1. In your jurisdiction, can the acquisition of a domestic target limit the target’s use of existing tax attributes, such as net operating loss carry forwards or tax credits? Are there strategies or structures to preserve such attributes?
Generally, the acquisition of a domestic target itself is not an event that limits the use of existing tax attributes.
However, existing net operating losses (NOL) can be lost to the extent that the domestic target undergoes a change of control or a change of business activity. Therefore, it is essential to carefully verify if between the period in which the company recognised the NOL and their use, there will be both a change of control and a change in business activity. Additionally, some merger transactions or pre-deal reorganisations could result in NOL losses, significantly affecting some discussions on the most effective structure.
In general, other tax attributes, such as tax credits, tax incentives, realisation of built-in gains or deferred losses are not impacted by the change of ownership in a domestic target, even though some prior approvals or notifications may be required in the case of certain tax incentives.
2. When companies that are resident in your jurisdiction are sold to foreign investors, is it more common to sell stock or assets?
A stock deal is the most common way for non-Brazilian investors to acquire a business in Brazil, mainly because it mitigates constrains of a transitional operating period, does not bring tax succession advantages and creates potential goodwill amortisation rights.
In Brazil, migrating an active business and obtaining operation approvals and licences can be a burdensome process, so an asset deal tends to be more critical, especially if the buyer does not have an operating domestic entity in place at the time of the deal.
Regarding succession matters, if a foreign or a local company acquires a business in the form of shares or assets, the tax liabilities are generally transferred to the acquirer, primary or jointly, irrespective of the type of transaction. Given that from a tax succession point of view, a buyer may end up liable for the past tax liabilities of a going concern irrespective of whether acquired through a share or asset deal and indemnities have to be carefully addressed in the transaction documents. Consequently, on this basis, tax succession does not usually drive the choice of a structure.
Finally, the ability to amortise goodwill in a stock deal is a very important driver for many transactions and this is a reason for them to be structured in the form of a share deal. In Brazil, goodwill generated in a stock deal can be amortised for tax purposes if certain requirements are satisfied. The availability of this tax treatment is not as clear in case of an asset deal. For this reason, because of the benefit of the goodwill amortisation and the value of goodwill involved is normally important, acquisitions tend to be implemented in the form of stock deals.
In addition to the foregoing, pre-restructurings (ie, drop-downs or splits) are also fairly common. In this case, the target becomes a new entity.
3. Are there particular structures that generate a step-up in the tax basis of assets in a tax-efficient manner?
There are no straightforward alternatives to achieve a step-up in the tax basis of assets other than an asset deal.
However, a share deal could achieve such step-up if the acquiring company is merged downstream into the target, or vice-versa. A step-up requires compliance with certain requirements set by tax law, such as the draft of a purchase price allocation report and filing of the report with Brazilian tax authorities within 13 months of the acquisition date.
Transactions carried out between qualifying related parties are not eligible for a step-up in tax basis of assets or goodwill tax amortisation.
In addition to setting up the basis of the assets, any goodwill resulting from the share acquisition can be amortised for tax purposes over a minimum period of five years upon a merger between the acquiring company and target.
The step-up of assets value and the amortisation of goodwill are highly controversial issues in Brazil, since Brazilian tax authorities have taken a very aggressive position of denying such tax efficiency resulting from share deals based on different arguments. In the context of non-Brazilian residents acquiring Brazilian shares, the use of a transitory acquisition vehicle has been noted as a point of contention because Brazilian tax authorities are of the view that the existence of a transitory vehicle lacks business purpose for the recognition of the fair value of the assets and the goodwill for further depreciation and amortisation.
4. Are there structuring opportunities that would enable a foreign acquirer to provide equity consideration to the shareholders of a domestic target in a tax-deferred manner? Are the rules similar if both the acquirer and the target are domestic?
Currently, it is very common to have equity consideration deals with domestic entities. Normally, structures involve swaps, mergers, mergers of shares or similar transactions.
