key tax structuring considerations to invest in and from brazil

Dewey & LeBoeuf | 1

KEY TAX STRUCTURING CONSIDERATIONSTO INVEST IN AND FROM BRAZIL

Welcome Address by Michael Fitzgerald, Dewey & LeBoeuf LLP

Introduction by Ary Oswaldo Mattos Filho, Mattos Filho, Veiga Filho, Marrey Jr. e Quiroga Advogados

Speakers

Bruce E. Blanco, Bank of AmericaJulio A. Castro, Dewey & LeBoeuf LLP

Luiz Felipe C. Ferraz, Mattos Filho, Veiga Filho, Marrey Jr. e Quiroga Advogados Alex Jorge, Avon Products, Inc.

VIABLE TAX REFORM

Past, present, and future

Ary Oswaldo Mattos Filho

3

Tax Burden – Brazil

Source: OECD, published in 2009.

4

Tax Burden per Government Sphere

Source: National Treasury Office / Center for Tax Studies (NEF)

Collection by government sphere(in billions of Reais, 2002 prices)

FederalMunicipal

Estate

5

Evolution of the Federal Government Tax Burden Taxes v. Contributions

Source: National Treasury Office / NEF

Evolution of Taxes and Contributions (without INSS)(in billions of Reais, 2002 prices)

ContributionsTaxes

6

Nature of Federal Government Expenses

Source: National Treasury Office / NEF

Federal Expenses(in billions of Reais, 2002 prices)

Debt chargeInvestment and Funding

Personnel

7

Tax Reform Proposals

Proposal for Amendment to the Constitution (PEC) – State Board of Tax Appeals (CERF) in 1992

• Amendment to 36 articles of the Brazilian Federal Constitution of 1988 (CF/88), including tax and public expenditure issues)

PEC 175 in 1995

• Amendment to 14 articles of the CF/88

PEC 175 in 1997


PEC 41 in 2003


PEC 233 in 2008


8

Tax Reform Proposals Reasons for Failure

Modification of many articles of the CF

Impossibility of consensus among the Federal, State, and Municipal Governments

General lack of trust among the Federation Entities

Absence of priority given to Tax Reform Projects by the Federal Government (Executive Branch)

Private initiative groups (Federations, Confederations, Associations, etc.) have failed to organize themselves in order to align demands

Fear of loss of collection from all federative entities, especially States and Municipalities

Lack of participation from the civil society in the debate so as to exert political pressure on the Executive and on the Congress

9

Current Proposal

Strict tax reform, without discussing public expenditure issues

Solely federal scope, thereby avoiding debates involving States and Municipalities

Minimizing constitutional amendments

Stimulating amendments to legislation seeking to rationalize tem federal tax system

10

What can be consolidated?

1. Corporate Income Tax (IRPJ) and Social Contribution on Net Income (CSLL)• Obstacles: different purposes and sharing of IRPJ with States and

Municipalities – Funds Shared by the States, Federal District, and Municipalities (FPE and FPM)

• Possible solution: unified collection, thereby facilitating the payment of such taxes to taxpayers and decreasing the amount of litigation and interpretive controversies existing among them.

2. Contribution for tem Social Integration Program (PIS) and Contribution for Financing of Social Security (COFINS)

• Obstacles: different purposes and constitutional grounds (PIS: article 239 and COFINS: article 195)

• Possible solution: unified collection by transforming such contributions into taxes subject to ex officio entry. In other words, Tax Authorities should interpret the complex, extensive, vague and ambiguous legislation currently in force, and merely send payment forms to taxpayers.

11

What can be replaced?

Payroll Contributions – National Social Security Institute (INSS)

Why replace?

• Informality• Incentive not to hire employees

What replacement?

