BRAZIL'S NEW SMALL BUSINESS LAW

UNCLAS SECTION 01 OF 02 BRASILIA 000032 SIPDIS SIPDIS SENSITIVE STATE PASS USTR FOR CRONIN TREASURY FOR OASIA - J.HOEK USDOC FOR 4332/ITA/MAC/WH/OLAC/JANDERSEN/ADRISCOLL/MWAR D USDOC FOR 3134/ITA/USCS/OIO/WH/RD/SHUPKA STATE PASS USAID FOR LAC STATE PASS OPIC E.O. 12958: N/A TAGS: ECON PGOV EFIN SOCI BR SUBJECT: BRAZIL'S NEW SMALL BUSINESS LAW ¶1. (U) SUMMARY: President Lula signed legislation on December 14, 2006 that expanded the scope and coverage of previous efforts to simplify the taxation system as applied to small and medium enterprises (SME) in Brazil. When it comes into full effect in July 2007, the new law, known as "Supersimples", will consolidate into one tax eight different federal, state and municipal taxes, dramatically reducing the compliance and tax burden for businesses with revenues under a ceiling of Reais 2.4 million (roughly USD 1.1 million). The GoB has not estimated how many companies will benefit from the changes, but the 2.2 million SMEs that were beneficiaries of the predecessor regime (Simples) will be automatically included in the new regime. The GoB estimated it would be giving up Reais 5 billion (USD 2.3 billion) in federal tax revenue under the new law, although this estimate does not account for potential increased revenues generated by the reduction in informality that the law is expected to encourage. The new law also aims to reduce substantially the amount of time necessary to register a business by creating a single registration for the national, state and municipal governments. The legislation makes a modest effort to simplify some formulaic work-place rules. The new legislation has the potential to have a positive impact on the business climate for SMEs in Brazil. END SUMMARY. Background -------------- ¶2. (U) The Brazilian Congress in December 2006 approved legislation, signed by Lula on December 14, which expands the scope of Brazil's previously existing "Simples" taxation regime for small businesses. The 2.2 million small businesses that currently make use of the Simples regime (i.e. small enterprises with annual revenues of up to Reais 240,000 or USD 114,00) will be transferred to the enhanced Supersimples system, which will include companies with annual revenues of up to Reais 2.4 million (USD 1.14 million). When the new legislation takes full effect in July 2007, SME beneficiaries of the existing Simples regime are expected to see their tax burden fall an additional 15 to 20 percent. Moreover, those SMEs newly-eligible to participate under the expanded eligibility criteria included in Supersimples may see their tax liabilities fall by 40 to 60 percent. According to Federal Government data, micro and small companies account for 99% of all formal companies in Brazil. They employ some 54% of the labor force and produce an estimated 20% of the Brazilian GDP. The Supersimples legislation was submitted to Congress in 2004 after a period of public consultation under the auspices of SEBRAE, Brazil's small-business promotion agency. Consolidates and Reduces Taxes -------------- ¶3. (U) The new law expanded the previous consolidation of six federal taxes (income tax, the industrial VAT known as IPI, social security payments, and three "social contributions" known as PIS, COFINS and CSLL),the Supersimples program will also include the state-level VAT tax (ICMS) and a municipal tax (ISS). Companies will make a single tax payment, dramatically reducing their compliance burden, on a scale that varies with revenue levels and by sector. Industrial enterprises will pay between 4.5% and 12.1% of revenues, service providers (accountants, etc.) paying from 6% to 17.42% of revenues and commercial enterprises (e.g. retail) paying between 4% and 11.61% of revenue. Under the existing Simples regime companies were paying from 3% to 12.6% of revenues, but still had to pay the state-level ICMS and municipal ISS separately. The three levels of government will share these tax revenues. Self-employed individuals will see a reduction in their social security payments. ¶4. (U) The Supersimples regime expanded the scope of its predecessor regime by including additional sectors. The new program extended the benefits to 21 new sectors, including civil construction, accounting firms, language schools, providers of technical training, real estate agents and publicity agencies. Law firms and business consultancy firms were notably excluded. Participants in the Supersimples regime will also receive other benefits. Government entities will give preference to SMEs in the procurement of goods and services of up to Reais 80,000 (USD 38,000). SME export BRASILIA 00000032 002 OF 002 earnings will not be taxed. In an attempt to ease the move into formality for potentially eligible companies, these will be allowed to restructure outstanding unpaid tax and social security system debt over a period of 120 monthly payments. The law also allows for a credit guarantee system to improve small businesses' access to credit, but the details of the system remain to be worked out. Cuts Red Tape -------------- ¶5. (U) In addition to lowering the tax compliance burden by allowing SMEs to make a single monthly tax payment in lieu of eight others, the new law simplifies the process for company registration and the procedures for opening and closing a company. SMEs will now have only one official registration to complete, which will replace previous separate filings at the federal, state and municipal levels. Certain classes of enterprises, those whose activities are judged not to pose risks to the environment, worker health or to be fire hazards, will receive permission to start functioning immediately, prior to receiving the approval of the environmental agency or fire department. ¶6. (U) The new legislation makes a modest effort at simplifying some of the formulaic requirements of Brazil's labor laws. Eligible SMEs, for example, will no longer be required to enter into each employee's labor registration booklet the dates on which the employee took leave. Organized labor groups resisted more ambitious reform to the labor code requirements applied to SMEs. The Supersimples legislation also creates a standard nationwide definition of what constitutes a small or medium enterprise, so that benefits will be uniformly available across different states. ¶7. (SBU) Comment: The new law is a very useful step towards improving the lot of small businesses in Brazil. Most analysts believe it will contribute to reducing informality and increase SME's capacity to invest and hire new employees. Much implementation work remains to be done. That the modest easing of rigid work-place rules for SMEs contained in this law became one of the most controversial points of debate in Congress suggests there is little appetite for more expansive labor reform. If successful, the new law could perhaps provide an impetus for broader-based reform, including tax simplification and labor reform. SOBEL