Brazil: Brazilian Taxation In The Oil & Gas Industry – Complexities Of Tax Compliance

There is no doubt that the recent developments in the Oil & Gas Industry in Brazil are very promising for our Economy.

However, there are still several challenges that the upstream companies must face. One of them relates to understanding and complying with our tax legislation from both a Federal and a State standpoint.

The Brazilian Tax system is extremely complex and bureaucratic, which ends up making it very difficult to be in full compliance with the rules at all times. This is so specially for the new companies that have recently established themselves in the country to search for Oil & Gas reserves.

Our experience indicates that no matter how much international experience one particular Group has, if it is their first time in the Brazilian market, there is a very steep learning curve to face.

One of the key elements in this process, is to get a very clear understanding of the system. Although it is a complex one, all the rules are detailed laid out in the applicable legislation.

A great part of the issues relate to the accounting records and supporting documentation requirements. Most of the Brazilian fillings and returns do not require attachments. The taxpayer is responsible for keeping all the records and calculation details in good standing in the event of an audit.

Interesting enough, such requirement becomes somewhat difficult to meet, if we take into account that Brazilian legislation has not yet defined the proper accounting procedures (under Brazilian GAAP) for the industry.

As a result of that, and also to minimize their exposure, currently, most companies have chosen to use one of the methods available for US GAAP purposes - full cost or successful efforts, depending on their balance sheet figures as well as management strategy. The idea is to be in line with internationally accepted procedures.

In addition to above, another issue that has significant impact to all of these companies is the lack of specific regulations for tax purposes. The system is complex enough as it is, but due to the lack of knowledge of the mechanics of the industry, it makes the task of full compliance almost impossible.

In the last few years, innumerous changes have taken place in the tax laws, trying to adapt to industry needs.

Unfortunately such changes create an unstable environment and add on to the risk factor for investments in Brazil, making it quite difficult to prepare an accurate cash flow for a 27 year project, when it comes to the tax line.

Although there is a strong likelihood that Brazil, in essence, will follow the international standards, there is also no doubt that we have a long way to go.

A good example of that relates to the need for clear consortium regulations. Due to the low chances of a commercial discovery and the high level of investments required, the industry operates through joint ventures and in Brazil, the consortium structure was implemented to make that possible.

However, our legislation does not fully cover the innumerous situations that a group of companies, operating under such structure, must face on a daily basis. This is so specially from the State’s perspective, which triggers a very time consuming process – the request for Special Regimes that can adapt the current regulations for accessory obligations to fit the needs of the industry.

It would be much simpler, if a set of separate and specific rules was published, based on industry knowledge and feedback from the companies directly impacted by the system.

This just explains and justifies one of the great concerns of the upstream companies – which is somewhat a timing issue. The authorities have 5 years to audit their books and records, which, on the other hand, must be prepared now and based on whatever guidelines are currently available. As such, by the time an audit on year 2001 books, for example, is made, four or five years from now, several issues and concepts may have been consolidated and maybe even solved, but the books may not reflect such changes since they were prepared based on what was available and accepted today.

In summary, the concern lies on the difficulty to properly anticipate how will authorities treat this transition and temporary phase. Will they recognize that it has been a joint learning process from both taxpayer and tax authority, or will they impose the strict and severe penalties and fines provided for in our tax code ?

The answer to that, only time will tell. However to avoid surprises and high penalties in the future, the companies must make sure that they have all these difficulties and concepts well identified and properly adressed on a current basis.