Red Flags on Cross-Border Cost Sharing Agreements in Brazil22/07/2019
Por: Gabriel Paranaguá
– Carefully look at your cost sharing structure when entering into the Brazilian market, a friend would say.
Those who have businesses in Brazil know that, when it comes to the interpretations and positions adopted by Brazilian tax authorities, the tropicalization of concepts reaches peculiar conclusions, which may differ significantly from what is seen worldwide. And unfortunately, the same outcome occurs when analyzing cross-border cost sharing agreements in our Country.
While the centralization of several costs and expenses in a given jurisdiction is frequently observed in multinational groups, where a holding company or an specific entity is placed to carry out back-office activities that benefit other companies of the group (e.g.: administrative, technical, financial, marketing, legal and commercial management), from a Brazilian taxes´ standpoint a closer look should be taken at the criteria for sharing the common costs and expenses.
That is because traditionally federal tax authorities have been regarding the amounts remitted abroad under cost sharing agreements by Brazilian subsidiaries or affiliated companies as compensation for the provision of technical services. It comes with no surprise that the interpretation given by the Brazilian Federal Revenue Service (“BFRS”) triggers the highest possible taxation.
Generally speaking, the following taxes are levied on the payment of technical services to a non-resident provider:
- Withholding Income Tax (“WHT”): 15% / 25%, being the highest rate applicable on remittances to beneficiaries located in the so-called tax havens (named “favorable taxation countries/jurisdictions” by Brazilian tax law). Double Taxation Avoidance Treaties, if and when applicable, may reduce/eliminate the WHT taxation;
- CIDE Contribution: 10%;
- PIS/COFINS-Imports Contributions: combined rate of 9,25%; and
- Municipal Tax on Services (ISS): generally, 5%.
Also, the currency exchange agreement required for the remittance of funds abroad is subject to IOF (Tax on Financial Operations) at a 0.38% general rate.
The classification of payments remitted under cost sharing agreements as compensation for technical services not only triggers a high tax burden on the remittance per se, but also implies in other potential consequences for the Brazilian subsidiary/affiliated company. Indeed, bearing in mind that most of the cost sharing agreements are executed between parties that are deemed as related ones according to the applicable Brazilian law, limitations on the shared costs/expenses deductibility, as provided by the Brazilian transfer pricing (“TP”) rules, are considered mandatory within the BFRS´ rationale – position with which I highly disagree, as TP controls are not consistent with the nature and purpose of cost sharing agreements.
TP controls were established in Brazil in 1996 in order to inhibit the practice of business between related parties under conditions other than the market (“arm’s length” principle), as well as transactions with third parties resident in tax havens. Thus, methods were created to regulate the deduction of costs and expenses on import operations, as well as define the minimum taxable revenue on exports. Later in 2008, the TP rules were extended to transactions performed with parties under privileged taxation regimes.
Currently, Brazilian legislation provides the following methods for defining the parameter price in services import transactions, such being understood as the maximum amount of cost/expense that may be deducted by the paying source:
- Independent Comparable Prices Method (“PIC”);
- Resale Price Less Profit Method (“PRL”); and
- Production Cost Plus Profit Method (“CPL”).
Please note that although the TP legislation provides the three above-mentioned methods (excluding the one applicable to transactions with commodities) and taxpayers are entitled to choose whichever better suits their transactions, PRL is the one generally adopted in import transactions, mainly because it depends only on documents that the importer has in its own controls. Also, it is the more common method when it comes to services that are imported by the Brazilian contracting party and resold locally. Concerning the other possible TP methods, one may note that PIC requires the identification of comparable transactions, while CPL would need the depiction of service provider´s costs. 
It should be highlighted that Brazilian TP rules, despite being inspired by the OECD guidelines, differ relevantly from those observed in the rest of the world. Thus, multinational groups usually struggle to equalize the prices charged and the (diverging) applicable TP controls.
The BFRS has recently started some discussions along with OECD´s representatives aiming at adjusting the local TP controls. Rumors are that this new approach by local tax authorities is grounded on the intention of Brazil joining the OECD as a member country.
Finally, one should point out that standard cost sharing agreements usually do not fall under the current criteria defined by the BFRS for classifying them as a typical cost sharing agreement. According to recent rulings, the following conditions should be met in order to deem an agreement as a cost sharing one:
- the amounts to be reimbursed must not be added by a profit margin whatsoever;
- the activities executed under the agreement must not be within the scope of the corporate purpose of the party receiving the reimbursement;
- the amounts received by the party which concentrates the shared costs/expenses should not be accounted as income;
- files/records that evidence the costs/expenses incurred must be duly kept;
- the agreement must provide the criteria for the allocation of costs/expenses, and such criteria should be compatible with the type of cost/expense reimbursed;
- terms such as “services” and “price” should be avoided, as “activities” and “reimbursement” are more adequate within the true scope of such type of agreement; and
- instead of invoices, debt notes should be issued in order to charge the reimbursable costs/expenses.
Please note that the aspects above do not guarantee that the remittance of reimbursements should not be treated as a compensation for services, but they should lower the chances of tax authorities challenging them. Bearing in mind that each cost sharing agreement is unique, as que costs/expenses and their apportioning criteria may vary materially, the conservative approach would be to present formal enquiries to the BFRS prior to remitting shared costs/expenses abroad, but tax authorities may not agree with the classification of agreements as cost sharing ones and further judicial measures may be necessary to confirm their nature.
