Brazil: The Brazilian Fiscal Plan

Walter Douglas Stuber and Ricardo Baraldi Macedo *

Brazil's government announced on October 28, 1998, the so-called "State Fiscal Stabilization Program" ("Programa de Estabilidade Fiscal"), an awaited fiscal austerity project aimed at controlling the country's fiscal deficit. For the purpose of "definitively making the State live within its budget", as declared by the government's economic team, two sets of initiatives were proposed: (a) structural/institutional changes to the existing fiscal regime; and (b) immediate-impact initiatives, compiled in a three-year cost-cutting plan denominated "1999-2001 Plan of Action".

Below we outline the main points of such Stabilization Program:

1. Measures of an Institutional Nature

1.1. Regulation of the Civil Service Reform

In order to promptly implement the clauses of the civil service reform1 approved by Congress in June 1998, the government will submit to Congress regulatory laws which (i) creates limits for personnel costs equivalent to 60 percent of federal, state and municipal revenues; and (ii) sets standards for the performance of civil servants (among them, rules for dismissal due to overstaffing and loss of a public function due to insufficient performance).

1.2. Social Security Reform

As the social security constitutional reform2 is pending a final vote in Congress on three remaining amendments, the government will concentrate efforts to have such amendments rejected and the original text of the reform approved in full.

If approved by Congress, the social security reform will then be regulated by law, under the principle of actuarial balance (the forecasting of the equivalence between the expected present value of the contributions and of the benefits).

Additionally, a law to prevent social security fraud and a law regulating pension plans for public sector workers will be submitted to Congress.

1.3. Law of Fiscal Accountability

According to the government's economic team, "the absence of a general law providing prudential rules for fiscal management, expenditure control and level of indebtedness is one of the main structural causes of the public sector fiscal desequilibrium". For such purposes, the government will submit to Congress a new law setting limits for the annual debt, deficit, spending and income, while establishing criteria to make all spheres of government more accountable for their spending.

1.4. Tax Reform

The government will submit to Congress a constitutional amendment eliminating a series of taxes and replacing them with a single value-added tax. The government's intention is to simplify the existing tax system without reducing the current state and municipal revenues or global tax collection level.

The government also intends to propose a constitutional amendment extending until December 31, 2006 its Fiscal Stabilization Fund (FEF), a temporary measure due to run out in December 1999, that enables the federal government to hold a certain amount in tax receipts that under the Brazilian Constitution would normally go to States and Municipalities.

1.5. The Labor Legislation Reform

The government announced its intention to send to Congress constitutional amendments destined to deregulate labor legislation and thus reduce the current unemployment levels.

1.6. Restructuring of the Federal Internal Revenue Service ("Secretaria da Receita Federal")

A new law will be proposed aimed at restructuring the Federal Internal Revenue Service, offering such governmental body more autonomy.

1.7. Deregulation of the Fuel Sector

The federal government will suspend some of the federal subsidies on fuel.

2. The 1999-2001 Plan of Action

The 1999-2001 Plan of Action is a three-year cost-cutting austerity fiscal plan, made up of immediate-impact spending cuts and tax increases, conceived to urgently narrow the huge budget deficit and generate primary surpluses of 2.6 percent in 1999, 2.8 percent in 2000 and 3 percent in 2001. Such measures are expected to produce a total economy of 28 billion Reais in 1999, 33.8 billion Reais in 2000 and 38 billion Reais in 2001 and thus trigger a cut in interest rates, from the current 42 percent to around 20 percent by 1999, 15 percent by 2000 and 10-15 percent by 2001.

Following we comment the key points of 1999-2001 Plan of Action:

I) Tax Increases and Similar Measures

1) Constitutional Amendment3 - CPMF transactions tax

A constitutional amendment will be proposed to extend the validity of the temporary financial transactions tax, known as CPMF, until 2001 (such tax was supposed to expire in February 1999). In addition, the constitutional amendment will raise CPMF tax to 0.38 percent in 1999, from the current 0.20 percent. In 2000 and 2001, the tax will be cut back to 0.3 percent.

The rise in CPMF is expected to retract the exportation level and negatively affect the Brazilian capital market, by excessively burdening the cost of national products and capital flow, respectively, in comparison to other markets.

2) Provisional Measure No. 1724 of October 29, 1998

a) COFINS Contribution

The contribution to finance social security due by legal entities, known as COFINS, was raised to 3 percent from 2 percent. Such a rise can be offset against the company's Income Tax liability in the same tax period.