• Financial operation contribution• Study ordered by the Federation of Services of the State of São Paulo

(FESESP) to the Getulio Vargas Foundation (FGV)• Exemption of employer contribution of 20% (INSS), education-salary of

2.5%, and National Settlement and Agrarian Reform Institute (INCRA) contribution of 0.2%

• Changing the tax base for payment of such payroll contributions would (i) increase the GDP by 2.5%, (ii) increase the employment level by 2.45%, and (iii) reduce the tax burden in 52 economy sectors

12

How to rationalize the system?

Ancillary ObligationsCountries selected from the “Paying Taxes” section of “Doing Business”, which rates

how easily tax payments are made in 183 countries.

País Time to Comply

(hours per year)

Tax Payments

(number per year)

Reino Unido 25 8

Canadá 30 9

Venezuela 31 71

Estados Unidos 69 10

Alemanha 73 16

Colômbia 82 20

Espanha 84 8

Chile 130 7

Portugal 135 8

I tália 138 15

J apão 144 13

Argentina 162 9

Bolívia 181 42

Brasil 183 10

Source: THE WORLD BANK, PRICEWATERHOUSECOOPERS. Paying Taxes 2010 – The Global Picture. Available at http://www.pwc.com/gx/en/paying-taxes/pdf/paytax-2010.pdf. Last access on 11/17/2010

Country

United Kingdom

Canada

Venezuela

United States

Germany

Colombia

Spain

Chile

Portugal

Italy

Japan

Argentina

Bolivia

Brazil

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Ancillary Obligations

Federation of Industries in the State of São Paulo (FIESP) Study in July 2010• Annual average bureaucracy cost: R$ 46.3 billions, which is

equivalent to:– 1.47% of the 2009 GDP– 10.1% of total private investments in 2009– 300% of private expenses involving Research and Development (R&D)

Possible Solution: Public Digital Bookkeeping System (SPED) for Accounts and Taxes

• Entering information into a single system• Detailed description of all information deemed necessary by Tax

Authorities• Reduction of Legal Entity (PJ) establishment inspections• More information at http://www1.receita.fazenda.gov.br/

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São Paulo

Al. Joaquim Eugênio de Lima 447

01403 001 São Paulo SP Brasil

Tel (55 11) 3147 7600

Fax (55 11) 3147 7770

Rua Campo Verde 61 3ºandar

01456 010 São Paulo SP Brasil

Tel (55 11) 3035 4050

Fax (55 11) 3035 4067

BrasíliaSHS Q.6 Bloco C Cj A sala 1901 70322 915 Brasília DF BrasilTel (55 61) 3218 6000 Fax (55 61) 3218 6090

Rio de JaneiroPraia do Flamengo 200 11º andar22210 030 Rio de Janeiro RJ BrasilTel (55 21) 3231 8200Fax (55 21) 2262 6675

New York135 East 57th Street 12th FloorNew York, NY, USA 10022Tel (1 646) 695 1100Fax (1 646) 695 1110

www.mattosfilho.com.br

Dewey & LeBoeuf | 15

Brazil Focus - The Good

● Debt -to-Equity ratio

– Brazilian thin-cap law enacted in 2010 and regulations last May

● Royalties

– Brazilian PTO (INPI) relaxing some rules allowing payment for royalties for trademarks registered before 1991 and licensed for free. However, still capped at 1% of Net Sales.

– Royalty payments not subject to 9.25% PIS/COFINS according to several rulings issued by the tax authorities.

– 10% CIDE not on grossed up withholding tax amount.

– Service Tax (ISS), generally at 5% rate, still uncertain.

● Dividends

– No withholding tax rate

– Interest on Net Equity subject to a 15% withholding tax

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Brazil Focus - The Good (cont’d)

● Central Bank

– User-friendly electronic access for registrations

● “RTT”

– Tax neutrality in light of new accounting standards (IFRS)

● Tax incentives to investors

– “MP Brasil Maior”: new incentives for certain industries and IT companies

– World Cup, Olympics and “Pre-Sal” incentives

– Innovation Law: bonus deduction for qualifying expenditures

– Regional Incentives for VAT: vary by States but may be a “trap for the unwary”

● Taxpayers Council (Administrative Appeals)

– trends to become very a technical dispute resolution appeals body

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Brazil Focus - The Bad

● High combined corporate income tax rate of 34% (IRPJ and Social Contribution).

