The more we study the terms of the tax reform currently under review by the National Congress through PEC 45/2019, the more we strengthen our conviction that the infrastructure sector will soon face significant new challenges. Borrowing a title from cinema, it’s necessary to talk – and a lot – about this “Kevin”[1].
From the outset, we know that the potential impact of tax reform on infrastructure will be multifaceted. Some business models in the sector will become taxable, such as the leasing of movable and logistical assets – which currently does not fall under ISS (Service Tax) or ICMS (Tax on Circulation of Goods and Services) [2]. Instead, it will be subject to CBS (Contribution on Goods and Services) and IBS (Tax on Goods and Services), which have a broader tax base and include “operations with goods and services,” including leases.
Additionally, Reidi (Special Regime of Incentives for Infrastructure Development), an important benefit for the infrastructure sector, as well as Reporto (Tax Regime for the Modernization and Expansion of Port Infrastructure), Repetro (Special Customs Regime for Export and Import of Goods for Oil and Gas Exploration), and Recof (Special Customs Regime for Industrial Warehousing under Electronic Customs Control). Were not included in the reform, despite the provision that the complementary law might address reductions in new taxes for Capex (capital expenditures) acquisitions.
Moreover, concession and PPP (public-private partnership) contracts will likely need recalibration. For instance, Article 9, §3 of the General Concessions Law allocates the risk of tax changes to the government, with the sole exception of income tax changes.
Given these implications, it is now crucial to systematize the potential tax impacts and their contours to understand how to respond to what is approaching. Even if immediate changes may not seem necessary – as the reform is still progressing through Congress – there must be a sense of urgency regarding potential impacts on modeling and negotiations, which should be addressed promptly.
This includes lease instruments for assets, movable (such as lighting fixtures or solar panels) and immovable (in the form of built-to-suit arrangements), whose contracts could already include clauses to address renegotiation if taxation on leases by the new taxes becomes mandatory.
It also involves projects benefiting from tax incentives, where development will need to clearly understand the transition rules from one tax regime to another. The end of certain benefits will likely lead to binary decisions: either anticipate the risk of losing tax benefits or establish a cautious – yet swift – action plan to secure authorization as a “perfect legal act” before the benefit is terminated by new legislation.
Similarly, concessions and PPPs will require an initial analysis of ongoing contracts to investigate how the risk of tax changes is allocated and whether the reform is considered a “prince’s act,” which would make contractual rebalancing absolutely necessary if costs increase relative to the original plans for exploiting public services and assets. Moreover, questions will persist about when the reform will actually impact contracts (as many provisions will need to be regulated) and how to measure the imbalance, for example, in terms of projected versus actual demand or how to calculate compensation for the imbalance – which, if based on real demand, will likely persist until the end of the partnership contract.
In parallel, it is timely for new concession contracts to address this issue in their modeling. Simply replicating the General Concessions Law does not ensure the most suitable formula for rebalancing the concession agreement, nor does it necessarily provide definitive security to the private investor. Clearer guidelines are needed on how to assess imbalances, calculate rebalancing, and address the entire contractual equation.
It is known that infrastructure contracts are mostly considered incomplete, meaning they cannot foresee all future events in service and project execution, often adjusted over extended periods. However, this sector characteristic cannot be used as an excuse to neglect the points raised here, especially since they are publicly known and pertinent to Brazil’s infrastructure agenda. However, this sector characteristic cannot be used as an excuse to neglect the points raised here, especially since they are publicly known and pertinent to Brazil’s infrastructure agenda.
Furthermore, the current stage of parliamentary discussions allows for other avenues of debate. For instance, mitigating much of the tax cost increase impact by including the sector in special regimes, i.e., by instituting exceptions to benefit infrastructure’s tax treatment, could be considered.
Despite criticisms about the complexity of such arrangements, the truth is that the infrastructure sector underpins the country’s economic development, with consequent impacts on fiscal revenue dynamism. If infrastructure is ready and operational, generating jobs, providing services, ensuring logistics, and creating numerous externalities, the state will ultimately collect more tax from the wealth generated by society.
Thus, there seems to be both social and economic sense in considering some exceptions in the infrastructure sector, such as the example of basic sanitation services, which are currently not taxed by ISS as the tax on these services does not serve the public interest, as stated in the veto reasons for the current legislation: “Taxing environmental sanitation services, including purification, treatment, and sanitation, as well as water treatment and purification services, does not serve the public interest. Taxation could undermine the government’s goal to universalize access to these basic services. The disincentive caused by taxation could result in increased long-term expenses for servicing populations lacking access to basic sanitation and treated water.” (Message 362, July 31, 2003, PL 161/1989).
Another legislative solution to infrastructure challenges could involve providing a precautionary or minimum regulatory framework for processing rebalancing already guaranteed by legislation. After all, there will be no doubt about the imbalance generated, but there will be questions about its processing, method, and timing of payment. Whether or not one agrees with the solutions, it is essential to think about and debate the impacts of tax reform on the sector to avoid negatively affecting users and the country, increasing transaction costs in Brazil, and leading to endless legal disputes over contractual rebalancing in concessions and private infrastructure projects. We need, therefore, to talk more about this “Kevin.”
[1] Reference to the British-American film “We Need to Talk About Kevin,” directed by Lynne Ramsay, based on the book by Lionel Shriver.
[2] As reiterated by the STF jurisprudence: Extraordinary Appeal 540829/2014.
The article was produced by SouzaOkawa Advogados and published by Agência Infra. To access the full version, click the link below.