2.7 National Simplified Taxation System for Small Business and ICMS credits ______ 11 ... In Brazil, according to the Brazilian Micro and Small Business.
São Paulo Law School of Fundação Getulio Vargas – FGV DIREITO SP Research Paper Series – Legal Studies Paper n. 123
Brazilian National Simplified Taxation System for the Small Business and the Value Added Tax
Leonel Cesarino Pessôa* São Paulo Law School of Fundação Getulio Vargas (FGV DIREITO SP)
Giovane da Costa† Nove de Julho University
Emerson Antonio Maccari‡ Nove de Julho University
June 2015
This paper can be downloaded without charge from FGV DIREITO SP’s website: http://direitogv.fgv.br/publicacoes/working-papers and at the Social Science Research Network (SSRN) electronic library at: http://www.ssrn.com/link/Direito-GV-LEG.html. Please do not quote without author’s permission
*
Doctorate in Law at the University of São Paulo, was a visiting scholar at the New School for Social Research and at Università Commerciale Luigi Bocconi. Researcher at the Center of Applied Legal Research of the Getúlio Vargas Foundation Law School – São Paulo, Professor of the Master’s Program in Business Administration, FMU. † MA in Business Administration, Nove de Julho University. ‡ Doctorate in Business Administration, USP. Professor of the Master and Doctorate Programs in Business Administration, Nove de Julho University.
Electronic copy available at: http://ssrn.com/abstract=2623286
Abstract: Since the 1970s, the importance of small business - SB – has increasingly been recognized in the world and in Brazil. Among the measures taken by the Brazilian government to encourage and promote SB, the National Simplified Taxation System– NSTS stands out.§ There are, however, many companies that meet the requirements to be in the NSTS, but they do not opt for this system. The objective of this study is to identify and analyze the reasons for this decision. This is an exploratory qualitative investigation based on a case study. The results show that the NSTS simply does not work for companies whose customers are large retail companies. Thus, the study concludes that, for certain sectors, SBs face a drawback: SBs can no longer pay federal taxes in a unified way. Keywords: Small Business; National Simplified Taxation System; Public Policy; Evaluation of Public Policy; Value Added Tax. Contents 1 Introduction ______________________________________________________________ 3 2 Theoretical framework and literature review ____________________________________ 4 2.1 Governmental intervention and economic efficiency ___________________________ 5 2.2 Economic intervention and job creation _____________________________________ 6 2.3 Taxes, entrepreneurship and small business __________________________________ 7 2.4 Public policies and tax exemption in Brazil __________________________________ 8 2.5 ICMS non-cumulativeness and the principle of neutrality in taxation ______________ 9 2.6 Laws on differential legal treatment _______________________________________ 10 2.7 National Simplified Taxation System for Small Business and ICMS credits ________ 11 3 Methodology ____________________________________________________________ 12 4 Presentation of results _____________________________________________________ 13 4.1 Case presentation______________________________________________________ 15 4.2 Case outcome ________________________________________________________ 16 5 Analysis of results ________________________________________________________ 16 6 Final considerations _______________________________________________________ 18 7 References ______________________________________________________________ 19
§
The National Simplified Taxation System created by Complementary Law nº 123 from 14/12/2006 is called in Brazil the‘Simples Nacional’
Electronic copy available at: http://ssrn.com/abstract=2623286
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1 Introduction Starting in the 1970s, the importance of Small Business (SB) for the economy and economic development has increasingly been acknowledged. Over the years, these businesses have grown in absolute numbers and the jobs created by them, mainly in times of crisis, have become increasingly relevant. In Brazil, according to the Brazilian Micro and Small Business Support Service [Serviço Brasileiro de Apoio às Micro e Pequenas Empresas – SEBRAE] (2010), between 2000 and 2008, there was an increase in the number of SBs from 4.1 million to 5.7 million. In the same period, the number of formal jobs created by the SBs has gone from 8.6 million in 2000 to 13.1 million in 2008. Due to the importance of SBs for job creation, public policies promoting their establishment have been implemented in several countries, especially since the 1970s. In Brazil, the SBs have been so important to the economy that the government of President Dilma Rousseff created a Ministry solely to address SB issues. The measures already taken by the government to promote SBs include the Statute of the Micro and Small Business (Estatuto da Micro Empresa e Empresa de Pequeno Porte), the Federal Simplified Taxation Act (Lei do Simples Federal) and, most recently, the National Simplified Taxation Act (Lei do Simples Nacional). The Special Unified System for Collection of Taxes and Contributions due by Small Business – the National Simplified Taxation System [NSTS] – was established by Complementary Act 123/2006. For those opting into it, it offers lower taxation than the other existent systems (especially the Presumed Profit System), and it provides simplicity regarding taxes, social security and labor laws because the several taxes covered by the system can be paid at once through a single tax collection form. Thus, compliance costs of taxation that affect SBs unequally are greatly reduced. However, many companies that could be included in the NSTS do not take part in the system. Many SBs in the textile industry, from southern Brazil and other parts of the country, prefer to keep paying taxes based on the Presumed Profit System because the NSTS could bring problems related to ICMS credit transfer and appropriation. In Brazil, there are three different taxes levied on the operations that in Europe are taxed by the VAT: the ISS is a tax levied on services, the IPI is a tax levied on industrial production and the ICMS is a tax levied on the Sales of goods. This work deals with problems related to credit transfer and appropriation of one of these taxes, the ICMS.
