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Tax deduction of royalties paid to indirect controlling entities

In Ruling 182 of the General Tax Coordination (“COSIT”), published on June 21, the Brazilian Federal Revenue (“RFB”) understood that royalties paid by a Brazilian legal entity to its indirect controlling entity abroad for the right to distribute/sell software are not subject to the Corporate Income Tax (“IRPJ”) non-deductibility rule applicable to royalties paid to shareholders.

Although all royalties paid to shareholders are considered non-deductible by the Brazilian tax rules, certain royalty payments made to indirect controlling entities abroad may be deductible for IRPJ purposes if certain conditions are met (registration of the agreement with the Central Bank of Brazil and the National Institute of Industrial Property – INPI and compliance with maximum deductibility limits imposed by the tax legislation).

Contrary to administrative case law on the subject, COSIT justified its position based on the following arguments:

(i) a shareholder is the one who contributes to the formation of the share capital, according to the Brazilian civil legislation;

(ii) indirect control means that the company abroad does hold direct equity stake in the invested company;

(iii) the rules on transfer pricing and on the disguised distribution of profits, which use the expression “related parties”, do not extend the concept of shareholder to group entities; and

(iv) as a rule, the Brazilian tax legislation expressly sets outs the expenses which may not be considered as tax deductible.

Finally, it should be noted that rulings issued by COSIT have a binding effect within the RFB, i.e., this position must be observed by all RFB units (including tax auditors) and applied to all taxpayers in the same situation.

For additional information on the matter, please contact Stephanie Makin and José Rubens Constant Pires.

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