Some of the equity consideration structures face certain challenges or restrictions for cross border deals and normally it is challenging to implement the deal with a tax-deferral effect in Brazil and abroad. Additionally, there are not that many transactions in place with equity consideration paid by a foreign acquirer, even though we have seen an increase of potential deals using this approach.
Pursuant to current Brazilian tax rules, a swap of shares allows any built-in gain on the shares (ie, fair value of the assets) to be deferred until the disposition of the received asset. In case there is any cash portion it is taxable for the seller. If the shares received as consideration are booked as short-term assets or liquid assets, no tax deferral of the gain is available.
5. Can management generally roll over its equity in an acquisition in a tax-deferred manner? Are there certain circumstances where a tax-deferred rollover is difficult or impossible?
Depending on how the transaction is structured, management can roll over its equity in an acquisition in a tax-deferred manner. When a deal contemplates the liquidation of an equity position held by management tax deferral is more difficult to be achieved. Additionally, there is a controversial discussion on stock option or stock plans for management and/or employees, which tend to raise sensitive exposures, costs in liquidity or rollover circumstances.
6. Which holding company structures are typically used by foreign investors to acquire domestic targets in your jurisdiction?
Foreign investors acquiring domestic targets generally make use of holding companies located in the following jurisdictions:
- the Netherlands;
- Spain; and
- the United States (specifically limited liability companies and limited partnerships). In this case, the holdings are more used by private equity and portfolio or inancial investors.
Currently, the use of holding companies to hold equity investments in Brazil is more of a tax strategy of the non-resident acquirer than a Brazilian tax play as discussed below. Generally, from a Brazilian perspective, the tax treatment is more favourable if the holding company is not in a jurisdiction deemed low tax and/or with a privileged tax regime jurisdiction.
7. What types of tax benefits typically arise in connection with transactions in your jurisdiction? Do the parties typically address allocation of such benefits in the transaction documents?
As mentioned above, transactions may generate tax savings from goodwill amortization if certain conditions are satisfied. This is the most relevant benefit arising from transactions in Brazil. It is not very common to address allocation of such benefits in the transaction documents, unless shareholders want to allocate such tax benefits only to certain types of shares to the detriment of others. Whenever this happens, any tax liability associated with the tax benefit is also agreed to be borne only by the shareholders that claimed the tax benefit.
8. Do real estate transactions (or transactions involving real estate holding companies) create special tax issues in your jurisdiction?
In general, transactions involving real estate holding companies do not trigger any special tax issue, such as FIRPTA in the US or similar rules. Brazilian capital gain tax applies to any capital gains realised on the sale of shares of a real estate holding company, even if carried out between non-Brazilian residents.
Real estate transactions do trigger real estate transfer tax in addition to capital gains taxation. The transfer tax is a municipal tax and its rate is generally between 2 and 3 per cent.
9. Are there other categories of transactions (involving other types of assets or specific types of entities) that raise distinctive tax issues (for example, in the United States, transactions involving real estate investment companies and regulated investment companies)?
Foreign investors generally take three structures to invest in non-publicly traded targets in Brazil: (i) direct acquisition from abroad; (ii) acquisition through a Brazilian holding company or (iii) acquisition through a Brazilian private equity fund (FIP). The decision to follow one path or the other varies a lot and depends on several characteristics of the transaction, such as corporate flexibility and governance, level of complexity, type of return, funding through debt, tax consequences, regulatory restrictions and requirements, maintenance costs, among others.
Please note that, the FIP structure because it has distinctive tax issues and can grant a non-taxable chain for flow of dividends and capital gains if certain requirements are satisfied.
From corporate perspective, a FIP is not incorporated as a company but as a closed-ended jointly owned pool of assets and it does not have legal personality. A FIP is generally not subject to taxation on revenues and capital gains arising from its portfolio of investee corporations. On the other hand, taxation applies at the level of its shareholders generally at 15 per cent. However, a special tax treatment has reduced such rate to zero per cent, provided that certain requirements are met. Among others, foreign investor INR cannot hold, directly or indirectly, individually or with related parties, 40 per cent or more of the FIP or have the right to receive an amount greater than 40 per cent of the total income earned by the FIP.
