In the old accounting system, companies were measured by their results and, consequently, by the profits and dividends they could distribute. Since Brazil adopted the accounting principles of the International Financial Reporting Standards (IFRS ) in 2007, with Law No. 11,638, everything has changed, with these entities now being measured by their ability to generate sufficient cash to meet their obligations. This change in instruments for evaluating the so-called financial health of companies operates with financial resources, money, the main instrument of payment. The topic we propose to examine is how much the tax reform may affect companies’ cash flows and the significance of this change.
The Accounting Pronouncement of the Accounting Pronouncements Committee (CPC), No. 03, in its R2 version, defines cash flows as inflows and outflows of cash, money, or cash equivalents. In turn, cash is defined as cash on hand and available bank deposits, while cash equivalents are short-term, highly liquid financial assets and investments convertible into a known amount of cash and/or subject to an insignificant risk of change in value. Therefore, when analyzing the topic involving cash flow and tax reform, we are focusing on examining how tax reform may affect/or will affect an entity’s cash outflow.
Before delving into more detail about cash flow, it’s relevant to briefly comment on the differences between cash flow and profit, remembering that both are the subject of specific financial statements in corporate accounting. Companies are required to present the financial statements stipulated by Law No. 6,404/76, including the cash flow statement and income statement, as discussed below.
The Statement of Cash Flows (SCF) presents cash inflows and outflows for the period, classified by operating, investing, and financing activities. The most important purpose of the SCF is to demonstrate the entity’s ability to pay its obligations and, consequently, its solvency. This economic valuation metric for companies is widely used to determine the value of a business, demonstrating its balance.
The Income Statement (or Profit and Loss Statement), in turn, will indicate whether the entity generated profits or losses in its activity. Profit is, by legal definition, the remuneration of partners and investors, and it is entirely possible for an entity to have a profit but not have the cash to pay its partners.
Given this scenario, the question arises: does tax reform affect cash flow? When and how?
The entry into force of the tax reform in 2023 led all entities subject to the new Consumption Tax—since there was already a tax of this nature represented by the Tax on Industrialized Products (IPI), embodied in the Tax on Goods and Services (IBS), under state and municipal jurisdiction, and the Social Contribution on Goods and Services (CBS), under federal jurisdiction—to undergo a complete review of the technology adopted, the classification of goods and services, the calculation parameters, the adaptation of tax documentation, the revision of contracts, and many other measures aimed at adapting the business model developed to the new legislative and operational circumstances .
As a result, companies are already incurring very high costs for new equipment, hiring third-party consultants, and hiring employees. The cost of compliance will also increase significantly, as some taxes that were part of the old tax system will continue to be required for several more years, multiplying the precautions required for compliance and its associated costs.
Furthermore, cash flow will be affected from the moment the new consumption tax system comes into effect, as the tax cost will be impacted not only by the application of increased rates, but also by new incidences that did not previously exist. In the first case, one can cite intangibles, software, and similar items, while regarding new incidences, the leasing activity, which was not subject to the Tax on the Circulation of Goods and Services (ICMS) and the Tax on Services (ISS), will now be subject to the IBS/CBS. With this, again, cash flows will be significantly affected, and taxpayers should be cautious about these repercussions. In this case, it is important to highlight that this is the cost of the incidence itself, which contradicts the initial idea that the reform would be neutral as a whole.
How will these initial impacts on cash flow be felt? Certainly through a reduction in working capital, or the set of financial resources used to cover the company’s day-to-day operations, such as paying bills, salaries, and suppliers while awaiting the inflow of operating funds. Furthermore, financial liquidity, which is the ability to pay liabilities and acquire assets that allow the business to continue operating, will also be affected by the new requirements, the implementation of the tax model, and the new tax costs, as discussed.
All of this will result, in the short term, in a loss of financial predictability for the taxpayer, or the inability to organize the inflow and outflow of resources, since the new costs are outside of long-term budgets built by the entities, given that no one prepares to operate in periods shorter than three or four years.
The reform will require a change in mindset from everyone, from the company president to the most junior employee, and especially from those involved in the tax area. The costs of raising awareness among various levels of employees will require technical instruction in a matter lacking regulation from the public sector itself, which is not yet able to provide it, as can be seen from the legislation that is being gradually developed. It is essential to verify whether the number of people allocated to the new tax practices is sufficient to meet both the tax incidence and ancillary obligations, which may require new hires focused on implementing the updates brought about by the reform.
There are certain sectors that didn’t even have a tax department, such as companies focused on leasing assets, which lacked a fiscal area and now must implement routines and hire or train people to be responsible for it. It’s always worth remembering that the “people” department is one of the biggest concerns for business owners, since employees are key to the success of these entities. All of this must be factored into the new expenses arising from the tax reform, which will require training these people to comply with the reform.