It is commonly understood that the payment of reimbursements due under cost sharing agreements should not be subject to the taxation referred to above (other than the 0.38% IOF), because such reimbursements are not designed to compensate the provision of a given service, but rather reinstate the assets that a party (i.e.: the company which concentrates the shared costs/expenses) disposed on behalf of other companies of the group. Also, in case of a typical cost sharing agreement, transfer pricing rules should not be applied and the amounts reimbursed to the company which concentrates the shared costs/expenses should be fully deductible by the Brazilian paying source. These conclusions, however, are not generally seen in practice, where due to the peculiar positions taken by the BFRS companies are required to bear a very high tax burden to be compliant with their intragroup cost sharing agreements.
The remarks above are summarized and aimed at pointing out, in a nutshell, the main tax aspects and implications that we deem important to highlight, based on the tax legislation, precedents and rulings to date, without going deep in each of their specifics.
Senior Associate of the Tax Team of Felsberg Advogados
 The following countries and jurisdictions are currently deemed as tax havens by Brazilian tax law: American Samoa; Andorra; Anguilla; Antigua and Barbuda; Aruba; Ascension Island; Bahamas; Bahrain; Barbados; Belize; Bermuda; British Virgin islands; Brunei; Campione D’Italia; Cayman Islands; Channel Islands (Alderney, Guernsey, Jersey and Sark); Cook Islands; Curacao; Cyprus; Djibouti; Dominica; Federation of St. Kitts and Nevis; French Polynesia; Gibraltar; Grenada; Hong Kong; Ireland; Kiribati; Labuan; Lebanon; Liberia; Liechtenstein; Macao; Maldives; Isle of Man; Marshall Islands; Mauritius; Monaco; Montserrat; Nauru; Niue; Norfolk Island; Panama; The Pitcairn Island; Qeshm Island; Saint Helena; Saint Martin; Seychelles; Solomon Islands; St. Pierre and Miquelon; St. Vincent and the Grenadines; St. Lucia; Sultanate of Oman; Swaziland; Tonga; Tristan da Cunha; Turks and Caicos; United Arab Emirates; US Virgin Islands; Vanuatu; and Western Samoa.
 According to article 23 of Law No. 9,430/96, it is deemed a related party to the Brazilian legal entity: (i) its head office, when located abroad; (ii) its subsidiary or branch located abroad; (iii) the individual or legal entity resident or domiciled abroad, whose shareholding characterizes them as its controller or associated, as defined in §§1st and 2nd, of art. 243 of Law No. 6,404/76; (iv) the legal entity located abroad characterized as controller or associated company, as defined in §§1st and 2nd, of art. 243 of Law No. 6,404/1976; (v) the legal entity located abroad, when such entity and the Brazilian one are under common corporate or administrative control or when at least ten percent of the share capital of each one belongs to the same person or entity; (vi) the individual or legal entity resident or domiciled abroad, that, together with the legal entity domiciled in Brazil, owns equity of a third entity, which sum characterizes them as controllers or associated companies of the last one, as defined in §§1st and 2nd, of art. 243 of Law No. 6,404/1976; (vii) the individual or legal entity resident or domiciled abroad, which is its partner, in the form of a consortium or a condominium, as defined in Brazilian law, in any venture; (viii) the individual resident abroad who is a relative or in-law up to the third degree, spouse or partner of any of its directors or its direct or indirect controlling share/quota holder; (ix) the individual or legal entity, resident or domiciled abroad, which enjoys exclusivity, as its agent, distributor or grantee, for the purchase and sale of goods, services or rights; and (x) the individual or legal entity, resident or domiciled abroad, for which the legal entity domiciled in Brazil enjoys exclusivity, as agent, distributor or grantee, for the purchase and sale of goods, services or rights. In addition to such hypothesis, there are two other cases in which the relation between the parties is presumed: (a) when in a commercial transaction, due to the circumstances, it is not possible to identify the corporate capital composition, its attorney-in-fact or directors, as well as when it is not possible to verify the effective existence of the seller; and (b) when the transaction is performed in Brazil through an intermediary not characterized as related party, who operates with another legal entity located abroad, characterized as related to the Brazilian entity.
 In accordance with Law No. 9,430/96, jurisdictions that impose no income tax or which income tax maximum rate is lower than twenty percent (20%) are deemed favorable taxation countries (i.e.: tax havens). As of 2009, countries or jurisdictions that do not disclose information regarding the corporate structure of legal entities, their ownership, or the identification of the beneficial owner of income attributable to non-resident, were also included in this concept.
 As provided by Law No. 9,430/96, Privileged Taxation Regimes are considered those regimes which: (i) do not tax the income, or tax it at a maximum rate lower than 20%; (ii) provide tax advantages to non-residents: (a) without requiring the performance of local substantive economic activity, or (b) conditioned to the absence of local substantive economic activity, (iii) do not tax or tax at a maximum rate of 20% income generated outside its territory, or (iv) do not disclose information regarding the corporate structure of legal entities, the owners of assets or rights, or the economic transactions carried out. It is worth stressing that those are alternative criteria, this way, if one of the above-mentioned characteristics is suitable to a certain regime, it is considered a Privileged Taxation Regime.
 Other TP methods, such as those applicable to the import of goods and commodities were intentionally not addressed herein.