A Few Notes about Sustainability and Taxes in Brazil
Tax Partner at Campos Mello Advogados in Cooperation with DLA Piper
One of the world’s top priorities nowadays is the sustainability agenda due to climate change. The conditions on Earth have been changing rapidly and drastically as a harmful effect of the global warming caused by the emission of Greenhouse Gases (“GHG”)in the atmosphere. Droughts, floods, large fires, and desertification are a few examples of climate changes derived from the global warming.
Several stakeholders are deeply involved in tackling global warming by adopting several measures to reduce or even stop the emission of greenhouse gases such as transitioning to clean energy, putting in place ways of capturing greenhouse gases, reforestation, and recycling as much as possible. So, reducing the carbon footprint in a journey to net zero is a common target to all economic sectors.
The global movement known as ESG is the best example of how stakeholders are engaged to turn the economy more equal, friendly, balanced, and transparent.
Nonetheless, of course, that journey to net zero is hard, costly and requires deep global engagement. However, there is no alternative route, and we shall join our hands and move on if we want to keep Earth livable.
Governments have a key role throughout this journey since public policies are a powerful tool to induce specific behaviors in order to shrink the carbon footprint. Under this concept of inducing behaviors is taxation as a way of fostering the implementation of measures to reduce the emission of GHG by granting tax benefits, for instance. Granting benefits is not the only way that tax administrations can help toward a greener economy. The mindset must change too. The interpretation and application of tax legislation shall consider the environmental scenario and its challenges so as to connecting them with business activities. The adoption of greener industrial processes, for instance, should be treated in more friendly manner by tax administrations in view of reducing the tax burden once the transition to a greener and less polluted manner of doing business requires heavy investments in technology, training and, sometimes, the reinvention of the venture itself.
Bringing this matter to the Brazilian reality, we must say that some measures have already been put in place by Federal Government as well as by State and Municipal Administrations. Yet, there are many policies to be implemented by tax administrations in Brazil.
The Legal Framework in Brazil
At the top of the Brazilian hierarchy of laws is the Federal Constitution which has a specific chapter dedicated to the environment. It is established therein that everyone has the right to an ecologically balanced environment, including the duty to protect it for the benefit of the future generations.
Just for sake of information, Section 225, amended in 2022, sets forth that privileged tax regimes will be granted to biofuels destined for consumption to make them more competitive toward fossil fuels.
The idea of protecting the environment is spread across the Federal Constitution as stated in Section 170, dedicated to economic activity, which sets out a number of principles on the grounds that economic activity will rely on such issues as free competition, protection of the environment including by differentiated treatment according to the environmental impact of products and services, and their preparation and provision processes, and the reduction of regional and social inequalities.
Section 186 states that the social duty of rural properties is fulfilled by the adequate usage of available natural resources and environment protection.
Once the protection of the environment is elected as one of the Brazilian values, it is logical to conclude that tax administrations shall interpret tax legislation as a contribution to enhance effectiveness of such value.
Putting aside the complexity of the Brazilian Tax System, we will restrict this topic to Corporate Income Tax and Social Contribution over Net Profits, jointly CIT, and PIS and COFINS contributions levied over gross revenue since they are common to all companies running business in Brazil.
According to several rulings from Higher Courts and guidance from scholars, there is a constitutional concept of income derived from the competences granted to the Federal Union by the Federal Constitution to institute its taxes such as CIT.
Section 43 of the National Tax Code establishes that corporate income tax shall be levied over income and earnings of any nature as of their economic and legal acquisition. Income is considered the result of capital, work, and the combination of both. On the other hand, earnings of any nature are qualified as asset increase not encompassed within income definition. Thus, the core of the tax triggering event comprises asset increase.
However, in view of allowing for the calculation of corporate income tax, the legislation sets forth that income and earnings of any nature shall be deducted of some expenses, allowed by the statute, accrued during each calendar year. The legislation applicable to social contribution over net profits follows the same principle.
