From FTSE 100 companies to SMEs, UK businesses are increasingly investing in Brazil.
Brazil is the fifth largest country in the world by area and by population and one of the most multicultural and ethnically diverse nations on the planet. Yet until relatively recently, Brazil was an economic back-marker by comparison with other major industrialised nations. That is no longer the case: it is now the world’s sixth largest economy by GDP. Although growth slowed in 2012, most economists believe temporarily, the boom in the Brazilian economy has caught the attention of foreign governments and multinational companies alike. There is growing and sustained interest in Brazil, with many companies expanding their activities and realising growth in that market, further buoyed by the infrastructure developments required for the 2014 football World Cup and the 2016 Olympics.
With the notable exception of the energy and mining sectors, the UK has been quite late to the party. China, the US, Japan, Germany, France, Spain and Portugal have long recognised the opportunities of a country that has developed a huge economy, in which 40 million people have moved up into the middle class in the last five years, and with many self-made billionaires.
The UK’s position is changing rapidly across all sectors and ranging from FTSE 100 companies to SMEs to high-tech start-ups, UK businesses are now investing in Brazil.
There is, however, at least one significant hurdle that has to be negotiated when investing in or trading with Brazil: taxation. Brazil has a complex tax system which contains numerous features that may be unfamiliar to many international tax practitioners. We hear from clients that the Brazilian tax system is difficult, bordering on the impossible, that it is very hard to extract money from Brazil and that the UK is hindered by the lack of a double tax treaty.
We say that
This report outlines the tax environment in Brazil and some of the key considerations when establishing a business in Brazil. We then provide an overview of corporate income tax, indirect taxes, import duties and withholding taxes, together with some thoughts on cross-border issues and finally some observations on structuring and financing a Brazilian acquisition.
Seeing the wood for the trees …
In what follows, we have set out summaries of some of the key taxes and rules that apply in Brazil. The fact that so many of these are unfamiliar in a non-Brazilian tax context is one of the main factors that
Taxes are levied at the federal, state and municipal levels, comparable in some ways to the USA.
Corporate income taxes are of a federal nature only, but many indirect taxes are levied at the state and municipality level as well. Administratively, this results in multiple tax registrations with the relevant states and municipalities and multiple deadlines for filings, tax payments and reporting requirements.
Tax compliance
The types of taxes that may be levied, and the tax treatment of individual items in tax returns, are established at the federal level, with authority in respect of interstate and intrastate rates being granted to the states and municipalities, with specified limits for maximum and minimum rates. However, there are frequently differences in the interpretation of tax treatment between states. This can sometimes result in different outcomes at
Furthermore, state tax authority offices can issue their own guidance on the tax treatment of specific items which will differ from the guidance issued by offices in other states. In these cases, a request can be made by the taxpayer for a federal resolution to confirm the correct interpretation, but these are extremely rare.
Federal law provides for states and municipalities to offer tax incentives in respect of certain taxes and within certain limits. These incentives are more prevalent in the north of Brazil, typically requiring investment in jobs and infrastructure. As a result, major multinationals have established substantial plants in these regions.
The process for enacting tax legislation is very different from that in the UK. Advance consultation with taxpayers or professional bodies is rare. Changes in interpretation or specific tax rules can be brought into effect not only through law
Brazil has a Roman-Germanic civil law system, similar to that of continental Europe, based on codified statute and thus, unlike the common law system used in the UK, legal cases are not binding on other courts presiding over a later case, although they may be persuasive.
The exception to this is cases heard by the Supreme Court which may publish binding rules. This aspect is undoubtedly one reason for the reputation that the Brazilian tax system has for lacking clarity, and can be frustrating for foreign investors, who may struggle to get a clear opinion from advisers – this is not helped by the absence of any advance ruling system from the federal tax authorities.
