19/05/2011
Brazil Regulates Thin Capitalization Rules
by David Roberto R. Soares da Silva
Brazil's Federal Revenue Department on May 13 published in the official gazette an instruction regulating the thin capitalization rules created by Provisional Measure 472/2009 (eventually converted into Law 12,249/2010).
Normative Instruction 1,154/2011 reproduces most of the original provisions and restrictions contained in Measure 472/2009 and Law 12,249/2010 but also provides additional clarification. It is effective from the date of publication.
In addition to the requirement that interest be a business expense, the following requirements apply to debt contracted with a foreign related creditor, depending on whether the related party participates in the capital of the Brazilian taxpayer:
- the amount of the relevant debt cannot exceed twice the amount of the participation of the foreign related party in the net equity of the Brazilian taxpayer;
- the amount of the relevant debt with a foreign related party (that does not participate in the capital of the Brazilian taxpayer) cannot exceed twice the amount of the net equity of the Brazilian taxpayer; and
- the total amount of debts (with foreign related parties) cannot exceed twice the total amount of all participations of foreign related parties in the net equity of the Brazilian taxpayer.
Instruction 1,154/2011 clarifies that the thin capitalization rules and limits also apply in transactions in which a financial institution is merely an intermediary between the Brazilian borrower and its foreign related party.
For interest paid to foreign parties domiciled in low-tax jurisdictions or under favorable tax regimes, the amount of debt with such foreign parties cannot exceed 30 percent of the net equity of the Brazilian taxpayer. Instruction 1,154/2011 clarifies that the rules and limits also apply to debt with a foreign company where the guarantor, legal representative, or any intervening party in the relevant transaction is resident in a low-tax jurisdiction or is under a favorable tax regime.
Any excess interest calculated according to the above rules will be disregarded as a business expense and will be nondeductible for tax purposes.
Instruction 1,154/2011 reproduces the concept of related parties used for transfer pricing purposes. The following parties are deemed to be related to the Brazilian taxpayer even if they do not participate in the capital of the latter:
1- its parent company, domiciled abroad;
2- its branch or agency, domiciled abroad;
3- the person or legal entity, resident or domiciled abroad, whose interest in the capital of the Brazilian company characterizes it as controlling equity holder or affiliate party as defined in the Corporations Act;
4- the legal entity, domiciled abroad, that is characterized as a controlled entity or an affiliate party of the Brazilian company as defined in the Corporations Act;
5- the legal entity, domiciled abroad, when such an entity and the Brazilian company are under the common corporate or administrative control or when at least 10 percent of the capital of each entity is owned by the same person or legal entity;
6- the person or legal entity, resident or domiciled abroad, that together with the Brazilian company holds interest in the capital of a third company, the amount of which characterizes them as the latter's controlling equity holders or affiliate parties, as defined in the Corporations Act;
7- the person or legal entity, resident or domiciled abroad, that is associated in the form of a consortium or condominium as defined by the Brazilian law, in any enterprise;
8- the individual resident in Brazil who is a relative up to the third family degree (as defined in Brazil's Civil Code), the spouse, or companion of the Brazilian company's management or direct or indirect controlling equity holder;
9- the individual or legal entity, resident or domiciled abroad, that has exclusive rights, as agent or distributor, to purchase and sell goods, services, and rights of the Brazilian company; and
10- the individual or legal entity, resident or domiciled abroad, that has the Brazilian company as an exclusive agent or distributor to purchase or sell goods, services, or rights.
Instruction 1,154/2011 also contains regulations concerning:
- passthrough transactions carried out by financial institutions;
- methods to calculate the level of debt for purposes of determining the limits established in the thin capitalization rules;
- a formula to calculate the excess of interest nondeductible for tax purposes.
Articles 11 and 12 of the instruction reproduce the rule from Law 12,249/2010 that amounts of any nature paid, credited, delivered, used, or remitted, directly or indirectly, to beneficiaries (individuals and legal entities) located in a low-tax jurisdiction or subject to favorable tax regimes are, by legal definition, nondeductible for Brazilian tax purposes unless:
- the beneficial owner of the payment is identified;
- the beneficiary is proven to be operational to perform the activity for which it is being paid; and
- there is documentary evidence of the payment and corresponding receipt (by the Brazilian company) of the good, service, or right that gave cause to the relevant payment.
Failure to comply with any of these requirements prevents the payment from being tax deductible for federal corporate tax (IRPJ) and social contribution on net income (CSL) purposes.
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