● Taxes on Cross-Border payments of services.

– What is creditable and what is not for the recipient.

– No respect to Treaties and sourcing rules.

– Permanent Establishment

● Concept of Intellectual Property

– Not well developed and dependent upon Brazilian Trademark Office Approvals.

– Statutory limitations on deductibility.

● No DTT with the United States

– Brazilian investors are urging the government for it.

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Brazil Focus - The Ugly

● Transfer Pricing rules and regulations

● CFC rules

– No deferral mechanism, but rather deemed distribution every Dec 31.

● Tax compliance extremely complex, burdensome and unclear with high penalties even for non-intentional mistakes.

– SPED, FCONT, DCTF, DIRF, DACON, etc.

– VAT Substitution Systems: cash trapped due to complexity and delays to refund.

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Brazil Focus - The Ugly (cont’d)

● Audit activity

– Extremely aggressive

– Default penalty of 75% but increased to 150% in the event o tax fraud

– No settlement mechanism, but quite often Amnesty programs are enacted

– FIN 48 implications on measurement of UTP

– Usually Brazil makes the headlines of the Contingency Section of SEC filings by U.S. multinationals i.e., 10-Q and 10-K forms.

– Business Purpose and Substance

• No case law or some sort of bright line test on business purpose and substance by CARF and/or Courts

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Brazil Focus - The Ugly (cont’d)

● IOF Taxation

– Used to have a relatively low rate (0.38%, depending on transaction) across the board.

– Recently increased to 6% on fixed income investments into Brazil with a maturity of less than 2 years.

♦ Intended to control appreciation of the Brazilian real.

♦ Happened “over night” – no prior notice to the market. Uncertainty.

♦ Will it be decreased if and when BRL depreciates?

– Problems for financial institutions and funds having to cover positions in Brazil.

– Deemed cash flows might be subject to taxation.

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Brazil Focus – Transfer Pricing

● Transfer pricing – Current discussions and difficulties

– Use of OECD methods – Comparable Uncontrolled Prices (PIC), Average Sale Price Method (PVEx)

– Deviation from original OECD methods – fixed margins

♦ Resale Price Method (PRL) – 20%, 60%

♦ Cost Plus Method (CPL) – 20%

♦ Price of Retail Sale on the Destination Country Minus Profit Method (PVV) – 30%

♦ Price of Wholesale Sale on the Destination Country Minus Profit Method (PVA) – 15%

♦ Acquisition and/or Production Cost Plus Taxes and Profit Method (CAP) – 15%

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Brazil Focus – Transfer Pricing (cont’d)

● PIC – information

● Stock/Commodities Exchanges

● Secret comparables

- Siscomex (goods)

- Siscoserv (services?)

● CPL – cost evidence

● PRL – CIF/FOB costs

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● Litigation profile

● PIC – similarity

● Use of CIF as opposed to FOB method

● PRL – 60% margins

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- Potential New Legislation

- PRL FOB cost

- PRL 20% - others by sector

- Minimum sample of 5% (PIC)

- Use of previous years (PIC)

- Commodities

- Rejecting

- Drawback

- Safe harbor – imports

- CPL – acquisitions

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●Profile

– No legal personality

– No taxation on revenues and capital gains arising from its own transactions

– Brazilian income tax arises at the level of the non-Brazilian investor and the respective treatment depends on the event that results the income and/or gain assessment: payment of income, redemption, amortization, sale and transfer of the quotas

●Inflows

– Inflow of funds in Brazil (acquisition of FIP shares, 2689 Investment) is subject to IOF/FX at (i) 2% if shares are acquired in stock exchange (unusual) or (ii) 6% in other cases.