Electronic copy available at: http://ssrn.com/abstract=2623286
This study aims to identify and analyze the factors that lead companies to choose a system that is, in principle, unfavorable for them. In doing so, the study contributes to the discussion of the NSTS as a public policy for incentivizing SBs. A case study is presented based on a clothing company located in Ibirama, in the state of Santa Catarina. The study is justified for several reasons. From a public policy perspective, even though the importance of ensuring differential treatment for SBs is generally acknowledged, not much is known about the results of such policies. According to Mancuso, Gonçalves and Mencarini (2010), this is the rule when addressing public policies of tax exemption. It is unknown if the policies are successful, if they are accomplishing their purpose or if the tax waiver amount compensates for the gains provided by the policy itself. From the company’s perspective, if the NSTS is not fulfilling its purpose in regards to a broad set of companies, it is important to identify and analyze the reasons so that the companies can enjoy the tax benefits or even to change the legislation to better fulfill its purpose. There is no study, however, that discusses the reasons for the partial failure of the National Simplified Taxation Act and that presents, from the company’s perspective, the difficulties involved in choosing the differentiated tax payment system. This study is divided into six parts, in addition to this introduction. Part 2 presents a literature review. Initially, justifications are raised for the differential treatment given to Small Business. Next, the effects of taxes and tax policies that grant tax benefits for entrepreneurship and SB development are discussed. Then, some fundamental elements of taxation theory are succinctly presented, namely, the principle of neutrality and the basic characteristics of value added taxation. Then, a review of the legislation on differential taxation treatment for SBs is presented. Part 3 presents the study methodology; part 4 presents the results, which are analyzed in part 5; and, finally, part 6 presents the final considerations.
2 Theoretical framework and literature review At first, it could seem obvious that the government should interfere in the market to assist SBs. The difficult conditions they often face seem to suggest that a law is necessary to assist them. However, if the governmental intervention issue is analyzed from an economic efficiency perspective, the inevitability of said law is not so obvious: if the purpose of an intervention by the government is only to ensure a better allocation of resources in order to guarantee the best operation of the market, such intervention would only be justified in cases
where the market presents some type of failure. However, it is not evident that government intervention to ensure differential treatment of SBs is an expression of market failures (OECD, 1994). 2.1 Governmental intervention and economic efficiency Some disadvantages faced by SBs competing with large corporations can be the result of market failures. Before discussing whether such failures really occur, these disadvantages must be identified. A study by the Organization for Economic Cooperation and Development (OECD) on taxation of small businesses (1994) lists four disadvantages. The first is associated with merely economic factors, the second is associated with administrative factors, the third is related to the financing of small businesses, and the fourth is related to laws and regulations imposed by the government, which include taxes. The disadvantages associated with economic factors are fundamentally related to the fact that SBs operate with high costs and do not make use of economies of scale because of their low levels of output. Government intervention to correct this type of factor is not recommended, as it would entail a social cost: it would be privileging a less competitive sector of the economy. The disadvantages associated with administrative factors are related to the lack of organizational techniques, which end up causing businesses to have a short-term focus, a precariously organized marketing strategy, and a lack of skilled workers and management capabilities for directing growth. All these factors interfere, for example, with the export capacity of the company. According to the OECD (1994), it is very difficult to determine whether these deficiencies effectively represent market imperfections. With regard to financing, the disadvantages are associated with a greater difficulty of raising resources and greater cost of the eventually obtained resources. Those who claim that this disadvantage should not be considered a market failure argue that higher costs most likely mean higher risk assessment by the market and higher transaction costs. According to the OECD paper (1994), in practice, also in this case, it is extremely difficult to justify an eventual governmental intervention based on economic efficiency criteria. If economic efficiency is taken as the criterion, according to the OECD paper (1994), the most evident justification for government intervention is the disadvantage faced by SBs due to the performance of the government itself. Studies demonstrate that compliance costs are highly regressive: they disproportionately affect SBs.
