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### Viewing cable 07SAOPAULO119, ICMS Tax Benefits Issue: Financial Concerns for U.S.

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Reference ID | Created | Released | Classification | Origin
--- | --- | --- | --- | ---
07SAOPAULO119 | 2007-02-14 12:55 | 2011-07-11 00:00 | UNCLASSIFIED//FOR OFFICIAL USE ONLY | Consulate Sao Paulo

`

    VZCZCXRO7596
    RR RUEHRG
    DE RUEHSO #0119/01 0451255
    ZNR UUUUU ZZH
    R 141255Z FEB 07
    FM AMCONSUL SAO PAULO
    TO RUEHC/SECSTATE WASHDC 6421
    INFO RUEHBR/AMEMBASSY BRASILIA 7514
    RHEHNSC/NSC WASHDC
    RUCPDOC/USDOC WASHDC 2707
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    RUEHPE/AMEMBASSY LIMA 1101
    RUEHCV/AMEMBASSY CARACAS 0444
    RUEHBO/AMEMBASSY BOGOTA 1492
    RUEHRG/AMCONSUL RECIFE 3369
    RUEHRI/AMCONSUL RIO DE JANEIRO 7783
    RUEHAC/AMEMBASSY ASUNCION 2926
    RUEATRS/DEPT OF TREASURY WASHDC
    RUEHC/DEPT OF LABOR WASHDC
    RUEAWJC/DEPT OF JUSTICE WASHDC

` `

    UNCLAS SECTION 01 OF 04 SAO PAULO 000119

    SIPDIS

    SENSITIVE
    SIPDIS

    DEPT FOR WHA/BSC, WHA/EPSC, WHA/PDA, AND EB/CBA
    STATE PASS TO USTR FOR MSULLIVAN
    STATE PASS EXIMBANK
    STATE PASS OPIC FOR MORONESE, RIVERA, MERVENNE
    NSC FOR FEARS
    USDOC FOR 4332/ITA/MAC/OLAC
    USDOC FOR 3134/USFCS/OIO
    TREASURY FOR OASIA, DAS LEE AND JHOEK
    DOJ FOR CMERRIAM
    AID/W FOR LAC/AA

    E.O. 12958:  N/A
    TAGS: EINV ETRD ECON PGOV KJUS BR
    SUBJECT:  ICMS Tax Benefits Issue: Financial Concerns for U.S.
    companies, Sao Paulo State and Brazil

    REF: (A) SAO PAULO 36; (B) 06 SAO PAULO 675

    SENSITIVE BUT UNCLASSIFIED; PLEASE PROTECT ACCORDINGLY

    Summary
    -------

    ¶1. (SBU) Consul General convened representatives of US and Brazilian
    companies at ConGen Sao Paulo on January 19 to discuss ongoing
    issues associated with tax benefits (ICMS - rough VAT equivalent
    collected at the state level) granted by the Sao Paulo state
    government.  Motorola and other electronics exporting companies have
    received ICMS tax benefits, which has encouraged investment in the
    state.  Similar incentives have been granted by other states to
    various industry sectors, generating "tax wars" and resulting in
    lawsuits between states.  Parana state had filed a suit against Sao
    Paulo state in 2001, arguing that the granting of tax incentives
    without the agreement of all the other states violated the Brazilian
    Constitution.  The case was scheduled to be ruled upon by the
    Supreme Court (STF) on February 2.  If the decision were to go
    against Sao Paulo, the decree governing the tax incentives could
    have been declared unconstitutional, resulting in the cancellation
    of the benefits with the possibility of retroactive tax liabilities
    for the companies.  This would represent a loss of hundreds of
    millions of dollars and jeopardize the continued presence in Sao
    Paulo of a number of companies, as well as the plans of at least one
    company to move its operations to the state.  Rather than risk this
    outcome, Sao Paulo state governor Serra, responding in part to
    concerns raised by Ambassador Sobel and ConGen Sao Paulo, revoked
    the existing state decree on January 30 in a legal maneuver to
    vacate the existing lawsuit.  Sao Paulo state intends to replace it
    in the next fifteen days with a new decree retroactively granting
    U.S. and other companies identical benefits.  ConGen and the Embassy
    plan to work with U.S. companies, the Sao Paulo government and the
    federal government to encourage a long-term solution to the ICMS
    quandary.  End Summary.

