KEY TAX STRUCTURING CONSIDERATIONS
TO INVEST IN AND FROM BRAZIL
Welcome Address by Michael Fitzgerald, Dewey & LeBoeuf LLP
Introduction by Ary Oswaldo Mattos Filho, Mattos Filho, Veiga Filho, Marrey Jr. e
Quiroga Advogados
Speakers
Bruce E. Blanco, Bank of America
Julio A. Castro, Dewey & LeBoeuf LLP
Luiz Felipe C. Ferraz, Mattos Filho, Veiga Filho, Marrey Jr. e Quiroga Advogados
Alex Jorge, Avon Products, Inc.
Dewey & LeBoeuf | 1
VIABLE TAX REFORM
Past, present, and future
Ary Oswaldo Mattos Filho
Tax Burden – Brazil
Source: OECD, published in 2009.
3
Tax Burden per Government Sphere
Collection by government sphere
(in billions of Reais, 2002 prices)
Federal
Municipal
Estate
Source: National Treasury Office / Center for Tax Studies (NEF)
4
Evolution of the Federal Government Tax Burden
Taxes v. Contributions
Evolution of Taxes and Contributions (without INSS)
(in billions of Reais, 2002 prices)
Taxes
Contributions
Source: National Treasury Office / NEF
5
Nature of Federal Government Expenses
Federal Expenses
(in billions of Reais, 2002 prices)
Debt charge
Investment and Funding
Personnel
Source: National Treasury Office / NEF
6
Tax Reform Proposals
Proposal for Amendment to the Constitution (PEC) – State Board of Tax Appeals
(CERF) in 1992
• Amendment to 36 articles of the Brazilian Federal Constitution of
1988 (CF/88), including tax and public expenditure issues)
PEC 175 in 1995
• Amendment to 14 articles of the CF/88
PEC 175 in 1997
• Amendment to 17 articles of the CF/88
PEC 41 in 2003
• Amendment to 9 articles of the CF/88
PEC 233 in 2008
• Amendment to 21 articles of the CF/88
7
Tax Reform Proposals
Reasons for Failure
Modification of many articles of the CF
Impossibility of consensus among the Federal, State, and Municipal Governments
General lack of trust among the Federation Entities
Absence of priority given to Tax Reform Projects by the Federal Government
(Executive Branch)
Private initiative groups (Federations, Confederations, Associations, etc.) have failed
to organize themselves in order to align demands
Fear of loss of collection from all federative entities, especially States and
Municipalities
Lack of participation from the civil society in the debate so as to exert political
pressure on the Executive and on the Congress
8
Current Proposal
Strict tax reform, without discussing public expenditure issues
Solely federal scope, thereby avoiding debates involving States and Municipalities
Minimizing constitutional amendments
Stimulating amendments to legislation seeking to rationalize tem federal tax system
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What can be consolidated?
1. Corporate Income Tax (IRPJ) and Social Contribution on Net Income (CSLL)
• Obstacles: different purposes and sharing of IRPJ with States and
Municipalities – Funds Shared by the States, Federal District, and
Municipalities (FPE and FPM)
• Possible solution: unified collection, thereby facilitating the payment
of such taxes to taxpayers and decreasing the amount of litigation
and interpretive controversies existing among them.
2. Contribution for tem Social Integration Program (PIS) and Contribution for
Financing of Social Security (COFINS)
• Obstacles: different purposes and constitutional grounds (PIS:
article 239 and COFINS: article 195)
• Possible solution: unified collection by transforming such
contributions into taxes subject to ex officio entry. In other words,
Tax Authorities should interpret the complex, extensive, vague and
ambiguous legislation currently in force, and merely send payment
forms to taxpayers.
10
What can be replaced?
Payroll Contributions – National Social Security Institute (INSS)
Why replace?
• Informality
• Incentive not to hire employees
What replacement?