Section 311 of Corporate Income Tax Regulations, approved by Decree n° 9,580/2018, establishes that operational expenses are not considered as costs, are needed to keep the venture and maintain the productive source. Necessary expenses are the ones paid or incurred to accomplish the transactions or operations required by the sort of activity developed by the venture as set forth in paragraph one. Paragraph two determines that admitted operational expenses are the ones conventional or normal according to the venture type of transaction, operations, or activities.
Having said that, there is a relevant inquiry to be addressed: Are expenses related to transforming the business process into a greener one deductible for CIT purposes?
The answer to the abovementioned inquiry relies on the mindset that shall guide tax legislation interpretation.
Assuming that the reduction of GHG and implementing measures to protect the environment are not only recommended but also mandatory, the conclusion is recognizing expenses related to those actions as necessary and ordinary under Section 311 of Corporate Income Tax Regulations and, thus, it authorizes the deductibility of such expenses incurred by legal entities in Brazil.
There are so many examples of expenses which should be considered deductible for CIT purposes such as recycling, reverse logistics and waste management, reusage of water but, not limited to industrial processes, GHG capture and training to achieve ESG targets.
Section 195, I, ‘b’, of the Federal Constitution sets forth that social security shall be financed through collection of social contributions levied over incomes or revenues accrued by legal entities in Brazil. Paragraph 12 of such section sets forth that law shall define the economic sectors in which social contributions shall follow the non-cumulative regime.
Section 3 of PIS/COFINS legislation listed inputs that authorize credits of such contributions under the non-cumulative regime. We will keep our focus on item II of Section 3 which recognizes goods and services as inputs for providing services and production or manufacturing goods or products destined for sales.
Following decades of litigation between the Brazilian IRS and taxpayers, the Superior Court of Justice has ruled in 2018, with binding effects, that the concept of input according to PIS/COFINS legislation must be interpreted according to the essentiality and relevance requirements, i.e., considering that the indispensability or importance of a certain item — good or service — for the development of the economic activity performed by the taxpayer comprises the so-called necessary expenditures for earning the revenue to be taxed. Hence, such items will allow the credits of PIS and COFINS contributions.
So, there is no closed concept of inputs under PIS/COFINS legislation. The ruling issued by the Superior Court of Justice approximated our legal framework, historically based on civil law, to common law jurisdictions by the necessity of analyzing each case due to its peculiarities in order to conclude which expenses are creditable for the purpose of PIS/COFINS contributions.
The same rationale applied to CIT above is completely applicable to PIS/COFINS legislation once investments to make business processes greener should be understood as inputs to authorize social contribution credits.
Albeit having in mind the formal approach made by the Brazilian IRS to qualify expenses or costs as inputs for the purpose of PIS/COFINS credits, there is an alternative route to follow as from the trial held by the Superior Court of Justice.
There is a very important feature under the relevance criterion such as costs or expenditures imposed by legislation in order economic activity development, or, in other words, inputs imposed by law as a condition to authorize the performing of business activities.
If a specific expense, such as individual protection equipment, is mandatory by the legislation to run a business, thus the letter is qualified as an input imposed by the law, which authorizes PIS and COFINS contribution credits.
In spite of the rationale derived from the Superior Court of Justice, the Brazilian IRS insists on disobeying this ruling by interpreting the legislation focusing only on the collection of taxes, as can be seen in the decision rendered in Answer to Advance Tax Ruling Request n° 215, dated December 28, 2021, in which credits of PIS and COFINS were dismissed over expenditures with reverse logistics by manufacturers and importers of fluorescent lamps in spite of such obligation imposed by the legislation.
The Brazilian IRS mindset raises a doubt about the reverse logistics involving solar panels in the forthcoming years. It is quite certain that new, more efficient models of solar panels will reach the market soon, and thus create an issue, which is the proper destination of replaced solar panels. This type of mindset creates more uncertainty, fosters litigation with taxpayers, and, at the bottom line, drives away new investors.
