Article by Leo Laranjeira, Monica Barros and Uales Bessa
The logistics networks of most Brazilian companies were built based on tax benefits. Therefore, to understand the impacts of a possible tax reform, ILOS conducted a survey with supply chain executives from large companies in Brazil, in which 78% of participants stated that fiscal factors were decisive in defining their respective distribution networks, with around 40% of these companies' revenue coming from incentivized distribution centers.
This pattern where fiscal logic overrides logistical efficiency happens because our current tax system encourages fiscal war between states. This occurs because today the tax is collected at source, causing states to reduce, postpone or exempt companies from taxes in an attempt to attract them.
It is common to have e-commerce distribution centers (DCs) with tax incentives in Minas Gerais, just as many import companies set up shop in Santa Catarina or Espírito Santo in search of a tax reduction. Two more classic examples are the pharmaceutical industry in Goiás and most of the electronics in Manaus due to the Free Zone. However, although the companies' facilities are in these states, the main demand is generally not there, which leads to higher transportation costs.
When creating a tax-oriented distribution network, it is common for logistics costs to increase. In logistics network review projects conducted by ILOS, on average there is an increase of around 10% in logistics costs in favor of a more than proportional tax gain. As a result of this equation, in practice, goods move more. If we remember that, according to the 2023 ILOS cost survey, around 63% of our transport matrix is road, when transporting these goods this means greater emissions of polluting gases that contribute to the worsening of the environment.
The recent progress in discussions on Brazilian tax reform raises a series of questions about its implications for logistics in the country. Given this scenario, ILOS conducted a survey with 86 supply chain executives from the thousand largest companies in Brazil to assess the potential impact of the tax reform on their respective logistics networks, outlining scenarios about its possible developments.
Origins of Brazilian tax complexity
Brazil's tax system is one of the most complex in the world, ranking among the ten countries with the greatest tax complexity among 190 nations, according to the World Bank. Every year, Brazilian companies dedicate around 1500 hours to comply with their tax obligations, in a system that encompasses more than 90 types of taxes and records more than 10 annual changes to tax rules. But how did we get into this situation?
With the Proclamation of the Republic in 1891, Brazil inherited the Empire's tax system, which depended heavily on the collection of import taxes, representing approximately two-thirds of tax revenues. Over the years, there have been efforts to diversify revenue sources, including the creation of taxes such as consumption tax and income tax. However, the import tax continued to play a predominant role. During this period, the National Bank for Economic Development (BNDE) was established to boost the country's industrial development, which resulted in an increase in public spending.
In the 1960s, the government sought to balance its accounts by increasing the Union's revenue, with the creation of the ICM and IPI, and a greater centralization of tax competence. The Union became responsible for collecting resources and defining transfers to states and municipalities, which resulted in a reduction in the funds transferred to these two entities, promoting dissatisfaction among governors and mayors.
In 1988, the Constitution was amended in the tax sphere, granting greater autonomy for states and municipalities to define their own tax rates and rules. However, this led to the tax war and a substantial increase in the complexity of the tax system for companies, which now have to understand the tax regulations and rates of each federative entity.
In the search for a simplification of the system, a constitutional amendment was proposed in 1995 to reduce taxes and adopt the destination principle, where tax collection would occur at the place of consumption, instead of the place of manufacture; however, this proposal was not approved by the Chamber of Deputies. Other reform attempts took place in 2008, 2015 and 2019, but were unsuccessful.
PEC 45/2019, approved by the Chamber of Deputies in July 2023, represents, to date, the closest step towards a comprehensive reform to reduce the complexity of our tax system.
Impact of the tax war on logistics: case study
By collecting taxes at the place of origin, the current tax system encourages fiscal war, in which states seek to attract economic activities by reducing, postponing or exempting companies from taxes. Some examples include incentives for electronics companies in Manaus, the pharmaceutical sector in Goiás, e-commerce in Minas Gerais, and imports in both Espírito Santo and Santa Catarina.
A recent logistics network review project carried out by ILOS exemplifies the impact of tax aspects on companies' logistics costs. In projects of this type, it is customary to mathematically model transport, storage and tax costs to meet the company's demand, in order to indicate the best location of stocks and logistical paths. In the case in question, a large company in the consumer goods sector wanted to optimize its logistics network, aiming to minimize costs while respecting the desired level of service. The consultancy focused on recommending the ideal number of warehouses and their respective locations to minimize costs and meet demand, resulting in savings of 15% in total cost (including logistical and tax costs), in addition to a 37% reduction in average lead time. company traffic. However, tax aspects promoted inefficiencies in logistics, despite the reduction in total cost.