Brazil Focus – Investment Funds - FIPs

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●Outflows

– WHT: 15% on income and gains

– WHT zero on income and gains if

♦ Investor does not hold more than 40% of the sum of the shares issued or is entitled to receive more than 40% of the total income earned by the FIP

♦ FIP does not have in its portfolio debt securities in more than 5% of its net equity (unless such securities correspond to convertible debentures or subscription bonus)

♦ Portfolio: at least 67% of shares of issuance of Brazilian corporations, debentures that are convertible into shares and subscription bonus

♦ Investor is not located in a jurisdiction deemed as a low tax jurisdiction.

●IOF/FX: zero

Brazil Focus – Investment Funds – FIPs (cont’d)

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Investment Funds on Rights related to Credits – FIDCs

● Profile

– FIDCs’ investment portfolios may be constituted of credit rights and related securities, originated from financial, commercial, industrial, real estate and services transactions. Being also authorized the investment in certain financial assets expressly established in the applicable regulation.

– The FIDC does not have legal personality and, as a rule, is not subject to taxation on revenues and on capital gains arising from its own transactions

♦ Income derived from transactions carried out by the FIDC would not be subjected to corporate taxation

● Inflows

– Inflow of funds in Brazil (acquisition of FIP shares, 2689 Investment) is subject to IOF/FX at 6%


Investment Funds on Rights related to Credits - FIDCs

● Outflows

• WHT: 15%

• Discussion concerning the WHT exemption on the gains assessed by a 2,689 investor not located in a jurisdiction deemed as a low tax jurisdiction in the sale of FII quotas within stock exchange markets

• IOF/FX: zero

• IOF/BONDS: 1% per day on the value liquidated, redeemed or disposed, limited to a percentage of the income assessed on the transaction, which vary according to the investment's term, as provided for in a regressive table. This limit equals 0% for terms equal to or above 30 days


●Profile

– FII may invest in the development of real estate ventures, real estate construction, acquisition of completed real estate properties, as well as projects that facilitate access to housing and services, including in rural areas, for purposes of future disposal, renting or leasing;

– The FII must distribute to its quotaholders at least 95% of its profits every six months

– Profits must be calculated based on a cash regime;

– FII is generally not taxed;

●Inflows

– Inflow of funds in Brazil (acquisition of FII shares, 2689 Investment) is subject to IOF/FX at (i) 2% if shares are acquired in stock exchange (unusual) or (ii) 6% in other cases.

Brazil Focus – Real Estate Funds – FIIs

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●Outflows

●WHT: 15% on income and gains

– Discussion concerning the WHT exemption on the gains assessed by a 2,689 investor not located in a jurisdiction deemed as a low tax jurisdiction in the sale of FII quotas within stock exchange markets

●IOF/FX: zero

Brazil Focus – Real Estate Funds – FIIs (cont’d)

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Brazilian Investment Funds – 2,689 Investments

FIP FDIC FII

WHT

-15% on income and gains

- 0% if the requirements are observed



IOF/FX

-Inflow: 2%

- Outflow: zero

-Inflow: 2% / 6%

- Outflow: zero

-Inflow: 6%

- Outflow: zero


U.S. Tax Focus

1. General Topics

– No local tax consolidation, loss management

– Creditability of Brazilian “corporate income taxes”

– Funding Mechanisms for Brazilian Subsidiaries

– Cost sharing between the U.S. and Brasil

● Recent Developments

– International tax reform (territorial vs credit system)?

– Active finance exception; section 954(c)(6), expiration.

– FATCA

– “Super” Limitation on Benefits provision?

– U.S.-Brazil tax treaty?