Furthermore, the collection of taxes at the state destination is expected to have a substantial impact on cash flow. This is because there is a reversal in the tax collection model, which, until now, has been at the origin of goods and services, and in the future will be at the point of consumption. While there might be some rationality in this decision, since the wealth to pay the tax should reside where the good is consumed, in reality, many entities have established themselves in locations where they enjoy tax benefits. Therefore, reversing this equation will not change consumption habits, but rather lead establishments and companies located there to reconsider their plans and seek locations where they enjoy better operating conditions.
Currently, due to a tax incentive policy practiced for many years, many companies maintain establishments in several states of the Federation, which will have to change, since all state tax incentives have been revoked. Thus, exemptions, deferrals, and suspensions of state and municipal taxes will disappear, which will cause a substantial change in the cash flow of companies, since the costs of operation without the incentives, whatever they may be, are considerably lower than the new amounts to be paid. Therefore, cash flow will also be affected by these tax benefits.
It is important to highlight that states that consume goods and services are not those that developed incentives to attract producers. Therefore, the revenue from the new taxes should go to the consuming states, which are those that consume, not those that produce. Logically, companies that maintain establishments in states that previously granted tax incentives (which are now prohibited) should choose to leave these locations because, without infrastructure, trained personnel, and supplies, the operational costs will become unbearable, once again demonstrating that cash flow is also affected in this circumstance.
During the transition period, until the full implementation of the reform, we will have consumption taxes due at the source (ICMS, IPI, and ISS) alongside the IBS/CBS. As already mentioned, and noteworthy in terms of cash flow, the coexistence of two tax systems originating from/supported by different premises generates an increase in compliance costs, in addition to exposing the taxpayer to fines and charges due to the difficulties in applying such different regimes. In this sense, it is relevant to analyze what are called tax residues, which affect the pricing of goods and services, since there are taxes from the old system that are calculated internally and on themselves, as is the case with ICMS, in addition to taxes that do not generate credit rights, such as ISS, unlike the new model which is based on the premise of not being levied on itself and operating on a broad credit model.
Beyond these aspects, some new mechanisms introduced by the tax reform may affect cash flow, such as split payment, supported by Article 156-A, paragraph 5, item II, subparagraph ‘b’, of the Constitution, which provides for the collection of tax at the time of the “financial settlement of the operation”. This model implies advance payment of the tax, thus affecting cash flow. Similarly, the so-called cash back provided for in Article 156-A, § 13, of the Constitution, which stipulates that the return of taxes is mandatory (§ 5, VIII) in the supply operations it lists. Therefore, the business owner must have resources to fulfill this obligation immediately. The purpose of cash back is to protect low-income consumers, and the supplementary law may determine that it be calculated and granted at the time of collection of the transaction, right at the time of sale. This could also substantially reduce cash flow, especially for retailers.
Although the effects of the reform are mostly negative in terms of cash flow, there is a positive aspect that should be mentioned: full non-cumulativeness, if properly exercised, has positive effects on cash flow, since credits generated in previous operations can be deducted from the tax to be paid . For this to happen, it is essential that the tax authorities become aware that the credit is a right of the taxpayer, moving away from the bias that has guided audits focused on contributions due to the Social Integration Program (PIS) and the Social Security Financing (Cofins).
It is important to mention certain business models that should be reviewed, such as the quite common case of the supplier receiving funds in advance as payment before producing goods or services. In this case, IBS and CBS should be calculated and paid on the provisional value that was delivered as payment before the supply. The tax base will be the value of the installment paid, with the rate in effect on the date of payment. The final value will only be known at the time of supply. It will be up to the supplier to reconcile the amounts and verify if there was an overpayment or undue payment and, consequently, if it is possible to claim a refund, affecting cash flow.
On the other hand, this new scenario of cash flow disruption could be used to raise opportunities for taxpayers to protect their cash flow, such as: outsourcing as a way to increase credit generation; reorganizing payment flow by extending payment terms to suppliers, all duly negotiated in a timely manner; reducing the granting of discounts and bonuses, which are commonplace today but affect cash flow because they decrease the inflow of resources; reducing the time to receive payments from customers with incentive policies for those who pay in advance, such as exclusivity or prominent shelf placement, among others.
There is an extremely perverse aspect to the new tax model that does not exist today, consisting of the right to claim and use credits as long as payment has been made. In the new model, the use of the tax paid on the acquisition can only occur if the supplier has collected the tax, allowing the purchaser to assume the burden in order to anticipate the credit, all of which, of course, has repercussions on cash flow. Negotiation in the new tax model is therefore essential.
As can be seen, the tax reform, despite all its difficulties, also appears as a shadow hanging over companies’ finances, risking stifling their cash flow and generating more problems than could be expected. The reform continues to frighten many.
- Elidie Palma Bifano holds a master’s and doctorate in Tax Law from PUC-SP, is a professor in the professional master’s program at the São Paulo Law School/FGV and in specialization courses at the Brazilian Institute of Tax Studies (Ibet), the Brazilian Institute of Tax Law (IBDT), and the CEU-IICS Law School, and is a lawyer in São Paulo.