Global Tax Alert (News from Americas Tax Center) | 1 October 2013
Brazilian Normative Instruction 1,397 may affect taxes due to IFRS conversion
The Brazilian Revenue Service issued Normative Instruction nr. 1,397 (NI 1,397), introducing relevant interpretations regarding the Transitory Tax Regime (TTR), which might have significant tax effects for Brazilian companies.
In force since 1 January 2008, Law nr. 11,638/2007 significantly changed the Brazilian Corporations Law, with the objective of aligning Brazilian accounting principles and standards to the International Financial Reporting Standards (IFRS).
Since its publication, Law nr. 11,638/2007 has generated debates on whether the new accounting principles would affect tax regulations. In this context, the Brazilian government enacted Law nr. 11,941/2009, introducing the TTR. According to the TTR, the new accounting principles should be neutral for purposes of calculating the income tax (IRPJ), the social contribution on net profits (CSLL) and the social contributions on gross revenues (PIS/COFINS). Such neutrality will last until a specific tax law regulating the effects of the IFRS is enacted.
Even though TTR was generally straightforward in relation to IRPJ, CSLL, PIS, and COFINS calculations, there was a grey area, which was generally related to indirect tax impacts of the adoption of the IFRS. Many doubts were related to which equity should be considered (pre or post IFRS) for equity pick-up purposes, or the calculation of thin capitalization and interest on net equity thresholds. Another relevant issue was how to determine the amount of exempt dividends that could be distributed by the companies. In all cases, the underlying question was whether Brazilian 2007 GAAP should be considered or if the new Brazilian GAAP post IFRS would apply.
Most companies understood that IFRS would apply in these situations. Therefore, for example, a company paying dividends would consider its IFRS profits and not its profits calculated in line with Brazil's 2007 GAAP. These topics are the subject of NI 1,397.
Normative Instruction 1,397
After almost six years of Brazil's IFRS conversion, on 17 September 2013, the Brazilian Revenue Service issued NI 1,397. The following summarizes its major impacts:
- • ECF (Escrituracao Contabil Fiscal – tax accounting records): Under the TTR, the Federal Tax Authority created a software tool (known as FCONT) that requires Brazilian companies to report adjustments from the new net income figures back to what they would have been under Brazil's 2007 GAAP. According to NI 1,397, from 2014 on, FCONT will be replaced by ECF, which is based on a new technological platform and will require more detailed adjustments from the IFRS based GAAP back to the 2007 Brazilian GAAP. It is expected that ECF will generate additional compliance costs for Brazilian companies.
- • Dividend distribution: Per NI 1,397, the existing tax exemption applies only to dividend distributions up to the net income calculated in accordance with the 2007 Brazilian GAAP. If the company pays dividends based on the IFRS, any excess should be taxed at the beneficiary level as follows:
- − Brazilian resident individuals: Income tax based on progressive rates, which vary from 7.5% to 27.5%.
- − Brazilian resident legal entities: Should be taxed at the corporate income tax and social contribution on net profit combined rate at 34%.
- − Nonresidents: Withholding tax (WHT) at a 15% rate.
- − Nonresidents located in low tax jurisdictions: WHT at a 25% rate.
- • Equity pick-up: The net equity pickup method shall consider the net equity of invested company under Brazil's 2007 GAAP. This interpretation might result in positive or negative impacts on capital gains or losses in the sale of investments, or affect the goodwill calculation on such investments, as most companies used the IFRS accounting as basis for such calculations.
- • Interest on net equity (INE): INE is a very important policy mechanism that serves as an incentive for equity investment and reinvestment into the country (as opposed to debt funding), and a key instrument to counterbalance the heavy tax burden corporate taxpayers carry in Brazil. According to NI 1,397, the equity basis for INE calculation is the 2007 Brazilian GAAP. This interpretation may reduce the amount of INE as a consequence of accounting differences (e.g., per Brazil's 2007 GAAP goodwill was amortized for accounting purposes). In addition, when calculating the deductible expense of INE, based on profitability limits (i.e., current earnings and retained earnings), taxpayers will also need to refer to the 2007 Brazilian GAAP).
- • Thin capitalization rules: Although the application of Brazil's thin capitalization rules was not the object of NI 1,397, it is likely that tax authorities will consider the equity and debt per Brazil's 2007 GAAP for the net equity vs. indebtedness ratio calculation.
As the Brazilian Revenue Service will apply these provisions retroactively, they could trigger unexpected liabilities for the last five years. Unless tax authorities review this interpretation, or a law is enacted clearly establishing that the IFRS GAAP should be used in the situations described above, it is likely that taxpayers will initiate litigation against the Federal Tax Office over NI 1,397.
Before analyzing the possibility of litigating against federal authorities, the first action of taxpayers should be to assess the potential tax effects of NI 1,397. This means reviewing IRPJ, CSLL, PIS, and COFINS calculations for the past five years. This analysis will provide the company's management with enough information for the decision about what to do next and how to handle NI 1,397 from a legal perspective.
Hence, the impacts of NI 1,397 must be analyzed on a case by case basis. Depending on the circumstances such effects might result in outstanding tax liabilities or in opportunities to recover taxes unduly paid.
For additional information with respect to this Alert, please contact the following:
Ernst & Young Serviços Tributários S.S., Business Tax Services, São Paulo
- • Eliezer Serafini
+55 11 2573 3704
- • Eneas Moreira
+55 11 2573 3117
Ernst & Young Serviços Tributários S.S., Global Compliance and Reporting, São Paulo
- • Ricardo Gomes
+55 11 2573 3348
- • Claudio Yano
+55 11 2573 3310
Ernst & Young Serviços Tributários S.S., International Tax Services, São Paulo
- • Luiz Sergio F. Vieira
+55 11 2573 3571
Ernst & Young Serviços Tributários S.S., International Tax Services, Rio de Janeiro
- • Sergio Andre
+55 21 3263 7236
Ernst & Young LLP, Brazilian Tax Desk, New York
- • Mariano Manente
+1 212 773 2744
- • Ingrid Berner
+1 212 773 2539
EYG no. CM3840