• Financial operation contribution
• Study ordered by the Federation of Services of the State of São
Paulo (FESESP) to the Getulio Vargas Foundation (FGV)
• Exemption of employer contribution of 20% (INSS), educationsalary of 2.5%, and National Settlement and Agrarian Reform
Institute (INCRA) contribution of 0.2%
• Changing the tax base for payment of such payroll contributions
would (i) increase the GDP by 2.5%, (ii) increase the employment
level by 2.45%, and (iii) reduce the tax burden in 52 economy
11
How to rationalize the system?
Ancillary Obligations
Countries selected from the “Paying Taxes” section of “Doing Business”, which rates
how easily tax payments are made in 183 countries.
País
Country
Reino
Unido
United
Kingdom
Canadá
Canada
Venezuela
Venezuela
Estados
Unidos
United
States
Alemanha
Germany
Colômbia
Colombia
Espanha
Spain
Chile
Chile
Portugal
Portugal
ItalyItália
Japan
Japão
Argentina
Argentina
Bolivia
Bolívia
Brazil
Brasil
Time to Comply
Tax Payments
(hours per year)
(number per year)
25
8
30
9
31
71
69
10
73
16
82
20
84
8
130
7
135
8
138
15
144
13
162
9
181
42
183
10
Source: THE WORLD BANK, PRICEWATERHOUSECOOPERS. Paying Taxes 2010 – The Global Picture. Available at http://www.pwc.com/gx/en/paying-taxes/pdf/paytax-2010.pdf. Last access on 11/17/2010
12
Ancillary Obligations
Federation of Industries in the State of São Paulo (FIESP) Study in July 2010
• Annual average bureaucracy cost: R$ 46.3 billions, which is
equivalent to:
– 1.47% of the 2009 GDP
– 10.1% of total private investments in 2009
– 300% of private expenses involving Research and Development (R&D)
Possible Solution: Public Digital Bookkeeping System (SPED) for Accounts and
Taxes
• Entering information into a single system
• Detailed description of all information deemed necessary by Tax
Authorities
• Reduction of Legal Entity (PJ) establishment inspections
• More information at http://www1.receita.fazenda.gov.br/
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São Paulo
Al. Joaquim Eugênio de Lima 447
01403 001 São Paulo SP Brasil
Tel (55 11) 3147 7600
Fax (55 11) 3147 7770
Rua Campo Verde 61 3ºandar
01456 010 São Paulo SP Brasil
Tel (55 11) 3035 4050
Fax (55 11) 3035 4067
Brasília
SHS Q.6 Bloco C Cj A sala 1901
70322 915 Brasília DF Brasil
Tel (55 61) 3218 6000
Fax (55 61) 3218 6090
Rio de Janeiro
Praia do Flamengo 200 11º andar
22210 030 Rio de Janeiro RJ Brasil
Tel (55 21) 3231 8200
Fax (55 21) 2262 6675
New York
135 East 57th Street 12th Floor
New York, NY, USA 10022
Tel (1 646) 695 1100
Fax (1 646) 695 1110
www.mattosfilho.com.br
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Brazil Focus - The Good
● Debt -to-Equity ratio
– Brazilian thin-cap law enacted in 2010 and regulations last May
● Royalties
– Brazilian PTO (INPI) relaxing some rules allowing payment for royalties for
trademarks registered before 1991 and licensed for free. However, still
capped at 1% of Net Sales.
– Royalty payments not subject to 9.25% PIS/COFINS according to several
rulings issued by the tax authorities.
– 10% CIDE not on grossed up withholding tax amount.
– Service Tax (ISS), generally at 5% rate, still uncertain.
● Dividends
– No withholding tax rate
– Interest on Net Equity subject to a 15% withholding tax
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Brazil Focus - The Good (cont’d)
● Central Bank
– User-friendly electronic access for registrations
● “RTT”
– Tax neutrality in light of new accounting standards (IFRS)
● Tax incentives to investors
– “MP Brasil Maior”: new incentives for certain industries and IT companies
– World Cup, Olympics and “Pre-Sal” incentives
– Innovation Law: bonus deduction for qualifying expenditures
– Regional Incentives for VAT: vary by States but may be a “trap for the
unwary”
● Taxpayers Council (Administrative Appeals)
– trends to become very a technical dispute resolution appeals body
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Brazil Focus - The Bad
● High combined corporate income tax rate of 34% (IRPJ and Social
Contribution).
