Tax win in the offing for Brazil's retail businesses

7 Sep 2018 , 1:25pm

The fashion retail industry's questions over PIS/COFINS credits could finally be solved, a white paper by Brazilian law firm Matthos argues.

Retail and tax

A great part of the business involving the fashion segment focuses on commercial activities, especially the retail business. Retail is a segment that, unquestionably, concentrates large tax disputes. This could not be any different. Sales activities are subject to countless taxes, especially the Tax on the Circulation of Goods and Provision of Services (“ICMS”), which is collected by the states and the federal district, the Contribution to the PIS (“PIS”) and the Contribution to Finance Social Security (“COFINS”), both of which are levied on the total revenue earned by taxpayers.


All entities that generate revenue in Brazil are subject to PIS/COFINS. However, the commercial segment is the one that undertakes the largest and most complex discussions on these taxes, especially regarding the application of the non-cumulative regime contemplated in the Constitution. The lack of an express definition of the term “inputs” for the levy of PIS/COFINS, as well as the wording of certain rules, which erroneously distinguish between commerce and industry and services, are challenges faced by taxpayers in the retail segment. 
In fact, until the enactment of Provisional Measure No. 66/2002, which was converted into Law No. 10,837, PIS/COFINS taxes were levied under the cumulative regime which did not permit taxpayers to deduct from the tax base (at that time, gross revenue) credits for expenses incurred, or amounts paid in previous phases in the economic chain.

Constitutional rule

Considering the onerous nature of such tax, the non-cumulative regime was implemented in respect to those taxes and became a constitutional rule by means of Constitutional Amendment No. 42/2005. Since then, however, there have been discussions concerning the concept of inputs for levying of PIS/COFINS because expenses related to such taxes must provide a margin of credit that reduce their tax base. Furthermore, with respect to taxpayers whose core business is commerce, which includes retailers, the infra-constitutional legislation did not expressly include the possibility of deducting credits related to inputs, being limited to credits for inputs used in manufacturing and provision of services. The same is true for credits with expenses in the acquisition of machinery, equipment and fixed assets: the legislation refers to the provision of services or manufacturing and it is silent to their use in the sale and resale of goods.

Deduction of credits

However, several reasons lead us to believe that taxpayers engaged in commercial activities are entitled to the deduction of credits related to the acquisition of inputs, as well as machinery, equipment and fixed assets, and that these should be understood, for the purpose of PIS/COFINS, as necessary expenses directly related to their activities. This is what we will explain in this article.

History of the legislation

On November 27, 1998, Law No. 9,718 was published, establishing, among other provisions, that the total gross revenue obtained by taxpayers were subject to PIS/COFINS taxes at rates of 0,65% and 3%, respectively. At the time, these taxes were cumulative since, at each stage of the economic chain, the taxpayer was obligated to submit the total revenue to taxation and there was no reducing factor to the basis of calculation of such taxes.

Late 2002, it was, for the first time, included in the legal regime what would become the non-cumulative system for PIS/COFINS with the publication of Provisional Measure No. 66, which was later converted into Law No. 10,637/2002. Legislators in this piece of legislation raised the PIS Contribution rate from 0,65% to 1,65% and introduced the concept that credits involving certain expenses incurred by taxpayers could be deducted from the basis of calculation of the PIS Contribution.

With the enactment of Constitutional Amendment No. 42/2003, the non-cumulative regime applicable to contributions levied on revenue became a constitutional principle with the addition of paragraph 12 to article 195, which reads: the law will define the economic sectors for which the contributions levied pursuant to sub-paragraphs I, b; and IV of the main paragraph, will be non-cumulative. 

Although the Constitution has said that the law would define the sectors of the economy for which the contributions ... will be non-cumulative, the truth is that Law No. 10,833/2003, created non-cumulative COFINS with taxable event as the taxpayer’s total revenue regardless of its name or accounting classification. This is, in our view, the general rule applicable to COFINS (and to PIS).

Continuing with the history of the legislation, Law No. 10,833/2003 raised the COFINS rate (from 3% to 7,6%) and listed the credits that could be deducted from the basis of calculation of such tax, allegedly introducing a non-cumulative system for this tax under article 3, including goods and services used as inputs in the provision of services and in the production or manufacturing of goods or products for sale, including fuel and lubricants (...).

This is the legal background as to the evolution of the non-cumulative basis applicable to PIS/COFINS, from the change in the materiality of the taxes (from profit to total revenues) to the introduction of the prevailing legal structure of said constitutional principle.