10. Does your jurisdiction impose any distinctive taxes (eg, non-income taxes) that need to be specifically addressed when structuring and documenting cross-border deals?
When structuring a cross border deal, tax on currency exchange transactions (IOF tax) should be specifically addressed to the extent that the inflow and outflow of funds into and out of Brazil are generally subject to IOF at the rate of 0.38 per cent on the cash proceeds converted into Brazilian currency or vice versa. Certain transaction carried out through special investment vehicles, such as FIP) and the stock exchange market are exempt from IOF tax on the transfer of cash proceeds in an out of Brazil.
Short-term financing (shorter than six months) are also subject to IOF tax at a rate of 6 per cent on the amount of cash proceeds.
IOF rates may be changed by the government up to 25 per cent. However, historically the rates have never been this high.
11. Do withholding taxes apply to transactions either from or into your jurisdiction?
Withholding taxation applies to most of type of payments from Brazil or in connection with Brazilian assets. Additionally, a transaction carried out within Brazil to by residents of a jurisdiction deemed low tax jurisdiction and/or with privilege tax regime are generally subject to a higher withholding tax rate.
Transactions into Brazil are generally not subject to Brazilian withholding tax. However, depending on the nature of the transaction, payments into Brazil may trigger indirect taxes, such as service tax (ISS) and turnover taxes (Pis/Cofins), if such transactions do not qualify as exports of goods or services.
In addition to withholding tax, outbound payments trigger an array of different taxes, which vary depending on the nature of the payment (eg, services, royalties, etc).
12. If withholding taxes apply to a transaction, what are the rates? Can they be reduced by treaty or are there structuring techniques or certification processes to avoid or mitigate the tax cost?
Any capital gains realised by a non-Brazilian resident on the sale of Brazilian shares is subject to withholding tax (WHT). WHT applies irrespective of whether or not the acquirer is domestic or foreign.
Capital gains tax is generally subject to brackets from 15 per cent to 22.5 per cent in accordance with the amount of the gains, as follows:
WHT applicable rate
up to BRL 5 million
from BRL 5 million and1 to BRL 10 million
from BRL 10million and 1 to BRL 30 million
greater than BRL 30 million
The above taxation is also applicable to capital gain realised by Brazilian resident individuals, while capital gains realised by Brazilian companies are treated as ordinary income and subject to regular corporate tax.
Except in relation to the tax treaty signed with Japan, capital gains realised by residents of a tax treaty partner jurisdiction are taxable in Brazil and do not have rates lower than the domestic one. Tax structures involving Japan for the mitigation of the Brazilian capital gains tax are not common.
A controversial subject for non-Brazilian residents disposing of Brazilian shares relates to the tax basis for the calculation of the capital gain tax. The question is if the cost basis should be determined based on historical investment made in non-Brazilian converted into Brazilian currency (BRL) on the date of the investment itself or, alternatively, if the cost basis should always be determined in reference to the amount of investments carried out in non-Brazilian currency converted into BRL on the date of the share disposition.
13. Are VAT or transfer taxes significant? If so, in which types of transactions?
Brazil is a well-known jurisdiction for relying on a number several value-added taxes (state level VAT, known as ICMS, Federal level excise tax, known as IPI) and other indirect taxes, such as services tax (ISS), turnover taxes (Pis and Cofins) and Pis/Cofins on the import of goods and services (Pis/Cofins Import). In general, value-added taxes and other indirect taxes, such as Pis/Cofins and ISS, are applicable to the import of goods, resale of imported products, manufacturing of local goods, sale of goods and certain type of services (eg, telecom services, transportation services and services in general). Owing to the burden imposed by such taxes, they normally attract more attention than corporate tax.
14. Are there strategies to mitigate VAT or transfer taxes? What party typically bears the costs of VAT and transfer taxes?
