Fiscal Wars in Brazil
In an attempt to attract investments and new companies Brazilian states and municipalities offer various tax benefits, resulting in disputes between them. This article explains what are the fiscal wars in Brazil and why do they happen.
What factors should a company analyze when deciding which is the best place to establish itself in Brazil? What are the best regions to open a new factory, store or branch? What are the best regions to start - or continue - its expansion process in the country?
There is no simple, immediate answer, but the factors commonly analyzed are related to cost-benefit. How the logistics systems available in certain regions will benefit or harm the business; how large and qualified is the available workforce in the region; how close will the company be from its suppliers and clients.
Among all of these factors being weighed up, one is recurrent: how much money will be spent. A place might be very attractive in terms of infrastructure, for example, but it becomes unattractive if it is just too expensive to settle there.
Thinking about this many states and municipalities in Brazil began to offer tax incentives for companies doing business in their territory. Actions like reducing tax rates or even tax exemptions for companies from certain sectors. The main issue is that the extension and intensification of this kind of policy lead to a problem felt by every governmental and private sphere: fiscal war.
If states and municipalities begin to grant more tax benefits, tax collection is decreased and there is less income. Also, companies that are already established in a state that offers tax benefits rarely have the opportunity to acquire exemptions or other similar benefits.
This scenario is quite common in Brazil, particularly relating to two specific taxes: ICMS and ISS. The first one is a state tax, while the other one is municipal. Yet, both require measures to stop fiscal wars in the country.
Imposto sobre Circulação de Mercadorias e Serviços (ICMS, or Tax on Circulation of Goods and Services) is considered one of the main causes of fiscal wars in Brazil. ICMS is a state tax, which means that, as long as some requirements and limits imposed by the federal government are followed, each state can define its rate and exemptions.
The ICMS discounts offered by some states - usually the poorer ones, farthest from large urban centers - often outweigh logistics and supply costs. There are several cases where the collection of ICMS can result in a fiscal war:
- Bahia collects lower ICMS from operations involving certain goods produced in the state, such as vehicles, shoes and furniture
- Pernambuco offers ICMS benefits to attract more operations involving imported goods
- Goiás grants ICMS benefits for companies that produce airplanes, parts and components
These processes are being analyzed by the Brazilian justice, in order to define if these practices are illegal or not.
Another discussion regarding ICMS is related to imported goods. Some Brazilian states, like Espírito Santo and Santa Catarina defined that operations involving foreign products were subject to an ICMS exemption. For some time, if an operation happened in Santa Catarina instead of Minas Gerais, for example, companies would face a rate of 0% instead of 7%. To solve this, the federal government established a unified 4% ICMS rate for all the interstate operations in the country.
The situation seen with Imposto Sobre Serviços (ISS, or Tax on Services) is quite similar to ICMS. ISS is a municipal tax, so each city defines its own tax rates, as well as tax benefits, incentives and exemptions. Municipalities offer lower ISS rates to attract companies, also reducing tax collection and harming the government’s income.
One of the main debates involving ISS is related to double taxation. There is no consensus whether this tax should be collected in the municipality where the company providing a service is established or where the service is being provided. This fact can result in two different municipalities charging ISS on the same service, since neither of them want to give up the tax collection.
The ISS rate should not be lower than 2% nor higher than 5%, according to federal law. But since municipalities are free to concede benefits and exemptions, cities in São Paulo’s countryside, for example, reduced the rate to 0,5% in some cases.
There are bills being processed in the Brazilian National Congress to set the ISS rate to a minimum of 2% for all municipalities in the country, also restraining the possibility to grant tax reductions and exemptions. The project, however, faces resistance by many cities whose attraction for establishing companies depend directly on such benefits.