● Taxes on Cross-Border payments of services.
– What is creditable and what is not for the recipient.
– No respect to Treaties and sourcing rules.
– Permanent Establishment
● Concept of Intellectual Property
– Not well developed and dependent upon Brazilian Trademark Office
Approvals.
– Statutory limitations on deductibility.
● No DTT with the United States
– Brazilian investors are urging the government for it.
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Brazil Focus - The Ugly
● Transfer Pricing rules and regulations
● CFC rules
– No deferral mechanism, but rather deemed distribution every Dec 31.
● Tax compliance extremely complex, burdensome and unclear with high
penalties even for non-intentional mistakes.
– SPED, FCONT, DCTF, DIRF, DACON, etc.
– VAT Substitution Systems: cash trapped due to complexity and delays to
refund.
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Brazil Focus - The Ugly (cont’d)
● Audit activity
– Extremely aggressive
– Default penalty of 75% but increased to 150% in the event o tax fraud
– No settlement mechanism, but quite often Amnesty programs are
enacted
– FIN 48 implications on measurement of UTP
– Usually Brazil makes the headlines of the Contingency Section of SEC
filings by U.S. multinationals i.e., 10-Q and 10-K forms.
– Business Purpose and Substance
• No case law or some sort of bright line test on business purpose and
substance by CARF and/or Courts
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Brazil Focus - The Ugly (cont’d)
● IOF Taxation
– Used to have a relatively low rate (0.38%, depending on transaction)
across the board.
– Recently increased to 6% on fixed income investments into Brazil with a
maturity of less than 2 years.
♦ Intended to control appreciation of the Brazilian real.
♦ Happened “over night” – no prior notice to the market. Uncertainty.
♦ Will it be decreased if and when BRL depreciates?
– Problems for financial institutions and funds having to cover positions in
Brazil.
– Deemed cash flows might be subject to taxation.
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Brazil Focus – Transfer Pricing
● Transfer pricing – Current discussions and difficulties
– Use of OECD methods – Comparable Uncontrolled Prices (PIC),
Average Sale Price Method (PVEx)
– Deviation from original OECD methods – fixed margins
♦ Resale Price Method (PRL) – 20%, 60%
♦ Cost Plus Method (CPL) – 20%
♦ Price of Retail Sale on the Destination Country Minus Profit Method
(PVV) – 30%
♦ Price of Wholesale Sale on the Destination Country Minus Profit
Method (PVA) – 15%
♦ Acquisition and/or Production Cost Plus Taxes and Profit Method
(CAP) – 15%
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Brazil Focus – Transfer Pricing (cont’d)
● PIC – information
● Stock/Commodities Exchanges
● Secret comparables
-
Siscomex (goods)
-
Siscoserv (services?)
● CPL – cost evidence
● PRL – CIF/FOB costs
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Brazil Focus – Transfer Pricing (cont’d)
● Litigation profile
● PIC – similarity
● Use of CIF as opposed to FOB method
● PRL – 60% margins
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Brazil Focus – Transfer Pricing (cont’d)
-
Potential New Legislation
- PRL FOB cost
- PRL 20% - others by sector
- Minimum sample of 5% (PIC)
- Use of previous years (PIC)
- Commodities
-
Rejecting
- Drawback
- Safe harbor – imports
- CPL – acquisitions
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Brazil Focus – Investment Funds - FIPs
● Profile
– No legal personality
– No taxation on revenues and capital gains arising from its own
transactions
– Brazilian income tax arises at the level of the non-Brazilian investor
and the respective treatment depends on the event that results the
income and/or gain assessment: payment of income, redemption,
amortization, sale and transfer of the quotas
● Inflows
– Inflow of funds in Brazil (acquisition of FIP shares, 2689 Investment)
is subject to IOF/FX at (i) 2% if shares are acquired in stock
exchange (unusual) or (ii) 6% in other cases.