Table 1 below illustrates the complexity of tax compliance in Brazil. It details the returns required to be filed by the average company: these include not only tax returns but also disclosure returns for certain transactions, such as those with non-resident parties. This is not a comprehensive list; the actual filings required will depend inter alia on the nature of a company’s activities.
Where taxes have been overpaid or there is a net repayment position on indirect taxes, it is extremely difficult to obtain
The conduct of tax enquiries differs from the UK. For example, meetings with the tax inspector are rare. Enquiries are often raised following the interrogation of electronic data by the tax inspector and are usually opened through the medium of a tax assessment rather than an enquiry letter. Although tax inspectors are beginning to demonstrate a more pragmatic approach to negotiation, it is still common that the taxpayer’s only realistic option, where there is a difference in interpretation of the law, is to take the matter to the courts. As a result, there is a significant backlog of cases at every level of the judiciary in Brazil.
Brazil was one of the first countries to implement electronic filing of tax invoices and tax returns, and most tax audits are conducted by electronic interrogation of taxpayer records. Brazil’s sophistication in this regard often comes as a surprise to the foreign investor. It can perhaps be better understood when seen as a powerful tool that recent governments have employed in the fight against corruption.
All tax returns are filed electronically, using tax authority software, which enables the tax authorities to cross-check different tax returns for discrepancies in disclosure – for example, comparing salaries disclosed in the corporate income tax return and the social security return.
In addition, a new accounting system nomenclature for tax (SPED) has been introduced, such that the account descriptions in a company’s trial balance are often dictated by the SPED requirements. SPED is an initiative to increase transparency between taxpayers and the tax authorities, aiming to consolidate and integrate most tax filings under one system. The overall goal of SPED is to prevent tax evasion and unfair competition. Since 1 January 2008, Brazilian corporate taxpayers are required to file electronically every tax and accounting operation with the federal, state and municipal tax authorities. The SPED programme also requires every invoice that a company issues to be filed electronically with the tax authorities, with further integration programmes expected.
Interest charges are high in comparison to UK interest
It should be noted that penalties are potentially due on both understatements of tax and underpayments of tax. Penalties on underpayments are set out in Table 2 below and are due not only in cases where fraud has
The penalty regime is rigorously enforced. In the past, it was usual for companies to be cautious and overpay taxes to minimise their exposure to penalties. However, that is becoming infrequent due to the less buoyant economy.
The bad news is that labour laws are complex and labour costs can be surprisingly high.
It is legally possible, but not commercially desirable, for non-residents to operate through a permanent establishment. Withholding and several indirect taxes would be applied to most amounts paid to the head office outside Brazil and would give rise to a higher tax burden than operating through a Brazilian company. It is legally possible for a foreign company to operate through a formal branch, but the formalities for setting up a branch are more stringent than for setting up a company and produce the same tax result.
Hence, the vast majority of groups establish a Brazilian company for their Brazilian operations, either a limited liability company (‘Limitada’ or LTDA) or a limited liability corporation (‘Sociedade Anônima’ or SA).
Limitadas are the most common type of company. They are formed by two or more individuals or legal entities known as ‘quotaholders’ (equivalent to shareholders). A
The liability of each
In general, a
The SA is the form that most closely resembles UK PLCs. SAs can issue different classes of shares, such as voting and non-voting shares. Shareholder liability is limited to the
This type of entity is suitable for large businesses seeking to obtain funds from the general public. Like the
All SAs must publish their results, usually in official gazettes or major private newspapers.
A foreign company may operate as a branch in Brazil. However, unless there is a substantial tax advantage in the investor’s home country, such as
In order to set up a branch in
Labour laws are complex and labour costs can be surprisingly high. As well as employer taxes, the labour laws entitle employees to certain benefits that must be funded by the employer. The constitution sets overtime rates, provides for a monthly minimum wage (salaries are expressed in monthly terms in Brazil) and regulates working hours. It lists a variety of labour entitlements, including maternity leave, holidays, workers’ compensation, social services, medical assistance and unemployment benefits.