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Main Taxes in Brazil

Tax Rate Calculation basis

IRPJ 25% Corporate Income Tax on the adjusted net profit

CSLL 9% or 15% Social Contribution on Net Profit on the adjusted net profit

PIS 0.65% or 1.65%Turnover tax - 0.65% for IF (on financial spread) / 1.65% for non IF (revenues less credits)

COFINS 4% or 7.6%Turnover tax - 4% for IF (on financial spread) / 7.6% for non IF (revenues less credits)

ISS 5% Service Tax (Municipal) - levied on service income (not creditable)

IOFvaries according to transaction

typeTax on Financial Transactions - levied on fx contracts, fixed income investments and some variable income investmens

WHT 10% to 25% Withholding tax on investments, interest, royalties, services, etc

CIDE 10% Tax on imported services

PIS/COFINS Import 1.65% and 7.6% Social Integration / Social Contribution on imported services

ISS Import 5% Service Tax (Municipal) on imported services

INSS 27.5% approx. Social Security Contribution ovn salary (employer)


Creditability of Brazilian Taxes

– Subject to certain limitations US corporations can claim credits for direct income taxes paid in a foreign country. It can also claim a tax credit for income taxes paid by subsidiaries upon certain (actual or deemed) distributions.

– To be creditable, the tax must constitute an “income tax” in a U.S. sense.

♦ The tax needs to satisfy a realization requirement (i.e., only apply to income realized by a taxpayer) and must be imposed on net income (i.e., taking into account the deductibility of costs).

– A corporation in Brazil pays corporate income tax + social security charge + PIS/COFINS.

– PIS and COFINS are imposed on gross revenues, not net revenues.

♦ In some cases, a deduction/credit can be claimed (cumulative or non-cumulative regime; services or goods sold).

♦ In that case would PIS/COFINS be creditable?

34


Funding Brazil Investments - Equity

● No Withholding Tax

● No Corporate Income Tax Deduction

US

BRZ

DividendsEquity

35


Funding Brazil Investments - Interest on Equity

● Benefit of “Interest” Deduction (40%)

● Cost of Withholding Tax (15%)

● U.S. tax cost/benefit

US

BRZ

IOE

36


Funding Brazil Investments - IOE -- Low Tax E&P Pool

Assumptions

● E&P Pool = 1,000

● Tax Pool = 100

● IOE = 100

● Adequate US FTC capacity

US

BRZ

IOE

37


Funding Brazil Investments - IOE - Low Tax E&P Pool (cont’d)

US Tax Analysis

● 100 Dividend Income

10 Section 78 Gross-up

110

35%

38.5 US Tax before FTC

(10.0) Section 902 FTC [(100/1,000) x 100]

(15.0) Section 901 FTC [100 x 15%]

13.5 US Tax after FTC

====

US

BRZ

IOE

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Funding Brazil Investments - IOE - High Tax E&P Pool

Assumptions

● E&P Pool = 1,000

● Tax Pool = 500

● IOE = 100

● Adequate US FTC capacity

US

BRZ

IOE

39


Funding Brazil Investments - IOE - High Tax E&P Pool (cont’d)

US Tax Analysis

● 100 Dividend Income

50 Section 78 Gross-up

150

35%

52.5 US Tax before FTC

(50.0) Section 902 FTC [(500/1,000) x 100]

(15.0) Section 901 FTC [100 x 15%]

(12.5) Excess US FTC

====

US

BRZ

IOE

40


Funding Brazil Investment with Debt

● Withholding Tax on Interest

● Corporate Income Tax Deduction (Subject to Thin Cap Rules)

US

BRZ

InterestLoans

41


Funding Investments in Brazil with Debt – “Simple Example”

Assumptions

● Principal = 1,000

● Interest = 10%

● Expense Allocation = 2%

● BRZ : USD = 1 : 1

US

BRZ

InterestLoans

42


Funding Brazil Investments with Debt – “Simple Example”

US Tax Analysis

● 100 Foreign Source Income

(20) Allocable Expenses

80

35% US Tax Rate

28 US FTC Limitation

(15) Brazilian Withholding

13 Excess US FTC Limitation====

US

BRZ

InterestLoans

43


Funding with Debt

Other Considerations

● Thin Cap

● Hedging

● Transfer Pricing

US

BRZ

InterestLoans

44


Other Sensitive U.S. Issues

● Global invoicing and cost sharing between U.S. parent and Brazil subsidiary.