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Brazil Focus – Investment Funds – FIPs (cont’d)
● Outflows
–
WHT: 15% on income and gains
–
WHT zero on income and gains if
♦ Investor does not hold more than 40% of the sum of the shares issued or
is entitled to receive more than 40% of the total income earned by the FIP
♦ FIP does not have in its portfolio debt securities in more than 5% of its net
equity (unless such securities correspond to convertible debentures or
subscription bonus)
♦ Portfolio: at least 67% of shares of issuance of Brazilian corporations,
debentures that are convertible into shares and subscription bonus
♦ Investor is not located in a jurisdiction deemed as a low tax jurisdiction.
● IOF/FX: zero
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Investment Funds on Rights related to Credits – FIDCs
● Profile
– FIDCs’ investment portfolios may be constituted of credit rights and related
securities, originated from financial, commercial, industrial, real estate and
services transactions. Being also authorized the investment in certain financial
assets expressly established in the applicable regulation.
– The FIDC does not have legal personality and, as a rule, is not subject to
taxation on revenues and on capital gains arising from its own transactions
♦ Income derived from transactions carried out by the FIDC would not be
subjected to corporate taxation
● Inflows
– Inflow of funds in Brazil (acquisition of FIP shares, 2689 Investment) is subject to
IOF/FX at 6%
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Investment Funds on Rights related to Credits - FIDCs
● Outflows
•
WHT: 15%
•
Discussion concerning the WHT exemption on the gains assessed by a 2,689 investor
not located in a jurisdiction deemed as a low tax jurisdiction in the sale of FII quotas
within stock exchange markets
•
IOF/FX: zero
•
IOF/BONDS: 1% per day on the value liquidated, redeemed or disposed, limited
to a percentage of the income assessed on the transaction, which vary
according to the investment's term, as provided for in a regressive table. This
limit equals 0% for terms equal to or above 30 days
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Brazil Focus – Real Estate Funds – FIIs
● Profile
– FII may invest in the development of real estate ventures, real estate
construction, acquisition of completed real estate properties, as well
as projects that facilitate access to housing and services, including in
rural areas, for purposes of future disposal, renting or leasing;
– The FII must distribute to its quotaholders at least 95% of its profits
every six months
– Profits must be calculated based on a cash regime;
– FII is generally not taxed;
● Inflows
– Inflow of funds in Brazil (acquisition of FII shares, 2689 Investment) is
subject to IOF/FX at (i) 2% if shares are acquired in stock exchange
(unusual) or (ii) 6% in other cases.
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Brazil Focus – Real Estate Funds – FIIs (cont’d)
●
Outflows
●
WHT: 15% on income and gains
–
●
Discussion concerning the WHT exemption on the gains assessed by a 2,689
investor not located in a jurisdiction deemed as a low tax jurisdiction in the
sale of FII quotas within stock exchange markets
IOF/FX: zero
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Brazilian Investment Funds – 2,689 Investments
FIP
-15% on income and
gains
FDIC
FII
-15% on income
-15% on income and
gains
and gains
WHT
- 0% if the requirements
are observed
-Inflow: 2%
-Inflow: 2% / 6%
-Inflow: 6%
- Outflow: zero
- Outflow: zero
- Outflow: zero
IOF/FX
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U.S. Tax Focus
1.
●
General Topics
–
No local tax consolidation, loss management
–
Creditability of Brazilian “corporate income taxes”
–
Funding Mechanisms for Brazilian Subsidiaries
–
Cost sharing between the U.S. and Brasil
Recent Developments
–
International tax reform (territorial vs credit system)?
–
Active finance exception; section 954(c)(6), expiration.
–
FATCA
–
“Super” Limitation on Benefits provision?
–
U.S.-Brazil tax treaty?