All employees must hold work and social security papers in which the terms of their employment contracts must be recorded. Employers must maintain files containing detailed information about each employee and submit this information electronically to the labour authorities annually. The working week in Brazil is 44 hours over a six-day period (five eight-hour days and one four-hour day). The constitution guarantees employees many labour rights and benefits, which may increase a company’s payroll costs by 70% to 80%. These include:
Employers must pay severance pay equivalent to the employee’s salary for their notice period when dismissing employees without cause and without prior notice. For these purposes, the minimum prior notice period is deemed to be 30 days, plus three days for each year of
If employees’ rights and benefits are not observed, employees may sue their employer up to two years after termination of employment, and courts frequently favour employees. Labour claims may be filed in respect of the five-year period preceding the exercise of these rights. An employee is not permitted to waive rights or benefits stated in
Both employers and employees pay social security contributions. Individuals who receive employment income from a Brazilian source are subject to the local social security contribution, which is withheld by the employer. Contribution rates range from 8% to 11%, depending on the amount of the salary. There is a cap to the employee’s contribution of 11% of the maximum income for contribution, resulting in a maximum R$457.49 (approximately £150) contribution.
The employer contribution ranges from 26.8% to 28.8% of each employee’s monthly salary, depending on the employer’s activity. There is no cap to the employer’s contribution.
Employers are required to make contributions to the federal severance pay fund (FGTS) of 8% of an employee’s monthly salary. Under certain circumstances, such as dismissal without cause, retirement, long-term sickness or, perhaps surprisingly, buying their first house, employees may withdraw these contributions from the fund.
Contributions are made as deposits in a restricted access bank account, in the name of each employee, and these accounts are managed by a federal government institution. If an employee is dismissed without cause, the employer must pay to the employee an additional fine, equal to 40% of the deposits made in the employee’s FGTS account during the time of their employment with the company.
The National Monetary Council sets Brazil’s exchange controls. The central bank (BACEN), which is responsible for implementing this policy, has a number of departments which deal specifically with foreign investment and exchange. The foreign exchange market is controlled by the international capital and foreign exchange market regulation (RMCCI).
The registration process of foreign investments is relatively straightforward. The exchange contract must be made through a financial institution, normally a commercial bank, authorised by BACEN to operate in the foreign exchange markets. BACEN registers all investments into Brazil, whether in the form of capital or loans.
As a general rule, the RMCCI allows companies and individuals to purchase and sell foreign currency and perform international transfers in Brazilian Reais, regardless of the nature of the operation, with no restriction with respect to the amount involved.
In order to perform a transaction in the exchange market, BACEN only requires the parties involved to formalise it through an exchange contract and to register it in the Central Bank database system.
Profits that are reinvested in the business must also be registered as foreign registered capital, and the amount corresponding to the profits that can be remitted as dividends will be registered in local currency.
Some foreign currency transactions are subject to IOF tax. For example, equity is subject to IOF at 0.38% and short-term foreign currency loans of less than two years will be subject to 6% IOF tax, although these rates and definitions change regularly.
As one might expect, companies are usually assessed on their actual profits, but it is also sometimes possible for companies to elect to be taxed under the simpler ‘presumed profits’ regime.
Corporation tax is levied at 34% of taxable profits, although this single rate is
The tax year is the calendar year, irrespective of the company’s accounting period. Corporation tax returns are very detailed and must be submitted by 30 June of the year following the calendar tax year. Tax is paid monthly based on a monthly computation that forms part of the company’s computerised records.
There is no system of group relief or tax consolidation. Mergers can generally be effected on a tax-free basis, provided that certain conditions are satisfied.
Brazilian companies are chargeable to Brazilian corporate income taxes on their worldwide profits, including the profits of their controlled foreign corporations (CFCs) and certain foreign affiliates (non-controlled subsidiaries), although this is subject to challenge in the courts. A very recent Supreme Court decision did not provide a definitive conclusion on this matter.
