Tax aspects of cost-sharing agreements

By: Fernanda Marques

On January 31, 2020, ruling n. 1401-004.049, of the 1st Judgment Section, of the 4th Chamber and 1st Ordinary Panel of the Administrative Council for Tax Appeals (CARF), was published, determining the incidence of withholding income tax (IRRF) in the event of payments made to legal entities domiciled abroad resulting from expenses apportionment agreements, also known as cost-sharing agreements.

Cost-sharing agreements are intercompany cooperation contracts, established to provide the correct allocation of costs between different legal entities but which belong to the same economic group, to determine the apportionment of expenses and costs resulting from the exercise of shared activities, such as internal accounting, communication, legal and administrative services.

Therefore, one of the companies will be able to centralize such activities, giving support to the other organizations in the group, thus establishing an apportionment of costs between them, since the execution of these supporting activities ends up benefiting all the parties involved.

Cost-sharing agreements are different from service agreements, since the former aims at reimbursement between companies, resulting from the sharing of expenses, while the latter is characterized as a provision of service, which means that they have profit as an end goal.

With that being said, cost-sharing agreements are widely used among multinational companies. Often a company of the same economic group, located abroad, may be the one that centralizes such supporting activities, collaboratively with the company domiciled in Brazil. It is in this very case that the aforementioned CARF decision is relevant.

There is ample discussion about the incidence of IRRF in these operations, even after CARF’s publication, ruling in favor of the appropriateness of the IRRF collection in such cases. This discussion permeates the very definition of income and equity increase, which are taxable in Brazil, as defined in art. 43 of the National Tributary Code:

Art. 43. The tax, which is the competence of the Union, on income and earnings of any nature has as a triggering event the acquisition of the available economic or legal:

I – income, thus understood as the product of capital, labor or a combination of both;

II – earnings of any nature, thus understood the equity increases not included in the previous item.

Therefore, when it comes to reimbursement, it must be concluded that there is, in fact, no increase in assets, since it is a mere cooperation operation within the same economic group.

The theme still advances, in the sense that many of the defenders of the appropriateness of the incidence of IRRF in cost-sharing transactions consider that these operations can be characterized as service provision—an incoherent definition, as already discussed above.

Although the winning thesis in CARF was in favor of the incidence of Income Tax, it is necessary to highlight the unsuccessful vote of Counselor Luciana Yoshihara Arcangelo Zanin:

[…] there is no way to confuse the “reimbursement” and “service provision” institutes, as they have different legal natures, and it is not correct to talk about taxation of reimbursements for costs incurred in terms of employee compensation made available by the parent company to the applicant since they are not remuneration for the provision of services, but a mere reimbursement of costs.

[…]

Once the requirements for characterizing these agreements as reimbursement of expenses are met, there is no need to talk about service provision or remuneration subject to taxes.

Therefore, I understand that the Appellant is right to affirm that the remittances made by it to companies belonging to its economic group abroad as expenses reimbursements do not correspond to services. These are values that can be qualified as reimbursement of expenses, in relation to which there is no profit margin, remuneration, income, gain, commission, equity increase, or any other addition that may represent income.

Although the Counselor’s vote was unsuccessful, it should be noted that the Council was divided on the situation, since the final decision was taken employing a quality vote, reflecting the controversial character of the issue.

Thus, if it is postulated that the vote of Counselor Luciana Zanin is correct, it is understood that, in the constitution of the so-called cost-sharing agreements, if no onerous transaction takes place, but there is merely a reimbursement of the exercise of activities within the same economic group, there is no space to raise the possibility of the incidence of IRRF, since such collection would distort the very conception of income, under the terms of Brazilian tax legislation.

Fernanda Marques is a Law student at PUC Minas and a collaborator with the legal team of Drummond Advisors, working in the corporate and international contracts area. Fernanda has international experience in Michigan (USA) and Messina (Italy), where she attended Università degli Studi di Messina.