As share deals are more common in Brazil and those structures do not impose VAT or transfer taxes, they normally are not an issue on transactions.
Whenever there is an asset deal, strategies to mitigate VAT or transfer taxes are considered on a case-by-case basis, given the complexities of the Brazilian indirect tax system.
In transactions designed as an asset deal, VAT is generally mitigated by transferring business) rather than its asset specifically. Real estate transfer taxes can also be deferred if the transaction is implemented as a share deal, instead of an asset deal.
When VAT or transfer taxes are triggered in a transaction, the cost of such taxes are generally born by the acquirer. In certain circumstances, these taxes may be recovered by the acquirer.
15. What is the statute of limitations for tax claims in your jurisdiction?
The statute of limitation for tax claims is generally five years. There are discussions concerning the point in which the statute of limitation begins to elapse, depending on the nature of the tax. In certain circumstances, as wilful misconduct, fraud or simulation perceived as tax evasion, the statute of limitations is increased to six years.
16. In your jurisdiction, can a target be liable for taxes of other members of the consolidated group of which it was a member prior to an acquisition? Is the tax authority likely to assert such a liability against a target?
There are no tax consolidated groups in Brazil. However, in certain exceptional events, such as fraud, tax liabilities may be attributable to the management of a company or shareholders.
17. Is there a typical approach to pre-closing tax indemnification in your jurisdiction?
There is no typical approach to pre-closing tax indemnification. A fair number of structures contemplated escrow account and purchase price hold-back mechanisms, with release based upon the statute of limitations. In other cases, indemnity clauses are inserted into the buy–sell agreement stipulating that the seller does not hold the buyer liable for any pre-acquisition tax liabilities or also specific pre-acquisition tax liabilities.
18. Are indemnification payments under a purchase agreement taxable to the recipient? Is an indemnity obligation in your jurisdiction typically grossed up for taxes?
In general, indemnification payments are taxable to the recipient, but actual tax implications vary depending on the nature of the recipient.
In a buy–sell agreement, an indemnity clause is typically grossed up for taxes if the beneficiary of the payment is a Brazilian company, even though any tax deduction related to corresponding loss normally reduces the indemnification payments.
19. Under what circumstances would an investor in a target in your jurisdiction have a tax filing obligation in your jurisdiction solely as a result of its equity interest in the target company?
There is no obligation for filing tax returns or similar obligations imposed on foreign investors.
However, Brazilian tax authorities requires beneficial ownership disclosure as a result of the acquisition of equity interest. The same obligation also applies to certain types of assets, such as real estate. The information is mainly required when a foreign investor is assigned a taxpayer number to engage in transactions locally, or after whenever the ownership is modified. A detailed analysis should be conducted regarding the disclosure of different levels of the corporate chain and the ultimate beneficial owner, which is also a type of information that should be provided the context of a tax audit.
20. In your jurisdiction, are there techniques to efficiently push debt down into subsidiaries in jurisdictions with high tax rates?
Debt pushdown is a base erosion technique deployed by several companies when acquiring a local target. In general, debt pushdown takes place when the acquisition is structured through a local acquiring entity funded with a combination of equity and debt. By merging the acquiring vehicle into the target (or vice-versa), the relevant debt is then pushed down to the operating entity (ie, target).
In other instances, it is possible to put debt directly at the level of the target through a refinancing of its capital structure.
These types of debt pushdown alternatives may result in risks of tax deduction being challenged. For this reason, they require careful consideration.
Thin-cap and transfer pricing rules should also be followed in both cases. In recent years, Brazilian tax authorities have taken a more aggressive stance on leveraged transactions by denying the need for interest expenses accrued at the target level.
21. Describe any limitations, such as earnings stripping or royalty stripping rules, that limit the ability to effectively shift taxable income when structuring M&A deals.
