This content is from: Brazil

Brazil: Administrative Court disagrees with tax authorities’ interpretation of rules on profit sharing plans

The Administrative Court has just issued a ruling that is bound to set a precedent concerning how companies’ profit sharing plans are viewed for the purposes of social security taxation.

Back in 2011 we published an article about profit sharing plans (PSP), a type of compensation allowed by the Brazilian Federal Constitution which, provided it is implemented in accordance with the provisions of Law No 10,101/2000, is exempt from social security taxation.

On that occasion, based on our analysis of the relevant provisions set forth both in the Constitution and Law No 10,101/2000, we concluded that the laws did not intend to restrictively control the use of PSP, but rather aimed at establishing the premises and guidance necessary to draw a line between the rightful use of PSP as a mechanism for sharing a company's profitability among those that contributed to such profitability, on the one hand, and potential abuses of using PSP for the mere purpose of evading social security taxation, by replacing payment of salaries with PSP payments, on the other.

Following that line of reasoning and inspired by the freedom of negotiation, we verified that both the Federal Constitution and Law No 10,101/2000 aimed at:

  • establishing parameters of periodicity that should be observed to prevent such payments becoming routine payments; as well as
  • making sure that the parameters taken into account to make one eligible to PSP refers to the enhancement of the company’s performance as a whole (and not with reference to the sole individual), thus removing the nature of compensation for work actually carried out (that is, any retributive nature).

However, tax authorities have taken a more literal approach to the interpretation of the provisions of the Federal Constitution and Law No 10,101/2000, repeatedly issuing assessments against taxpayers that adopted PSP, claiming that the plans lacked clear and objective rules regarding the substantive rights of workers and questioning the difference between the amounts paid to employees and the amounts paid to executives.

In our former article we reviewed a few precedents from the administrative court that, though could not be taken as definitive, pointed towards a promising outcome of the disputes with tax authorities. Such precedents rejected the restrictive interpretation of tax authorities and acknowledged that what should be taken into account is the spirit of sharing the results and profits considered within the reality in which the relevant PSP was introduced, hence respecting the freedom of negotiation between the parties and the characteristics of the respective sectors of the economy.

Accordingly, and in line with our expectations, an important and definitive decision was recently handed down by the last level of the administrative court, determining that administrative authorities may not interpret the PSP rules in a way that does not respect the freedom of negotiation between the parties, and the characteristics of the respective sectors of the economy.

Considering the quality and extension of its grounds, we believe that this is an important precedent that will surely become a guide to future decisions.

Joao Marcos Colussi (jmarcos@mattosfilho.com.br) of Mattos Filho, Veiga Filho, Marrey Jr. e Quiroga Advogados, the principal Brazilian correspondents for the tax disputes channel ofwww.internationaltaxreview.com.

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