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Main Taxes in Brazil
Tax
Rate
IRPJ
25%
CSLL
9% or 15%
PIS
0.65% or 1.65%
COFINS
4% or 7.6%
ISS
5%
IOF
Calculation basis
Corporate Income Tax on the adjusted net profit
Social Contribution on Net Profit on the adjusted net profit
Turnover tax - 0.65% for IF (on financial spread) / 1.65% for non IF
(revenues less credits)
Turnover tax - 4% for IF (on financial spread) / 7.6% for non IF
(revenues less credits)
Service Tax (Municipal) - levied on service income (not creditable)
varies according to transaction Tax on Financial Transactions - levied on fx contracts, fixed income
type
investments and some variable income investmens
WHT
10% to 25%
CIDE
10%
PIS/COFINS Import
1.65% and 7.6%
ISS Import
5%
INSS
27.5% approx.
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Withholding tax on investments, interest, royalties, services, etc
Tax on imported services
Social Integration / Social Contribution on imported services
Service Tax (Municipal) on imported services
Social Security Contribution ovn salary (employer)
Creditability of Brazilian Taxes
– Subject to certain limitations US corporations can claim credits for direct
income taxes paid in a foreign country. It can also claim a tax credit for
income taxes paid by subsidiaries upon certain (actual or deemed)
distributions.
– To be creditable, the tax must constitute an “income tax” in a U.S. sense.
♦ The tax needs to satisfy a realization requirement (i.e., only apply to income
realized by a taxpayer) and must be imposed on net income (i.e., taking into
account the deductibility of costs).
– A corporation in Brazil pays corporate income tax + social security charge
+ PIS/COFINS.
– PIS and COFINS are imposed on gross revenues, not net revenues.
♦ In some cases, a deduction/credit can be claimed (cumulative or noncumulative regime; services or goods sold).
♦ In that case would PIS/COFINS be creditable?
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Funding Brazil Investments - Equity
US
●
No Withholding Tax
●
No Corporate Income Tax Deduction
BRZ
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Funding Brazil Investments - Interest on Equity
US
●
Benefit of “Interest” Deduction (40%)
●
Cost of Withholding Tax (15%)
●
U.S. tax cost/benefit
IOE
BRZ
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Funding Brazil Investments - IOE -- Low Tax E&P Pool
Assumptions
US
IOE
BRZ
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●
E&P Pool = 1,000
●
Tax Pool = 100
●
IOE = 100
●
Adequate US FTC capacity
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Funding Brazil Investments - IOE - Low Tax E&P Pool
(cont’d)
US Tax Analysis
●
US
100 Dividend Income
10 Section 78 Gross-up
110
IOE
35%
38.5 US Tax before FTC
BRZ
(10.0) Section 902 FTC [(100/1,000) x 100]
(15.0) Section 901 FTC [100 x 15%]
13.5 US Tax after FTC
====
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Funding Brazil Investments - IOE - High Tax E&P Pool
Assumptions
US
IOE
BRZ
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●
E&P Pool = 1,000
●
Tax Pool = 500
●
IOE = 100
●
Adequate US FTC capacity
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Funding Brazil Investments - IOE - High Tax E&P Pool
(cont’d)
US Tax Analysis
●
US
100 Dividend Income
50 Section 78 Gross-up
150
IOE
35%
52.5 US Tax before FTC
BRZ
(50.0) Section 902 FTC [(500/1,000) x 100]
(15.0) Section 901 FTC [100 x 15%]
(12.5) Excess US FTC
====
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Funding Brazil Investment with Debt
US
●
Withholding Tax on Interest
●
Corporate Income Tax Deduction
(Subject to Thin Cap Rules)
BRZ
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Funding Investments in Brazil with Debt – “Simple Example”
Assumptions
US
BRZ
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●
Principal = 1,000
●
Interest = 10%
●
Expense Allocation = 2%
●
BRZ : USD = 1 : 1
42
Funding Brazil Investments with Debt – “Simple Example”
US Tax Analysis
US
●
100 Foreign Source Income
(20) Allocable Expenses
80
35% US Tax Rate
BRZ
28 US FTC Limitation
(15) Brazilian Withholding
13 Excess US FTC Limitation
====
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Funding with Debt
Other Considerations
US
●
Thin Cap
●
Hedging
●
Transfer Pricing
BRZ
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Other Sensitive U.S. Issues
● Global invoicing and cost sharing between U.S. parent and Brazil
subsidiary.
