The use of a local holding company mitigates or in some cases even avoid taxation of foreign investments in Brazil. Hence, to take advantage of such opportunities, the acquisition of shares of a Brazilian company or shares of an equity investment fund needs to be made through a Brazilian acquisition vehicle.
The first significant example of this matter is related to the premium eventually paid in an acquisition of shares of a local company, once the amount paid in excess of the net equity of the target company may generate an amortizable premium or a step-up in the tax bases of otherwise depreciable or amortizable assets. This opportunity is not available where shares in a Brazilian company are purchased directly by a non-resident.
Most of the M&A deals in Brazil might provide tax amortization of the premium eventually paid, once they involved a share transaction with goodwill attributed to future profitability of the target company. However, the foreign investor must know that to take advantage of this opportunity the acquisition of shares or quotas needs to be made through a Brazilian acquisition vehicle. Therefore, the foreign investor has to incorporate a local holding company.
The liquidation or merger of the acquisition vehicle and the target company allows the premium paid on the shares to become recoverable in certain situations. To the extent that the premium relates to the value of recoverable fixed assets or the value associated with the future profitability of the company, the premium could be amortized or otherwise recovered through depreciation.
However, at the time of acquisition of shares, the excess payment must be splatted between equity value and premium, and such premium has to be subject to a purchase price allocation (PPA) local rule. However, an accurate planning is therefore mandatory to ensure the acquisition structure is consistent not only in its form but also in its substance, with best practices and the prevailing case law on this matter.
In accordance with such local PPA rule, the premium paid over the local company's net equity first of all has to be allocated to fair value of assets/liabilities and intangibles. Then, its remaining portion price might be allocated as goodwill, based on future profitability.
The firs portion of the premium allocated to the fair value of the assets will be amortizable/deductible upon the merger of the acquirer and the acquired company; and the second one (the goodwill portion of the premium) will be amortizable in five years, over a maximum limit of twenty percent per year.
Noting that, regarding the taxation of a share sale for a non-resident, the taxable gain is usually calculated as the difference between the amount of foreign capital registered with the Brazilian Central Bank and the gross sales proceeds in the foreign currency, and it is mandatory to state in the sales contract whether the sale price is gross or net of the Brazilian withholding income tax.
Another significant example of this matter is related to the acquisition of shares of an equity investment fund. This is because, in Brazil equity investment funds are not legal entities but condominiums with shares held by their investors.
In this context, non-resident investors are also not subject to Brazilian taxation on the redemption of quotas of an equity investment fund, but such exemption only applies where very specific requirements are met by that non-resident investor such as, among others: i) hold less than forty percent of the quotas of the equity investment fund; ii) not be entitled to more than forty percent of the income paid by the equity investment fund; and, iii) not be resident in a low-tax jurisdiction. Hence, to be benefited by the exemption from corporate income taxes anyway and then remit the related income as dividends, is better to incorporate a local entity.
To sum-up, beyond these two situations, there are others in which the incorporation of a local holding company might promote some significant tax advantages. Among them, we can mention others such as: i) kept and carried forward tax losses indefinitely; ii) be in charge to pay pre-sale dividends in a way to realize part of the value of the investment as income; iii) the situation where tax relief for interest is available to offset the target's taxable profits; iv) avoid the withholding income tax on a direct sale of a Brazilian company's shares by a non-resident; and v) the fact that the Brazilian controlled foreign company rules subject any profits recorded by foreign subsidiaries to tax in Brazil only at the end of the year.