In any case, economic efficiency is not the only criterion for government intervention. It is also justified, among other reasons, by the need to promote economic development, the need to promote balance among regions of the country and the need to achieve distributive justice. The strongest argument for interventions that protect SBs has always been the potential of these companies to create jobs. According to Puga (2000), the current interest in small businesses is due to the role they play in net job creation, especially during times of recession. 2.2 Economic intervention and job creation According to Tilley and Tonge (2003), until the 1960s, all government intervention in the economy was aimed at supporting large corporations. Small companies were viewed as poorly organized and badly managed and were seen as not having a relevant role in economic development. According to the same authors (2003), this situation would start to change in the United Kingdom in 1971 with the issuance of the Bolton Report – a governmental report on the status of small businesses. This report indicated that the number of small companies in the United Kingdom was decreasing more rapidly than in other western countries, and it concluded that they faced a series of difficulties due to bureaucratic, administrative and financial burdens that hindered their performance. For that reason, still in the early 1970s, a series of public policies were introduced aimed at correcting this situation and supporting SBs. By 1983, according to Curran (2000), 98 measures had been enacted, and it is estimated that financial aid to SBs totaled 1.1 billion pounds sterling between 1980 and 1985. Although it is difficult to identify the specific goals of each measure, Curran (2000) argues that two main objectives can be identified from the statements of politicians and government officials: support for small business due to their role in job creation, and the promotion of corporate culture. According to Dennis, Phillips and Star (1994), the ability of small business to generate jobs was first discussed in the academic literature in the study “The Job Generation Process”, of 1979, by the Massachusetts Institute of Technology (M.I.T.) researcher David L. Birch. An oil crisis occurred in the 1970s, which affected almost the entire world economy. Birch’s book (1979) shows how, at that time, small businesses were creating many more jobs than large corporations. Until then, large corporations were considered the only focus of vitality in the economic system, so Birch’s ideas were revolutionary at the time. Many years later,
according to Dennis, Phillips and Star (1994), small businesses came to be widely considered as the main creators of new jobs in the United States. The fundamental role played by SBs in job creation is also observed in Brazil. In the year 2010, according to SEBRAE (2010), between January and August, SBs created 1,343,479 new jobs with formal contracts, more than double the 611,061 jobs created by medium and large corporations. In October of the same year, the situation was even more evident: SBs were responsible for 84.9% of jobs created in Brazil. Although it is widely acknowledged that SBs are important for job creation, especially during economic crises, it is difficult to know the effects of taxes on entrepreneurship and on the creation and growth of SBs. 2.3 Taxes, entrepreneurship and small business There is a vast literature on the theme of taxes and SB entrepreneurship. According to Wasylenko (1997), there have been at least 75 studies that included taxes as an important factor affecting job growth, investment growth or the decisions of companies to establish themselves in certain regions. According to Bruce and Deskins (2010), two significant lines of study can be identified. The first specifically addresses the latter topic. Wasylenko (1997) conducted a comprehensive review of the literature and found that taxes have little effect on a company’s decision to locate in a particular region, although the effect is statistically significant. Although the interregional elasticity is estimated to be -0.2, the author concludes that the data must be analyzed in the context of the relative position of the state in terms of tax burden compared to other states. The second line of empirical studies addresses the impact of taxation on entrepreneurship. Some studies have focused on federal taxes, especially income tax. According to Bruce and Deskins (2010), for the first set of studies, higher tax rates on individual income would lead to higher entrepreneurship rates, suggesting that higher rates end up making workers leave their jobs. However, there is a second set of studies reaching the opposite conclusion. Bruce and Gurley (2005), for example, conclude that marginal tax rates can significantly increase or decrease entrepreneurship, suggesting that the decision to start a business is in part determined by the tax laws pertaining to business income. However, all these studies are focused on federal taxation. Some studies have analyzed the effects of taxes other than Income Tax – Personal or Corporate – on entrepreneurship. Bartik (1989) studied the effects of property tax, corporate