Analyzing a strictly logistical optimization scenario, without considering tax effects, the proposal would result in the recommendation of three distribution centers (DCs) for the company, promoting a 9% reduction in logistics costs, in relation to the baseline. However, when taking tax benefits into account, the optimization model suggested an additional CD, thus totaling four CDs instead of three. As a result, the logistics cost increased by 10% in relation to the optimal level, in exchange for a more than proportional reduction in tax expenditure, resulting in a 15% reduction in the total cost for the company, as shown in Figure 1.
Thus, even with logistical inefficiencies, such as more kilometers traveled by vehicles, sub-optimal transit time and an increase in the cost of facilities due to the opening of another DC, the reduction in total cost was greater due to the tax benefits provided by the states.
Figure 1: Result with and without tax – costs, savings and inefficiency
Source: ILOS Project
Recent advances on tax reform
Faced with such complexity, the discussion on tax reform has been a topic on the agenda for more than four decades, gaining greater prominence from the beginning of the 2st century, as shown in Figure XNUMX.
Figure 2: Evolution of academic mentions of tax reform
Source: Google Scholar; ILOS
The reform proposal currently under discussion (PEC 45/2019) aims to simplify the tax system by reducing the amount of taxes. The PIS, COFINS and IPI taxes would be replaced by the CBS (Social Contribution on Goods and Services) at the federal level, while the ICMS and ISS would be unified into the IBS (Tax on Goods and Services) operating at both the state and municipal levels. Furthermore, the proposal introduces a selective tax of federal scope, the purpose of which is to penalize goods and services that are harmful to health and the environment.
Another objective of the text is to eliminate or, at least, reduce the fiscal war between states. The proposal suggests that the collection of taxes no longer follows the principle of origin and starts to be carried out in the state of destination, that is, the tax no longer remains in the state of origin where the product is manufactured, being collected in the state of destination where the product is consumed.
The project proposes a gradual transition to the new tax system over the next ten years, with greater impact from 2027 and completion in 2033, as shown in Figure 3.
Figure 3: Transition of taxes to new tax system
Note: IS: selective tax
Source: gov.br; ILOS
However, the content of PEC 45/2019 is controversial and raises a series of questions and uncertainties, mainly related to:
-
- Company migration: reduction of capital and labor in the poorest states, with companies moving to richer states, due to the logic of destiny in which companies benefit from being closer to their consumer market
- Resource distribution: uncertainty regarding the criteria for compensation and redistribution of revenue between states
- Subjectivity of selective tax: lack of clarity in the classification of products and services that are harmful to health and the environment
As reported, the text approved by the Chamber of Deputies presents points subject to modification in the Federal Senate, whether due to subjectivity or the impact on the poorest states.
Scenarios for Brazilian tax reform
Given the growing demand and pressure, we believe that we will have a tax reform in Brazil; however, the crucial questions lie in when it will occur and how intense the changes implemented will be. Therefore, we developed four scenarios for the Brazilian tax system, also shown in Figure 4:
-
- He swam and died on the beach: the discussion will take place over a long period, promoting a climate of persistent uncertainty in the economic and political environment. The text will undergo several changes to accommodate multiple interests and, in the end, will not result in substantial changes to the tax system
- "Nothing changes: the proposal will undergo several modifications, practically nullifying its impact; however, it will be approved quickly, reducing the climate of uncertainty in the market
- Fast and impactful: the reform will be approved quickly, introducing changes of great relevance to reducing the complexity of the system, with an impact expected until 2030
- Better late than never: the discussion will take place over a long period, promoting a climate of persistent uncertainty in the market; however, the reform will bring significant changes to the system, with an impact expected after 2030
Figure 4: Tax reform approval scenarios
Source: ILOS
But what is the impact of these scenarios on logistics? The impacts will vary from company to company, however it is up to logistics executives to evaluate these scenarios and look for alternatives. For example, if the company needs to increase or open a new CD because the current ones are no longer sufficient, an alternative is to opt for shorter contracts of two or three years, where the value per month will be higher compared to the contract of longer duration, but in return it will allow you greater flexibility. Another case, if the company already wants to open a DC in São Paulo, one option is to accelerate this implementation because if the reform is in fact more structuring and changes the billing format for the destination, in the medium term the cost of the facilities in São Paulo tend to increase due to greater demand.
ILOS survey on the logistical impact of tax reform
In order to assess the potential impact of tax reform on logistics, we conducted a survey involving leaders from strategic sectors. The survey covered executives from 86 companies, all classified among the thousand largest in Brazil, with representatives from the following segments: agribusiness, basic industry, consumer goods industry and retail trade. The profile of respondents includes members of the board, management and coordination.
