Brazil guidance addresses taxation of amounts paid under “cost-sharing” agreements

By Francisco Lisboa Moreira, Tax Partner, Bocater Advogados, São Paulo

Brazil’s Federal Revenue Service on October 2, once again issued guidance on the tax treatment of contracts between companies of the same business group addressing the sharing of functions and activities (cost-sharing agreements).

The conclusions of Consultation Solution no. 276, from the Federal Revenue Service´s perspective, are very clear:

1. IRRF and CIDE-royalties apply to the amounts paid, credited, delivered, employed or remitted to a party that is resident or domiciled abroad as remuneration for technical services rendered between companies of the same business group, even if resulting from performance of a contract generically denominated a “cost-sharing” agreement, but that does not satisfy the requirements for its characterization; and
2. The incidence of PIS-Pasep Importation and COFINS Importation shall occur on the payment, credit, delivery, employment or remittance of amounts to parties that are resident or domiciled abroad, in return for the provision of service carried out in Brazil, or abroad when the result occurs here.

At first glance, the consultation solution would appear to represent a step back from the immediately preceding pronouncements of the General Office to Coordinate Taxation (COSIT) of the Brazilian Federal Revenue Service. However, some aspects should be considered before jumping to conclusions.

Related party transactions

The consultation was requested by a company whose direct parent company is located in the Netherlands and whose business group is controlled by a company located in the United States, with operations in both countries.

The consultation mentions that the transactions were carried out with the Brazilian company’s related parties in the Netherlands and that the United States activities are only support activities of an administrative nature or to sustain the group’s main activity. Further, the joint contracting with a centralizing entity brings “unquestionable benefits of an operational nature,” the consultation said.

It cites the information systems and engineering departments of the US parent and also stresses that the activities are performed internally, not by an outsourced third party.

With respect to the cost charged or shared, the Brazilian company mentions that there is no pass-through of the cost of service rendered by third parties since all the apportioned expenses are incurred internally and are usual and necessary to the Brazilian entity´s activity.

Additionally, the agreement expressly states that there is no profit margin (mark-up) passed through, only the cost of the activity.

Based on these considerations, the Brazilian company expressed its position that there is no event generating IRRF, because the contractual arrangement only involves the recovery of costs or expenses, without any addition of net worth or inflow of taxable income. The company also argued that there is no event generating CIDE since the sharing of costs does not presuppose the provision of administrative services. Further, PIS-Importation and COFINS-Importation are not owed because the contractual arrangement does not involve domestic provision or importation of services.

The government’s response makes it clear that the “consultation” route is not the proper way to obtain an analysis of a factual situation. However, it does delve into some theoretical questions to clarify the matter.

Nature of the contract

For the Brazilian tax authority, the analysis starts with the definition of the nature of the contract, whether it can be classified as a cost-sharing agreement or service provision agreement.

The government cites the position of the late Professor Alberto Xavier to segregate agreements for sharing of costs and expenses into three categories: cost-sharing agreements, intragroup service provision agreements; and agreements for contribution to costs.

Cost-sharing versus provision of service

In a cost-sharing agreement, according to the position expressed in CS 276:  

“[T]he financial resources delivered to the expense-centralizing unit refer to the performance of activities with an instrumental character (means activities); a contribution to achieve a common purpose and with the exact value of each party’s participation, either advanced or reimbursed, without profit margin; with a structure where activities are performed in benefit of the group (benefit to more than one entity, with lasting character, with without having the purpose of rendering services.”

The intragroup service provision agreement assumes the payment by the participating companies for the rendering of services performed by the centralizing entity.

According to the government, the return consideration has the nature of a price paid for the provision of services.

Finally, the agreement for contribution to costs is a “contract formalized to share the costs and risks of the development, production, and obtainment of assets, services or rights, as well as to define the extent of the interests of each participant.”

Furthermore, the Brazilian Federal Revenue Service cites the OECD’s Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2017 to state that the concept of mutual benefit is fundamental for a valid cost-sharing agreement.

The Brazilian Federal Revenue Service also states that “if one of the companies of the group performs a specific function without necessarily expecting any benefit, the situation will be the provision of intragroup services” (according to item 8.14 of the OECD transfer pricing guidelines).

