As early as this week, the Federal Senate of the Brazilian National Congress may vote a potentially historic tax reform, revamping a tax system that has been in place since the 1960s and has increased in complexity, inefficiency, and compliance cost over the years.

The reform is a draft constitutional amendment (PEC) that requires a favorable vote by at least three-fifths of the members of each chamber of Congress in two rounds of voting (308 in the House of Deputies and 49 in the Senate).

The House approved the amendment on July 7, 2023, with 382 and 370 votes in the first and second rounds, respectively.  The Senate must now vote on the amendment.

Pressure Politics in the Senate

The reform is largely focused on consumption taxes, creating a full-fledged value-added tax (VAT) for Brazil, although it also includes changes in property taxes.  Its outline, political economy, and approval process was discussed in this blog post.

The Senate rapporteur’s report includes key changes to the House-approved draft text.

The Senate is under pressure to establish a tax ceiling for the VAT.  President Luiz Inácio Lula da Silva’s administration is pursuing a strategy to increase government revenue in order to achieve the country’s ambitious new fiscal framework goals.  Private sector groups are concerned the administration might push for a VAT rate higher than the existing tax level, increasing the burden on companies.  They are also concerned about the scope of the proposed Selective Tax on goods and services with negative health and environmental externalities.  The opposition in Congress in echoing these fears.

The Senate is also under pressure to increase the number of exceptions to the standard VAT rate and rules.  Several industries fear the rebalancing of the existing tax burden among sectors of the economy will result in a tax increase once the reform is fully implemented.

Finally, a number of states and cities are requesting changes in the powers and decision-making process of the new entity that will manage the VAT at the subnational level.  They are also requesting more funding from the federal government as compensation for ending several tax-related subsidies benefiting states and that will be phased out once the reform is fully implemented.

Key Changes by the Rapporteur

In response to these pressures, the Senate rapporteur made the following key changes:

  • VAT rate ceiling: creation of a VAT rate ceiling by establishing a so-called “neutrality mechanism” that uses a historic dataset of real tax levels based on a ratio of tax revenue over GDP.  In practice, the goal of this mechanism is to avoid a VAT tax rate that increases the existing tax burden, but without fixing a specific rate into the Constitution;
  • More exceptions: expansion of exceptions foreseen in the House-approved text.  This was done in at least three different ways: (i) by increasing the number of sectors covered either by discounted VAT rates or special tax rules; (ii) by creating a third, 30% VAT discounted rate in addition to the House-approved 60% and 100% discounted rates; and (iii) by extending existing tax-related subsidies to the automotive sector through a longer phasing out period.  The rapporteur also changed the text to allow Congress to further detail, through law, the exceptions based on the list of sectors included in the amendment;
  • Selective Tax: increased control of the new tax by Congress through (i) the explicit designation of it as a non-revenue-generating, regulatory tax; (ii) its detailing by supplementary law, that requires absolute majority votes in the House and the Senate; (iii) the definition of its rate by Congress, with the possibility of changes by the President through Provisional Measures (MPs), that require congressional approval; and (iv) a trigger mechanism that will only allow its implementation in 2027.  The Selective Tax was also extended to include extraction operations, thus potentially affecting the mining, and oil and gas sectors;
  • Federal government funding: increased funding by the federal government to compensate states with the end of existing tax-related subsidies; and
  • Management Committee: transformation of the proposed Federative Council into a Management Committee with the goal of collecting and distributing the VAT at the subnational level.  The new Committee will no longer have the normative power of the Council, will have simplified decision-making rules, and its president will have to be approved by the Senate.  In practice, its institutional design was changed to make it work more as an enforcement agency rather than as a regulatory one.

Next Steps

In addition to the rapporteur’s changes, new amendments to the text are still possible during the debate in the Senate. Hundreds of proposed additional amendments have been filed.

If approved by the Senate, the draft constitutional amendment will return to the House, where it will require another two three-fifths majority votes.  Further pressures to incorporate more changes are expected.

Congress’ leadership has led the tax reform, but it is also considered a key priority of the Lula administration as a way to reignite Brazil’s economic growth and job creation.

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Photo of Diego Bonomo Diego Bonomo

Diego Bonomo is a senior advisor in the firm’s London office. Diego, a non-lawyer, has more than 20 years of Brazil regulatory, trade, and foreign affairs experience at leading business associations, think tanks, companies, and academic institutions. Diego also served in the Brazilian…

Diego Bonomo is a senior advisor in the firm’s London office. Diego, a non-lawyer, has more than 20 years of Brazil regulatory, trade, and foreign affairs experience at leading business associations, think tanks, companies, and academic institutions. Diego also served in the Brazilian government.

Before joining the firm, Diego was Team Leader of the Brazil Trade Facilitation Program at Palladium and Executive Manager for International Affairs at Brazil’s National Confederation of Industry (Confederação Nacional da Indústria, CNI). At the U.S. Chamber of Commerce, he served as Senior Director of the International Division and Senior Director for Policy of the Brazil-U.S. Business Council. Diego also was Executive Director of the Brazil Industries Coalition (BIC), the leading Brazilian business coalition in the United States, and General Coordinator of Foreign and Trade Affairs at the Federation of Industries of the State of São Paulo (Federação das Indústrias do Estado de São Paulo, FIESP). He previously served in the Office of the President of Brazil as advisor to the Minister of Long-Term Planning.

Diego holds a bachelor’s and master’s degree in international relations from the Pontifical Catholic University of São Paulo.