Brazil’s path to decarbonisation: tax incentives and policies on hydrogen and biofuels

Leonardo Homsy

Mattos Filho, Rio de Janeiro

leonardo.homsy@mattosfilho.com.br

Marcus Vinicius Araújo de Souza

Mattos Filho, Rio de Janeiro

marcus.araujo@mattosfilho.com.br

Introduction

The climate crisis has highlighted the need for collaborative efforts among countries to protect the environment. As greenhouse gases (GHGs) have been identified as one of the main contributors to the climate crisis, reducing these emissions has materialised into an international commitment to promote the energy transition and decarbonise certain economic sectors, particularly hard-to-abate sectors, such as heavy industry, transportation and logistics, among others.

In this context, the Paris Agreement was signed in 2015, during the UN Climate Change Conference (COP21) of the UN Framework Convention on Climate Change (UNFCCC). The main goal of the Paris Agreement is to limit global warming by achieving net zero GHG emissions by 2050. To this end, countries that are parties to the Paris Agreement submit an ‘action plan’ detailing the measures they will adopt to reach these objectives: so-called nationally determined contributions (NDCs).

Brazil’s NDC is focused on key elements for decarbonisation, namely expanding the use of renewable sources as opposed to fossil fuels. This focus is strategic, as Brazil is the second-largest producer of biofuels globally[1] and has an electricity matrix that is composed of 84.8 per cent renewable sources.[2]

To encourage the use of renewable sources and promote the energy transition, Brazil is using taxation as a key instrument for this purpose. This intent was evidenced by the enactment of the Brazilian Tax Reform (Constitutional Amendment No 132/2023), which expressly states that the national tax system must observe the principle of environmental protection.

With the aim of consolidating its position as a major player in decarbonisation and the energy transition, Brazil has already highlighted its main targets: biofuels/green fuels and hydrogen. This focus is the reason for recent legislation that provides tax incentives and establishes public policies in regard to these energy sources, as detailed below.

Hydrogen in focus

Hydrogen has the potential to decarbonise key sectors of the economy, such as mining, transportation, nitrogen fertiliser production and energy. Brazil’s mostly renewable electricity matrix places it in a favourable position to attract investments in hydrogen plants. However, the establishment of a legal and tax framework was still needed to enable such projects.

In this context, the Legal Framework for Low-Carbon Hydrogen (Law No 14,948/2024) and the Low-Carbon Hydrogen Development Program (PHBC, provided by Law No 14,990/2024) were enacted on 2 August 2024 and 30 September 2024, respectively. Both laws are pending the issuance of regulations, which is expected to occur later this year.

Law No 14,948/2024 aims to define terms and assign responsibilities for the production and commercialisation of hydrogen and its derivatives.

According to this law, low-carbon hydrogen is defined as hydrogen fuel or an industrial input with GHG emissions of up to 7kg of the CO₂ equivalent per kg of H₂, based on a lifecycle analysis (the bill of law initially set a limit of 4kg of the CO₂ equivalent per kg of H₂, which was increased to 7kg to encompass different hydrogen production routes).

The law grants the Brazilian Agency of Petroleum, Natural Gas and Biofuels (ANP) the authority to regulate and authorise the production and commercialisation of hydrogen in Brazil.

Regarding tax incentives, one of the main incentives for the hydrogen sector established by Law No 14,948/2024 is the Special Incentive Regime for Low-Carbon Hydrogen Production (Rehidro).

The purpose of Rehidro is to extend the benefits currently granted under the Special Incentive Regime for Infrastructure Projects (REIDI) to hydrogen projects. REIDI is a tax benefit that reduces certain federal taxes (PIS/COFINS) on domestic purchases and imports of machinery, equipment, construction materials and services related to infrastructure projects.

Companies involved in the production, packaging, storage, transportation, distribution or sale of low-carbon hydrogen, as well as those generating renewable electricity or producing biofuels such as ethanol, biogas or biomethane for low-carbon hydrogen production, may qualify for Rehidro. These incentives will be available for a five-year period, beginning on 1 January 2025.

Rehidro offers further incentives, including the option to issue incentivised debentures under section 2 of Law No 12,431, in order to raise funds for hydrogen project implementation or expansion. Additionally, companies located in Export Processing Zones (Zonas de Processamento e Exportação or ZPEs) are eligible to benefit from Rehidro.

Another significant benefit is provided by Law No 14,990/2024 (PHBC). This law offers tax credits totalling up to BRL 18.3bn for low-carbon hydrogen producers or purchasers, from 2028 to 2032.

The tax credit will be granted through a competitive process, prioritising projects that propose the lowest GHG emissions and those with the greatest potential for enhancing the national value chain.

The tax credits granted under the PHBC will consist of credits for social security on net income (Contribuição Social sobre o Lucro Líquido or CSLL) and must be recognised in the beneficiary’s operating results. These credits can be offset against the company’s federal tax debts or reimbursed in cash within 12 months of the request date.

Biofuels/green fuels

Brazil’s other major strategy for promoting decarbonisation is to stimulate the use of biofuels by imposing GHG emission reduction requirements in specific sectors, such as requirements related to natural gas, diesel and aviation kerosene. This mandate was established under the so-called ‘Fuel of the Future Law’, enacted on 9 October 2024.

The law establishes several mechanisms to increase the use of biofuels/green fuels to replace fossil fuels. For example, it mandates an increase in the percentage of regular diesel required in the biodiesel blend, raises the mandatory ethanol blend in regard to gasoline, requires the use of Sustainable Aviation Fuel (SAF) as a substitute for aviation kerosene and mandates GHG emission reductions in the natural gas sector through the purchase or use of biomethane.

Although this law does not specifically provide for tax incentives for biofuels, it sets out important guidelines and a legal basis to foster the production of biofuels/green fuels.

Currently, there are already tax incentives applicable to biofuels and low-carbon hydrogen, but new incentives for both are expected under the tax reform. This is stipulated in the Federal Constitution, which allows for the establishment of a favourable tax regime for biofuels and low-carbon hydrogen to ensure that such fuels benefit from lower taxation compared to fossil fuels (section 225, §1, VIII). This provision was originally introduced by Constitutional Amendment No 123/2022 and has already served as the legal basis for reducing the state value-added tax (VAT) (Imposto Sobre Circulação de Mercadorias e Prestação de Serviços or ICMS) rate on ethanol in São Paulo state, for example.

This favourable regime is currently applicable but will probably be further addressed within the scope of Brazil’s tax reform regulation.

Conclusion

The world is undergoing a crucial phase in realising the energy transition and reducing GHG emissions. To meet the commitment on net zero GHG emissions by 2050, Brazil is betting heavily on fiscal incentives to attract investments, with its targets set on low-carbon hydrogen and biofuels/green fuels.