Tax reform is expected to simplify consumption taxes but introduce a high degree of exceptionality
While the operating environment will certainly benefit from the simplification this reform will bring, predominantly by decreasing the cost of tax compliance in the country, the bill is expected to impact sectors differently. Brazil’s manufacturing and industrial sector is poised to be one of the biggest winners, as the expected 25% VAT rate would represent a lower tax burden for the industry and address the distortions caused by accumulated taxation throughout the production chain. However, retail and services are expected to experience the biggest increases in tax burdens.
Overview
On July 7, Brazil’s lower house of Congress approved the main text of a tax reform that will change the structure of the country’s consumption taxes. The Chamber of Deputies approved the reform 382-118 in the first round and then passed it in a second round 375-113, well above the necessary 308 votes for approval. The bill now heads to the Senate, where it is expected to receive sufficient support but undergo changes. In sum, the reform aims to introduce a “dual VAT” structure with a unified rate across the country. In practice, this means merging five state and federal consumption taxes—IPI (on manufactured goods), PIS & Cofins (social security contributions), ISS (services), and ICSM (goods and services)—into two value-added taxes on goods and services levied by states (IBS) and the Union (CBS), within 10 years. Goods and services relating to healthcare, medicines, education, transportation, basic food baskets, and rural production will likely have their own tax rates (expected to be 40% of the general VAT). Additionally, the bill also creates a levy on goods and services considered harmful to health and the environment, including cigarettes and alcoholic beverages. The approved proposal also shifts the tax basis from where goods are produced to where they are consumed over a 50-year transition period starting in 2029.
Our View
While the preliminary approval of Brazil’s long-sought tax reform is nothing short of historic, the plan still has a few hurdles to clear: the bill now heads to the Senate, where it should garner sufficient support, albeit with changes to the final text (presumably addressing the last-minute sector exemptions added by the lower house). As a result, the bill will likely return to the Chamber of Deputies, creating a tight timeline for finalizing negotiations before the end of the year. Furthermore, many details will still need to be decided through complementary laws once the reform is approved, including the effective VAT rate—expected to be about 25%, one of the highest in the world. Finally, it’s important to note that these changes will be introduced gradually, and a full transition won’t be completed before 2033; it is only in 2027 that the federal VAT would enter fully into force, while the local-level taxes are only expected to be fully replaced in 2032.
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