Brazil's Supreme Court (STF) ruled on Wednesday, October 7, that presumed ICMS credits, tax breaks granted by states under the state-level value-added tax, cannot be included in the tax base of PIS and Cofins, two federal levies that fund social security. By 7 votes to 4, the justices rejected the federal government's appeal in case RE 835.818, a binding precedent that will guide lower courts, and closed a dispute that had dragged on for over a decade. The defeat could cost federal coffers up to R$16.5 billion (about US$3 billion), according to a Federal Revenue Service estimate cited by InfoMoney.

Majority built with votes from retired justices

The majority was opened by the case rapporteur, Marco Aurélio Mello, in a virtual session back in 2021, and includes the votes of Rosa Weber, Ricardo Lewandowski and Luís Roberto Barroso, all kept valid under court rules even after those justices left the bench. In the in-person session, Cármen Lúcia, Dias Toffoli and Edson Fachin joined the thesis. Alexandre de Moraes, Gilmar Mendes, Luiz Fux and Kassio Nunes Marques sided with the federal government.

Toffoli reversed the position he had taken in the virtual session. "The oral arguments convinced me of the need to evolve my understanding," he said, adding that taxing the credits under PIS and Cofins offends federalism by stripping out the effects of states' fiscal policy. Moraes, in turn, warned that the score could still change when procedural appeals are heard, since André Mendonça, Cristiano Zanin and Flávio Dino, who have not yet voted, will be able to weigh in.

At stake was whether a presumed ICMS credit, which cuts the state tax a company owes in order to stimulate an activity, a sector or a region, should be treated as revenue for the federal levies. The government argued it is an economic gain that stays with the taxpayer, unlike ICMS charged on an invoice, which merely passes through the company's accounts before being handed to the state. "The taxpayer stops disbursing a given amount and takes on no obligation to return or transfer that sum," said Gilmar Mendes. Moraes summed up the position: "A state can waive what is its own, but not what belongs to the Union."

The rapporteur's view prevailed: the presumed credit amounts to a reduction or reimbursement of costs, not the inflow of new wealth that defines revenue. Industry lobby CNI, which joined the case as amicus curiae, argued that companies factor these breaks into cost formation and investment decisions, and that federal taxation would hollow out the economic content of state incentives. Tax lawyer Ana Paula Baruel, a partner at Baruel Barreto Advogados, said the outcome is consistent with the so-called "thesis of the century," the 2017 ruling that removed invoiced ICMS from the PIS/Cofins base: values that are not a company's effective revenue should not be taxed.

In practice, the ruling shields the supply chain installed in states that grant the benefit: the savings from the presumed credit will no longer be eroded by federal taxes, which tends to sharpen the race among state governments for investment. On the other side of the counter are the Treasury, which loses revenue the Federal Revenue Service estimated at up to R$16.5 billion, and consumers, who will feel the effect indirectly: a lighter tax load on benefited companies can help hold prices, while the hole in federal revenue may lead to spending cuts or a search for offsetting taxes.