income tax and sales tax on equipment and concluded that these taxes negatively affect the creation of new small businesses. Bruce and Deskins (2010) also studied the effect of state taxes on entrepreneurship and concluded that, although the tax policies of the states do not exert a statistically significant influence on entrepreneurship, higher marginal rates of individual income tax tend to reduce entrepreneurship. 2.4 Public policies and tax exemption in Brazil In Brazil, some studies focus on the effect of taxes on corporate activity, but they do not focus on SBs. Fernandes, Teixeira and Baptista (2010), for example, discuss how the change in the Social Security Funding Contribution (Contribuição para Financiamento da Seguridade Social – COFINS) collection system from cumulative to non-cumulative affects corporate profits and the collection of taxes. The authors concluded that it affected the profits of companies in seven of the 18 sectors (three companies reacted positively, and four reacted negatively), and they find that it led to an increase in tax collection by the Federal Government. Some studies specifically address the impact of public policies that grant tax incentives. Mancuso, Gonçalves and Mencarini (2010) analyze public policies of tax exemption and conclude that they are frequent in Brazil, causing a very large waiver of revenue, but the authors find that they pose significant problems in the formulation, implementation and evaluation stages. These authors make a series of suggestions to improve the three stages of each public policy. In another study, Mancuso and Moreira (2010) consider the criteria identified by Mancuso, Gonçalves and Mencarini (2010), which are essential for ensuring the transparency, efficiency, and effectiveness of the benefits. They attempt to determine whether these criteria are satisfied in the formulation stages of public policies that grant tax exemptions, and they conclude that the criteria are not satisfied. They analyze 52 statutes passed between the ratification of the 1988 Constitution, on October 5th, and January 1st, 2009, and they show that the regulations usually result from provisional measures5, that their explanatory statements are drafted in general terms and only one mentioned measurable results would be achieved with tax exemption. However, there have been no studies that specifically discuss the effects of the Act that established the NSTS, and there has been little discussion of the problems regarding its application. Additionally, there have been no studies 5
Article 62 of the Brazilian 1988 Constitution states that in cases of exceptional relevance and urgency, the President of the Republic can issue provisional measures with the binding effects of laws and must immediately submit them to the national congress.
that specifically address the problem created by the Act when, in its original wording, it specified that companies opting into the NSTS could not use or transfer ICMS credits. The following discussion of taxation theory topics and laws applicable to the matter at hand aims to succinctly introduce some fundamental elements for the understanding and analysis of this Act: the principle of neutrality in taxation theory, the basic characteristics of value added taxation and the law that establishes the privileged treatment of SBs. 2.5 ICMS non-cumulativeness and the principle of neutrality in taxation According to Rezende (2011), taxation theory is built on two fundamental principles: neutrality and equity. In his words, "the principle of Neutrality refers to the non-interference on decisions related to the allocation of resources made based on the market mechanism" (Rezende, 2011, p. 159). Because the market works such that relative prices are the determinant criteria for decision-making on the allocation of resources, taxation cannot interfere with the formation of relative prices. The principle of neutrality is the basis of both direct taxation and indirect taxation of consumption. In Brazil, since 1967, the consumption tax levied on the sales of goods is the ICMS, established in that year as ICM. It is a non-cumulative tax similar to the European VAT. This is a value added tax levied on each step of the production and sale of goods. Succinctly, added value is given by the value of goods and services produced minus the value of goods and services acquired for use in the production process (Costa, 1978, p. 23). For example, when company “A” purchases a product from company “B”, the former company records, as a credit, the tax paid by “B” when the product left its facilities. When company “A”, in turn, sells the product to “C”, it will record as debit the tax levied on the sold product. At the end of the month, the value to be paid from the respective tax will be the debit value subtracted from the credit value. Thus, in value added taxation, the formation of relative prices can be affected in two ways: by increasing or decreasing the tax to be paid on the sale of a good and by increasing or decreasing the credit to be generated as part of the purchase of a good or input for its production. For such tax to be vested in the principle of neutrality, the principle shall be observed both at the taxation stage of the good to be sold and at the prior stage of credit formation. As stated by Rezende (2011), the principle of neutrality in the allocation of resources is complemented by the principle of equity and can also have some exceptions. In this sense,
