Originally published in the March 18 edition of World Tax Daily (Copyrights Tax Analysts – www.taxanalysts.com)
Intercompany loans between foreign parent companies and their Brazilian subsidiaries have been among the latest targets of Brazil’s Federal Revenue Department (FRD). The FRD has challenged the deductibility of interest paid or accrued on such loans, even though Brazil still does not have minimum capital or thin capitalization rules.
The amounts involved are substantial. In 2007 alone, private companies received approximately $16 billion in intercompany loans, according to Brazil’s Central Bank. Interest payments remitted outside Brazil during the same period totaled $1.8 billion.
The FRD is challenging the deductibility of that interest for purposes of the corporate income tax and the 9 percent social contribution on net income (CSL), arguing that the interest payments are not necessary expenses for the Brazilian company (the interest payer).
According to article 299 of Brazil’s Income Tax Code, only expenses necessary to maintain the taxpayer’s main source of income are deductible. It says:
- Art. 299 — Operational expenses are those not computed as costs, necessary to the activity of the company and to the maintenance of the respective source of income.
- Section 1 — Necessary expenses are those paid or incurred as required by the company’s activities to the realization of its transactions or operations.
- Section 2 — The allowed operational expenses are those usual and normal to the type of transactions, operations, or activities of the company.
In several cases, the FRD has based tax assessments on that the intercompany loans — after generating interest and deductions for a few years — eventually were converted into investments by means of a contribution to the subsidiary’s capital. In such cases, the FRD argues that the parent company’s intention from the beginning was to make a capital contribution, and not a loan, and that the interest paid until capitalization should therefore not be deductible.
Because Brazil does not have minimum capital requirements or thin capitalization rules, many multinational companies with Brazilian subsidiaries use loan structures for tax and financial planning. One objective is to receive interest regardless of the Brazilian subsidiary’s profit/loss situation: As long as the subsidiary has cash, interest can be paid — and deducted — for Brazilian tax purposes. Also, while interest paid abroad is subject to a 15 percent withholding tax (or 25 percent when paid to companies in tax havens), Brazilian companies can take a deduction of almost 34 percent (the 25 percent corporate income tax plus the 9 percent CSL).
Another advantage is that loans can be repaid without any major obstacles, while capital reductions or disinvestments require amendments to the company’s articles of organization or bylaws, no pending tax debts, a minimum of 60 days notice to creditors, and so on.
Until 2003, foreign loans also had the advantage of allowing the Brazilian debtor to take a tax deduction on the appreciation of the foreign currency (usually the U.S. dollar) in relation to the Brazilian real.
The problem with the FRD’s recent tax assessments against the interest deduction is their subjectivity. Rules governing minimum capital or thin capitalization would allow for a clearer, more objective approach to interest payments abroad. Because no such rules exist at the moment, tax auditors have to construe actual facts and circumstances to build their cases. But there is no guarantee of success, as Brazilian companies have the opportunity to show that the loans were necessary and were not forbidden by law. Also in taxpayers’ favor is that Brazilian tax laws do not leave much room for subjectivity.
David Roberto R. Soares da Silva