Brazil clarifies law on goodwill and step-up deductibility
Priscila Vergueiro and Mark Conomy of PwC Brazil set out how Brazilian tax authorities have provided guidance on the definition of ‘dependent parties’ for the purpose of goodwill and step-up deductions.
On March 25 2020, the Federal Brazilian Tax Authorities (RFB) published Solução de Consulta – Cosit No. 13 / 2020 (dated March 17 2020) providing that the corporations law definition of ‘control’ should be applied when determining whether parties should be considered ‘dependent’ for the purposes of the rules concerning goodwill and step-up deductibility (SC 13/2020).
By way of background, Law No. 12,973/2014 brought about important amendments to the legislation surrounding acquisitions and the ability to access deductions relating to asset step-up (mais-valia) and goodwill related to future profitability. The legislation specifically included within the conditions for deductibility, the requirement that the relevant acquisition generating the step-up and/or goodwill must be between ‘non-dependent parties’. It also included a specific definition, providing that parties will be considered dependent when:
I. The buyer and the seller are controlled, directly or indirectly, by the same party or parties;
II. There exists a relationship of control between the buyer and the seller;
III. The seller is a partner, titleholder, director or administrator of the company making the acquisition;
IV. The seller is a relative or similar to the third degree, spouse or partner of the persons listed in item III; or
V. As a result of other relationships not described in items I to IV, in which corporate dependence is proven
The relevant legislation also goes on to provide that in the case of staged acquisitions, the relationship between buyer and seller should be tested at the time of the first acquisition, provided that the relevant business conditions related to future acquisitions are included in the acquisition document.
In summary, SC 13/2020 deals with a situation whereby the buyer acquired the shares in a Brazilian company in which the buyer already held an account receivable relating to a previous loan arrangement. Upon the acquisition of the entity, the buyer simultaneously capitalised the loan payable, including interest remuneration until the relevant date. The previous loan agreement contained terms including a guarantee by way of shares in the Brazilian company, as well as creditor approval in relation to certain matters. In light of above, the taxpayer sought the RFB’s view in relation to the potential application of item II and V to its particular case.
In relation to item II, the RFB considered that although a broader interpretation may be possible, taking into account the context of the rule, the use of the term ‘control’ and its derivatives should follow the meaning of ‘corporate legal control’ (controle societário) as defined in the corporations law, which has also been accepted into the Brazilian tax regulations. As such, in the event that there is no corporate legal control between the buyer and the seller, directly or indirectly, item II should not apply.
In relation to item V, the RFB considered that in the particular circumstances (including creditor approval being required relation to certain matters), it could not be ruled out that the acquisition of the equity interest may set up a relationship of corporate dependence. However, applying a literal interpretation to the relevant legislation, it is necessary prove (or disprove) the existence of such relationship based on evidence. The RFB concluded that the assessment of evidence is a task that, as a rule, should be performed during a tax audit/dispute process and not via a Solução de Consulta and therefore found that this part of the taxpayer’s request was invalid.
While a Solução de Consulta does not represent law or a legal precedent, it does provide support and guidance for taxpayers in relation to how the RFB are treating such arrangements. The decision highlights the importance of carefully evaluating previous arrangements with potential targets prior to acquisitions taking place in order to minimise the risk of jeopardising the buyer’s ability to access step-up and goodwill deductions upon acquisitions.