Soon thereafter, the Brazilian Federal Revenue Service correlates the activities mentioned by the company posing the query with the concept of sharing costs, concluding that the activities performed by the engineering department of the parent company, although resulting in a benefit to the Brazilian subsidiary, do not have the key element, in the words of the tax authority, for classification as a cost-sharing arrangement – a mutual benefit.

The government further states that “it is possible to identify that the parent can be considered as a provider of services to the subsidiary” and “as long as those services have such relevance that an independent company would be willing to contract them.” For this reason, it concludes that the price should be equivalent to what an independent party would pay for them, at arm’s length.

It should also be mentioned that the Brazilian tax authority’s position, in comparing the contract at issue with a cost-sharing agreement, is that the benefit of each party must be measured indirectly based on objective criteria, not on direct allocation as the provision of services.

Prior guidance

Later, CS 276 cites some relevant previous consultation solutions to support its interpretation.

The first of these is COSIT Consultation Solution no. 8/2012, according to which a cost-sharing agreement has the following characteristics:

There must be a division of the costs and risks inherent to the development, production, or obtainment of goods, services or rights;

The contribution of each company must be consistent with the individual benefits, either expected or actually received;

1. There must be an identification of the benefit, specifically, to each company of the group, such that if it is not possible to assume that a company can expect any benefit from the activity developed, that company cannot be considered a legitimate party to the contract;
2. There must be a stipulation of reimbursement, defined as defrayal of the costs corresponding to the efforts or sacrifice incurred in performing an activity, without any profit;
3. There must be a collective advantage offered to all the companies of the group;
4. The remuneration for the activities, irrespective of their effective use, must be sufficient to “place at the disposal” of the activities in benefit of the other companies of the group; and
5. There must be a stipulation of conditions that any company, in the same circumstances, would be interested in contracting.

Next, there is mention of COSIT Divergence Solution no. 23/2013, which has general binding effect within the Brazilian tax authority, dealing with the deductibility, for purposes of IRPJ, of the amounts referring to apportionment of costs and expenses among companies of the same business group, domiciled in Brazil, besides the incidence of PIS/Pasep and COFINS, as based on the same conclusions related to cost-sharing indicated in COSIT CS no. 8/2012.

In concluding the first part of the analysis, the Brazilian Federal Revenue Service states that the contract presented cannot be classified as an agreement for sharing of costs and expenses among companies of the same group because there is no mutual benefit expected by the foreign parent company in relation to the activities carried out by its engineering department and because the contractual form used for remuneration involves direct retribution for the advantage obtained by the Brazilian company.

Therefore, due to the bilateral nature and cost aspects, the conclusion is that the contract is a service provision agreement.

Some conclusions

Summarizing CS 276/19, and based on the previous CS 43/2015, which analyzed the remittance under a contract for the provision of technical and technical assistance services, which the party posing the query classified as a cost-sharing agreement, there will be incidence of IRRF and CIDE-royalties on remittances for what most companies classify as “cost-sharing agreements”.  

In this respect, Brazilian tax authority stated that the “denomination” as reimbursement or apportionment of costs does not override the fact that payment is being made to a party resident or domiciled abroad in return for the rendering of technical services.

It is important to observe that SC no. 43/2015 sought to eliminate the character of apportionment and, instead, correlated the payment with return consideration for services rendered.

A further conclusion is that, with respect to PIS/Pasep Importation and COFINS, the classification is based on the “payment, credit, delivery, employment or remittance of amounts to a party resident or domiciled abroad in return for services rendered,” as per Art. 3, numeral II, of Law 10,865/2004.

Thus, based on the text of CS 276, we can affirm that what taxpayers have been calling “cost-sharing agreements” do not have the same meaning in Brazil and within the OECD transfer pricing guidelines. Both parties are clearly not speaking the same language.

We should recap that the doctrine of the “common costs” incurred within the same business group, which the Administrative Tribunal (CARF) has long decided that do not represent taxable revenue of the recipient, is not automatically applied by the Brazilian tax authority to cross-border business transactions. The latest decision on the matter is dated September 24, 2019, and its headnote mentions that “the amounts obtained as reimbursement from the other companies belonging to the same business group for the payment of common expenditures do not integrate the Cofins calculation basis”.

Although its text was not good for taxpayers, it provided a good path to understand what is in the Brazilian tax authority’s mind, and perhaps shows how problematic the harmonization Brazilian and international tax law would be.