The Brazilian tax system provides for a number taxes with a VAT nature. Amongst them, there are two federal welfare contributions – the PIS and the COFINS – which basically aim at supporting the social security and the social welfare with funds arising from the Brazilian legal entities’ gross revenues, as well as from the importation of goods and services.
Although originally imposed on cascading basis, currently, most Brazilian companies accrue the PIS and COFINS under a VAT system at a combined rate of 9.25 percent (7.6 percent COFINS plus 1.65 percent PIS). Under such system, the taxpayer is entitled to accrue PIS/COFINS credits – at a 9.25 percent rate – over listed transactions, as well over the acquisition of inputs, to be offset against their PIS/COFINS outputs.
However, over the years, Brazilian taxpayers and the federal government have been fighting over the concept of input.
In effect, as there is no clear concept of “input” within the PIS and COFINS legislation, Brazilian tax authorities understand that only goods and services directly applied or consumed during the manufacturing process or the performance of services shall fit into such concept.
Brazilian taxpayers, on the other hand, argue that a bigger array of goods and services should have been deemed as inputs for PIS and COFINS purposes, especially if one considers that the PIS and COFINS generally levy over the taxpayer's gross-revenues. In this sense, by searching in the Brazilian tax legislation for a closer parallel, some Brazilian taxpayers have been arguing that the concept of "input" for PIS/COFINS purposes must be follow the same criteria adopted by the Brazilian Income Tax Legislation while defining "operational expenses" and which refers to any and all disbursements required by the company’s activities and for generation of revenues.
Although, at first, there were some administrative decisions acknowledging the taxpayers’ position, the Brazilian Taxpayers’ Council, which is the administrative appeal court for federal taxes, adopted a middle ground understanding, which is neither the one adopted by the Brazilian IRS nor the one supported by the taxpayers'. According to the Brazilian Taxpayers’ Council, the concept of "input" must be defined as every asset or service which, directly or indirectly, is used in the provision of services and in the production or manufacturing of goods or products destined to sale. In addition, they must correspond to essential, necessary or indispensable expenses required by taxpayer’s service or manufacturing process.
On the judicial level, the case law is still under construction. Second level decisions, issued by the Brazilian Federal Courts of Appeals, still differ between the strict understanding of “input”, as defended by the Brazilian tax authorities, and the broader understanding related to the essential criteria, first proposed by the Brazilian Taxpayers’ Council.
In effect, even at the Superior Court of Justice (“Superior Tribunal de Justiça - STJ”) – which is Brazil’s highest appeal court for non-constitutional issues – there is still some controversy between the two Chambers which typically rule on tax matters. In effect, while the First Chamber is still debating the concept of input, the Second Chamber considers that the acquisition of assets and/or services, which are essential for the manufacturing of goods and/or performance of services, fits under the concept of input.
Recently, Domingos Costa Indústrias Alimentícia S.A., a taxpayer from the food and beverage industry, obtained an important decision at the Superior Court of Justice level (REsp # 1.246.317/MG). In a case that was lingering for more than 10 years, the STJ’s Second Chamber acknowledged that cleaning products and fumigation services, although not directly used on the food manufacturing process, are essential to the production itself and, therefore, their acquisition must generate PIS and COFINS credits.
This was indeed an important award for Brazilian taxpayers and shall serve as a paradigm for other industry players, being the first time a taxpayer from the food and beverage industry is granted the right to offset PIS/COFINS credits originated from cleaning and fumigation costs. This decision also puts pressure on the STJ to settle the controversy at the Chamber’s level.
The discussion, however, is still open as tax authorities continue to assess taxpayers based on a restrictive interpretation of the PIS and COFINS legislation while there is no settled position at both the STJ and the Brazilian Supreme Court levels. As a matter of fact, even though one may argue that the discussion on the concept of input deals with a breach of non-constitutional rules only, there is a high likelihood that Brazilian tax authorities appeal to the Brazilian Supreme Court level should the STJ favors the taxpayers’ position.