Answer ... Brazilian corporate entities are subject to several SAARs, which include the controlled foreign company (CFC), transfer pricing and thin capitalisation rules, limitations on the deductibility of royalties and limitations on the deductibility of losses. The most relevant rules are outlined below.
Controlled foreign companies: Pursuant to the current CFC rules, taxation is imposed at the level of the Brazilian controlling company on profits accrued by each direct or indirect foreign subsidiary on 31 December of each calendar year, on an accrual basis and regardless of any distribution. Foreign tax credits are available against IRPJ.
Transfer pricing rules: The transfer pricing rules have applied since 1997, when Law 9,430/96 came into force. The system allows for the determination of the maximum amounts of deductible expenses and the minimum amounts of taxable revenues for Brazilian entities engaged in transactions with related parties established outside Brazil or in cross-border transactions with parties domiciled in low-tax jurisdictions or entities subject to privileged tax regimes.
Although inspired by the Organisation for Economic Co-operation and Development (OECD) Transfer Pricing Guidelines, the Brazilian rules do not provide for a functional analysis, but rather provide for the calculation of the benchmarks through the application of objective methods provided for by law.
Thin capitalisation rules: Brazilian law also includes thin capitalisation rules, which establish limitations on the deductibility of accrued interest based on debt-to-equity ratios in case of loans executed with related parties and parties under a privileged tax regime or domiciled in low-tax jurisdictions.
In general terms, a 2:1 debt-to-equity ratio applies to transactions where the related party creditor, individual or legal entity resides in a jurisdiction subject to regular taxation. A 0.3:1 debt-to-equity ratio applies where the creditor is domiciled in a low-tax jurisdiction or is subject to a privileged tax regime. If any excess is verified regarding the limits set forth in the legislation, the excess interest will be considered a non-deductible expense in calculating IRPJ.
Restrictions on deductibility of royalties: Brazilian law imposes limitations on the deductibility of royalties which vary, depending on the industry involved, to a maximum of 5% calculated on the net sales of the products manufactured or services rendered under an agreement, including payments for the transfer of technology, the rendering of technical assistance and the licensing of patents and trademarks.
The 1% to 5% deduction limitation rules have been subject to debate, particularly as regards payments between companies in Brazil and cases where several items of intellectual property are licensed in a single agreement. In such cases the tax authorities may seek to restrict the deduction of several licensed rights up to a global limit of 1%, instead of applying the 1% limit to each item and the 5% globally.
Restrictions on deductibility of payments abroad to low-tax jurisdictions and privileged tax regimes: In addition to the transfer pricing and thin capitalisation rules, Article 26 of Law 12,249/10 states that amounts paid, credited, delivered, employed or remitted under any title (except for interest on equity), either directly or indirectly, to individuals or legal entities domiciled in low-tax jurisdictions or that are subject to privileged tax regimes will not be deductible for IRPJ purposes, unless the following facts are cumulatively evidenced:
- the identity of the effective beneficiary of the payment overseas;
- the operational capacity of the non-resident individual or legal entity performing the transaction; and
- the payment of the respective price and receipt of the goods or services, or use of the right transacted.
Disguised distribution of profits: Domestic transactions between related parties are subject to disguised distribution of profits rules, which require assets and transactions to be valued at a level that is not excessively below market value. If the transaction is conducted for a value that is excessively below market value, the difference between the value attributed to the assets or transaction and the actual market value is imputed as a taxable gain to the seller. If the assets or transaction is overvalued, the excess will not be deductible for the buyer.
Market value is calculated based on prior recent negotiations involving the same asset, or recent negotiations involving similar assets, between parties that are not compelled to transact, or that benefit from the knowledge of circumstances that may influence the price determination. If such criteria cannot be used, the market value may be calculated based on expert appraisal.
Limitation on deductibility of losses: According to Brazilian law, net operating losses (NOLs) generated in a given period can be offset against taxable income for the following period, up to a cap of 30% of taxable income (ie, for each R$1.00 of income, R$0.70 must be subject to taxation, regardless of the amount of NOLs). Tax losses may be carried forward indefinitely.