some criteria can justify differential treatment, such as distributive justice and also correction of economic imbalances. The differential treatment established for SBs is one such exception to the principle of neutrality. Hence, before discussing how the National Simplified Taxation Act regulates the matter, we present the fundamental traits of the system that justify and establish the differential treatment of SBs. 2.6 Laws on differential legal treatment Article 170 of the 1988 Federal Constitution states that “The economic order, based on the valuation of human work and free enterprise, aims at ensuring a dignified existence to all, as per the precepts of social justice, according to the following principles: IX – preferential treatment to small businesses incorporated under the Brazilian law that are headquartered and managed in the country” Article 179, in turn, states that “The Federal Government, the States, the Federal District and the Municipalities shall provide small businesses, defined as such by law, with differential legal treatment, aiming to incentivize them through the simplification of their administrative, tax, social security and credit duties or by the elimination or reduction thereof through the law”. Considering these two constitutional provisions, on December 6 th, 1996, Act no. 9.317 was enacted, setting forth the differential tax treatment assigned to Small Business. In article 1, it specifies that “This Act governs, in accordance with article 179 of the Constitution, the differential, simplified and privileged treatment, applicable to Small Business, related to the taxes and contributions mentioned therein”. Article 3 of the Act established the idea that if company invoicing would not exceed a certain annual amount, the company would be classified, by law, as a small business. In these two situations, the company could opt for its inclusion in the Federal Simplified Taxation System for Small Business – FSTS6. As per paragraph 1 of this article, the inclusion in the FSTS would imply unified monthly payment of the following taxes and contributions: a) Corporate Income Tax (Imposto de Renda das Pessoas Jurídicas – IRPJ); b) Contribution for the Social Integration Program 6
The system is called ‘SIMPLES’, which means ‘Sistema Integrado de Pagamento de Impostos e Contribuições das Microempresas e Empresas de Pequeno Porte’, i.e., Integrated System for the Payment of Taxes and Contributions of Micro and Small Business.
and Public Servant Fund (Contribuição para os Programas de Integração Social e de Formação do Patrimônio do Servidor Público – PIS/PASEP); c) Social Contribution on Net Income (Contribuição Social sobre o Lucro Líquido – CSLL); d) Social Security Funding Contribution (Contribuição para Financiamento da Seguridade Social – COFINS); and e) Tax on Manufactured Goods7 (Imposto sobre Produtos Industrializados – IPI). Because only federal taxes were included in the new system, the Act was called the Federal Simplified Taxation Act (Lei do Simples Federal). Article 5 of this Act established the amounts to be paid monthly by Small Businesses included in SIMPLES. The amount was to be determined by applying the following percentages to the earned monthly gross income: I – for small business gross income accrued in the calendar year: a) up to BRL 60,000.00 (sixty thousand Brazilian reais): 3% (three percent); b) from BRL 60,000.01 (sixty thousand Brazilian reais and one cent) to BRL 90,000.00 (ninety thousand Brazilian reais): 4% (four percent); c) from BRL 90,000.01 (ninety thousand Brazilian reais and one cent) to BRL 120,000.00 (one hundred and twenty thousand Brazilian reais): 5% (five percent); and d) from BRL 120,000.01 (one hundred and twenty thousand Brazilian reais and one cent) to BRL 240,000.00 (two hundred and forty thousand Brazilian reais): 5.4% (five point four percent), values updated by Law n. 11,307 from May 19th, 2006. In addition, it established other amounts for small business. In December 2006, Complementary Act no. 123 was enacted, which established the National Statute of the Small Business. Among other measures, it revoked the FSTS, which was then superseded by the NSTS (Simples Nacional). The next section analyzes how this new Act regulated the differential treatment given to SBs regarding ICMS. 2.7 National Simplified Taxation System for Small Business and ICMS credits The new taxation system created by Complementary Act no. 123 allowed the monthly collection of all federal taxes based on a single tax collection form. Such simplified payment was already possible in the previous system, but the new system also included employer social security contributions, ISS and ICMS. Article 23 of this act, in its original wording, established that “Small Business opting for the NSTS shall not be entitled to allocation nor shall transfer credits related to taxes or contributions covered by the NSTS”. 7
A type of Brazilian Federal Excise Tax.
