Finocchio & Ustra Sociedade de Advogados | View firm profile
As many readers may know, taxes are not straightforward anywhere in the world but this is particularly true in Brazil and even more so when one looks at Brazil´s indirect taxation on sales and goods, the “Imposto sobre Operações relativas à Circulação de Mercadorias e sobre Prestações de Serviços de Transporte Interestadual e Intermunicipal e de Comunicação” or simply ICMS.
ICMS is a state tax, which means that each of Brazil´s 27 states can legislate, levy, impose and collect it. Also, it causes harmful tax competition between the states that grant tax incentives to attract local investments.
But in particular, it causes a lot of confusion due to the long list of different rules and interpretations.
In order to have some basic rules and provide at least a degree of certainty, there is a national law – law number 87/1996 – that regulates the main items of ICMS taxation according to the Federal Constitution and limits what the States can alter by local legislation. For example, the triggering events are defined by Law n. 86/1996, however, the tax rates can be different as defined by local legislation.
Interstate sales (e.g. a company in São Paulo sells to a company in Rio de Janeiro) have only three possible rates: a) 12% (general rule); b) 7% (when the seller is in a state of the south or southeast regions and the buyer is in the north, northeast and center-west regions); and c) 4% in any situation if the good is imported or does not meet a local content 40% threshold.
These interstate rates are always lower than the rates applicable in internal sales (i.e. when a company in São Paulo sells goods to another company or final consumer in São Paulo) and as a result, Brazil´s Federal Constitution sets forth a tax equalization regime, where the difference between the interstate rate (which is paid to the state of the seller) and the internal rate needs to be collected in order to equalize the tax rate (known in Brazil as “Difal”).
In cases where the buyer of the product is the final consumer and is not an ICMS taxpayer (usually natural persons and companies that are service providers), the difference between rates is paid by the seller to the state where the buyer is located. When the buyer is an ICMS taxpayer (purchasing fixed assets or items that will not be utilized in production or resold), the difference between rates must be collected to the state where the taxpayer is located.
For example, if an industry in São Paulo buys stationery items for its administrative office from a company in Rio de Janeiro, it will have to pay 6% ICMS to São Paulo since the interstate rate between Rio and São Paulo is 12% and the internal rate in São Paulo is 18%.
Until January 4, 2022, no national law provided the general rules regarding ICMS rate differences on interstate sales. However, given the provision in the Constitution, states charged such amounts, and taxpayers usually collected them to the state coffers. In 2021, the Supreme Court issued a binding and final ruling declaring that levying the ICMS rate difference was unconstitutional in the absence of federal law.
As a consequence of the ruling, Brazilian Congress approved on December 16, 2021, Bill of Law n. 32/2021, amending Law 87/1996 to comprise specific provisions for the rate difference levy and nationally regulating the matter, thus allowing states to levy the ICMS rate difference in line with the ruling from the Supreme Court. But the President only signed the bill into law in January 2022.
However, as strange as it may sound, the new law (n. 190/2022) that aimed to correct an unconstitutional charge of ICMS rate difference should also be deemed unconstitutional.
This owes to the fact that the Brazilian tax system, according to the Federal Constitution, should obey the principle of legality (no tax without prior law) and the principle of an enhanced nonretroactivity of the tax legislation. Thus, allowing new taxes or tax increases only if the relevant legislation is passed into law in the prior calendar year (and with at least 90 days between publication) before entering into effect.
In practice, this results in a highly debated issue: if Law 190/2022 should apply to triggering events happening in 2022 or only as from 2023, since it was passed into law only in January 2022. And the only way for taxpayers to solve the problem is to litigate it, requesting a writ of mandamus before state courts to have an order allowing them not to pay the rate difference. (This means that a company might have to file lawsuits in each one of the 27 years. Although, recently, the Brazilian Association of Industries filed direct action before the Supreme Court where a binding ruling could be issued and valid for all taxpayers)
There are arguments in favor of both sides – tax authorities will argue that there is no new tax or tax increase since the internal rate was not modified by the new law, on the other hand, taxpayers will certainly ground their allegation on the nonretroactivity of the tax legislation.
Once again, the Brazilian tax strategy can be the driver for winners and losers in specific economic sectors. Particularly the retail e-commerce segment can achieve tax savings of up to 11% (18% less 7%) if a logistics hub is set in the north or northeastern regions of Brazil to supply final consumers in São Paulo and if the company files for a lawsuit aimed at striking Law 190/2022 in 2022.