Provisional measure revokes limits on the deductibility of royalties in Brazil
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Provisional measure revokes limits on the deductibility of royalties in Brazil

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Paulo Victor Vieira da Rocha, Murilo Jakuk Ferreira Lopes and Marina da Silva Fernandes of VRMA Advogados discuss the effects of Provisional Measure No. 1,152/22 regarding the deductibility of royalties from the corporate income tax assessment basis.

This article analyses the recent modifications to Brazilian legislation regarding the limits imposed on the deductibility of royalties from the corporate income tax assessment basis.

Brazilian legislators introduced these limits for historical reasons, seeking to prevent tax evasion. However, the limits affected an enormous range of taxpayers who entered into transactions without any feature of tax planning and even less of abusive tax planning or tax evasion. These limits are finally being reviewed by Provisional Measure No. 1,152/22, which intends to remove them and improve other mechanisms to prevent tax abuse, such as transfer pricing rules.

Historical perspective

The restrictions regarding the deductibility of royalties were introduced into the Brazilian legal system by Article 74 of Law No. 3,470/58, determining that royalties could be deducted for the exploitation of industrial and commercial trademarks and invention patents, for technical, scientific, administrative or similar assistance, but up to a maximum rate of 5% of the revenue derived from the sale of the respective goods.

Article 74, paragraph 1, added that the percentages allowed for the deduction should be established and reviewed periodically by the minister of finance, considering the types of production or activities, according to the degree of essentiality of the intangible goods in consideration of which the royalties are paid. With regard to the degree of essentiality, Ordinance of the Ministry of Finance No. 436/58 set forth percentages for the limits, which range from 1% to 5%, according to the business activity.

In addition, in 1964, Law No. 4,506 provided that, as a rule, the deduction of royalty expenses for the calculation of the corporate tax basis is permissible "when necessary for the taxpayer to maintain the possession, use or enjoyment of the good or right that produces the income". However, it also set forth that royalties paid to abroad shall not be deductible.

The Supreme Court analysed the relationship between Article 74 of Law No. 3,470/58 and Article 71 of Law No. 4,506/64 and decided that the latter did not revoke the first; as such, both were in force and there was a special relationship between them. Law Act No. 4,506/64 is a special rule and Law Act No. 3,470/58 is the general rule. Accordingly, the limitation applies to royalties paid to abroad and to Brazilian companies.

All these provisions were enacted in a context of avoiding tax evasion and abusive international tax planning. At the time, it was common practice that foreign controlling companies and Brazilian subsidiaries signed technology transfer licensing agreements, in order for Brazilian companies to pay large amounts of royalties to the controlling company, instead of having profits and paid dividends (which were both taxable at that time). Thus, in the past, there was enough justification to limit the payment of royalties to abroad, to prevent tax evasion.

The problem is that this limitation was too broad and affected companies that did not practise abusive international tax planning, or international tax planning at all. In fact, this limitation affected companies that only needed to pay for using intangible assets – remunerable through royalties – to develop their activities.

It is possible to assume that the payment of royalties to Brazilian companies was not common, since the technologies were mostly imported. This could justify the failure to distinguish between payments of royalties to abroad and to Brazilian companies.

Despite the historical justifications, the Brazilian context is now very different. Indeed, tax legislation provides for other mechanisms to prevent abusive international tax planning, such as transfer pricing rules and lists of countries considered as tax havens.

In this new scenario, the inconsistency of the limitations was noticed by the Brazilian legislator, which, in 2022, issued Provisional Measure No. 1,152, amending the legislation of corporate tax to improve the transfer pricing rules, fully repealing the provisions that set forth limits on the deductibility of royalties for payments made to beneficiaries in Brazil and abroad.

Provisional Measure No. 1,152/22

Provisional Measure No. 1,152/22 addressed royalties and revoked Article 74 of Law No. 3,470/58 and Article 12 of Law No. 4,131/62 and other related articles that provided for a maximum deduction limit of 5% of the gross revenue related to the product manufactured or sold with the use of the trademark, patent, technical assistance, etc.

It also revoked articles 52 and 71, subparagraphs d to g of Law No. 4,506/64, which set forth that a deduction of expenses with royalties and technical assistance is impossible when they are:

  • Paid by a Brazilian branch to another establishment of the same company which is established abroad;

  • Paid by a Brazilian subsidiary to the direct or indirect parent company abroad; and

  • For partners, shareholders and legal representatives of the payor.

There are other related restrictions and limitations, but these are the main situations.

The original text of the provisional measure was published on December 29 2022, then it went to a joint commission of the National Congress (a commission with members of the Senate and the House of Representatives), where it was submitted for amendments. Then, on February 6 2023, the provisional measure was sent to the House of Representatives, where its text was finally approved on April 13 2023 and thus sent to the Senate. At the time of writing, it is still in the Senate, awaiting the start of the next steps of the deliberative procedure.

Provisional measures are norms with the force of law that act in a narrow sense (acts of parliament) and are used by the president of the republic in situations of relevance and urgency. Despite producing immediate legal effects, provisional measures need approval by both houses of the National Congress (the lower House and the senate) to become definitively an ordinary law.

The initial term of validity of a provisional measure is 60 days. This is automatically extended for the same period if the vote is not concluded in both houses of the National Congress, which has already happened in this case.

Finally, on February 24 2023, Normative Instruction RFB No. 2,132/23 was published, which governs the taxpayer's option to apply the new rules brought in by Provisional Measure No. 1,152/22, for transactions occurring in the calendar year from 2023.

A highlight of Normative Instruction RFB No. 2,132/23 is the provision that for the purposes of calculating corporate income tax (IRPJ) and the social contribution on profit (CSLL) for the months of the calendar year 2023 prior to the exercise of the option, the taxpayer must adopt the new rules for deducting royalties.

If the taxpayer has adopted the new procedure but has not selected the option for it on the electronic platform of the tax administration in the digital system (e-CAC), the taxpayer must correct the respective federal tax debt and credit statements (DCTF) already presented and the respective bookkeeping to ensure it is in compliance with the royalty deductibility limits provided for in the legislation previously in force.

Final considerations

Provisional Measure No. 1,152/22 has the potential to drastically change the scenario relating to royalties’ deductibility in relation to corporate income tax. Besides that, these changes may already be implemented in the current fiscal year. The next steps to be taken by the taxpayer now depend on the last stages of the legislative process.

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