By David Roberto R. Soares da Silva and Roberto P. Vasconcellos
Reforming the Brazilian tax system seems to be a need recognized by tax professionals, entrepreneurs, executives, and all government levels. The recognition of this need has been further reinforced by the global pandemic that hit Brazil, which, simultaneously, caused a considerable increase in public spending and increased the need to raise the revenue by taxation.
The World Bank’s annual report (Doing business 2020) places Brazil in the shameful 124th place in the ranking regarding business regulation in 190 countries. According to the World Bank, it takes about 1,504 hours a year to comply with tax obligations in Brazil. Interestingly, this number is much higher than that of countries with an even more complex reporting/compliance system than Brazil, such as the United States. In the latter, approximately 175 hours are required annually for tax compliance.
However, unfortunately, the consensus on the need for Brazilian tax reform does not go beyond the mere premise of this need.
For almost 25 consecutive years, Brazilian companies have been accustomed to distributing their profits without any taxation based on Article 10 of Law 9,249/1995. The lack of taxation of members and shareholders of legal entities in Brazil leads many to believe that this is an unjust privilege in a country with very high social inequality. However, the tax exemption on dividends cannot be seen separately from the context of the taxation of the legal entity that determines its distribution.
The corporate income taxation in Brazil is made with four different taxes: corporate income tax itself (IRPJ), social contribution on net income (CSL), and two contributions on monthly gross revenues (P.I.S. and COFINS. Their combined rates reach 43.25%, for companies under the “actual profit” income tax calculation regime.
In other words, merely making dividends taxable in Brazil would only increase the already heavy tax burden on legal entities, possibly expanding the number of insolvent companies, making it even more challenging to generate jobs and, inevitably, increasing tax evasion in the country.
On the other hand, the tax exemption on dividend distributions does not need to be unconditional. For instance, it could apply to distributions to operating companies, enabling the recipient company to reinvest the money into productive business activities. It could also be conditioning it to a certain percentage of equity interest or how long the investor holds the investment, measures that some countries have already adopted. But more substantial studies must precede the feasibility of any of these options in the Brazilian context.
A law project in Congress (Law Project No. 1952/2019) proposes the end of the deduction of interest on equity, reduces the basic corporate income tax rate from 15% to 12.5% and corporate surcharge rate from 10% to 7.5%. The law project also reintroduces taxation on dividend distributions at 15% to all companies, including small businesses under the Simplified Tax Regime.
It is possible that, for the time being, legislators end up choosing dividend taxation as an easy and practical alternative compared to a more profound tax reform that makes the country’s tax system simpler and more taxpayer-friendly. Tax reform would require a lot of compromise from all government levels, but the current pandemic crisis does not favor such a debate, despite some scarce and uncoordinated initiatives by some Congress members.
Due to constitutional limitations, if passed into law in 2020, the new taxation on dividends can only apply as of January 1, 2021. The question remains whether the new tax could reach profits generated before its enactments even if distributed thereafter.
David Roberto R. Soares da Silva and Roberto P. Vasconcellos are founding partner and senior tax associate of do Battella, Lasmar & Silva Advogados, in São Paulo.