The definition of a CFC includes significant influence over corporate decision-making, a minimum 20% voting stock interest in the foreign company or being a member of the ‘same economic group’ as
Companies are usually assessed on their taxable profits as computed by reference to book profits (‘actual profits’), but it is also possible for companies that satisfy certain criteria to elect to be taxed under the simpler ‘presumed profits’ regime. In exceptional circumstances, the ‘arbitrated profits’ regime may be used.
The actual profits regime is based on adjusted book profits and has many similar principles to other taxation systems, including
Tax losses can be carried forward indefinitely and utilised against future profit; however, the amounts offset are limited to 30% of taxable income in the year.
The presumed profit regime can apply if the company’s total revenues were below R$48m (£15m) in the previous calendar year and it is not otherwise excluded (e.g. financial institutions). This limit will increase to R$72m (£23m) from 1 January 2014. The tax liability is calculated as a percentage of turnover rather than profit, which means that the tax return is much simpler to complete. The percentage varies depending on the activities of the company. For example, services are usually subject to a 32% rate, while goods are usually subject to an 8% rate for IRPJ and 12% for CSLL, an effective combined rate of just over 9%.
The arbitrated profit regime is rarely used and generally only applies where the company is unable to provide supporting information or the tax authorities suspect fraud. It is similar to the presumed profit regime but applies higher tax rates.
A tale of two VATs …
Brazil has a multitude of indirect taxes and, in view of the considerable indirect and withholding tax obligations, there is a strong incentive to source goods and services locally in Brazil wherever practicable and not to recharge expenses incurred abroad.
Indirect rates can vary from business to business and from state to state and care needs to be taken in order to minimise exposure to interest and penalties for incorrect filings and underpayments. Table 4 summarises the principal indirect taxes.
IPI applies on industrialised products, generally those that have been through an industrial process as opposed to raw materials. It is a non-cumulative tax added to the invoice price at the time of sale. Each individual establishment offsets the total IPI paid on purchases (inputs) against the total IPI collected on its sales (outputs). IPI is thus ultimately borne by the final consumer. IPI is also levied on the importation of goods, in which case the IPI calculation basis would include the value of the goods, plus customs duties. Regarding imports, IPI rates may vary according to the nature of goods, from zero-rate for basic supplies and rising for non-essential goods, depending on the product’s specific code in the harmonised tariff system.
The net amount of IPI due
Certain products can be imported under special customs regimes which are exempt from
The 1998 Constitution granted authority to the Brazilian States to collect the tax on the sale of goods, interstate and inter-municipal transportation services and communication services, even if the transaction and/or services rendered began in another country.
As with IPI, ICMS is not a cumulative tax. Each month, the supplier of goods or those services specified above calculates the amount of ICMS debits, generated on the sale of goods/ services rendered, and ICMS credits, generated on the acquisition of goods/services received. If the supplier has more
The credits are computed at the time the merchandise enters the taxpayer’s premises and the
ICMS is due on the value of the transaction or service carried out by the taxpayer, which includes the value of the tax itself (i.e. a gross-up calculation is required). For imports, ICMS is due on the value of the goods, plus customs duties, plus IPI, plus PIS/COFINS if applicable (see below) and the ICMS itself (gross-up method).
ICMS is collected by most states at the rate of 17%, except for the states of São Paulo and Minas Gerais, where the rate is 18%, and Rio de Janeiro, where the rate is 19%. Special rates apply to interstate sales, as illustrated in Table 5 (above).
ICMS legislation provides for certain incentives and exemptions and each of the 26 states and one federal district ICMS tax authorities provides its own distinct benefits.
Supplies of services, other than those subject to ICMS, are subject to a cumulative service tax (ISS) due on
In general, ISS is levied by the municipality in which the company is established. There are exceptions to this rule, such as the construction industry, dock services and towage vessel services, when the tax is levied by the municipality in which the work is performed and municipalities are also known to take a similar view in respect of other activities carried out in their jurisdiction.
