INTEREST ON NET EQUITY

Brazilian legislation (Law 9,249/05) states in addition to dividends, Brazilian companies may also pay shareholders with “interest on net equity" (in portuguese, "Juros sobre Capital Próprio").

The Interest on net equity election should result in  a deductible interest amount based on the entity’s net equity calculated from a Brazilian perspective. The interest on net equity represents a tax-deductible item for corporate tax purposes (income tax and social contribution tax on profits currently charged at a combined rate of 34%).

Interest on net equity is calculated by applying the long-term interest rate (TJLP) on the Brazilian entity’s adjusted equity, considering all equity variations occurred during the year (increases and reductions). The interest on equity deduction is limited to the larger of 50% of the payer’s retained earnings and 50% of the payer’s current profits, with some adjustments.

Interest on net equity is subject to 15% Brazilian income withholding tax on the date it is paid or credit to the recipient. Remittances will be also subject to IOF at 0%. The WHT can be reduced if the DTT provisions applies (e.g. Japan - 12.5% WHT).

The interest on equity amount can either be paid by the Brazilian entity to its owners or the amount can be capitalized by the Brazilian entity without the need to make an actual payment (the 15% Brazilian income tax withholding applies in any event and there are discussions whether a “symbolic” IOF would be charged).

The calculation of the interest on net income can be done in monthly, trimester, semester or anual basis. Moreover, the taxpayers can eventually make the election for this procedure till the maximum period of the submitance of the Income Tax Return to the tax authorities (June, 30 of the subsequent year).

The interest on equity deduction can be claimed on an annual basis. 

Retroactive Application.  This is support for taxpayers taking a position that interest on equity can be claimed retroactively in situations where the taxpayer could have benefited from the the election but failed to claim the deduction on its timely filed Brazilian income tax return. 

The statute of limitations in Brazil runs for five years from the filing due date of the income tax return.

IOF - FOREIGN LOANS

BRAZILIAN GOVERNMENT INCREASES THE TERM OF LOANS SUBJECT TO IOF/EXCHANGE AT A 6 % RATE


On March 01, 2012, Brazilian federal government published the Decree nº 7,683, that extends the minimum average term from 720 days to 1080 days (3 years), for purposes of applying the 6% IOF/Exchange rate due on the inflow of funds in connection with foreign loan transactions, either contracted directly or by the issuance of bonds in the international markets.

Such increase of the term, which applies to exchange transactions contracted as from March 01, 2012 aims to restrain the excessive upward pressure on the Brazilian currency in view of the inflow of foreign funds into Brazil.

The exchange transaction related to the outflow of funds intended to liquidate this type of loan remains subject to the IOF/Exchange at the zero rate.

Foreign exchange transactions for inflow and outflow of resources related to foreign loans with a minimum average term superior to 1080 days also remain subject to IOF/Exchange at a zero rate.
In view of Decree nº 7,683, Brazilian Central Bank issued Circular No. 3,580, according to which, as of March 02, 2012, export prepayment agreements may be contracted with a maximum term of 360 days. In case such term is not observed, the exporter may convert the amount related to the prepayment in a direct investment or in a foreign loan. In the hypothesis of a loan, IOF/Exchange may be due at a 6% rate, depending on the minimum average term of the agreement.

Additionally, Circular No. 3,580 established that export prepayment agreements may be only contracted with the foreign importer. Before such rule, such transactions could be also agreed with any legal entity located abroad, including financial institutions.

FEDERAL REVENUE FURTHER REGULATES TAXATION OVER FINANCIAL AND CAPITAL MARKETS

Normative Ruling 1,236 (NR 1,236), published in the Official Gazette of 30 January 2012 and in force as of that date, introduced amendments to Normative Ruling 1,022 (NR 1,022), which regulates the levy of income tax over income and gains earned within the financial and capital markets.

