that in that extension.

In Brazil this is no different. The country officially registered its first case in February and, considering the progressive deterioration of the social situation, in March it established a collective lockdown for an indefinite period, except for some essential services.
Immediate demands during the lockdown period

It is needless to say that the collective lockdown stopped the economy at the same time and at once. On the one hand, a rapid drop in revenues demanded companies to seek cash maintenance through lawsuits to postpone the payment of federal, state and municipal taxes. Layoffs, suspensions of employment contracts or reductions in workload became subjects of routinely internal meetings.

In turn, the federal government faced a real catch 22: while it should defend the financial health of companies (and thereby preserve jobs and avoid bankruptcies), it would need cash not included in the budget to fund its aid to the market.

At the present time, the government has taken the route of generating liquidity and not increasing taxes. Along with the National Congress, it approved tax rules as follows:

• Reduction to zero of the import tax rate of products related to the combat of Covid-19
• Reduction to zero of the IOF rate on loans of any nature contracted between April 3 and July 3, 2020
• Suspension of procedural deadlines at the Internal Revenue Service and administrative tax courts
• Deferral of payment of certain federal taxes (including employee’s severance fees – FGTS)
• Extension of validity of tax clearance certificates
• Suspension of collection acts made by the office of the Attorney General
• Approval of new rules to encourage the renegotiation of federal government tax debts

Although important, several companies have understood that the measures are still not enough and therefore have reached out to courts with further requests, like the permission to postpone the payment of other taxes not covered above and the authorization to withdraw escrow amounts deposited in legal proceedings. A certain increase of demands in the judicial courts is therefore expected for the upcoming months.

Potential future federal measures in the view of the National Congress

Extreme situations like that of the Covid-19 pandemic naturally open the door to different types of legitimate and doubtful opportunities in the tax policy arena. If, on the one hand, the pandemic has positively advanced some issues that would probably be mature in a few years, on the other hand it tends to postpone other discussions.

Tax reform is one of those good opportunities that can be missed. In a year of municipal elections, the goal of the federal government for 2020 was to move forward in the first semester with the discussion and approval of the constitutional text that establishes a single federal Value Added Tax in replacement for federal, state and municipal consumption taxes. Six months of negotiations would be expected to be seen with state and municipal governments, which to date estimated a concrete loss of taxation power – and, with the new rules, feared greater dependence on transfers from the federal government.

With a prioritized focus on health, it is natural that complex and controversial – and sometimes inconvenient – issues such as the reform of an entire tax system are left behind. If not approved this year, the subject would be resumed in 2021, a year in which not only the country will be facing the post-Covid-19 hangover but the current federal government will already be in its third year – and, with an eye on the presidential elections of 2022, possibly with less bargaining power or even without the intention to disagree on the subject. If this happens, a tax reform will be on the agenda of a new government starting in 2023.

That being the case, what would be expected for 2020 in terms of a new fiscal policy after the Covid-19 crisis?

In the case of tax collection in Brazil, the Federal Constitution establishes that a tax may only be collected as of the financial year following the publication of the law that created or increased it – this is the constitutional principle of anteriority, which guarantees security and predictability to the taxpayer. In relation to social contributions (of the same enforceability as taxes, despite different natures), this anteriority is only of ninety days.

This principle is the biggest obstacle to the federal government in a situation like the current one, in which immediate cash would not afford a gap until 2021. The most notable exception to the constitutional anteriority is the so-called compulsory loan – a cash that may be immediately collected but returned in future years to the same taxpayers. The Federal Constitution equals the compulsory loan to a tax and allows that exceptional charges to meet extraordinary expenses generated in cases such as the Covid-19 pandemic.

Although legal, a compulsory lending is an abnormality in the tax system. For the federal government, this is a trap: despite being quickly collectable, the need to return it in the future – with proper financial updates – evidently turns it into a financing that will compromise future budgets. For the taxpayer, there is the obvious surprise of the immediate and burdensome commitment of a current budget – and, in the past, the cases of devolution were long-term and with remunerations incompatible with the inflation of the times.