The ISS rate varies between 2% and 5% from city to city and between services, with 5% being the most common.
ISS is charged on the invoice by the supplier and, as ISS is not
The social integration programme (PIS) was conceived as a means for employees to share in profits through a mandatory national savings programme, financed by monthly deposits collected as a percentage of gross sales revenues. The social contribution on revenues (COFINS) was created to finance special federal social programmes by levying a percentage of gross sales revenues. They are subject to broadly similar rules and hence are commonly regarded as a single levy (PIS/COFINS).
PIS/COFINS can be either cumulative or non-cumulative (i.e. with input credits for the
PIS/COFINS is charged on all revenues except for:
Exports of goods are exempt from PIS/COFINS, as are services rendered to overseas
Companies are also required to self-assess PIS-importation and COFINS-importation on
Under the non-cumulative regime, the rates of PIS and COFINS are 1.65% and 7.6% respectively. The recipient of the goods or services can claim PIS/COFINS credits to offset amounts due on their own sales at the same rates. Credits can be claimed on amounts related to:
However, credits cannot be claimed on:
Rights to PIS/COFINS credits generally apply only to goods and services acquired from, or costs and expenses incurred, paid or credited to, companies established in Brazil. However, credits from imported goods and services are allowed, provided they are subject to PIS-importation and COFINS-importation.
It is a matter for the providers of goods or services to decide whether or not the law requires them to add PIS/COFINS to the invoiced price. The amount is not necessarily identified on the invoice, so it may not always be clear to the purchaser whether they are entitled to a credit in filing their own PIS/COFINS returns, which can create uncertainty over the purchaser’s own PIS/COFINS compliance position.
PIS/COFINS is due on a monthly basis and credits not used in one month may be carried forward to the following month. The exemption granted to export transactions does not prevent PIS/COFINS credits from being claimed on inputs. Indeed, as PIS/COFINS is a federal tax, export companies can utilise PIS/COFINS credits associated with export transactions to offset against future liabilities of PIS/COFINS or any other federal taxes.
Under the cumulative regime, the rates of PIS and COFINS are 0.65% and 3% respectively, but no credits are available to offset amounts due on their own sales. The cumulative regime is simpler to
Examining export credits, import duties, withholding taxes, transfer pricing rules and tax treaties.
Revenues from exports are exempt from PIS/COFINS, and exporting companies can use PIS/COFINS credits from inputs associated with export transactions to offset against their monthly PIS/COFINS liabilities or any other federal taxes.
Goods exported from Brazil are exempt from IPI and exporting companies can use the credits on inputs. If the exporting company is unable to offset IPI credits for a three month period, it is entitled to offset the accumulated credit against any other federal taxes.
Export transactions are also exempt from ICMS, but carried-forward credits from exports can only be used to offset against future liabilities of ICMS itself.
The importation of goods into Brazil attracts import duty and PIS/COFINS and, if applicable to the goods in question, ICMS and IPI. Import duty rates are included in Table 4.
All Brazilian goods importers and exporters are required to have a trading licence (RADAR), which grants a password to access the Brazilian Integrated Foreign Trade System (‘Sistema Integrado de Comércio Exterior’, known as SISCOMEX).
SISCOMEX is an electronic integrated trade documentation system designed by the government to control and monitor Brazilian foreign trade. SISCOMEX is supervised by the Chamber of Foreign Trade, the Federal Tax Authorities and the Central Bank.
There are three types of RADAR licences: express, limited and unlimited. The requirements to qualify for each type can be checked directly at SISCOMEX, by inputting the harmonised tax system code for that product.