    Background
    ----------

    ¶2.  (U) In order to develop and maintain industrial capacity
    manufacture and create greater investment in Brazil, many states
    have offered tax incentives to companies investing and operating in
    the state.  These take the form of credits to exporters on the state
    Tax on the Circulation of Merchandise and Services (ICMS - VAT
    equivalent administered and collected by state governments).  Sao
    Paulo state, as one of Brazil's major industrial centers,
    representing 31 percent of Brazil's GDP, also has offered such
    incentives.  However, the rivalry between states has led to "tax
    wars," and frequent lawsuits.  The Sao Paulo state government has
    adopted the legal tactic, once an unfavorable court ruling is nigh,
    of revoking the decree governing the tax credits and then
    immediately issuing a new one.  This results in the vacating of the
    lawsuit against the old law but allows companies to continue to
    receive their tax credits.  However, as the legal action of Parana
    vs. Sao Paulo concerning ICMS credits for electronics manufacturers
    made its way to the Supreme Court, companies became increasingly
    concerned that this tactic was not providing a durable solution to
    the continuing threat of adverse rulings and the possible loss of
    hundreds of millions of dollars.  For this reason, they requested
    the USG's assistance in encouraging the new Governor to work on a
    more durable, long-term solution.

    SAO PAULO 00000119  002.5 OF 004

    ICMS Tax Benefits:  The Need for a Permanent Solution
    --------------------------------------------- --------

    ¶3.  (U) ConGen hosted a series of meetings with affected companies
    to discuss issues surrounding state ICMS benefits.  Initially,
    Motorola had approached the Consul General (CG) and the Ambassador
    to express their concerns.  On January 19th, CG convened a second
    meeting that included additional companies and industry
    representatives facing this same problem.  Brazilian and U.S.
    companies, including Motorola, Flextronics, Dell, and Hewlett
    Packard, along with representatives of the electronics trade
    association ABINEE, Amcham and the state Federation of Industries
    (FIESP), met with with the CG, Econ/Pol, and FCS.

    ¶4.  (U) All in attendance at this meeting, which took place before
    Governor Serra revoked the old tax benefit legislation, agreed that
    even if the tax issue is resolved temporarily, as it has been in the
    past, there needs to be a longer term solution to the problem. The
    companies cannot continue to operate in a climate of instability and
    uncertainty; they have other options in terms of investment, such as
    India, China and Mexico. Sao Paulo state is particularly affected,
    as a large number of U.S. and other companies that employ thousands
    of people are based here.  These companies depend on ICMS credits to
    make their operations viable.  For example, Dell had decided to
    relocate from Rio Grande do Sul to Sao Paulo specifically because of
    the ICMS benefits.  Otherwise, the costs of production and problems
    with security would weigh against investing in Sao Paulo.
    Ultimately, there needs to be a long term solution.

    ¶5.  (U) It was resolved that ABINEE, the electronics trade
    association, would take the lead and coordinate efforts to bring
    about a resolution.  In addition to approaching the state and
    federal governments, ABINEE decided to seek the support of CONFAZ,
    the National Council for Fiscal Policy.  CONFAZ is an organization
    comprising the Secretaries of Finance of all 27 states; its members
    discuss important federal and state fiscal matters.  Created to
    allow the federal government and state tax authorities to jointly
    manage ICMS, CONFAZ is perhaps the best vehicle to begin to tackle
    the ICMS problem.  ABINEE met recently with Sao Paulo Finance
    Secretary Mauro Ricardo Machado Costa and several members of

    SIPDIS
    Brazil's Congress to emphasize the importance of resolving this
    issue.

    Meetings with the Ambassador:  Weighing in on the Issue
    --------------------------------------------- ----------

    ¶6.  (U) In an effort to assist in resolving this issue, Ambassador
    Sobel raised the ICMS benefits problem in a January 10 meeting with
    Governor Serra in Sao Paulo (ref A) and later with Minister of
    Development, Industry, and Foreign Trade Luiz Fernando Furlan in
    Brasilia.   Minister Furlan responded that this was a state issue
    and had to be resolved among the governors.   Governor Serra, for
    his part, gave assurances that he would revoke the tax incentives
    and then reinstate them.