Companies opting into the NSTS would pay much less in taxes than other companies that would remain subject to the existent fiscal systems: ‘presumed profit’ and ‘real profit’. However, the Act established that these companies would not be entitled to appropriation or transfer of ICMS credits. Some fundamental aspects of Complementary Act no. 123 were amended by Complementary Act no. 128, which was passed in December, 2008. Article 23 of Complementary Act no. 123 had six new paragraphs, and the first new paragraph of article 23 established that “Legal entities and those equivalent thereto by the tax law not opting for the NSTS shall be entitled to credit corresponding to ICMS levied on their purchase of goods from small businesses opting for the NSTS, provided that allocated to trading or manufacturing and in accordance with, as a limit, the ICMS effectively due by companies opting for the NSTS for such purchases.” Thus, until December 2008, companies that bought from ‘NSTS companies’ would not be entitled to any ICMS credits related to the operation. With the enactment of Complementary Act no. 128, they were entitled to credit in some amount, but the amount was limited to the amount effectively due by the companies opting for the NSTS. Because these companies pay the ICMS and other taxes at a much lower rate than companies not opting for the NSTS, the companies that buy from them are only entitled to the ICMS credits established according to the rate paid by ‘NSTS companies’. This provision had a significant impact on companies, and the case study presented below aims to analyze this impact. This is the fundamental theoretical framework for understanding the problem to be presented and analyzed in this study.
3 Methodology This study is the result of qualitative and exploratory research. The case study method was chosen because, according to Yin (2005), case studies represent the preferred strategy for answering “how” and “why” questions. The study of a single case provides what Stern (1980) calls “theoretical sampling”. Without representing all the possible scenarios, it still allows for an understanding of the analyzed phenomenon. Data collection was based on multiple sources of evidence: interviews, analysis of corporate documents and a review of the applicable laws. The data collection was based on a guideline interview questionnaire applied directly to the owner in March 2011. In this
interview, open-ended questions were predominant, which allowed the interviewer, when necessary, to obtain further details on a topic by asking new questions. This data collection strategy allowed for the investigation of problems and company decision-making processes associated with the choice to opt out of a taxation system that, in principle, would be more favorable. Results were analyzed in accordance with the precepts of Miles, Huberman (1994) and Eisenhardt (1989), who claim that the analysis of results is particularly important in the case study method because it involves more complex procedures and requires the construction of categories of analysis. After collection, the data were structured in the form of a case narrative, aiming to report the situation found in the studied organization. This narrative will be presented in the following section.
4 Presentation of results The company considered in the case study is a company that operates in the textile industry. It is located in southern Brazil, in the city of Ibirama, state of Santa Catarina. The company currently has nine employees and an average annual turnover of BRL 180,000.00. It is focused on the production of men’s shirts, polo shirts and jackets, mainly using cotton. Its main customers are large chain stores in southeastern Brazil. According to the owner, the business consists of producing and selling cotton-made articles for shops and distributors, which then resell them to the end user. The respondent also stated that a large portion of sales is concentrated in the state of São Paulo, specifically in the city of São Paulo, in the Brás neighborhood, which represents a cluster for this segment, as shown in figure 1.
Figure 1: Concentration of Sales per Federal State, 2009
60% 50%
54%
40%
SP
30%
PR
20%
SC
21%
RS
13%
10%
9%
Other states
3%
0%
Source: Company Data
The company’s sales are highly concentrated. Sales-related data per customer are presented in Figure 2.