The current pandemic scenario has already created a tendency to its imposition. Late in March, Complementary Law 34 was presented to the National Congress suggesting a charge on Brazilian legal entities with a net worth of R$ 1 billion (approximately US$ 200 million) of up to 10% of their net profits calculated in 2019. If the loan were approved, the Ministry of Economy would define the percentage applicable to each economic sector, and the payment would be made from thirty to ninety days after the publication of the law.

According to Complementary Law 34, the amounts by the government would be returned to the financing companies within four years after the end of the public calamity situation related to Covid-19. The refund would be made in up to twelve monthly installments according to budget availability.

In addition to the natural restriction that this theme has for society in general, the draft of Complementary Law 34 was object of formal rejection in a letter to the House of Representatives signed by national confederations such as Health, Transport and Financial Institutions. They argue for the presence of confiscation, the lack of equality among taxpayers and the inexistence of a relationship between the amounts charged and the wealth that companies may necessarily have.

The political and economic environments do not seem to favor an approval of the project, thus, as they do not seem to favor the approval of another project under discussion: the tax on large fortunes.

Like the compulsory loan, the tax on large fortunes has never been well received by society, but its potential implementation has also been discussed by some parliamentarians since March.

Unlike the compulsory loan, however, this controversial tax was never effectively levied in Brazil, and for clear reasons: not only does it generate irrelevant revenue for the government budget, but it also applies to relevant (and often illiquid) assets that have already been subject to income tax to add to the taxpayers’ equity – in addition to tending to generate capital departure. Entities that represent tax auditors, however, defend the creation of the tax on the grounds that, although irrelevant, the corresponding collection would have the function of “social justice”.

A few projects for implementing the tax have been presented to the National Congress in recent years, but the Covid-19 crisis brought six new projects to the table. The most complex and relevant proposal – and the most advanced in the discussions – is described in Supplementary Law 183, of 2019, which determines the calculation of the amount through the application of progressive rates of 0.5% to 1% on higher net assets as from R$ 22.8 million (approximately US$ 5 million) held by Brazilian individuals or estates (in relation to the equity they hold in Brazil and abroad) and by nonresident individuals, estates or legal entities (in relation to the equity they hold in Brazil) .

The project allows the reduction of the calculation base by amounts corresponding to the taxpayer’s work instruments, intellectual or industrial property rights and small value assets – and even previously paid taxes on real estate and vehicles that are part of the taxable assets that are part of the fortune range.

When considering the history of resistance of the National Congress, it would be argued that this would be one more tax not to advance in the corresponding discussions. Considering the current demands for cash and the politically correct approach of the tax in a Covid19 situation, however, it would not be a huge surprise if the project moved towards the start of collection in 2021. This is a matter to be monitored.

In the case of fiscal policy with less hurried planning and more in line with world standards, the federal government and the National Congress could seek reinforcement of cash in legislation focusing on dividend taxation – an issue that, after all, has been on the table for years and has gained more strength in the last presidential elections, when all the candidates brought the topic to their speeches.

Arguments in favor of this tax range from a vision of social justice to an alleged alignment of investments in Brazil to the profile of member countries of the Organization for Economic Cooperation and Development (OECD), which mostly tax dividends and, at the same time, allow lower corporate taxation – 23.7% on average.

Taxation in this sense would correspond to a paradigm shift: the Brazilian government has maintained dividends exempt from income taxation for more than twenty-five years under the argument of attracting investments, while maintaining the most onerous corporate taxation. It seems quite natural, therefore, that a potential revocation of the current exemption should be accompanied by a reduction in the corporate income tax burden, currently in force at the rate of 34%.
Brazil has almost thirty draft bills dealing with the taxation of dividends in the files of the National Congress. The vast majority of these projects are quite simple, just removing the current exemption to impose different rates (from 15% in exclusive taxation at source to 27.5% as an ordinary income), without any reference to corporate taxation, with no provision for the treatment of credits or discussion on the avoidance of double taxation – exceptionally, Bill 1952, of 2019, proposed to reduce corporate taxation to 29%, but still insufficient to neutralize the proposed dividend taxation.