We observed that tax aspects play a decisive role in formulating the logistics structure of companies, in most cases, with 78% of respondents indicating that the tax context has a high or very high relevance in determining the configuration of their respective logistics networks ( Figure 5).
Figure 5: Relevance of the tax for defining the logistics network (% resp.)
Source: ILOS – 2023 survey
Furthermore, companies also reported that, among their respective distribution centers (DCs) that have some type of tax incentive, Minas Gerais stands out as a leader in tax competition in the logistics field (Figure 6).
Figure 6: Location of CDs with tax benefits (qty.)
Source: ILOS – 2023 survey
On average, companies have around 40% of their revenue associated with CDs that benefit from tax incentives, with the consumer goods sector being the one that stands out with an average representation of 58% of revenue coming from CDs with tax benefits ( Figure 7).
Figure 7: Average representation of CDs in revenue
Source: ILOS – 2023 survey
Although the search for cost reduction is the predominant motivation for an initiative to review a company's logistics network, it is important to note that cost is not the only driver of logistics structure review initiatives. The survey also revealed that 30% of companies review their logistics networks in search of improvements in customer service and increased market share (Figure 8).
Figure 8: Motivation for mesh review (% resp.)
Source: ILOS – 2023 survey
When we consider tax reform, it is notable that companies are paying attention to the ongoing discussions. Only 21% of them indicated low or very low monitoring of the process. Furthermore, the majority (70%) expect the reform to reduce or at least maintain logistics costs at current levels, while 30% predict an increase in total logistics costs, mainly due to increased transportation costs (Figure 9) .
Figure 9: Impact of logistics costs with tax reform
Source: ILOS – 2023 survey
Furthermore, most companies are already analyzing what the impacts of the tax reform will be on the logistics of their operations, a matter addressed by management, and with the expectation of a relevant impact on the logistics operations of their companies (Figure 10).
Figure 10: Impact of tax reform according to company analysis (% resp.)
Source: ILOS – 2023 survey
Regarding the logistical implications of PEC 45/2019, half of the companies expect to reposition their distribution centers (DCs). As for the positive impacts on business, companies anticipate a reduction in transportation, inventory and storage costs, as well as an increase in the level of service. On the other hand, negative consequences may include an increase in transport and storage costs, as well as the termination of contracts with service providers (Figure 11).
Figure 11: Expected consequences of tax reform
Source: ILOS – 2023 survey
With regard to investments in logistics, 76% of companies say they continue to invest, despite the uncertainties associated with tax reform. However, it is important to highlight that the logistics structure of many large companies is not very flexible, based on strategies anchored in the current context and with high capital expenditure (CAPEX), difficulties in allocating and re-allocating properties and challenges in mobilizing and demobilizing labor. of work (Figure 12).
Figure 12: Main difficulties in implementing the logistics network
Source: ILOS – 2023 survey
Conclusions:
One of the main changes with the tax reform is exactly that the tax will be collected at the destination. And what impact does this have on logistics? If the reform passes as it is, it means that the location of the CD will no longer be a difference, given that the tax will be charged by the location of consumption.
We see that the current proposal promotes greater relevance of logistics, efficiency gains, improved service levels and social benefits:
- Relevance of logistics: With the collection of tax at the destination, logistics begins to play a greater role in defining the distribution network of companies, reducing the role of the tax professional.
- Greater efficiency: with a reduction in the influence of the tax aspect on the network, companies will tend to seek greater logistical efficiency, with better positioned stocks and shorter distances covered by vehicles
- Customer proximity: The adoption of the destination concept will also lead companies to establish themselves closer to consumer markets
- Best level of service: Prioritizing the shortest route due to the elimination of “tax tourism” will contribute to a better level of service
- Social benefits: These changes could also result in fewer road accidents and a reduction in CO2 emissions from reduced distances travelled.
The trend will be for companies to migrate their DCs closer to their consumer markets in order to speed up deliveries, improving the service. The supply chain executives who responded to the survey believe this, so much so that the main consequence of the tax reform for logistics in their opinion will be the repositioning of facilities (53%), followed by a reduction in transportation costs (41%) and an increase in service logistics (30%).
We still don't know when the reform will be approved, much less whether the final text will be exactly what is being processed now. However, it is a fact that changes must happen and will have an impact on the supply chain. The most important thing is to have mapped out what impacts could happen, draw up scenarios and monitor them.
More than half of the executives interviewed (56%) stated that they are already analyzing what changes they may need. Is your company already analyzing what the impacts will be? If not, better start.
References:
- gov.br;
- Doing Business, 2020;
- Academic Google;
- Ipea;
- Camara.leg;
- Economic value;
- Examination;
- FGV;
- ILOS