Brazilian tax rules have not yet addressed earnings or royalty stripping rules in the same manner as other jurisdictions. In the absence of such regulations, taxpayers should focus on complying with rules imposing limitations on outbound payments, especially to non-resident shareholders. As consequence, transfer pricing rules, thin cap and general limiting rules regulating the deduction of expenses are the ones applied on transactions seeking to erode the tax basis of Brazilian companies through outbound payments.
22. Is there transfer pricing legislation in your jurisdiction that could apply to transactions among a target and its subsidiaries or affiliates? If so, how restrictive is it?
Brazilian transfer pricing rules are applicable to cross-border transactions between related parties. Such rules may also apply to transactions between the target and its subsidiaries residing outside Brazil. Brazilian transfer pricing rules are unique to the extent that they diverge the OECD transfer pricing guidelines by establishing fixed profit mark-ups, irrespective of actual risks and the functions carried out between related parties. Because of such divergence, the risk of double taxation is extremely high because of the differences between Brazilian transfer pricing rules and the rules of other jurisdictions that rely on OECD transfer pricing guidelines.
The Brazilian transfer pricing rules also apply to payments made to a beneficiary located in a jurisdiction deemed as low tax jurisdiction and/or in privilege tax regime jurisdiction.
Domestic transactions between a target and its domestic subsidiaries and affiliates are subject to rules similar to transfer pricing, called disguised distribution of profits (DDL). Under DDL rules, a transaction that is not carried on an ‘arm’s-length’ basis between the above companies may be subject to tax adjustment so long as the particular transaction generates a benefit to the local shareholder, otherwise not available had not the parties engaged in the transaction.
23. Does your jurisdiction have anti-deferral regimes that apply to operations and income of subsidiaries (for example, a controlled foreign corporation regime, whereby a parent entity would be required to take into income undistributed income earned by a subsidiary)? Do these regimes affect cross-border planning?
The laws on Brazilian taxation of income generated by non-Brazilian subsidiaries or affiliated companies controlled by Brazilian companies are rather harsh. Formally, Brazil does not have CFC rules, although, in substance, the existing rules are very similar to the extent they avoid any deferral of CFC income realised outside of Brazil.
Irrespective of the actual distribution of any dividend or the nature of income generated by a non-Brazilian subsidiary (eg, passive income) or execution of any transaction deemed an income distribution to the Brazilian shareholder, the income of a qualifying CFC entity is subject to taxation in Brazil by year-end at the level of the Brazilian shareholder. Foreign tax credit is allowed but limited to the amount of Brazilian corporate income tax on CFC income.
Cross-border planning should consider the application of the Brazilian anti-deferral regime when structuring Brazilian investments outside of Brazil. The structuring of outbound investments relying on tax treaties remains one of the most important techniques to mitigate the application of such rules, even though their application is very controversial. Nevertheless, Brazilian tax authorities disagree that tax treaties signed by Brazil can avoid the anti-deferral tax regime.
24. Are there exit strategies, besides stock or asset sales, that are used in your jurisdiction to achieve tax benefits?
The acquisition of Brazilian companies through FIP is eligible to capital gains exemption on the distributions of cash proceeds by the FIP, as mentioned above.
Capital gains realised on qualifying transactions in the stock exchange market by non-Brazilian residents are also tax-exempt.
25. Discuss your tax treaty network and how that facilitates or impacts tax structuring for cross-border deals. Are any treaties being negotiated or renegotiated? Are any major changes in the structure of your treaties expected?
For almost 40 years, Brazil has completed tax treaties with 33 jurisdictions, mostly located in Europe and in the Americas. Brazil does not have a tax treaty with the United States though. Recent tax treaties were signed with Singapore and Switzerland but ratification by the Senate is still pending and as such these tax treaties are not yet in effect. Although Brazilian authorities do not disclose tax treaties under negotiation, it has been informally reported that Brazil is in tax treaty negotiations with the UK, Germany, Colombia and Australia.
Since Brazil has stated that it is unlikely to accede to the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (‘Multilateral Instrument’), it will probably start renegotiating its tax treaty network, seeking to adopt similar measures as those contemplated by the Multilateral Instrument. The tax treaty signed with Argentina has already been renegotiated relying on provisions similar to the ones of the Multilateral Instrument.
