We refer to the wrongful decision of the highest level of
Brazil's tax administrative court1 (CSRF,
Decision 9101-001.908 of May 13, 2014) against the deductibility
for income tax purposes (IRPJ)2 of any
royalties3 whatsoever (e.g. copyright royalties
regarding software, books, songs, movie, magazine and cartoon
characters) paid by a Brazilian company to its partners
(individuals or legal entities, foreigners or not, with any
shares), with the exception of royalties for patents and trademarks
(forgetting that know-how is also included) regarding agreements
signed from 1992 on with its foreign parent company. The case
refers to software royalties.
Nowadays intellectual property licensing agreements (e.g. patent,
trademark, know-how) – import of technology – are still
subject to strict regulations regarding necessary clauses of the
agreements and, specially, the amount to be paid/remitted/deducted
for tax purposes (limited to royalties of 5% instead of other
transfer pricing rules methods), involving the Brazilian Patent and
Trademark Office (INPI), the Central Bank of Brazil (Bacen) and the
Brazilian IRS (RFB).
Copyright royalties on the other hand are not subject to such
restrictions and shall comply with Brazilian transfer pricing
rules, although we are not aware of tax assessments in this
regard.
In order to understand and proceed with the adequate interpretation
of Brazilian regulatory tax legislation regarding royalties for
intellectual property rights it is necessary to understand the
historic perspective of its enactment since royalties for
intellectual property rights were one of the first instruments of
abusive international tax planning in Brazil.
In the 1950's Brazil taxed heavily a company's profit and
its dividends with a joint taxation (income tax, compulsory loan,
additional income tax and withholding income tax) that could reach
50% or more of such amounts. Royalties on the other hand were
deductible without limitation and taxed by withholding income tax
of 25%. There was also a shortage of dollars due to dividends
remittances restrictions in several countries. Thus it was better
to pay royalties than dividends.
Corporate groups always look to the whole taxation of its
transactions and since royalties had a lower taxation, abusive
royalty rates of 10%, 15% or more were established in intragroup
transactions regarding patents, trademarks and know-how (technical
assistance). The problematic was limited to the transactions
regarding such intellectual property rights, with copyright not
being an issue. Such royalties were above the highest rates between
non-related parties transactions, which were of 3% or 4% tops
(according to Brazilian IRS tax assessments back then).
Since royalties were fully deductible as a necessary expense
without any quantitative limitation, such abusive royalties were
deducted and remitted abroad resulting in loss of tax revenues to
Brazil since only the withholding income tax over royalties was
being paid.
In this scenario Brazilian legislation limiting royalty deduction
for income tax purposes was first enacted in 1958 (art. 74 of law
3.470/58) regarding only the licensing of patents, trademarks and
know-how (technical assistance). Copyright was not included. Back
then - and now - a major problem was how to establish reasonable
royalty rates.
With the lack of a clear method or fixed regime in this regard,
Brazil chose to establish a royalty rate cap of 5% for deduction
for income tax purposes (since between non-related parties
transactions, the royalty rates were of 3% or 4% tops). Such rate
was subject to regulation according to its necessity to the country
(and not to the company), a clear non-fiscal purpose. Another
requirement was the prior registration of the agreements in the
Brazilian Patent and Trademark Office4.
Ministry of Finance's Rule 436/58 ("MF Rule 436/58")
was enacted in this regard according to President Juscelino
Kubitschek economic plan (Plano de Metas) and the goal of import
substitution. Technologies necessary to develop Brazilian heavy
industries were higher than others and trademarks were at the
minimum rate of 1% since they do not add any technology to the
country. MF Rule 436/58 has a non-fiscal (regulatory taxation)
purpose and it has never been changed since then (only the
inclusion of few new activities/technologies, such as information
technology and, by IRS rulings, franchising and cultivars).
Such tax problem soon has become a balance of payments between the
early 1960's and 1991 (Law 4.131/62), since royalties from
group companies could not be deducted or remitted with the transfer
of technology being a kind of performance requirement (technologies
for free) for foreign companies investing in Brazil.
In the 1960's new tax provisions were enacted establishing the
non-deductibility of royalties between companies and its partners
(art. 71, sole paragraph, d of Law 4.506/64). While scholars and
taxpayers always considered such provision limited to individuals,
the Brazilian IRS wrongly insists (by reading the provision alone)
that legal entities are also included.
In our view the non-deductibility of necessary expenses for fiscal
purposes (even in transactions between related parties) is
unconstitutional. Only in case of non-fiscal purposes and if
observed the substantive due process of law requirement, it could
be considered constitutional.
Also, the non-deductibility of royalties between companies and its
partners shall not be interpreted alone, but jointly with other
provisions and according to our historic analysis where patent,
trademark and know-how royalties between Brazilian affiliate
companies and its foreign parent companies were the ones resulting
in abusive tax planning. An interpretation claiming that only these
royalties are now deductible (while licensing from minority
shareholders are not) is absurd and contrary to several other tax
administrative court decisions against such limitation regarding
e.g. copyright royalties, being also clearly against Brazil's
goal to foster R&D&I of its companies (regarding
transactions between Brazilian companies).
Footnotes
1 Câmara Superior de Recursos Fiscais
– CSRF.
2 There is a discussion if such restriction also applies
to CSLL, but this was not part of the trial.
3 Royalties are amounts due for the licensing of
intellectual property rights. They are established as a percentage
of the revenue of the products manufactured and sold by the
licensee.
4 Back then, except the know-how one.
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