The extent of the non-cumulative basis applicable to PIS/ COFINS

Once the principle of the non-cumulative basis was introduced, for the first time, to the PIS/COFINS, it remained to the legislator to establish the mechanism by which it would operate, especially the mechanisms for deduction of credits. The legislator, unlike what happened in the case of ICMS and IPI, opted to disregard the amounts required/paid in previous transactions, indicating instead the expenses, which once incurred would permit the deduction of credits. Such expense was calculated by applying the required rate of that taxpayer’s PIS/COFINS to the amount of the expense incurred.

Specifically, for taxpayers engaged in buying and selling goods sub-section I of article 3 of Law No. 10,833/2003, which determines the right to credit on the acquisition of assets acquired for resale.

However, when we read two other sub-sections, which are of great interest to this analysis, sub-sections II and VI, we note that their wording apply exclusively to provider of services and/or manufacturer of goods. This is precisely where various discussions begin concerning the extent of the non-cumulative regime applicable to PIS/COFINS contributions.

The concept of input, for the purposes of PIS/COFINS 

At this point, it is essential to read the text of the law:Law No. 10,833/2003.

Article 3, sub-section II - goods and services used as inputs for providing services and in the production or manufacturing of goods or products for sale, including fuel and lubricants, except in case of payment covered in article 2 of Law No 10.485, dated July 3, 2002, due by the manufacturer or importer to a dealership for intermediating or delivering vehicles listed in positions 87.03 and 87.04 of the Tipi;(...)

Although the law does not define input, jurists have supported that everything considered essential to the production of any goods or utilities, material or immaterial must be considered inputs. 

And, this could not be different. By including the systematic of the non-cumulative basis to PIS/COFINS, the constituent assembly granted the ordinary lawmaker the responsibility for indicating which sectors of the economy in Brazil would be subject to it. It is not a casualty that the lower law that followed Constitutional Amendment No. 42 excluded from the systematic of the non-cumulative basis different profits that remained subject to the cumulative basis systematic.

No restrictions or prohibitions

However, once the choice has been made (for one or other systematic by the ordinary legislator), the non-cumulative basis must be exercised entirely with no restrictions or prohibitions on the taxpayer’s right to credit. The lower level legislator, therefore, indicates those subject to the non-cumulative regime and, once they become subject to it, they must be guaranteed extensive rights to appropriate from credits arising from all costs that are essential in calculating the added value at a certain stage of the economic chain.
In this case, no amounts incurred by the taxpayer, which can be shown to be necessary for achieving his business purpose, can be disregarded when establishing the PIS/COFINS basis of calculation. This is what underpins the principle of the non-cumulative basis.

But, that’s not all. Jurists and court precedents have settled that the non-cumulative basis applicable to ICMS and IPI and to social contributions (PIS/COFINS) have a common ground, but the manner in which they are applicable varies from tax to tax.

In the specific case of the non-cumulative basis for PIS/COFINS, although they possess their own implementation rules, which unlike those of ICMS/IPI are established in the infra constitutional legislation, they have an identical ground to the regime applicable to other taxes. Notwithstanding the fact that the wording of the law is identical, the structure by which it is implemented is completely different.

Value added by the taxpayer

And what would this common meaning be? The principle that all non-cumulative taxes must be levied exclusively on the value added by the taxpayer and nothing more. In other words: (i) for the purpose of appropriating PIS/COFINS credits, it does not matter what was paid in the previous or subsequent stage of the economic chain; (ii) the taxes must be levied on the value added in that stage of the economic chain in which they are to be levied; (iii) and if the expenses incurred are not fully taken into account, the contributions will be levied (even if partially) on a cumulative basis.

Accordingly, credits (expenses) to calculate revenues (materiality) must be considered in the general statement of taxes to be paid by the taxpayer otherwise it would risk missing the exemption (even if partially) and to be taxed well beyond the value it added.

Essentiality as a fundamental element in defining inputs for PIS/COFINS purposes

The essentiality of these expenses justifies considering those amounts in the calculation for the book-entry form of credits for calculating PIS/COFINS. 
Indeed, article 3 of Law Nos. 10,637/2002 and 10,833/2003 establishes situations in which credits can be used for the purpose of PIS/COFINS, respectively. Among these situations, is sub-section II, which explicitly covers the use of credits on expenses with goods and services used as inputs on the following terms: 

Article 3 – From the amount calculated pursuant to article 2, entities may discount credits calculated in relation to:

II - goods and services used as inputs in the provision of services and in the production or manufacturing of goods or products for sale, including fuel and lubricants, except in case of payment covered in article 2 of Law No. 10,485, dated July 3, 2002, due by the manufacturer or importer to the dealership for intermediating or delivering vehicles listed on numbers 87.03 and 87.04 of the Tipi;

From the wording of the rule, we note that with respect to goods and services used as inputs, we conclude that they are used in manufacturing of goods for sale or in the provision of services. There is no reference in the rule to their use in essentially commercial activities. 

