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Brazil: Comparing systems for the taxation of profits

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Though most Brazilian companies are taxed on their worldwide profits at a combined rate of up to 34% (taking into account Corporate Income Tax (IRPJ) and Social Contribution on Net Profits (CSSL)), the total tax burden of these companies may vary for a number of reasons.

One such reason is the choice between the two main systems for the taxation of profits: the Actual Profit System or the Deemed Profit System.

Under the Actual Profit System, companies should apply the appropriate tax rate on accounting profits ascertained on an accrual basis according to the rules in force on December 31 2007, with certain adjustments (additions and/or exclusions) set forth by tax law.

According to the Deemed Profit System, companies should calculate the taxable profits by applying specific percentages to their gross revenues, which vary depending on the activity that generated the respective operational revenues (for example, 8% for IRPJ and 12% for CSSL on revenues deriving from the sale of merchandise and products, and 32% for both taxes on revenues deriving from the rendering of services). The company should then add other taxable revenues, including financial revenues and capital gains, and apply the 34% rate on the whole amount.

Other significant differences between said tax systems are the following:

- Tax deduction of expenses: Effective and usual expenses are tax deductible under the Actual Profit System. Companies taxed under the Deemed Profit System may not deduct expenses;

- Tax losses: Tax losses may be offset against taxable profits under the Actual Profit System (certain annual amount limit applies). The Deemed Profit System does not allow for said offsetting;

- Social Contributions on Revenues (PIS/COFINS): Companies subject to the Actual Profit System are generally obliged to follow the PIS/COFINS non-cumulative system, which subjects the company’s revenues to such contributions at a combined rate of 9.25%, with the possibility to use credits arising from contributions paid in previous transactions (several limitations apply). Under the Deemed Profit System, companies are generally subject to the PIS/COFINS cumulative system, in which the applicable combined rate is lower (3.65%), but the offsetting of credits is not authorised.

Though most companies may irrevocably choose (at the beginning of each year) the tax profit system to be adopted for that whole year, certain companies are mandatorily subject to the Actual Profit System, if they fall under the scope of the following provisions, among others:

- Engage in activities of banking, brokerage of bonds, securities and exchange, securities dealership, private insurance, factoring, among others;

- Earn profits, income or capital gains originated from abroad. The income arising from the direct rendering of services abroad is not considered as income earned from abroad;

- Enjoy tax benefits that resulted in the reduction of IRPJ; and/or

- Accrued, in the previous year, over 78 million Reais (approximately $34.5 million) of revenues, or 6,500 million Reais multiplied by the number of months in operation, for newly incorporated companies.

The previous revenue limit was of 48 million Reais ($22 million) since 2003. After several alteration attempts throughout the last ten years, recently the revenue limit was finally increased to 78 million Reais, thus allowing a substantial number of companies that were previously forbidden to adopt the Deemed Profit System as from 2014.

Brazilian companies should consider several variables and facts when making the choice for one of the available systems, such as their average profit margins, the impacts of other taxes (PIS/COFINS especially, as commented above), and timing of tax payments, among others. A wrong decision could generate considerable cost, as the option for one of the systems is irrevocable for the whole year.

Cristiane Magalhães (cmagalhaes@machadoassociados.com.br) and Stephanie Makin (smakin@machadoassociados.com.br) are members of the direct tax practice at Machado Associados, principal Corporate Tax correspondent for Brazil.

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