McDonald’s Brazil subsidiary must withhold tax on cost-sharing payments, court rules

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

In a problematic decision, the Brazilian Administrative Tax court has ruled that income tax withholding should be levied on a McDonald’s subsidiary’s payments made under a cost-sharing agreement (“rateio de despesas”) (Collegiate Decision 1401-004.049).

CARF (Brazil’s Administrative Tribunal for Tax Appeals) reached a split decision in the case, which was resolved by the Minerva vote.

At issue were payments made by McDonald’s Brazilian subsidiary (Arcos Dourados Comércio de Alimentos Ltda.) during calendar-years 2012 and 2013 which were remitted for administrative and management costs for finance, systems, human resources, marketing, legal, strategy design, and other items.

The tax authorities argued that such costs should be treated as “technical services and technical assistance, administrative and related costs,” thus being subject to the 15% withholding tax, even though such payments were made without any markup being added, as stated in prior Consultation Solutions COSIT 43/2015, DISIT/SRRF09 163/2012, DISIT SRRF06 6024/2017 and DISIT/SRRF 462/2006.

The Brazilian tax authorities’ report also quotes other CARF decisions, such as 1402-002.272 and 1103-001.044.

McDonald’s challenged the assessment, noting that prior rulings concluding that mere reimbursement of administrative expenses shared between entities of the same Brazilian court reaches surprising decision on tax treatment of McDonald’s subsidiary’s business group are treated as a return of the equity of the payor, with the beneficiary obliged to file a tax return. 

We must note that CARF is a tribunal composed by an equal number of judges appointed by the taxpayers and the tax authorities, with the latter always presiding each judging session and holding the tiebreaker. Therefore, almost every time the two positions conflict, the tax authorities’ position will succeed.

The dissenting vote in the case, issued by Judge Luciana Zanin, the rapporteur, aligned with the taxpayers position, explained that mere administrative support non-core activities borne by one group-member should be shared with the other beneficiaries of the same group, invoiced at cost – with no markup – solely for restatement of the prior equity position, as expressed in Consultation Solution 8/2012, Divergence Solution 23/2013, Consultation Solution 378/2017 and Consultation Solution 94/2019.

Judge Zanin’s opinion was based on Consultation Solution 378/2017, which explained the landmark position of the tax authorities concerning cases where an employee is transferred to a Brazilian subsidiary, but part of the remuneration is paid by the overseas transferor entity and reimbursement is paid by the Brazilian entity.

In such case, payments to the group company overseas are not subject to the withholding tax and no taxes are due on the importation of services, such as the PIS, the COFINS, or the CIDE.

The dissent in the McDonald’s case concluded that the terms “reimbursement” and “service providing” should not be treated the same. As the cost sharing agreement was signed and the centralizing entity appointed prior to the execution of the contract – all characteristics necessary for its implementation — the taxpayer should prevail in his request.

On the other hand, the winning tiebreaker vote, issued by Judge Carlos André Soares Nogueira, explained that Consultation Solutions 8/2012, 378/2017, 94/2019, and Divergence Solution 23/2013 had different facts and should not be used as grounds for deciding the case.

The focus of Consultation Solution 94/2019 and Divergence Solution 23/2013 is on the deduction of expenses under the cost-sharing agreement, which was never disputed in this case. Consultation Solution 8/2012 instead focuses on deductibility and application of the transfer pricing rules for verifying payments.

Judge Carlos Nogueira points out that Consultation Solution (8/2012) only marginally mentioned the income withholding tax as the cost-sharing agreement could allow the subcontracting of the services (indirect service contracting), which should not have the same treatment. Consultation Solution 378/2017 also should not be used as a basis for this case, as its object differs from Arcos Dourados situation. His vote also mentions that the tax authorities’ position is not bound by these consultation solutions

It also points out that art. 685 of the 1999 income tax regulations was still in force at the time of the remittance, and that its material triggering event mandates that any income or remuneration paid to a beneficiary abroad should be subject to the income withholding tax.

His opinion states that only Consultation Solution 43/2015 should apply to the case, as its object concerns payments for cost-sharing agreements; it holds that the CIDE Tax shall be levied, as it applies when technical services and administrative assistance payments are made; and the act of remunerating other entities for the provision of services shall trigger the CIDE and income withholding tax due.

Finally, the majority opinion rejected the allegation of the taxpayer that the cost-sharing agreement’s “non income” characteristics, should fit under art. 7 (business profits) of the Brazil – Netherlands double tax agreement, and concluded that the protocol to the treaty, which addresses technical and administrative services of art. 12 of the treaty, should prevail.

The tax authorities’ position is clear – that any payment should be treated as income, and subject to income withholding tax even if common costs are shared between companies of the same business group under a contract, without markup, and not constituting a service.

We must not forget that Brazil is formally requesting to join the OECD, and at some point, adherence to the OECD transfer pricing guidelines will be an issue.

Chapter 5 of the guidelines allows payments under a cost-sharing agreement to be made without income withholding tax levies, and not subject to the transfer pricing regulations.

However, Brazil’s extreme source taxation is a tough obstacle to overcome. Taxpayers must continue to challenge the tax authorities’ position.