Tax reform stalls

The Brazilian government on 25 June 2021 delivered to Congress the second phase of a tax reform package, which proposes changes to the income taxation of corporations and individuals. The first phase, which relates to VAT tax reform, is still under discussion.

During the presentation to Congress, the government highlighted the principles underpinning the tax reform proposal: (i) simplification and reduction of costs; (ii) legal certainty and transparency; (iii) reduction of distortions and termination of privileges; (iv) maintenance of the tax burden; (v) prevention of tax evasion; (vi) neutrality in economic decisions; and (vii) more investment and employment.

While these principles are laudable, the reality regarding the tax reform project is completely different.

On 2 September, the Chamber of Deputies approved the income tax reform bill (Project of Law 2.337/21). The bill has 80+ pages, 68 articles and provides a long list of possible discussion topics, but this article will focus on the most relevant items for a foreign investor, such as reduction of the corporate income tax rate, taxation of dividends distributions and repeal of the interest on net equity (INE).

The bill proposes to reduce the corporate income tax rate from the current 34% to 27% or 26% (depending on the repeal of some tax incentives), which could be seen as beneficial if viewed in isolation. An 8% tax rate reduction is relevant and important for any company operating in Brazil.

However, dividend distributions, which are currently tax free, would become subject to a 15% withholding tax (certain exceptions may apply). Depending on the jurisdiction of the foreign investor, this may not be relevant, but it may be for multinational entities that are structured and invest in Brazil through a holding company established in the Bahamas, British Virgin Islands or Cayman Islands, for example.

From a local perspective, this balance between the reduction of the income tax rate and the taxation of dividends has to be reviewed and discussed more carefully, assuming that the principles of “less cost” and “maintenance of the global tax burden” will be observed. The bill approved by the Chamber of Deputies may lead to a higher tax burden for most companies and was not well received by taxpayers and tax professionals.

Another not-so-popular measure proposes the elimination of the interest on net equity (INE), which is essentially remuneration paid as interest to shareholders for keeping their capital in the company. This interest is currently tax deductible and a 15% withholding income tax is applied. If the INE repeal is approved, companies could borrow from a bank paying 12% (or even more) of interest per year but could not remunerate their shareholders that keep their investment in the company.

There is no “one size fits all” solution when we talk about tax reforms, it is not easy to satisfy the federal revenue and taxpayers simultaneously.

The good news, from a taxpayer’s perspective, is that the senator in charge of the bill has already declared publicly that he is strongly opposed to the bill as approved by the Chamber of Deputies and that he would not sign such a proposal. He also said he is not in a hurry to approve the bill and that he will not give in to pressures from the government or from other senators.

There is a long road ahead before the bill is enacted into law. The bill was sent to the federal senate, where it has remained, almost untouched, since early September. The Senate will propose the necessary changes and amendments to the current text and send it back to the Chamber of Deputies, which could accept or reject the proposed changes. Finally, the bill would go to the president, who can sign it or veto it (partially or fully).

It is difficult to know what may motivate politicians to approve a bill, and some pieces of legislation have been approved very fast by Congress. However, considering the current relationship between the two houses of Congress, it is unlikely that these proposed changes will be approved this year to be in force in 2022.

Hugo Amano
hugo.amano@bdo.com.br