Figure 2: Sales Concentration per Customer, 2009
25% 20%
22% 21%
19%
18%
Cliente A Cliente B
15%
Cliente C 12%
10%
Cliente D 8%
5%
Cliente E Other states
0% Concentration of sales per state (2009)
Source: Company Data
This chart shows that five customers represent 81% of the company’s sales. The owner explains that this happens because these five customers are chain stores, and their orders are very significant. The remainder of sales is what the owner calls “small retail”. However, what stands out is that, although its earnings are below BRL 240,000.00, which is the cap for inclusion in the NSTS, the company has opted for the Presumed Profit system. 4.1 Case presentation To understand the reasons why the company opted out of the NSTS – National Simplified Taxation System for Small Business, we asked the respondent to describe in detail the events that led to the current situation. The company started its activities in 2005, and at that time, it opted for the NSTS system. In the beginning, sales were focused on the nearest states: Rio Grande do Sul (RS), Santa Catarina (SC) and Paraná (PR). However, by the end of 2005, as the business was growing, the company started focusing on the São Paulo market. In 2006 and 2007, the company was growing every month, and it ended 2007 with an average annual turnover of BRL 40,000.00. In 2008, it started with six employees, and it still opted for the NSTS system. During the first half of 2008, there was a decline in growth as sales stabilized. After surveying the customer portfolio, it was observed that all customers were small retailers and that their orders were generally small, approximately BRL 2,000.00. The adopted strategy was then to seek larger customers who had more than one store. Thus, the owner hired a representative mainly focused on chain stores. In the beginning of the second half of 2008, the first chain store order was received. This order was a reason for celebration because one customer alone purchased the equivalent of 30% of the average turnover, approximately BRL 12,000.00. Then, a large effort was made to produce articles and obtain earnings as fast as possible. As the raw materials were already available, 20 days after the order had been made, a truck loaded with products was sent to a single customer. Then, there was a large surprise: the products were refused by the customer. The owner traveled from the countryside of the state of Santa Catarina directly to São Paulo to find out what could have happened. When he entered the purchase office of the chain store, he saw the answer to his question, printed in large letters on the front door: “WE DO NOT PURCHASE FROM ‘NSTS COMPANIES’”.
Then, a negotiation was started with the purchaser to deliver the products, but his mind could not be changed, and the only argument used was that “these are instructions from the top management”. The company could not, in any way, purchase from any supplier if the purchase would not generate ICMS credit. The order was cancelled, and the products of the cancelled order had to be sold at cost. According to the respondent, there is a rule in the retail market When shopkeepers are included in the NSTS, they purchase from any company, with no restrictions. When shopkeepers expand their business and are no longer in the turnover range allowed for inclusion in the NSTS, they stop purchasing from companies that do not generate ICMS credits. This is a general rule applicable to all, and suppliers must comply with market requirements to survive. 4.2 Case outcome After the initial trauma, the solution found by the co-owner was to open another company, as the law does not allow changing company status during the year. Therefore, a second company – a small business – was founded in October 2008, which opted for the Presumed Profit system and, in the end of the same year, it was receiving new orders from new chain stores. Thus, the co-owner kept focusing on large chain stores, but to do that, he had to open a new company that opted out of the NSTS. The company that was included in the NSTS kept operating, so the co-owner faced the following situation: he had two companies, one included in the NSTS and co-owned by his wife, and the other using the Presumed Profit system. The NSTS company has four employees and continues serving small customers. It has a monthly turnover of approximately BRL 20,000.00. The presumed profit company currently has five employees and mainly serves large customers such as chain stores. It has an average monthly turnover of BRL 160,000.00.
5 Analysis of results In the review of the law, it was found that the government, based on the articles of the 1988 Federal Constitution that establish the preferential treatment of SBs, implemented public policies aimed at supporting them several years ago. The various measures taken by the Federal Government include the NSTS, under which the payment of almost all taxes and
contributions due by the SBs is replaced by a unified monthly payment of an amount based on their turnover. The amount is calculated based on a rate that may range from 3% to 5.4%, depending on the turnover range. Given that, in the Presumed Profit System, the amount of taxes due can reach almost 20% of the turnover, in addition to the ICMS, all companies that have annual turnover within the permitted range for inclusion in the NSTS should opt for this tax payment system. However, in the case of the company under analysis, that did not occur because it had a business relationship with large chain stores. Thus, the situation of the company under analysis is the following:
Annual turnover below BRL 240,000.00
Not included in the NSTS
Developed business relationships with large companies.
