GOODWILL BENEFIT

Tax Treatment upon Goodwill generated on acquisition of participation of Brazilian Companies

This year was issued important administrative decisions (CARF), which cancelled Brazilian IRS's tax notifications associated with the non-deduction of goodwill amortization derived from certain acquisitions (e.g. Santander, VIVO, among others).

These precedentes brought a certain comfort for companies that have the intention to utilize the goodwill benefit. However, there are several fundamentals related to the accounting recognition of the goodwill and its tax treatment.

The "goodwill" issue is also relevant in terms of commercial perspective, since in case of partial acquisition of companies participation, usually the buyers mention the potential benefit of goodwill and force to input such benefit into the negotiation of the prices.

Under the Law 9.532/97 (articles 7 and 8) and Decree-Law 1,598/77 (article 20), in some situations this tax deduction is possible and represents an economy of 34% upon the amount of the goodwill paid (tax rate of Corporate Income Tax and Social Contribution on Net Profit), deduction that could be granted only in some specific hypothesis, but in gradual form and in future periods.

For the sellers, this may result in capital gains. For individuals selles, the Income Tax of 15% is levied upon the amount of the shares registered at the Income Tax Return. For Corporate sellers, the capital gain is taxed  by Corporate Income Tax and Social Contribution, being the joint-rate achieves the 34%.

The goodwill is the difference between the amount paid by the shares and the amount of net equity of the acquired company. For example: in case of selling of 80% of shares of the company; if the price paid is BRL 1 million and the net equity is BRL 500 thousand, then the goodwill is BRL 600 thousand (BRL 1 Million - (BRL 500 thousand x 80%). However, the price paid could derived from several reasons, such as:

a) fair value of the assets acquired;
b) a perspective of future profitability of the business combination;
c) value of potential intangible assets.

But the tax legislation does not permit the investment aquirer to choose freely which reason of the goodwill is used for tax perspective. The classification of the goodwill into several economic reasons should be fixed by a appraisal report preapred exclusively for the acquisition of the company participation.

The appraisal, signed by a expert and by acquirer's administrator, should inform, among the three economic reasons above (letter a, b and c), what is considered to justify the amount of the goodwill. This selection should not be aleatory. It should be well supported, arguable, specificaly before Brazilian IRS, since the tax treatment may differ depends on the reason selected.

Besides that, during the period that the investment is not realized, there is no tax implication for the buyer, meaning that, they cannot deduct the goodwill amortization for tax purposes. The realization occurs when the alienation of the investment (through selling) or by means of corporate reorganization - merger or consolidation.

With effect, if further the acquisition of company participation, the buyer merger the company acquired, the tax implication for acquirer side is the following, depends on the economic reason adopted:

a) fair value of the assets: goodwill inputted into the cost of assets when the merger occurs would be deductible upon the registration of depreciation or amortization of the assets;
b) expectation of future profitability: the goowill may be deducted in the Corporate Income Tax and Social Contribution, within a period of 5 years. Brazilian IRS has notified companies that defines this option as the economic reason of the goodwill, when the appraisal report does not clearly justify the goodwill.
c) Amount of intangible assets: eg. trademarks. The goodwill paid could not be deducted under such option.

At last, due to the potential tax risk involved, in case of the goodwill is not duly justified under the Brazilian IRS view, it is important to include into the instruments of acquisition, a clause which the sellers and the company acquired have no responsability regressive (civil law) in case of the goodwill amortization is challenged by Brazilian IRS.