● Form over substance.
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U.S. Recent Developments
● International Tax Reform?
– Currently, U.S. imposes corporate income tax on earnings of U.S.
corporations from offshore operations. Subject to various limitations, a
credit is provided for foreign taxes imposed on such earnings. This
system is generally called a “credit” system.
♦ It’s very complicated. In general, incentivizes U.S. corporations to keep
active earnings offshore in low tax subsidiaries.
– Several other OECD countries operate on a “territorial system.”
♦ Offshore earnings are not taxable in the home countries.
– General perception that U.S. tax system puts U.S. companies in a
competitive disadvantage. Demand for migration to territorial system.
Movement gaining force.
– Recent Obama proposals indicate that the administration is not aligned
with the idea.
– Stay tuned.
●Dewey
Active
finance exception/section 954(c)(6), renewal.
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U.S. Recent Developments
● FATCA
– New legislation requiring non U.S. financial institutions (FFIs) to identify
U.S. clients and report information regarding the same to the IRS.
Additional withholding tax imposed on non-participating FFIs.
– Original effective date: 1/1/2013 but postponed to 1/1/2014 in most
areas.
– Several aspects involve extra-territorial application of U.S. law.
– Resistance from several representative groups (U.S. citizens residing
abroad, foreign banks and insurance companies).
– Guidance already issued by the IRS in 3 notices. Still lots of questions
as to how the rules will be implemented. Proposed Regulations
detailing the application of FATCA expected until the end of the year.
– Most non-U.S. financial institutions, funds and insurance companies
already implementing FATCA compliance programs.
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U.S. Recent Developments
● “Super” Limitation on Benefits provision
– Under almost all U.S. tax treaties, taxpayers from a non-treaty country
(e.g., Brazil) generally find it very hard to benefit from a tax treaty
between the U.S. and a third-country (e.g., UK, France, Germany) (i.e.,
do “treaty shopping”).
– Usually significant and relevant presence in third country is required.
– Some Brazilian multinationals have use U.S. tax treaties of third
countries where they have significant operations.
♦ Example: Brazilian company with significant activities in the Netherlands
forms a U.S. company as a subsidiary of a Dutch operating company.
– Proposed legislation would effectively preclude a company in a non-tax
treaty country (such as Brazil) from claiming benefits of a U.S. treaty
even it is has significant presence in the treat jurisdiction.
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U.S. Recent Developments
● U.S. Brazil tax treaty?
– Currently there is no tax treaty between the U.S. and Brazil.
– Very expensive for a Brazilian company to invest in the U.S. because of the
absence of a U.S. Brazil treaty.
♦ 30% withholding rate on all sorts of U.S. source income.
♦ Brazilian companies are in a significant disadvantage in relation to other
countries in accessing U.S. markets.
– Is the treaty likely to happen any time soon? NO, unfortunately.
– No progress regarding treaty. Negotiations are stalled. Same old issues:
♦
♦
♦
♦
♦
transfer pricing
withholding rates
services
competent authority
tax sparing, and the list goes on
● Exchange of Information Treaty
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General Topics
● No Tax Consolidation
– In the U.S. a group of controlled entities may elect to file tax returns on
a consolidated basis. General results:
♦ Net losses from one group member may be used to offset net income;
♦ Taxation of intercompany transactions deferred.
– In Brazil, companies cannot consolidate.
♦ So even if group has net losses, may need to pay some tax if one of the
members are profitable.
– Approaches to address the issue?
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IRS Circular 230 disclosure
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To ensure compliance with requirements imposed by the Internal
Revenue Service ("IRS"), we inform you that any U.S. federal tax
advice contained in this presentation is not intended or written to
be used, and cannot be used, for the purpose of (i) avoiding
penalties under the Internal Revenue Code, or (ii) promoting
marketing or recommending to another party any transaction or
matter addressed herein.
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