The Brazilian tax treaty network has been negotiated based on the OECD convention model, however, with several reservations. In addition to the reservations made by Brazil, the Brazilian tax authorities are well-known for having a particular way of interpreting tax treaty provisions that differ from the interpretation made by their peers in other jurisdictions. For this reason, taxpayers should take into account the particular view of Brazilian tax authorities when structuring a cross-border deal relying on the application of tax treaty provisions. Very few cross-border deals are executed in reliance on provisions of the Brazilian tax treaty network.
26. Does your jurisdiction identify certain jurisdictions as tax havens and subject them to adverse tax consequences when they are involved in M&A transactions? Give details.
There are two important concepts with respect to tax havens: low tax jurisdictions and jurisdictions with privileged tax regimes. Residents of those jurisdictions are subject to a more burdensome tax treatment. For instance, certain payments are subject to 25 per cent withholding tax as opposed to the statutory withholding tax rate of 15 per cent or the capital gain tax rate of 15 per cent to 22.5 per cent.
Brazilian tax authorities do provide a list of jurisdictions deemed low tax jurisdictions and jurisdictions with privileged tax regimes, and this list is considered exhaustive by them. In general terms, traditional tax havens are included in the list issued by the Brazilian tax authorities, with few exceptions.
27. Describe any material state, provincial or local taxes that may arise in an M&A deal involving a target, a buyer or a seller located in your jurisdiction.
In M&A transactions, many discussions exist on how likely it is for the target to have paid VAT by the target. This discussion surfaces because of the complexity of the Brazilian VAT system. In many different cases, VAT and other indirect tax liabilities are a deal breaker because the amounts under discussion may reach sums as high as the purchase price of a target.
One of the most important aspects of a transaction involving a Brazilian target is to manage and to understand the VAT and other indirect taxes liabilities of a target.
28. Are there any proposed laws or regulations that could significantly change how transactions are structured in your jurisdiction?
So far, we are not aware of any measure currently in discussion that may affect the M&A landscape in Brazil, even though there is an important bill of law to increase dividend taxation (currently at zero per cent), which could impact on, and modify, group structures. Additionally, as Brazil will have a newly elected president in 2019, new tax measures and reforms may arise.
29. What are the corporate tax rates applicable in your jurisdiction on ordinary income and capital gains? Are there any other categories of income subject to preferential rates that are relevant in M&A deals in your jurisdiction?
Ordinary income as well as capital gains realised by Brazilian companies are subject to 34 per cent corporate taxation (ie, 25 per cent of corporate income tax and 9 per cent of social contribution tax on profits). There are no other categories of income subject to preferential rates in Brazil. All types of income are generally taxed at 34 per cent corporate tax rate.
30. Are there significant tax issues relating to foreign currency matters in transactions in your jurisdiction involving buyers or sellers resident in other jurisdictions?
Under Brazilian law, domestic transactions must be carried out in Brazilian currency.
Only cross-border transactions may be carried out in foreign currency. Such transactions naturally create both foreign currency exposure and tax consequences because of taxable FX results. Brazilian companies may recognise FX results on a cash basis as the default tax regime. However, Brazilian companies may choose every year to recognise FX results on an accrual basis. This choice can be made every year by taxpayers subject to the recognition of FX results.
In M&A transactions with non-Brazilian resident buyers or sellers, payables or receivables denominated in non-Brazilian currency will cause the recognition of FX results. As consequence, Brazilian taxpayers have to choose whether to recognise FX results on a cash or accrual basis.
From a business point of view, exposure to FX results is always a concern for parties. Hedges may be required to prevent any fluctuations of the price of the transaction, but hedges tend to be very expensive and not financially feasible in practice.
31. Discuss and describe any other relevant tax issues in cross-border M&A transactions in your jurisdiction that are not covered in the prior questions.
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