Camillo Giamundo and Leonardo Muradian Cundari

The impact of Brazil’s tax reform on public contracts, highlighting bills that seek to ensure economic and financial rebalancing during the tax transition.

At the end of 2023, the National Congress approved Constitutional Amendment 132/23, which laid the foundations of tax reform in Brazil. The aim of the reform is to simplify the national tax system and give effect to the constitutional principles of taxation, unifying five taxes (PIS, Cofins, IPI, ICMS and ISS) into a single levy, divided between two levels of the federation: a VAT (Value Added Tax) made up of the CBS (Contribution on Goods and Services), under federal jurisdiction, and the IBS (Tax on Goods and Services), to be levied concurrently by the states, the Federal District and the municipalities. In addition, the creation of the IS (Selective Tax) is provided for, with a regulatory purpose, levied on goods and services harmful to health or the environment.

It took long years of discussion in Congress, with the Executive Branch and civil society, culminating at last in the approval of the base text of CA 132/23, bringing important changes to the 1988 Federal Constitution.

Accordingly, discussions on the regulation of the tax reform began in Congress. So far, thirteen bills have been submitted to regulate the many elements included in the Constitution by CA 132/23 that require infra-constitutional provisions to work properly and effectively.

Turning specifically to the topic of this article — the impact of the reform on public contracts — two bills are relevant: (i) PLP 68/24, which proposes to establish the IBS, the CBS and the IS, and (ii) PLP 33/24, which defines instruments for adjusting administrative contracts signed before the law establishing the IBS and CBS comes into force.

First, PLP 68/24 devotes a chapter to the economic and financial rebalancing of long-term administrative contracts. Articles 362 to 366 of the bill address, among other things, the elements for determining the tax burden actually borne by the contractor for rebalancing purposes, considering the possibility of passing the financial burden of taxes on to third parties, as well as the effects of non-cumulativeness on the contractor’s purchases and costs.

In addition, mechanisms for restoring the financial equation are also provided for, namely: revision of the agreed amounts; financial compensation and tariff adjustments, including by way of contributions of funds or monetary consideration; renegotiation of deadlines and conditions for delivery or provision of services; increase or reduction of amounts owed to the Public Administration, including concession fees; and transfer to one party of costs or charges originally assigned to the other, depending on the greater or lesser burden that may fall on each of the contracting parties.

However, the wording of art. 362, §2 allows the review even of contracts whose risk matrix already provides for supervening tax impacts. This is because the incalculable consequences of the tax reform, which cannot be mathematically predicted during the transition, require revisiting the initial allocation of risks, whose resulting burden may fall, in specific cases, on either the Administration or the contractor — which, for now, cannot be determined.

Second, PLP 33/24 goes even further into the dynamics of public contracts and establishes tools for the economic and financial restoration of administrative contracts signed before the complementary law establishing these taxes comes into force. Its goal is to neutralize any negative externalities that may arise from the levying of the new taxes on long-term infrastructure contracts and the various types of public service concessions.

The wording of bill 33/24 suggests that the legislator is concerned with the crucial need for the administration to handle rebalancing claims quickly during the transition period of the tax regime. To this end, if the bill is approved, the administration will be required to open the rebalancing procedure on its own initiative if it has not been opened by June 30, 2026.

After that date, the PLP requires priority processing of administrative proceedings related to contract rebalancing. In addition, §7 of art. 2 defines “precautionary rebalancing” methods, of an anticipatory nature, if the government has not restored the financial equation by the stipulated deadline (December 31, 2026).

The measures provided for include, among others, increasing the obligations assumed by the Public Administration and paying amounts directly to the contractor as compensation, reimbursement or similar.

In addition, depending on the nature of the contract, the bill seeks to establish mechanisms that the contractor may use at its discretion to mitigate the effects of the imbalance if the administrative proceeding is not concluded within the set deadline or if precautionary rebalancing is not implemented. Some of them are set out in §§ 9 and 10 of the same art. 2: (1) adding amounts to the consideration owed by the government; (2) applying discounts to concession fees due or to become due; and (3) adding the difference between the current tax rates and the rates of the new taxes in subsequent years.

Another important point is that PLP 33/2024 seeks to exclude IBS and CBS from revenues from the construction, recovery, renovation, expansion or improvement of infrastructure, or arising from any regulatory rights whose counterpart is an intangible asset representing an operating right, as well as from revenues from the sale of non-current assets classified as investments, property, plant and equipment, or intangible assets.

These measures are important to avoid placing an excessive burden on the infrastructure sector, which depends on actually receiving fair consideration for its services, and to avoid revenue losses for the federative entities, which need to keep public works and services going, so that the change in the tax system does not disadvantage either contracting party.

There is clearly no doubt about the contractors’ substantive right to have the initial equation rebalanced, especially considering that the Theory of Unforeseeability itself, in its classic form, allocates tax risk to the Public Administration, within the scope of the so-called “act of the sovereign” (which, incidentally, is expressly provided for in the caput of art. 2 of PLP 33/24). Even so, appropriate procedural criteria must be developed to help contractors seek rebalancing transparently and quickly, giving effect to art. 37, XXI of the 1988 Federal Constitution.

Finally, another issue that arises concerns the transition period, in view of the implementation of the Reform and its regulation. In this regard, in addition to providing for a gradual increase in tariffs in line with the new rates until 2030, art. 3 provides that tariffs charged under long-term public contracts may be revised and implemented by the concessionaires themselves, with formal notice to the oversight body. In addition, art. 6 allows contractors to offset the PIS and Cofins credits to which they are entitled until the end of the legal deadline, that is, December 31, 2026.

From this overview of the Tax Reform and the complementary bills intended to regulate CA 132/23, as far as the infrastructure and public contracts sector is concerned, protection of the right to the economic and financial rebalancing of contracts is expected, ensuring the maintenance and continuity of public works and services without the private contractor bearing an undue and unfair burden.

This reform, of a magnitude never before seen in Brazilian tax law and with clear repercussions in administrative law, will certainly bring profound changes to various sectors of the economy and society, including the infrastructure and public contracts market. A considerable number of economic and financial rebalancing claims is therefore expected, and the Public Administration, oversight bodies and the Judiciary will need to address each case with composure and impartiality, maintaining, on the one hand, the effective provision of public services and, on the other, fair remuneration of capital, under the terms initially agreed and constitutionally guaranteed.

Originally published by Migalhas (in Portuguese).