Mechanisms to Mitigate the Impacts of the Brazilian Consumption Tax Reform on M&A Transactions

With the recent enactment of Complementary Law No. 214, which regulated the Brazilian Consumption Tax Reform, mergers and acquisitions (M&A) transactions in Brazil are already being analyzed in light of the new system’s implications on valuation processes. 

The new system introduced several structural changes that are expected to impact economic activities and alter the dynamics of consumption in Brazil. Destination-based taxation, a limited number of rates and exceptions, gross-up taxation, and a broad non-cumulative regime are some of the features of the new system that will shape consumption taxation in Brazil in the coming Years. 

For this reason, this article seeks to examine three key points of attention that should be considered in such transactions: (i) the timing effects of the Brazilian Consumption Tax Reform, (ii) a clear understanding of how the new system will affect company valuation processes, and (iii) the existence of alternatives to mitigate the Brazilian Reform's impacts on the target company’s activities. 

In the conclusion, we will analyze potential mechanisms that may be used to allow transactions to move forward despite uncertainties related to the new rules. 

1. Timing Effects of the Brazilian Consumption Tax Reform 

The implications of the new system on variables that are sensitive to company valuation processes may be mitigated during the transition period, which will end only in 2033. This is because the current system will remain partially in effect during those years. 

Several effects of the new rules will be softened during the transition period. For instance, the impact of the elimination of ICMS state tax benefits — which can account for a significant portion of a company's EBITDA — will be more strongly felt only after 2033, not immediately. This should be considered in the valuation process, so that the tax benefits in effect until 2033 are reflected in the company’s market value. 

2. Understanding the Impact of the New System on Valuation Processes 

The new tax rules may cause various tax impacts across different sectors, including a potential increase in the overall tax burden. 

Examples include sugary drinks, gambling, and vehicles, which not only did not benefit from reduced IBS (State and Local VAT) and CBS (Federal VAT) rates under the new system but will also be subject to an Excise Tax. As such, these sectors may face a higher tax burden. 

Other examples of sectors likely to be significantly impacted are sanitation services and leasing of goods. Under the current system, these activities are subject only to PIS and COFINS (current federal Tax on Revenues), with no ISS (current Tax on Services) or ICMS (current State VAT). Under the new system, both will be subject to the standard IBS and CBS rate, estimated by the Ministry of Finance at 28%, representing a significant change in taxation. 

Therefore, it is essential to understand the new system’s impact on the target company’s operations to assess whether the new rules will affect sensitive variables in the valuation process, such as profit margin, EBITDA, among others — which could ultimately impact the conclusion of the M&A transaction. 

3. Existence of Alternatives to Mitigate the Brazilian Reform’s Impact on the Target Company 

It is also important to evaluate whether the impacts of the new system can, to some extent, be mitigated. 

Returning to the example of ICMS tax benefits: with taxation shifting to the destination, states that previously adopted aggressive tax benefit policies to attract businesses may see a decrease in revenue. 

Although the Brazilian Consumption Tax Reform created the National Fund for Regional Development (FNDR) to reduce regional and social inequalities, there is no certainty that the amounts states will receive will fully offset the loss of regional tax incentives. 

However, states have other revenue sources that may help offset such losses. In addition to revenue from IPVA (Tax on Property of Vehicles) and ITCMD (Tax on Donation and Estate Tax) — both of which were amended by the Reform with the potential to increase collection — states may also raise funds through new contributions, asset revenues, service fees, and credit operations. 

Thus, it remains uncertain whether states will adopt alternative mechanisms to maintain their revenues, even if in formats other than tax incentives — which could affect the pricing of companies that rely on state tax benefits. 

Accordingly, understanding whether measures are being implemented to mitigate the effects of the new system is essential in the valuation process of the target company and may prove decisive in the success of a merger or acquisition. 

4. Mechanisms to Ensure Completion of M&A Transactions 

Finally, despite the uncertainty surrounding the impact of the new consumption tax system on certain sectors, in our view, mechanisms can be created to make M&A transactions viable through conditional arrangements. 

The inclusion of contractual provisions for conditional additional payments (earn-outs) may be the most effective way to overcome uncertainties regarding the new tax system’s impact on the target company’s business. 

If buyers and sellers disagree on part of the company's value due to the potential impacts of the Brazilian Consumption Tax Reform, the agreement may include an earn-out clause requiring an additional payment if the company manages to maintain its profit margin despite the increased tax burden. 

The earn-out clause may also require an additional price payment if the company maintains its EBITDA despite the elimination of ICMS tax benefits — or if these financial indicators are sustained during the transition period, which will end in 2033. 

Therefore, even though the new Brazilian consumption tax system may create uncertainty regarding its impact on certain business segments, providing for conditional price adjustments may be a viable path to ensure the successful completion of M&A transactions. 

5. Conclusion 

In conclusion, the Brazilian Consumption Tax Reform has introduced structural changes that directly impact the valuation processes of companies in mergers and acquisitions. 

During the transition period, which will last until 2033, some of these impacts will be mitigated — such as the end of ICMS tax benefits, which will continue to influence company valuations for several more years. Accordingly, it is essential that these temporary effects are properly reflected in asset pricing. 

Furthermore, it is crucial to clearly understand how the new system will affect the tax burden across different economic sectors, as increases in tax rates or the introduction of new levies, such as the Excise Tax, may change sensitive variables like profit margins and EBITDA. Depending on the target company’s sector, such changes could significantly modify or even hinder the terms of an M&A transaction, requiring more detailed analyses and realistic projections about the company’s future under the new tax regime. 

Finally, contractual mechanisms such as earn-out clauses emerge as practical solutions to address the uncertainty caused by the Consumption Tax Reform. These clauses allow part of the transaction value to be made conditional upon the company’s future performance, especially regarding the maintenance of profitability and financial indicators during the transition period. Thus, even amid uncertainties, it is possible to structure M&A transactions in a secure and adaptable manner within the new tax environment. 

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