It was found that the NSTS does not work for companies in the situation faced by the case study company. If it is necessary to sell to large chain stores, companies are compelled by the market not to opt into the NSTS. This study does not consider how representative the chain store situation is to the entire set of companies covered by the NSTS, but it shows how some of the goals of the National Simplified Taxation Act are not being met. If a company has large chain stores as customers, it will not opt for this taxation system, even if it has compatible turnover. As was highlighted in the literature review, public policies for tax exemption in Brazil present their objectives in a general way and are not usually assessed as to whether the objectives have been achieved. When the NSTS was established, it was not intended that companies that sell to large chain stores should be excluded from the program, but as implemented, the public policy was unsuccessful in helping such companies. Some chain stores apparently do not purchase products from small businesses included in the NSTS due to the inability to obtain ICMS credits. It could be argued that this is not due to a deficiency in the taxation system because the lower volume of ICMS credits could be offset, in regards to the purchaser, by the proportional reduction in the price of the product supplied by the SB to maintain attractive economic conditions for the purchaser. However, if the SBs followed that course, the advantage of the differential and preferential tax treatment introduced by the new Act would be nullified, as it would be transferred to the end user. In other words, a tax benefit accompanied by the need for price reduction in an amount equivalent to the benefit itself ultimately equates to no tax benefit at all.
Based on the taxation theory topics presented, we have shown how the principle of neutrality is ensured if there is no interference of the tax in the formation of relative prices, and we have shown that, for ICMS, this interference could occur either in the taxation stage or in the prior stage of credit formation. We also noted that an exception has to be made in the principle of neutrality to ensure differential treatment for SBs. The differential legal treatment is achieved by reducing the ICMS tax rate levied on the sale, but if the credit amount to be appropriated by the purchaser is simultaneously reduced, this requires the SB to adjust its price. Thus, the intended tax benefit is reversed, and the privileged situation created for the SB ceases to exist. In turn, from the company’s perspective, the fact that it could not opt for the NSTS and that the owner had to open two companies that carry out the same activity generates an additional cost not only in terms of money but also in the large amounts of time involved. Every month, the owner has to make purchases for both companies and manage two cash accounts, two payrolls, and fees from two accounting companies. There is much effort required to manage the situation. Because these are two small businesses, much operational work has to be performed or supervised by the owner. If he has to manage both companies at the same time to the meet compliance costs – which are already proportionately higher for SBs – of both companies, then very little time is left for him to devote himself to what would be his true function. Thus, according to him, the medium-term goal is to close the NSTS company and to go forward with only the Presumed Profit company. 6 Final considerations The Federal Simplified Taxation Act established in 1996 a preferential taxation system for Small Business that covered federal taxes. In 2006, the National Statute of Small Business was enacted, and with it, the Federal Simplified Taxation System was superseded by the NSTS, which allowed unified payment of federal taxes and of ICMS and ISS. We studied the effects of this new system on trading companies that are ICMS taxpayers and have large chain stores as customers, and we found that the tax benefit did not produce the intended effects. The key factor for these companies that causes them to opt out of the NSTS is the impossibility of selling to large chain stores. Large chain stores do not purchase from companies included in the NSTS because the volume of ICMS credits generated is lower than if the purchase is made from companies not opting for the system.
The National Simplified Taxation Act was intended to extend the benefits of SBs; it included two more taxes in the set of taxes eligible for differential treatment. However, it ended up not giving any advantage to SBs in the conditions studied because they started to opt out of the simplified system of tax payments. Furthermore, the new law created a huge disadvantage for SBs: the National Simplified Taxation Act revoked the Federal Simplified Taxation System – FSTS – and these SBs could no longer pay federal taxes in a unified manner. In this case study, to address the difficulty created by the law, the businessman was forced to open two companies to be able to manage his sales for companies that require and do not require ICMS credit calculated on the total sale amount. That increased his costs and increased the time he spent managing the two distinct structures. If, to compensate for the fact that the sale of the product does not generate ICMS credit, the SB reduces its prices by an amount equivalent to the obtained tax benefit, the benefit itself would then be neutralized. Thus, a possible solution to this problem involves making the tax benefit effective. This could be achieved, for example, by creating conditions for obtaining the same credit volume when purchasing from a company not included in the NSTS as when purchasing from a company included in the NSTS. This study is an exploratory study. Other studies may provide more detailed information, especially if they are based on quantitative surveys that provide more robust results on the impact of the NSTS on the dynamics of SBs. Future studies could quantify the number of companies that have rejected the NSTS or that no longer use it. They could also conduct an in-depth analysis of the possible ways of making the tax benefit effective, and they could investigate whether there are other reasons for companies refusing to purchase from SBs, such as, for example, an idiosyncrasy of the purchasers themselves.
7 References
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