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Brazilian consumption taxes are highly complex. Different levels of government have the authority to levy taxes on consumption, leading to the coexistence of multiple taxes, each governed by distinct rules. This complexity creates numerous challenges, such as tax competition between states and conflicts of jurisdiction among different tiers of government. Despite doubts about the possibility of tax reform in Brazil, the long-awaited simplification of the tax system has finally been enacted after nearly four decades of discussions and several unsuccessful attempts.
Current Brazilian consumption tax system
The Brazilian Federal Constitution of 1988 granted the authority to levy consumption taxes to all levels of government — federal, state, and municipal. As a result, Brazil operates with multiple layers of taxation, with various taxes existing concurrently. This constitutional framework delineates the division of taxation responsibilities regarding goods and services as follows:
- The federal government is empowered to impose a non-cumulative tax on manufactured products (IPI) and social contributions (PIS/COFINS).
- States are authorized to collect a non-cumulative tax on tangible goods, communication services, and inter-state and inter-municipal transportation (ICMS).
- Municipalities are granted the right to levy a cumulative tax on services (ISS).
The tax on manufactured goods (IPI) is imposed at each stage of industrial production and on the importation of manufactured goods. Typically ranging from 5% to 30%, the statutory rate structure can escalate up to 300% for certain products, such as tobacco, effectively functioning as an excise tax. PIS/COFINS are social contributions levied under three distinct regimes based on taxpayers' business activities. In certain scenarios, taxpayers may be subject to more than one regime, rendering PIS/COFINS a highly complex tax and a significant source of litigation in Brazilian courts.
State tax (ICMS) is imposed on goods and selected services, including communication and inter-state and inter-municipal transportation services. State tax complexities arise from fragmented legislation across 27 state jurisdictions as states possess considerable autonomy in administering the tax, setting rates, and determining taxable bases, primarily following the origin principle. ICMS rates vary among the states, ranging from 17% to 25%.
Municipal services tax (ISS) applies to services not covered by state tax, with rates ranging from 2% to 5%. Since ISS does not allow input tax credits, taxes accumulate throughout the production chain, exacerbating compliance burdens.
Brazil's complex consumption tax system and fragmented legislation render tax administration and compliance arduous and costly. Conflicts of jurisdiction among different levels of government frequently arise in determining which entity has the authority to tax specific items. Disputes often emerge between municipalities and states regarding the classification of goods or services, a pivotal distinction dictating the applicable tax level. The lack of harmonization in state tax, coupled with its grounding in the origin principle, fosters economic distortions and complexities, as states wield ICMS as an industrial policy tool, offering exemptions or reduced tax rates to attract industries. This practice, prevalent across states, contributes to a phenomenon known as the "tax war" among states. Furthermore, disputes stemming from the existing consumption tax framework typically escalate to administrative and judicial courts. Due to the presence of numerous tax provisions in the Brazilian Constitution, tax-related cases frequently find their way to Brazil’s Supreme Court. This process may extend over several years before a decision is reached, thereby exacerbating tax uncertainty.
Brazilian tax reform
Efforts to enact broad reforms of Brazilian consumption taxes have long been part of the political agenda. However, conflicting interests among states, municipalities, and the federal government have led to the failure of many reform proposals in the National Congress. One of the primary challenges hindering the approval of tax reform in Brazil was the federative structure and the autonomy of each governmental level. States and municipalities feared that proposed reforms could undermine their fiscal autonomy, as they would rely more on revenue sharing rather than direct collection. Additionally, opposition from various business sectors presented another hurdle. This was primarily due to the uneven distribution of consumption tax burdens across sectors, with reform proposals aiming to align them, potentially increasing taxes for some sectors while decreasing them for others.
On 20 December 2023, Brazil approved the long-awaited reform, replacing the existing consumption taxes with a dual VAT system comprising a subnational VAT (imposto sobre bens e serviços, IBS) and a federal VAT (contribuição sobre bens e serviços, CBS). Both federal and subnational VAT will share key features, such as the taxable transaction and base, and will operate on a non-cumulative basis following the destination principle. Each level of government — federal, state, and municipality — will have the authority to set its own VAT rates, which will apply uniformly to all goods and services within their respective territories, unless exceptions apply. Estimates suggest the general rate of the dual VAT will be approximately 27%. The details of the dual VAT system will be regulated by complementary laws that are still to be enacted. The full implementation of the dual VAT is scheduled over a seven-year transition period, spanning from 2026 to 2033. In 2026, CBS will be introduced at a rate of 0.9%, while IBS will start at 0.1%. These rates will gradually increase throughout the transition period until their complete phase-in by 2033.
