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After a tumultuous year in Brazilian politics, two presidential candidates have emerged from the first phase of a two-part election process. Based on the October 7 election results, the following candidates will compete for the presidency on October 28:

• Jair Bolsonaro, 63, who received 46% of the vote, is a six-time federal deputy, and a conservative who got the anti-petista voice (anti-petistas oppose the Workers Party). Bolsonaro was stabbed while campaigning and political observers have been quoted as saying that the attack strengthened his political standing and "practically guaranteed him a place in the second round."
• Fernando Haddad, 55, who received 28% of the vote, is the former mayor of Sao Paulo City and Minister of Education during Lula da Silva's term. He is a member of the PT (Workers Party), the party of convicted ex-president Lula, who is in prison for corruption.

Tax positions of two finalists

Although neither candidate has released detailed tax reform proposals, their statements to the media suggest they support the following:

Taxation of corporate dividends

Like many policymakers, both candidates appear to support taxation of corporate dividends, which are currently exempt from taxation. This support is based on perceptions that:

• The upper and middle classes pay less income tax than the lower classes because they generally receive more of their total income in the form of dividends
• Some workers use strategies to convert high-tax wages into lower-taxed corporate income and tax-exempt dividends

Bolsonaro has raised the issue of reducing Brazil's 34% corporate income tax. Dividends taxation could be paired with such a reduction in corporate income tax to make the Brazilian corporate tax system more competitive.

Shifting the taxation of foreign profits from a worldwide system of taxation to a territorial system might also be considered. Many Brazilian multinationals with extensive operations outside Brazil consider restructuring to manage the taxation of their worldwide profits and to benefit from OECD transfer pricing rules.

However, budgetary pressures, due to mounting public debt, may prevent the less competitive aspects of the Brazilian corporate tax system from being addressed. The budget situation will require some increase in the tax base, and such measures (which could include elimination/reduction of special tax regimes used by small businesses) are always politically difficult to enact.

In the end, it is unlikely that Brazil will enact tax legislation that will be effective in 2019, but it is generally understood that some action on the corporate income tax system will soon be necessary.

VAT reforms

Both candidates appear to support reform of the current indirect tax system, though the details (to the extent available) differ. A VAT reform bill has been proposed in the Brazilian Lower House. The bill may be discussed this year, but its fate ultimately depends on the outcome of the elections.

If enacted, this bill will significantly change the system of indirect taxes in Brazil. The proposed changes include the following:

• Replacing the ISS (municipal indirect tax), ICMS (state indirect tax), PIS and COFINS (federal indirect taxes), and IPI (federal excise tax) with just one federal VAT (Imposto sobre Bens e Serviços, the IBS) with a few exceptions and special regimes
• Charging the IBS based on the destination of goods and services rather than origin
• Centralizing IBS collection
• Distributing IBS revenues to states and cities based on their contribution to the tax base and phasing in the new distribution model over 50 years to avoid short-term impacts on state and municipal budgets
• Phasing in full IBS implementation over 10 years

The current Minister of Finance said recently that, if there is support from the newly elected President and Congress, the Government will be ready to reform the PIS and COFINS into a federal VAT this year. It is possible that the PIS and COFINS reform could have a lower impact on revenue distribution to the states and municipalities, and could work as a test for full IBS implementation.

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Contact Information For additional information concerning this Alert, please contact:   Ernst & Young Serviços Tributários SP Ltda • Sergio Fontenelle +55 11 2573 3169 • Washington Coelho +55 11 2573 3446 • Orlando Veloci +55 11 2573 3583 Ernst & Young LLP, Latin American Business Center, New York • Gustavo Carmona Sanches +1 (212) 773-9325 • Aline Nunes +1 (212) 773-9109 Ernst & Young's Center for Tax Policy • Cathy Koch +1 (202) 327-7483