Originally published in the September 11 edition of World Tax Daily (Copyrights Tax Analysts – www.taxanalysts.com)
Brazil’s Federal Revenue Department (FRD), in a recent private letter ruling (PLR), has clarified the tax treatment of cost-sharing arrangements between a Brazilian company and its foreign parent company for transfer pricing and tax purposes.
For both income tax and transfer pricing purposes, the FRD excluded a cost-sharing arrangement from transfer pricing controls, but disallowed the deduction of costs incurred by the foreign parent company under the same cost-sharing arrangement for Brazilian tax purposes. Also, the FRD found that those arrangements are subject to a 15 percent withholding tax and the 10 percent royalty tax (CIDE).
PLR 23/08, issued by the Tax System General Coordination Office (Coordenação-Geral do Sistema de Tributação, or CST), was published in Brazil’s official gazette on August 20. Its summary reads as follows:
SUBJECT: Corporate income tax
SUMMARY: Rendering of services between related parties. [Service] provider domiciled abroad. Cost sharing agreements. Expenses paid or incurred by the Brazilian legal entity. Nondeductibility. Tax base of corporate income tax and CSL. Transfer pricing. Implications.
Expenses paid or incurred by a company domiciled in the country [Brazil] to its parent company domiciled abroad, for services related to development of routine systems to be implemented in all group’s affiliates, are nondeductible for corporate income tax and CSL purposes, because they refer to a permanent establishment located outside the national territory and, as a consequence, cannot negatively impact the tax basis of those taxes in Brazil.
Once those amounts are nondeductible for income tax and CSL purposes, the corresponding original transactions are not subject to transfer pricing controls, which function is to determine the maximum deductible amount of expenses in transactions with related parties.
The amounts paid, credited, remitted or used by the Brazilian company, in this context, are subject to withholding tax and CIDE, at the rates of 15 percent and 10 percent, respectively, because they are originated from technical services which income is earned by a nonresident. The amounts paid, credited, remitted, delivered or used by the Brazilian company have the nature, to the [foreign] beneficiary, of reimbursement, as they represent recovery of expenses previously incurred. Therefore, computation of those expenses in the taxpayer’s income is disallowed and, thus, nondeductible for corporate income tax and CSL basis, as they have been incurred by the foreign beneficiary.
The summary of PLR 23/08 has an unusual length and description of its rationale. It seems that the Coordination of the Tax System (COSIT), a normative and consulting body within the FRD, was willing to send a clear message on the tax treatment applicable to similar cost-sharing arrangements.
From the text it can be determined that the filing taxpayer tried to deduct a cost-sharing arrangement for tax purposes at the same time it claimed to comply with transfer pricing rules.
Brazil’s transfer pricing rules provide for multiple methods to determine the maximum deductible amount of a cost or expense arising from import transactions with a related party. One method is the cost of production plus profit, in which local laws provide for a maximum profit margin of 15 percent.
Because in a cost-sharing arrangement the parent company’s profit margin, if any, usually does not exceed 5 percent or 10 percent, it seems that the taxpayer concluded that its cost-sharing arrangement documented as a service agreement with a small markup should achieve two goals: compliance with Brazilian transfer pricing laws, and deductibility for local tax purposes. COSIT, however, seems to have fully rejected the taxpayer’s position based on the argument that the relevant technical service (development of routine services) would benefit only the foreign parent company and, thus, should not be deductible for Brazilian tax purposes. As a consequence, no transfer pricing should apply, because a nondeductible expense does not affect the taxpayer’s taxable income. Finally, because of the technical nature of the services, COSIT concluded that a 15 percent withholding tax and a 10 percent CIDE (royalty tax) should apply.
PLR 23/08 is valid only between the tax administration and the filing taxpayer. However, it may represent an important precedent to tax agents when auditing similar cost-sharing arrangements.
David Roberto R. Soares da Silva