Key tax structuring considerations to invest in and from brazil
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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

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KEY TAX STRUCTURING CONSIDERATIONS TO INVEST IN AND FROM BRAZIL

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Key tax structuring considerations to invest in and from brazil

KEY TAX STRUCTURING CONSIDERATIONSTO 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.


Viable tax reform

VIABLE TAX REFORM

Past, present, and future

Ary Oswaldo Mattos Filho


Tax burden brazil

Tax Burden – Brazil

Source: OECD, published in 2009.


Tax burden per government sphere

Federal

Estate

Municipal

Tax Burden per Government Sphere

Collection by government sphere

(in billions of Reais, 2002 prices)

Source: National Treasury Office / Center for Tax Studies (NEF)


Evolution of the federal government tax burden taxes v contributions

Taxes

Contributions

Evolution of the Federal Government Tax Burden Taxes v. Contributions

Evolution of Taxes and Contributions (without INSS)

(in billions of Reais, 2002 prices)

Source: National Treasury Office / NEF


Nature of federal government expenses

Debt charge

Personnel

Investment and Funding

Nature of Federal Government Expenses

Federal Expenses

(in billions of Reais, 2002 prices)

Source: National Treasury Office / NEF


Tax reform proposals

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


Tax reform proposals reasons for failure

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


Current proposal

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


What can be consolidated

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.


What can be replaced

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), education-salary 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 sectors


How to rationalize the system

Country

United Kingdom

Canada

Venezuela

United States

Germany

Colombia

Spain

Chile

Portugal

Italy

Japan

Argentina

Bolivia

Brazil

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.

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


Ancillary obligations

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/


Key tax structuring considerations to invest in and from brazil

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


Brazil focus the good

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

15


Brazil focus the good cont d

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

16


Brazil focus the bad

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.

17


Brazil focus the ugly

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.

18


Brazil focus the ugly cont d

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

19


Brazil focus the ugly cont d1

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.

20


Key tax structuring considerations to invest in and from brazil

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%

21


Key tax structuring considerations to invest in and from brazil

Brazil Focus – Transfer Pricing (cont’d)

  • PIC – information

  • Stock/Commodities Exchanges

  • Secret comparables

    • Siscomex (goods)

    • Siscoserv (services?)

  • CPL – cost evidence

  • PRL – CIF/FOB costs

22


Key tax structuring considerations to invest in and from brazil

Brazil Focus – Transfer Pricing (cont’d)

  • Litigation profile

    • PIC – similarity

    • Use of CIF as opposed to FOB method

    • PRL – 60% margins

23


Key tax structuring considerations to invest in and from brazil

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

24


Key tax structuring considerations to invest in and from brazil

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.

Brazil Focus – Investment Funds - FIPs

25


Key tax structuring considerations to invest in and from brazil

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

Brazil Focus – Investment Funds – FIPs (cont’d)

26


Investment funds on rights related to credits fidcs

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%


Investment funds on rights related to credits fidcs1

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


Key tax structuring considerations to invest in and from brazil

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.

Brazil Focus – Real Estate Funds – FIIs

29


Key tax structuring considerations to invest in and from brazil

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

Brazil Focus – Real Estate Funds – FIIs (cont’d)

30


Brazilian investment funds 2 689 investments

Brazilian Investment Funds – 2,689 Investments


U s tax focus

U.S. Tax Focus

  • 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?

32


Main taxes in brazil

Main Taxes in Brazil


Creditability of brazilian taxes

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 non-cumulative regime; services or goods sold).

    • In that case would PIS/COFINS be creditable?

34


Funding brazil investments equity

Funding Brazil Investments - Equity

No Withholding Tax

No Corporate Income Tax Deduction

US

Dividends

Equity

BRZ

35


Funding brazil investments interest on equity

Funding Brazil Investments - Interest on Equity

Benefit of “Interest” Deduction (40%)

Cost of Withholding Tax (15%)

U.S. tax cost/benefit

US

IOE

BRZ

36


Funding brazil investments ioe low tax e p pool

Funding Brazil Investments - IOE -- Low Tax E&P Pool

Assumptions

E&P Pool = 1,000

Tax Pool = 100

IOE = 100

Adequate US FTC capacity

US

IOE

BRZ

37


Funding brazil investments ioe low tax e p pool cont d

Funding Brazil Investments - IOE - Low Tax E&P Pool (cont’d)

US Tax Analysis

100 Dividend Income

10 Section 78 Gross-up

110

35%

38.5 US Tax before FTC

(10.0) Section 902 FTC [(100/1,000) x 100]

(15.0) Section 901 FTC [100 x 15%]

13.5 US Tax after FTC

====

US

IOE

BRZ

38


Funding brazil investments ioe high tax e p pool

Funding Brazil Investments - IOE - High Tax E&P Pool

Assumptions

E&P Pool = 1,000

Tax Pool = 500

IOE = 100

Adequate US FTC capacity

US

IOE

BRZ

39


Funding brazil investments ioe high tax e p pool cont d

Funding Brazil Investments - IOE - High Tax E&P Pool (cont’d)

US Tax Analysis

100 Dividend Income

50 Section 78 Gross-up

150

35%

52.5 US Tax before FTC

(50.0) Section 902 FTC [(500/1,000) x 100]

(15.0) Section 901 FTC [100 x 15%]

(12.5) Excess US FTC

====

US

IOE

BRZ

40


Funding brazil investment with debt

Funding Brazil Investment with Debt

Withholding Tax on Interest

Corporate Income Tax Deduction (Subject to Thin Cap Rules)

US

Interest

Loans

BRZ

41


Funding investments in brazil with debt simple example

Funding Investments in Brazil with Debt – “Simple Example”

Assumptions

Principal = 1,000

Interest = 10%

Expense Allocation = 2%

BRZ : USD = 1 : 1

US

Interest

Loans

BRZ

42


Funding brazil investments with debt simple example

Funding Brazil Investments with Debt – “Simple Example”

US Tax Analysis

100 Foreign Source Income

(20) Allocable Expenses

80

35% US Tax Rate

28 US FTC Limitation

(15) Brazilian Withholding

13 Excess US FTC Limitation

====

US

Interest

Loans

BRZ

43


Funding with debt

Funding with Debt

Other Considerations

Thin Cap

Hedging

Transfer Pricing

US

Interest

Loans

BRZ

44


Other sensitive u s issues

Other Sensitive U.S. Issues

  • Global invoicing and cost sharing between U.S. parent and Brazil subsidiary.

  • Form over substance.


U s recent developments

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.

  • Active finance exception/section 954(c)(6), renewal.

46


U s recent developments1

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.

47


U s recent developments2

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.

48


U s recent developments3

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

49


General topics

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?

50


Irs circular 230 disclosure

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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