Nonetheless, there is light at the end of the tunnel. In the Answer to Advance Tax Ruling Request n° 60, dated March 23, 2023, the Brazilian IRS recognized taxpayer rights of setting credits of PIS and COFINS contributions over the expenditure with sewage treatment, imposed by legislation as a condition to the textile industry.
Despite the tax administration mindset, there is an alternative to granting PIS and COFINS credits over investments in environmental measures through the publication of ordinances by the competent public agencies providing specific conditions under which business activities would be performed. Approving ordinances is faster and easier than passing bills to the Congress. To avoid excessive or unfeasible conditions, public hearings should be strongly recommended to gather technical and market information, suggestions, and criticism from stakeholders.
Protective measures have already been taken by several companies in the market, including addressing ESG demands, although without granting tax credits or, at least, without sufficient certainty to avoid or mitigate challenges by Tax Administrations. Therefore, ordinances would have the effect of standardizing the sector and, as a consequence, improving the grounds for pursuing PIS and COFINS credits.
State and Municipal Examples
The Brazilian State VAT, so called ICMS, is the most important tax collected by the States. It is imposed over transactions with goods and products as well as over interstate and intermunicipal transportation, and over communications services.
There are some benefits applicable to ICMS which qualifies such tax as Green ICMS. As part of the ICMS revenues is shared with municipalities, the legislation of some States sets forth that an additional share shall be given in case municipalities maintain environmental conservation units and other protected areas in their territories.
Recently, the State of São Paulo has granted ICMS credits to the car industries manufacturing hybrid cars or fueled with clean energy by Decree n° 66,610/2022.
At the municipal level, São Paulo City Hall has issued Law n° 17,563/2021, which gives credits to electric car owners or those fueled by hydrogen to be offset with debts of municipal property tax.
There are other benefits granted by Municipalities across the country.
CMA in cooperation with DLA Piper
The purpose of this brief article is not to present answers to all questions or define the best way to address all the issues involving sustainability and taxes in Brazil. Actually, it is quite the opposite. The purpose of this article is to raise inquiries to fosters stakeholder’s searching for alternatives with the aim of building a more sustainable society.
Taxes are a huge part of business costs and therefore must be understood as an alternative to incentive ventures to implement greener processes and putting in place ESG values to the benefit of the whole society.
The way to reach net zero depends exclusively on the engagement of all stakeholders.
 For the purpose of this article this concept encompasses the wise way of using natural resources, environmental protective measures and ESG values.
 The most common greenhouse gases are carbon dioxide, methane, and nitrous oxide.
 Environment, Social and Governance.
 There are specific provisions in the Federal Law n° 11,196/2005 related to benefits in investments in research and development of technological innovations applicable to the transformation of business processes into greener ones.
 Chapter VI (Section 225).
 Such as the decisions rendered in the Extraordinary Appeals N°s 71,758, published in 1973; 89,791, published in 1978; 117,887, published in 1993; 195,059, published in 2000; 1,063,187, published in 2021.
 Traditional scholars: Rubens Gomes de Sousa, in Pareceres I – Imposto de Renda. Resenha Tributária, 1975; Bulhões Pedreira, in Imposto de Renda, Vol. I. Justec-Editora, RJ, 1971; and Ricardo Lobo Torres, in Tratado de Direito Tributário Constitucional Financeiro e Tributário, Vol. V. Renovar, RJ, 2007.
 There are a number of debates regarding specific corporate income tax provisions which were not replied in the social contribution legislation, which is why certain additions to the calculation basis cannot be enforced by it.
 Laws 10,637 and 10,833 are quite similar and they will be mentioned herein of solely as PIS/COFINS legislation.
 The cumulative regime is regulated by Federal Law n° 9,718/98, applicable to legal entities that do not reach more than 78 million reais per year in revenue. Such regime is mandatory for financial and similar entities in Brazil.
 Special Appeal n° 1,221,170/PR.
 Pará State – Law n° 7,638/2012.