The main innovations brought by NR 1,236 are as follows:

–	modification of the methodology for classification of a fund as long or short–term, and determination that the portfolios held in real estate investment funds shall be excluded from the consideration of whether or not the fund is medium-term;
–	determination that the re-classification of an investment fund's term (i.e. from short- to long-term), resulting from alterations to its portfolio, may only be carried out once a year;
–	establishment of new requirements for the enjoyment of income tax exemption granted to investment funds;
–	amendments to the regulations pertaining to the taxation of activities carried out by Infrastructure Private Equity Funds, and introduction of regulations regarding the taxation of activities carried out by Research, Development and Innovation Private Equity Funds;
–	exclusion of the application of withholding income tax upon earnings resulting from investments held by Real Estate Funds in certain specified bonds related to the agri-business sector;
–	introduction of regulations pertaining to the taxation of Investment Funds whose portfolios are composed of debentures;
–	clarification that the transformation of an investment club into an investment fund of the same nature does not imply any alteration of its applicable tax regime;
–	determination that costs and expenses incurred in all transactions carried out in 1 day within the stock exchange market can be attributed to each transaction proportionally to the financial values involved;
–	determination that capital reduction transactions that result in a monetary restitution of the investment made in legal entities to the shareholders are considered as a deduction of the acquisition cost of the shares for transactions undertaken within the cash spot market (mercado à vista); and
–	for shares acquired up to 31 December 1999 whose cost cannot be proven for the purpose of determination of the income tax taxable base, determination that the cost may be determined by: –     the average price of the share, pursuant to negotiations carried out with the share within the stock exchange market in December 1999; or –     in case no negotiations carried out within that month, in the closest previous month in which the share was negotiated.

DIVIDENDS PAYMENTS

Dividends paid to foreign entities or local companies are not subject to WHT in Brazil (before 1995, the dividends were subject to WHT at 15%).

We noticed in the news that sometime Congress representatives mention about the possibility to reintroduce the WHT on dividends payments. However, it has not been formalized into a project law. It seems that they have other priorities...

ROYALTY PAYMENT

Cross border payment of royalties is taxed by:

- WHT: ordinary rate is 15%, but if the beneficiary is established in a low tax jurisdiction the rate is increased to 25%.
- CIDE: Special contribution of 10% on the royalty amount.
- IOF: 0.38% on the amount remitted.

Journal entries are:

Assumptions:
Royalty Amount: BRL 100.000

D - Royalty (P/L) - BRL 100.000
C - Royalty Payable - BRL 85.000
C - WHT Payable - BRL 15.000

D - CIDE Cost (P/L) - BRL 10.000
D - IOF Cost (P/L) - BRL 323

C - CIDE Payable - BRL 10.000
C - IOF Payable - BRL323


Double Tax Treaties may grant some benefits in terms of reduction of WHT. For instance, in case of Japan, the rate may be reduced to 12,5%.

Corporate Tax Deduction.
Under the Corporate Tax Code, the royalty is deductible if meet the maximum rate allowed for remittance. INPI (Intellectual Property Agency) is reponsible to determine the applicable rate for royalties. Usually, Brazilian companies present the royalty agreement to INPI and, after approved, they receive a formal act, stating the applicable rate for royalties. Usually, the rate varies from 1% to 5%.

Royalties duly registered at INPI is not subject to Brazilian transfer pricing rules.

FOREIGN CORPORATE CAPITAL

Usually, foreign investors invest in Brazil by means of Equity. Brazilian tax law imposes the taxation of IOF (Taxes on Financial Operation), in case of foreign investors invest in foreign currency (99.9% invest in foreign currency, since it is hard to find out Brazilian Reais in overseas).

The tax rate applicable is 0.38% upon the amount invested.

Thus, in case of foreign investor invests USD 100.000 in a Brazilian company, the following should be the entries:

On the date of capital injection, the exchange rate is USD 1.00:1.85 BRL.

D - Cash - BRL - 185.000

C - Corporate Capital - BRL 185.000

D - IOF Cost (P/L) - BRL 703

C - Cash - BRL 703

Brazilian Central Bank requires the registration of foreign investments in the electronic system RDE-IED. The registration is simple and it could be concluded in 30 minutes through the internet.