    Sao Paulo State: Concerns, Actions, and Future Plans
    --------------------------------------------- -------

    ¶7.  (U) On January 30, the decree governing the ICMS credits was
    officially revoked by the Sao Paulo state government.  After the
    revocation, industry and ConGen took action on two fronts:  1)
    ABINEE convened a meeting of all concerned companies that day to
    meet and draft recommended language for the new decree, which they

    SAO PAULO 00000119  003 OF 004

    will submit to the state government, and 2) on the following day, CG
    met with Vice Governor Alberto Goldman to discuss the revocation and
    future actions of the state government to resolve the ICMS issue.
    Responding to the CG's concerns about the impact of this issue on
    U.S. companies, Goldman reiterated the government's intention to
    issue a new decree restoring the credits within 15 days.  The 15-day
    waiting period, Goldman explained, was not required by law but
    rather was based on "public image" concerns.  Goldman implied that
    an immediate turnaround would not be viewed in a positive light by
    the Supreme Court; for the sake of appearances, it was better to
    allow a decent interval before issuing a replacement decree.
    Although it was not clear whether the companies would be able to
    re-coup revenue losses incurred during this 15-day period, Goldman
    suggested that such losses would not be too detrimental since they
    would be shared equally throughout the sector.  He was aware that a
    new decree will be only a temporary solution and agreed on the
    urgent need to find a longer term solution.  He also confirmed that
    the state government has created an internal working group to
    develop a proposal for a permanent solution, which he hopes to
    present to the federal government in the next three months.

    ¶8.  (SBU) Goldman is confident that the states will reach a solution
    to these "tax wars," as he considers Sao Paulo State to be the
    "heavy hitter" in the war, and the most influential state in
    negotiating a modus vivendi with the others.  "We don't want to
    fight a war, we want to find a peaceful solution everyone can live
    with," Goldman said. "If we go to war, everybody loses.  But if it
    does come to that, we have the ammunition and will win."  He is also
    of the opinion that this early stage in President Lula's second
    administration offers an opportune moment to find a solution,
    implying that if there is a long delay in resolving the problem, the
    chances for reaching a successful conclusion would diminish.  He
    also considers that CONFAZ could be a major player in resolving this
    issue, as a solution reached by this organization would motivate the
    GOB to enter into serious talks to resolve the issue.  Goldman
    suggested that Ambassador Sobel could talk with Minister Furlan and
    Finance Minister Guido Mantega, and with Lula's Chief of Staff,
    Dilma Rousseff.  Another opportunity to resolve the issue would be
    to approach Governors from the major states involved.

    COMMENT
    -------

    ¶9.  (SBU) Comment:  At present, all the companies are waiting for
    the re-issuance of the new tax benefits decree, which they hope will
    include some of their input.  Upon re-issuance, the ICMS tax
    benefits issue will be temporarily resolved, but a permanent
    solution is necessary to create a stable financial climate for
    present and future business investment.  Based on our meetings with
    Governor Serra and Vice-Governor Goldman, we believe Sao Paulo state
    understands what is at stake and is committed to resolving the
    issue, which represents hundreds of millions of dollars to the
    companies, and affects future investment in the state.  After years
    of tax wars, revocations, and re-issuances, it appears that the Sao
    Paulo government is ready to roll up its collective sleeves and
    attempt to tackle this problem, and hopes to carry the rest of
    Brazil along with it.  Prospects for Sao Paulo state carrying the
    day on the issue, however, are not at all clear.  It is likely that
    any reform of the ICMS system, which necessarily raises a host of
    thorny fiscal federalism issues, will require clear federal
    government leadership in the Confaz and in the federal congress.
    The last serious attempt to reform the ICMS system, an ambitious
    effort that incidentally would have grandfathered and frozen

    SAO PAULO 00000119  004 OF 004

    existing tax breaks to companies, was roundly defeated in 2004 as
    many states proved unable or unwilling to compromise on changes to
    the tax that is their main source of income.  End Comment.

    ¶12. (U) This cable was coordinated with Embassy Brasilia.

    McMullen

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