Brazilian tax authorities provide guidance on ‘debit to shareholders account’ transactions

On July 1 2019, the Federal Brazilian Tax Authorities (RFB) published Solução de Consulta – Cosit 210/2019 (dated June 24 2019), providing that withholding tax should be levied at a rate of 15% on interest that is accrued but not yet due, where the outstanding debt is used to reduce accounting losses of a Brazilian company via a 'debit to shareholders account' transaction.

By way of background, a 'debit to shareholders account' (débito à conta de sócio) is a transaction whereby the Brazilian entity performs a balance sheet transaction involving an accounting debit to the relevant liability in the balance sheet and a corresponding accounting credit to the balance of accumulated accounting losses within the net equity of the Brazilian entity.

The tax legislation dealing with this type of transaction is relatively limited, with the key provisions merely confirming that the absorption of accumulated losses in the commercial accounts via a debit to shareholders account should not prejudice the right to compensate the Brazilian entity's carried forward tax losses.

Under the previous administrative guidance (see Paracer Normativo Cosit 4/1981), such transactions were considered equivalent to a contribution of capital that did not impact the results (that is, income statement) or to represent an effective inflow for the Brazilian entity. As such, when correctly accounted for, the transaction has generally been considered not to give rise to taxable income in the hands of the Brazilian entity.

The issue under consideration was whether the debit to shareholders account transaction, involving an accrued but not yet due interest liability, should be subject to withholding tax. Specifically, in view of the transaction not representing an effective inflow of value, it was questioned whether there should be a triggering event for withholding tax purposes in relation to the accumulated interest amount – being the payment, credit, employment, delivery or remittance of the interest to the shareholder. Consistent with recent administrative guidance, the RFB focused on whether the shareholder had 'legal or economic availability' of the interest income.

The RFB considered that the 'employment' (emprego) of the interest by its lender or a third party, in this case the shareholder, for its benefit, is considered a triggering event for withholding tax purposes, denoting clearly a legal and economic availability to the income. In this regard, the RFB took the position that the use of the accrued interest to reduce the Brazilian entity's accumulated accounting loss balance would benefit the shareholder by effectively increasing the Brazilian entity's capital stock – that is, an account that is negatively influencing the net equity of the Brazilian entity is being reduced as a result of the transaction. Interestingly, the argument for 'employment' focuses on the improvement of the net equity of the Brazilian entity and does not go further to explore whether the non-resident actually verified an income or obtained an actual economic benefit from the transaction.

In light of the above, the RFB concluded that withholding tax should be levied at a rate of 15% on interest that is accrued but not yet due, where the outstanding debt is used to reduce accounting losses of a Brazilian company via a debit to shareholders account transaction.

While a Solução de Consulta does not represent law or a legal precedent, it does provide further support and guidance for Brazilian entities in relation to how the RFB is treating such arrangements. In this case, accepting that a non-resident shareholder is benefiting from the transaction and has legal and economic availability to the income, which it is then employing in relation to its Brazilian investment, non-resident taxpayers with investments in Brazil should monitor how the RFB addresses the issue of whether such transactions should result in an increase to the tax cost base that a non-resident shareholder may have in its Brazilian subsidiary for non-resident capital gains tax purposes.

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