Impact of corporate income taxation on government grants in Brazil
Bruno Santo and Leandro Lucon of Finocchio & Ustra discuss corporate income taxation on government grants given in the form of ICMS tax incentives.
Taxpayers have faced a setback regarding corporate income taxation on government grants given in the form of ICMS (‘VAT’ style state taxation on goods) tax incentives and reductions.
The Brazilian revenue authority, the Receita Federal do Brasil (RFB), issued a public consultation changing its own opinions on the topic and contradicting decisions from the judicial and administrative courts.
Is it possible for companies to enjoy ICMS incentives (reductions, presumed tax credits that reduce ICMS due, exemptions, etc.) to treat this as a government grant exclusion when calculating corporate income?
This is a discussion that has existed for a long time and basically distinguishes government grants given as an investment subsidy (not taxed by corporate income taxes, namely IRPJ/CSLL) from the ones given as compensation for costs subsidies (taxed by IRPJ/CSLL).
In a nutshell, taxpayers argued that ICMS tax incentives given by local governments should not be subject to IRPJ/CSLL, alleging that they are given as an investment subsidy, for example, as a relief of the ICMS tax burden, but with the corresponding obligation for the company to re-invest the equivalent amount in expanding its operations in the region.
On the other hand, the RFB, with a normative opinion dated from 1978, understood that a non-taxed investment subsidy can only happen when there is effective proof that the amount equivalent to the ICMS reduction was reinvested by the company, physical demonstration of the investments made, and that the amounts were not distributed to the shareholders, otherwise it is necessary to tax the grant.
At the Administrative Council for Tax Appeals (CARF), this subject has been analysed many times and the judges had a case-by-case approach when deciding, but at the judicial level most decisions favoured taxpayers.
In 2014, with the noble, but difficult, objective of disciplining the differences in accounting treatment (in the IFRS) and tax treatment in several points, Law No. 12.973/2014 was enacted.
Article 30 of Law No. 12.973/2014 establishes that government grants given as an investment subsidy, thus not subject to corporate income taxation, are the ones (i) granted as a form of an incentive for the expansion and development of a business; and (ii) which have been maintained in the company under special surplus reserves, that is to say, without distribution to shareholders.
In 2017, in order to put an end to harmful tax competition between states, the House of the Representatives published Law No. 160/2017 which amended part of Article 30, determining that any government grant related to the ICMS is to be treated for corporate income tax as an investment subsidy (not subject to tax), without any further requirements besides the ones provided in Article 30.
Therefore, the requirements utilised by the RFB in determining when ICMS tax incentives should be treated as an investment subsidy were no longer applicable. This includes the physical/effective proof of the investments made and the demonstration of synchronism between obtaining the benefit and its destination as investment.
Since 2017 several taxpayers have aligned their tax practices with the wording of Article 30, as amended by Law No. 160/2017, and started to no longer tax their ICMS incentives by the IRPJ/CSLL. CARF has also, in most cases, aligned itself with the new legal command, and the judiciary has maintained the line it has been following for some time.
The RFB issued public consultation No. 11/2020 (SC 11/2020) because it was finally time for the RFB to publish its new understanding on this matter and it did this very well, confirming the main understanding of Law No. 160/2017, without requiring any specific consideration or any other demonstration of the investment made in order to exclude the ICMS grants from corporate income taxation. Thus, the most desired confirmation by taxpayers occurred, the seal of tax authorities.
Surprisingly, on December 22 2020, the RFB published another public consultation on the subject, SC 145/2020, arguing taxpayers still need to demonstrate that ICMS tax incentives have been granted to them as a form of an incentive for the expansion and development of a business, which is a broad concept and difficult to prove. As a result, we envisage that RFB will likely adopt a ‘case-by-case’ approach and impose tax notices to audit this issue in each specific case.
Thus, in spite of legal and administrative precedents, the clear wording of new legislation and, against its own view of the matter expressed in SC 11/2020, created havoc for taxpayers and potentially countless more years in litigation.
Albeit, this is a minor bump in the road and the Brazilian courts will uphold their interpretation on the matter. The Supreme Court has issued a ruling determining that ICMS tax incentives given as presumed tax credits are not subject to PIS/COFINS taxation, shedding some light on how the court could envisage the case for corporate taxes.
Partner, Finocchio & Ustra
Partner, Finocchio & Ustra