Accordingly, a rushed and out-of-context reading of the provisions that only considers the wording of the law could lead to the conclusion that the appropriation of credit for PIS/COFINS on expenses with goods and services used as inputs would not be applicable to taxpayers whose core business is retail.

Indeed, this is the position from the Brazilian Federal Revenue Services on a number of cases.In this regard, the summary of the Reply to Consultation DISIT/SRRF04 No. 42, of May 28, 2013 provides information: 

SUBJECT: Contribution for Financing Social Security – Cofins

SUMMARY: NON-CUMULATIVE BASIS. CREDIT. COMMERCE. INPUTS. In commercial activities, one cannot calculate credits for the non-cumulative basis of Cofins tax based on sub-section II of article 3 of Law No. 10,833 of 2003, since the situation established in that provision is solely intended for industries or service providers.

LEGAL PROVISIONS: Law 10,833 of 2003, as amended, article 3; Decree 3.000, of 1999, article 346; SRF NI 404, of 2004, articles 8 and 9.

SUBJECT: Contributions to PIS/Pasep

SUMMARY: NON-CUMULATIVE BASIS. CREDIT. COMMERCIAL ACTIVITIES. INPUTS. In commercial activities, it is not possible to calculate credits for the non-cumulative basis of the Contribution to the PIS/Pasep tax, based on sub-section II of article 3 of Law No. 10,637 of 2002, since the situation provided for in that provision is solely intended for industries or service providers. 

LEGAL PROVISIONS: Law No. 10,637 of 2002, article 3, I to X; Law No. 10,833, of 2003, article 3, VI, VII and IX, and article 15, II; SRF NI 404, of 2004, article 8, I, “b”, c/c para. 4, I and II, and c/c para. 9, I.

However, if on one hand the provisions contain no explicit rule dealing with the right to use credits under the situations in which commerce is concerned, on the other hand, there is no prohibition against doing so and, even more, there is no reason why the right to use the credit be recognized when engaging in one given type of core business (industrial/provision of  services) and not in another (commerce).

There is no question that, those engaging in industrial activities and provision of services have as essential, for pursuing their core business, expenses with goods and services (inputs), but those whose core business is commerce equally consider such expenses as essential. In fact, the drafting of the rules that authorise the use of credits in the non-cumulative regime of PIS/COFINS involves the reading of the law and the analysis of the subjective extent of the non-cumulative basis for the contributions established in the constitution. 

 Expenses with machinery, equipment and fixed assets (Law No. 10.833/2003, article 3, sub-section VI)

If, as mentioned above, the legislation concerning the use of PIS/COFINS credits on inputs indicates goods and services used in the provision of services and in the production or manufacturing of goods or products for sale, we can see that in the case of the use of credits on the acquisition of machines, equipment and fixed assets, the same error was committed. Here,  the law says:

 Article 3 – From the amount calculated pursuant to article 2, entities can discount credits, calculated involving: (...)

VI – machinery, equipment and other goods incorporated into  fixed assets acquired or manufactured for lease to third parties or for manufacturing goods for sale or provision of services; 

Please note that there are several provisions in the legislation containing express prohibitions from the right to ascertain PIS/COFINS credits. Nevertheless, none of them refer to the exclusion of expenses involving goods and services used as inputs by a company in the retail sector. Therefore, if the legislation is silent about the possibility of using credits, by retailers, we can conclude that the non-cumulative regime is applicable since it is the rule. When the rule is silent, the exception is not applicable.


If there is a “loophole” in the infra-constitutional regime regarding retail companies, the applicable law is the constitution, which as shown above, is fully in effect. 
Accordingly, reference to certain activities in the provisions dealing with the possible use of credits must not be seen as exhausting those for which the credit is authorised, rather as a reference to all business activities, rendering effective the constitutional principle of the non-cumulative basis.

In light of the above, we conclude that if the rule was explicit regarding the use of PIS/COFINS credits involving goods and services used as inputs by industrial and services companies, it certainly did so assuming that (i) the use of those goods and services by the taxpayer in developing their core business; and, if this is the case, (ii) such goods and services are as essential to commercial activities as they are to the industry and the services sector, (iii) this demands, under the constitutional non-cumulative regime, the equal recognition of the right to credit for those engaged in commercial activities. This, without questions, is the most reasonable interpretation to the rule, not to say the only one that is in accordance with the Constitution.


