Brazil is a federation formed by the inseparable partnership of states, municipalities, and the Federal District, where the Brazilian political-administrative organization includes the Federal Government, states, the Federal District, and municipalities. Each one of these entities are autonomous in adopting local governance policies, as outlined by the Federal Constitution.

To ensure the autonomy of federal entities, the Federal Constitution has set up legal frameworks, financial obligations, resource collection methods, the operational fields of the federative entities, and the prohibition of taxing revenues among the federal entities (reciprocal immunity).

Exercising their constitutional autonomy, states in the federation may choose to forego a portion of the revenues they could collect through ICMS, by offering tax incentives in the form of ICMS presumed credits. This is done to attract investments aimed at enhancing operations, encouraging, and increasing strategic sectors that could lead to more investments and local economic and social development.

In practice, for taxpayers, these fiscal incentives granted by states represent a significant cost recovery for the relief of operations. Often, relocating companies involves high investments ranging from relocation costs and the construction of economic enterprises to the transportation of finished goods, considering Brazil’s vast territory.

Despite this, historically, the Federal Government has viewed the fiscal incentives provided by states as an opportunity to increase its revenues by taxing these values with federal taxes – IRPJ, CSLL, PIS, and COFINS. The issue has been addressed by the Superior Courts , arguing that due to the federative pact, reciprocal immunity, and the constitutional concepts of income, revenue, and gross revenue – which are the bases for federal taxes – the possibility of taxation was broadly rejected.

According to Justice Regina Helena of the Superior Court of Justice (STJ), in the judgment of Motion to Rescind a Special Appeal Ruling No. 1.517.492, the Federal Government’s intention to tax the ICMS fiscal incentives granted by the States is “to allow the Federal Government to indirectly withdraw the fiscal incentive that the state member, exercising its tax competence, granted.” This represents a clear affront to the federative principle, resulting in the depletion or reduction of the fiscal incentive that was legitimately granted by the federative entity.

After the Federal Government’s continuous defeats in the Judiciary, the only alternative left was to change the rules of the game, leading to the enactment of Provisional Measure 1185/2023, converted into Law 14.789/2023 (with effects starting from 01, January 2024).

However, the Federal Union chose the wrong legal instrument to seek this change in the judiciary’s understanding, as Law 14.789/2023 could not alter the constitutional concepts that defined the impossibility of taxing the ICMS fiscal benefits granted by the States of the Federation (Federative Pact, reciprocal immunity, and the constitutional concept of revenue, profit, turnover).

Thus, despite the legislative change, courts have maintained the historical understanding of the matter. Judicial decisions have reinforced the constitutional pillars, as allowing such taxation by the Federal Government would violate:

1. the principle of legality, the hierarchy of norms, and the reserve for complementary law, in addition to allowing Ordinary Legislation to change an understanding established by the Federal Constitution;
2. the FEDERATIVE PACT, reciprocal immunity, and the autonomy of the States of the Federation to grant ICMS fiscal benefits, as it would represent authorization for the Federal Government to withdraw, even partially, the fiscal benefits granted by State Governments;
3. the legal and constitutional concept of income and profit since the materiality of IRPJ and CSLL necessarily presupposes the existence of an increase in wealth.

Therefore, it is expected that more injunctions will be issued to prevent the taxation of ICMS fiscal incentives by the Federal Government.