The reform designates the Federal Revenue Agency to administer the federal VAT and establishes a separate, independent entity — the IBS Federative Council — to oversee the subnational VAT. Composed of representatives from 27 states and 27 municipalities, the IBS Federative Council will centralize the collection, administration, and regulation of IBS. It will also harmonize interpretations and rulings, manage administrative disputes, and coordinate subnational tax audits. Under the new system, suppliers will register and remit CBS to the Federal Revenue Agency and IBS to the IBS Federative Council only, streamlining processes compared to dealing with multiple state and municipal entities. Moreover, tax credits and refunds will no longer be contingent on individual subnational levels, as is currently the case, reducing delays and uncertainties in the refund process.
Although Brazil's dual VAT model drew inspiration from Canada and India, both of which also have consumption tax jurisdiction shared with subnational entities, it differs significantly from its counterparts. Canada operates a centralized system where the federal government administers and collects the Harmonized Sales Tax (HST) for participating provinces. On the other hand, India utilizes a system that applies a separate tax (Integrated Goods and Service Tax) to interstate supplies. Initially proposing a single VAT system, Brazil faced opposition to transferring tax enforcement power to the federal government from states and municipalities. Concerns about centralization weakening federalism's checks and balances prompted a compromise — a dual VAT system with federal and subnational components, each overseen by different tax authorities.
Implications for foreign remote sellers
Foreign remote sellers currently have no tax compliance obligations in Brazil. Unlike many other countries, Brazil has not implemented special regulations mandating remote sellers to collect Brazilian consumption taxes on digital services provided to Brazilian customers.
Although the proposed reform does not explicitly outline rules for foreign sellers of digital services, some initial insights can be drawn based on its overarching principles. Under the Brazilian dual VAT system, taxable transactions will include both domestic and import transactions involving tangible goods, intangible goods, and services. The destination principle will apply to both cross-border transactions and domestic ones, but the criteria for determining the customer's location will be specified in the complementary law. As a result, services provided by foreign sellers will be subject to taxation in Brazil. However, the specific tax collection mechanism Brazil will adopt has yet to be determined. If tax collection obligations are imposed on foreign sellers, they will face significant challenges in determining the customer's location and the applicable tax rate, which may vary from one municipality to another.
It will be interesting to see whether Brazil will follow the OECD recommendations on tax collection mechanisms for foreign sellers. The OECD guidance recommends implementing a simplified registration regime for business-to-consumer suppliers of services and intangibles, involving intermediaries in the tax collection process whenever possible, using electronic procedures for registration and return submission, and eliminating invoicing obligations. Some LATAM countries follow the OECD recommendations and require foreign sellers to register, limiting their compliance obligations to what is strictly necessary for effective tax collection. However, other countries view the recipient of the digital service as the person liable for paying the tax, designate local payment service providers as VAT withholding agents and relieve foreign providers of cross-border digital services from any tax collection responsibilities.
An intriguing aspect of the Brazilian dual system is that it will levy VAT on transactions involving tangible or intangible goods, as well as the provision of services. In the EU VAT system, supplies of goods entail the transfer of tangible property ownership. However, under the Brazilian new system, the supply of goods no longer necessitates tangibility. This implies that digital products in Brazil could be categorized as either goods or services. As a result, the same product could be considered a service in the European Union and simultaneously classified as a good in Brazil.
Concluding remarks
The Brazilian tax reform aims to address long-standing issues of tax competition and jurisdictional conflicts among different levels of government. Once fully implemented, it is expected to simplify taxation and enhance tax administration and compliance. The new system will align more closely with international tax principles and will also encompass digital services provided by remote sellers to Brazilian customers. However, clarity is still needed regarding the application of tax collection responsibilities. Furthermore, the tax reform is anticipated to stimulate foreign investments in Brazil. Many companies interested in investing in the country currently hesitate due to the complexity of the tax system. However, the cost reductions resulting from the reform may lead to increased interest in establishing a local presence in Brazil.
