Tax Substitution (ST) is undoubtedly one of the most complex and burdensome aspects of Brazil’s current tax system, and its elimination is one of the most anticipated promises of the Tax Reform.

However, at Synchro, we believe it is important to set realistic expectations: the end of this regime will not happen immediately. The transition to the new consumption tax model (IBS and CBS) will occur gradually until 2033.

This means that companies will have to coexist for years with the old ICMS-ST logic while implementing the new Dual VAT framework.

Ignoring this hybrid phase is a mistake. Companies that disable their ST controls too early risk paying taxes twice or facing assessments related to legacy transactions.

What Is Tax Substitution and What Is Its Future Under the Tax Reform?

Tax Substitution is a regime in which the responsibility for collecting tax (generally ICMS) is assigned to a single participant in the supply chain, anticipating the tax due on subsequent transactions.

To understand what Tax Substitution means in the new scenario, we must look at the VAT (Value-Added Tax) model.

The new system, composed of IBS (Tax on Goods and Services) and CBS (Contribution on Goods and Services), operates under the principle of full non-cumulativity.

This eliminates the need for ST as we know it today. Under a VAT model, each participant pays tax only on the value it adds.

Therefore, the concepts of “presumed profit” and the Value-Added Margin (MVA), which are the foundation of ICMS-ST calculations, technically cease to exist for the new taxes.

However, it is important to note that some sectors, such as fuels, will remain subject to a single-phase taxation regime, which shares certain collection characteristics with ST but operates under a different mechanism.

Relief is coming, but it requires patience and, above all, dual compliance throughout the transition period.

Phase-Out Timeline: The Coexistence of ICMS-ST and the New Taxes

Will Tax Substitution disappear under the Tax Reform? Yes, traditional Tax Substitution will cease to exist, but not overnight.

It will be phased out gradually between 2029 and 2032, following the reduction of ICMS rates.

The official timeline establishes a significant challenge:

• 2026 (Testing Phase): Collection of IBS (0.1%) and CBS (0.9%) begins. ICMS-ST remains fully applicable (100%).
• 2027: PIS and Cofins are eliminated, and CBS becomes fully effective. ICMS-ST remains in force.
• 2029–2032 (ICMS Transition): ICMS rates—and consequently ST amounts—will be reduced proportionally: 90% in 2029, 80% in 2030, and so on.
• 2033: Definitive extinction of ICMS and Tax Substitution, with full implementation of IBS.

For four years (2029–2032), companies will issue invoices containing both ICMS Tax Substitution amounts (old rules) and IBS/CBS amounts (new rules).

This requires tax systems capable of calculating the progressive reduction of MVA and interstate tax rates.

This hybrid tax environment is expected to be one of the greatest stress tests for tax departments.

How Should Inventory Subject to ST Be Managed During the Transition to IBS?

Inventory management will require complete segregation of stock based on the acquisition date.

Goods acquired with retained ST (embedded tax cost) and sold under the new tax regime (with IBS due on sale) will require immediate tax adjustments to avoid financial losses.

Consider the following scenario: a company purchases a product in 2032 with ST already withheld (tax prepaid through to the final consumer).

However, the product is sold in 2033, after ST has been abolished and IBS is fully in force. Without proper controls, the company could end up paying IBS on the sale despite having already borne ST on the purchase.

To avoid double taxation, companies will need to determine their entitlement to credits for taxes previously paid.

Inventory assessments and reimbursement or tax credit claims will need to comply with strict regulatory requirements.