In addition to import duty and the indirect taxes mentioned above (IPI, PIS/COFINS and ICMS), imported goods are subject to other charges, such
The definition of services for Brazilian indirect tax importation and withholding tax purposes is much broader than in many other countries. As well as the ordinary definition of services, royalties are treated as services for Brazilian tax
As described earlier, imported services are subject to PIS/COFINS and ISS if the service is performed in Brazil or if the benefit of the service is received in Brazil. The calculation basis of the PIS/COFINS-importation comprises the amount paid, credited, delivered, utilised or remitted abroad (before the withholding tax deduction – see below), plus ISS and the contributions (PIS/COFINS Importation) themselves (i.e. gross-up method).
Services are only deductible expenses of Brazilian companies if they are necessarily incurred for that company’s business. However, in
As from late 2012, the importation of services is now required to be registered on SISCOSERV, the services equivalent of SISCOMEX. In addition to PIS/COFINS and ISS, imported services are subject to withholding tax and in certain instances the ‘contribution for intervention in the economic domain’. These are discussed below.
On applying to remit any funds overseas at a company’s bank, the company is required to identify what the remittance relates to, to confirm that the correct withholding tax has been withheld and, sometimes, to provide evidence of payment of withholding tax.
Any payment, credit or remittance made by a company located in Brazil in respect of a service, royalty or interest to an individual or legal entity residing or domiciled abroad is subject to withholding income tax (IRRF). The usual rate is 15%, although payments made to tax haven jurisdictions are subject to a 25% withholding tax rate.
CIDE is levied at the rate of 10% on amounts paid, credited, turned over, employed or remitted each month to parties resident or domiciled abroad, in respect of licences or contracts relating to a transfer of technology or contracts providing technical and administrative assistance.
CIDE is not a withholding tax, as the payer is the party primarily liable to CIDE and does not withhold it from the payment received by the payee.
There can also be a withholding tax on a capital gain realised by a non-resident on the sale of shares in a Brazilian company. The gain would be measured as the difference between the consideration received and the tax basis registered with BACEN at the time of the original acquisition. The tax would be 15% of the gain. None of Brazil’s tax treaties
If the capital gain is derived by a tax haven resident, the rate is increased to 25%. According to domestic law, the purchaser is responsible for withholding and paying the tax to the Brazilian tax authorities if they are Brazilian resident, while the legal representative in Brazil of the non-resident buyer is liable if they are non-resident.
It is possible to transfer companies within a group at cost and, therefore, without generating a gain or crystallising a withholding tax charge.
Brazil’s transfer pricing regime includes provisions aimed at preventing Brazilian subsidiaries of multinational companies from diverting profits abroad by overcharging intercompany exports or reducing taxable income in Brazil by undercharging intercompany exports. The rules apply to cross-border transactions between related parties, with certain uncontrolled agents, distributors or consortium partners, or with entities located in tax havens or in a jurisdiction that allows secrecy regarding equity
The Brazilian rules deviate substantially from the OECD transfer pricing guidelines. They do not adopt the arm’s length
The salient features of the Brazilian transfer pricing regime are as follows:
In September 2012, the government amended the transfer pricing rules applicable to the importation of goods, services and rights, set new profit margins for certain sectors, and created two new transfer pricing methods. Although the new law applies to fiscal years starting on or after 1 January 2013, taxpayers may opt to apply the rules from
The law introduced two additional transfer pricing methods to the existing Brazilian methods: the commodity exchange import price, and the commodity exchange export price, for inbound and outbound transactions with commodities, respectively. Under these methods, the basis for comparison is the average commodity exchange price for the relevant items, adjusted for upward or downward spreads.
For commodity products not negotiated in commodity exchanges, the amended law also allowed the use of prices obtained from reputable market institutions. The tax authorities provide a non-exhaustive list containing 21 classes of products that the Brazilian tax authorities consider commodity products. These include cotton, meat, soy, orange juice, petroleum, gold, iron and steel.