Banks and financial institutions as well as companies engaged in the real estate business will be required to pay the COFINS contribution for the first time (at the 3 percent rate). Such measure, together with the rise in CPMF transaction tax, shall cause a rise in loan interest rates, which already are maintained at extremely high levels (42.4 percent per annum), and in banking services.

b) Individual Income Tax

Individuals entering the country under both temporary and permanent visa will now be subject to taxation as residents. Formerly, temporary visa holders were subject to a special tax regime for their first 12 months in the country.

c) Corporate Income Tax

(i) Monetary Variations

For income tax purposes variations due to inflation, index or exchange booked shall be considered as financial revenue or expenses, depending on the case.

(ii) Premium Amortization

Premium derived from future profitability perspective in a merger or acquisition will no longer be subject to a maximum 10-year-period. As from 1998, premium amortization will be at 1/60, at the most, for each month of the period. Therefore, the minimum 5 year amortization period was maintained.

(iii) Deferred Assets

For the purposes of accounting for the deferred asset arising from the premium based on profitability perspectives, taxpayers can choose to reclassify such amount in the Net Equity accounts.

(iv) Presumed Profit - Extension

The possibility of legal entities adopting the presumed profit method for income tax purposes was extended to those companies earning up to 24 million Reais per year as gross income while other limitations for such taxation method adoption were eliminated (for example, foreign controlled subsidiaries can now chose this regime).

3) Retired Federal Workers Pension Contribution ("INSS")

Approximately 446,942 retired federal servants will be required to pay a minimum 11 percent pension contribution, currently assessed only on active federal servants.

4) Provisional Measure No. 1.720 of October 28, 1998 - rise in pension contribution

Federal servants earning over 1,200 Reais per month (488,989 servants) will be required to pay an additional 9 percent social security contribution, for five years as from February 1, 1999.

5) Provisional Measure No. 1721 of October 28, 1998

Judicial deposits regarding federal tax disputes, made in court or administratively, will now be incorporated into current tax revenue as soon as the involved litigants provide such cash deposits. The government is obligated to return such deposits immediately in case of defeat. The conversion of judicial deposits into government's revenue is only acceptable, according to the existing system, when the disputes to which such deposits are connected with are definitely settled. Such measure shall be in effect as from December 1, 1998.

II) Spending Cuts

The government will submit to Congress a bill presenting a new version of the 1999 budget, including cuts of 8.7 billion Reais in federal government spending and a reduction of 2.7 billion Reais in federal state company spending between 1999 and 2001.

In 2000 and 2001, the government expects to save 8.84 billion Reais and 9.02 billion Reais, respectively, in federal cuts.

III - Other Considerations - Help from the IMF

Such triennial austerity fiscal plan, together with an approximately 30 billion dollar line of credit to be presumably granted by the International Monetary Fund ("IMF") and other lending agencies, is expected to guarantee the success of the Brazilian anti-inflation economic program until the structural reforms mentioned in item 1, above, are not completely performed, as well as restore investor confidence in Brazil's battered economy, discredited after the massive capital outflow triggered by the Asian and Russian crisis.

São Paulo, November 4, 1998

* The authors are respectively founding partner and articled clerk of the Brazilian law firm Amaro, Stuber e Advogados Associados. Amaro, Stuber e Advogados Associados is a member of Globalaw - the International Law Group, a network of independent law firms, as well as legal consultant to the Brazilian Association of Multi-Service and Commercial Banks ("ABBC").


1 Constitutional Amendment No. 19, of June 4, 1998, introduced the following changes in the civil service framework: (i) end of employment stability, enabling dismissal of public servants for unsatisfactory performance; (ii) greater expenditure control; (ii) new limits and criteria for the payroll policy; (iii) deregulation of the public servant hiring/dismissal procedures; (iv) professionalism of the public function; and (v) greater autonomy for the indirect administration.

2 The Social Security Reform creates a new regime for public and private employees, the main features of which are the following: i) elimination of the possibility of retirement based exclusively on the number of years in service; ii) establishment of a minimum age for retirement (60 for men and 55 for women) as well as of a minimum period of contribution to social security before retirement (35 years for men and 30 years for women); iii) elimination of exceptions to the retirement rules and of special privileges associated to it; iv) establishment of a ceiling for social security benefits' payments; v) prohibition of the establishment of special funds within public administration to grant special retirement benefits.

3 Constitutional amendments in Brazil require congressional approval by a three-fifths majority.

The content of this article is intended to provide a general guide to the subject matter. A specialist's advice should be sought in order to provide professional advice on a case to case basis which will meet specific circumstances.

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