The agenda of the moment is undoubtedly the tax reform. Despite the wide-ranging debate on the subject in recent years, the most recent discussions in the National Congress make it clear that the proposal, in addition to lacking definitions on how various aspects of the new system will be implemented, is not being seen with a strategic eye by its debaters in relation to problems that could make the evolution of startups in Brazil unfeasible.

The list of tax reform proposals is long and there are many proposals, but for the point we want to analyze, the proposals for constitutional amendments 45 and 110 (PEC 45 and PEC 110) stand out.

These two texts propose the creation of a Value Added Tax (VAT), similar to that adopted in Europe, India, and Oceania. In an attempt to break paradigms, it is suggested to adopt a broad tax base, which considers transactions involving goods and services (as well as the rights related to them).

Despite the similarities between the two proposals, they differ in one fundamental aspect. While PEC 45 provides for the creation of just one VAT to replace ISS, ICMS, PIS, and Cofins (i.e. the taxes that are currently levied on consumption, services, or products), PEC 110 provides for the creation of a federal VAT and a state/municipal VAT (i.e. a dual VAT), with the same calculation bases.

Both proposals provide for the IPI (federal tax) to be abolished. On the other hand, a selective tax will be created, which will be levied on goods and services that may have harmful impacts on health and the environment, for example.

Given the need to make progress on the issue, a working group (WG) was set up in the Chamber of Deputies with the aim of combining the two proposals and resolving problems identified in the debates, in order to define the text (substitute) that will be sent to the floor. At the beginning of June, the WG presented a report with some guidelines.

Thus far, it is known that the substitute will include a kind of dual VAT. Standard and differentiated rates will be adopted for certain sectors and a broad right to credit will be guaranteed; in other words, the tax paid at one stage will be used to write off the tax due at the next stage.

Among these issues, the most worrying is the tax rate. The proposals stipulate that the tax will be levied on the basis of a standard rate, regardless of the sector, which will correspond to the sum of percentages defined by the entities. This percentage, however, remains unknown, with speculation that a rate of around 25% will be adopted. This is the big obstacle that startups have to face.

As is known, most startups are service providers, following the global trend towards the "servitization" of the economy.

Currently, services in Brazil are taxed at a rate that varies from 2% to 5%, depending on the municipality. To this must be added PIS and Cofins, which are also levied on service transactions, at the rates of 3.65% in the cumulative system and 9.25% in the non-cumulative system. Depending on their field of activity, startups can also be covered by the Simples Nacional system, which has rates similar to those mentioned above.

The definition of a rate higher than the aggregate rate of the taxes currently levied means, therefore, a clear increase in the tax burden.

It could be argued that the tax reform preserves the Simples Nacional system, which guarantees taxation more in line with small companies and to which some startups are subject.

Perhaps that is why there has not been much movement from this segment of companies around the reform. This is a worrying attitude, as it disregards its own growth in the short term, a fact that would limit the continuation of a Simples Nacional company.

It is clear that rapid growth, a characteristic (and objective!) of startups, will lead these companies to bear a higher tax burden, much higher than the one applied today when they leave Simples Nacional. This could even influence tax planning to keep companies in the most beneficial tax system, a very questionable initiative.

Proponents of the reform say that there will be no increase because there will be ample credit rights. However, this mechanism does not have much impact on the service sector for three reasons: 

  • the provision of services is not conditional on the large purchase of goods or services that could accumulate credits in this chain;
  • the biggest expense in the service sector is labor, which does not generate credit - this impossibility of credit will induce more and more services provided through individually owned corporate entities in these chains; and
  • the increase in the tax burden cannot be neutralized by non-cumulative taxation because, for the most part, services are provided directly to the end consumer.

The congressmen are aware of this, but they believe that, in general, it is the richest who consume services. However, even if this premise is true, the reality is changing. Startups operate on two major fronts which, indirectly or directly, promote consumption of services by a broad spectrum of the population.

Indirectly, startups develop technological and disruptive solutions to meet the needs of the productive sectors, making it possible to reduce the cost of end products. In a direct, and remarkable, way, they help to decentralize access to goods and services, favoring the most varied sections of the population.

A large increase in the tax burden, however, will certainly reduce the scalability potential of these solutions, not because of their nature, but because of the loss of competitiveness due to the market's inability to absorb the price increase.

Tax simplification, with the adoption of standard rates, cannot be a pretext for penalizing the services sector, especially startups, given their economic importance.

On this issue, sectors of the economy have managed to raise awareness among congressmen. Understanding the importance and effective impact of this increase, the congressmen included in the WG's report the possibility of establishing differentiated rates for certain sectors, such as health, education, and agricultural production.

Even if it is not possible to extend this mechanism to all sectors, it is necessary to look for other instruments to reduce this final cost. One of the alternatives suggested by the technology sector, through the Association of Brazilian Information Technology Companies (Assepro), is the adoption of a mechanism to exempt payroll. It is an interesting idea, as it avoids the proliferation of services provided through individually owned corporate entities} of the chain or the inclusion of employees in the corporate framework as a form of tax planning.

Another point is tax breaks, which, according to the proposals under discussion, should in principle be banned.

Therefore, whether through differentiated tax rates, payroll tax relief, or any other mechanism, such as tax benefits, it is certainly still necessary to deepen the debate regarding the proposals on the tax mechanisms that should be implemented. The discussion is fundamental for guiding tax policies to encourage investment in startups, whatever the sector in which they operate.