● Form over substance.


U.S. Recent Developments

● International Tax Reform?

– Currently, U.S. imposes corporate income tax on earnings of U.S. corporations from offshore operations. Subject to various limitations, a credit is provided for foreign taxes imposed on such earnings. This system is generally called a “credit” system.

♦ It’s very complicated. In general, incentivizes U.S. corporations to keep active earnings offshore in low tax subsidiaries.

– Several other OECD countries operate on a “territorial system.”

♦ Offshore earnings are not taxable in the home countries.

– General perception that U.S. tax system puts U.S. companies in a competitive disadvantage. Demand for migration to territorial system. Movement gaining force.

– Recent Obama proposals indicate that the administration is not aligned with the idea.

– Stay tuned.

● Active finance exception/section 954(c)(6), renewal.

46



● FATCA

– New legislation requiring non U.S. financial institutions (FFIs) to identify U.S. clients and report information regarding the same to the IRS. Additional withholding tax imposed on non-participating FFIs.

– Original effective date: 1/1/2013 but postponed to 1/1/2014 in most areas.

– Several aspects involve extra-territorial application of U.S. law.

– Resistance from several representative groups (U.S. citizens residing abroad, foreign banks and insurance companies).

– Guidance already issued by the IRS in 3 notices. Still lots of questions as to how the rules will be implemented. Proposed Regulations detailing the application of FATCA expected until the end of the year.

– Most non-U.S. financial institutions, funds and insurance companies already implementing FATCA compliance programs.

47



● “Super” Limitation on Benefits provision

– Under almost all U.S. tax treaties, taxpayers from a non-treaty country (e.g., Brazil) generally find it very hard to benefit from a tax treaty between the U.S. and a third-country (e.g., UK, France, Germany) (i.e., do “treaty shopping”).

– Usually significant and relevant presence in third country is required.

– Some Brazilian multinationals have use U.S. tax treaties of third countries where they have significant operations.

♦ Example: Brazilian company with significant activities in the Netherlands forms a U.S. company as a subsidiary of a Dutch operating company.

– Proposed legislation would effectively preclude a company in a non-tax treaty country (such as Brazil) from claiming benefits of a U.S. treaty even it is has significant presence in the treat jurisdiction.

48



● U.S. Brazil tax treaty?

– Currently there is no tax treaty between the U.S. and Brazil.

– Very expensive for a Brazilian company to invest in the U.S. because of the absence of a U.S. Brazil treaty.

♦ 30% withholding rate on all sorts of U.S. source income.

♦ Brazilian companies are in a significant disadvantage in relation to other countries in accessing U.S. markets.

– Is the treaty likely to happen any time soon? NO, unfortunately.

– No progress regarding treaty. Negotiations are stalled. Same old issues:

♦ transfer pricing

♦ withholding rates

♦ services

♦ competent authority

♦ tax sparing, and the list goes on

● Exchange of Information Treaty

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General Topics

● No Tax Consolidation

– In the U.S. a group of controlled entities may elect to file tax returns on a consolidated basis. General results:

♦ Net losses from one group member may be used to offset net income;

♦ Taxation of intercompany transactions deferred.

– In Brazil, companies cannot consolidate.

♦ So even if group has net losses, may need to pay some tax if one of the members are profitable.

– Approaches to address the issue?

50


IRS Circular 230 disclosure

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To ensure compliance with requirements imposed by the Internal Revenue Service ("IRS"), we inform you that any U.S. federal tax advice contained in this presentation is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting marketing or recommending to another party any transaction or matter addressed herein.

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key tax structuring considerations to invest in and from brazil

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