A discussion concerning the concept of inputs for the levy of PIS/COFINS has been growing lately. The prevailing position in administrative and judicial precedents is that expenses deemed essential for the undertaking of a company’s core activities and, consequently, for obtaining revenue, can be considered inputs.

Special Appeal No. 1.221.170 is on-going, under the repetitive appeal procedure, at the Superior Court of Justice – STJ, in which 5 (five) justices have already ruled as follows:

Four of them – Napoleão Maia, Benedito Gonçalves, Mauro Campbell and Regina Helena Costa have ruled that inputs, for the purpose of PIS/COFIN, are all expenses that are essential for calculating a company’s revenues on which the taxes will be levied on;

One of them, Og Fernandes, has ruled that the interpretation given by tax authorities (RFB) on the issue contains is legitimate.

Close to recognising the right of taxpayers to appropriate credits

One can see, therefore, that we are very close (a single vote away) to recognising the right of taxpayers to appropriate credits regarding all essential expenses, including those for achieving their business purpose, provided that there is demonstration of how essential they are.

In the same vein, the Superior Chamber of the Administrative Tax Appeals Council – CARF recently ruled, on the appellate decision published on October 2, 2017, the following passage of which was excerpted from the vote of the Rapporteur:

'In this case, it is my understanding that one cannot apply the interpretation that the consumption of such goods and services is used DIRECTLY in the production process, but it is sufficient to consider them essential for the company’s production or business. In the case in hand, the Special Appeal deals specifically with the right to PIS and COFINS credits on freight expenses incurred between the company’s premises, notably between the distribution center of the goods and the company’s stores.

Please note that the Appellant is a private entity engaged in providing services for repairing, replacing and installing automotive glass and accessories, selling windows, headlamps, taillights and other accessories for cars and managing the service providers in its network of affiliates.

Therefore and considering my position on the concept of inputs, when freight is involved, and bearing in mind the business purpose of the taxpayer, the freight services used by the company generate PIS/Pasep and Cofins credits because they are necessary for the core business.' (Appeal No. 13896.721081/2013-12 published on October 2, 2017).

Notwithstanding the fact that this opinion refers to freight expenses between premises, it is important to emphasise the reasoning used, precisely the one that classifies as inputs those expenses which, considering the taxpayer’s business purpose, are essential for him to pursue his business.

So, all the arguments that have underpinned the rulings, both in the administrative and in the judicial sphere, concerning the definition of inputs, contribute to show that the best interpretation of the rules here discussed  is that, when such expenses are essential for those engaged in commerce – as well as those engaged in manufacturing and/or services – they must give rise to the appropriation of PIS/COFINS credits.

Accordingly: (i) whether as a consequence of the extensive interpretation of article 3, sub-sections II and VI of Law Nos. 10,637/2002 and 10,833/2003, (ii) or as a consequence of the best interpretation of the rules, considering the concept of inputs as all and any expense essential for engaging in production, whatever that might be, OR (iii) by applying the constitutional rule of the non-cumulative basis, there is no doubt as to the right of the taxpayer to appropriate the PIS/COFINS credits to expenses with goods and services used as inputs, or machines, equipment and goods intended for fixed assets, in view of the fact that they engage in predominantly commercial activities.


Although the constitutional non-cumulative basis has been established in respect of PIS/COFINS, with no discrimination in regard to its application to a range of economic segments – it applies to them all – the infra-constitutional legislation has ended up creating obstacles for commerce to enjoy occasional credits.

The examples mentioned above clearly demonstrate this, to the extent that if we consider the wording of the rules, only taxpayers engaged in providing services and in manufacturing could appropriate credits involving expenses with inputs and machines, equipment and fixed asset items.

Now then, if in order to apply the non-cumulative basis it is fundamental that the essential expenses are factored in for credit appropriation purposes, there is no justification for the fact that only services and industry can appropriate credits referring to expenses that are just as essential for the commerce segment.

Bearing in mind that in the fashion segment many companies are engaged in commerce, especially in the retail sector, the outcome of those discussions will be of significant interest to the sector, which enjoys a considerable share of the Brazilian economy and is an important source of job creation and development of technology.

Interpreting those rules in accordance with the Constitution is not only mandatory within the context of the law, but will also mean excellent news for those engaged in selling and reselling goods.