Additionally, the new rules specify the institutions the Brazilian tax authorities consider reputable and that can be used as
Brazil has signed a total of 29 treaties that are currently in force, most of which follow the OECD model treaty, although there are notably no treaties with the UK or the US and none expected. Brazil is implementing the OECD initiative on
A foreign tax credit may be claimed for foreign tax paid, limited to the corporate income tax liability on taxable foreign-source income. Withholding taxes are
How to structure and finance a Brazilian investment.
Brazilian vendors tend to prefer to sell shares rather than assets. Hence, acquisitions are likely to be structured as share acquisitions rather than asset deals. If debt finance is to be introduced via a Brazilian acquisition vehicle (see also debt financing below), it is necessary to merge the acquisition vehicle with the Brazilian target, as there is no tax grouping in Brazil. Tax-free mergers are possible and indeed quite common, in order that interest on acquisition debt and interest on net equity (discussed below) can be offset against the target’s profits.
In addition, it is possible to obtain a tax deduction in respect of goodwill amortisation, although not for any other intangibles, in the merged company. The amount of goodwill must be supported by an independent valuation report which, inter alia, will support the economic substance underpinning the valuation and determine the range of periods over which the taxpayer can choose to deduct the amortisation (minimum five, maximum 20 years).
The tax authorities have, so far with limited success, challenged the deductibility of goodwill amortisation in the courts on several occasions, generally on the basis that they consider the merger to be designed to obtain a tax deduction. It must be noted, however, that draft legislation provides that, for acquisitions made on or after 1 January 2014, goodwill amortisation deductions remain available but are deferred for five years.
Historically, debt financing was relatively straightforward: provided an
Thin capitalisation rules were introduced in 2010, under which interest paid to related parties can only be deducted if the interest expense is necessary for the company’s activities and both of the following thresholds are met:
For interest paid to an entity or individual located in a tax haven or that benefits from a preferential tax regime, regardless of whether the parties are related, the above debt-to-equity ratio is reduced to 0.3:1.
Any excess interest will be treated as a non-deductible expense for IRPJ and CSLL purposes. There is no re-characterisation of the disallowed interest, meaning that interest is taxable and continues to be subject to withholding tax.
However, the recent changes to the transfer pricing rules introduced a new restriction on interest paid to overseas connected parties for new
Understandably, this has caused great uncertainty. In practice, it is understood that many companies are now structuring their debt in line with the limits originally announced (US$ LIBOR plus 3%). Alternatively, companies are choosing to inject more equity, instead of debt finance, and claim a higher ‘interest on net equity’ deduction, as this is not subject to these new limitations.
Normal dividends are not tax deductible and do not attract any withholding tax. But Brazil also provides for a tax deduction based on a company’s equity – INE. This is effectively a tax-deductible dividend.
INE is calculated by applying the long-term interest rate, as determined by BACEN, to the company’s equity. The amount of deductible INE is limited to the greater of 50% of the current year profit before tax or 50% of accumulated brought forward earnings. It is deductible without regard to the thin capitalisation position of the company or the new transfer pricing restriction that applies to interest. INE is subject to 15% withholding tax (WHT), in the same way as normal interest.
INE is generated by the making of an election, similar to a dividend declaration, and indeed generally accounted for as a dividend. It is deductible for Brazilian corporate income tax purposes when the WHT is paid, and the INE itself need never be actually paid.
The INE is most efficient when the immediate shareholder is a company located in a jurisdiction that does not tax the INE as income (e.g. The Netherlands). Here, there will be a 19% reduction in the overall tax burden, since the expense will reduce Brazilian corporate income tax at 34%, but the WHT will not normally be recoverable by the recipient company.
This benefit would be eroded, however, if the ultimate parent is subject to the UK CFC rules. Under UK rules, although an ordinary dividend would be tax free, INE is considered to be taxable in the hands of the recipient, as it is akin to a tax-deductible dividend, so the UK parent would be subject to UK CFC tax, with credit for withholding tax, on any INE received by its foreign sub-holding company.
