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RUEHPE/AMEMBASSY LIMA 1101
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RUEHRI/AMCONSUL RIO DE JANEIRO 7783
RUEHAC/AMEMBASSY ASUNCION 2926
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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