Foreword by Andrew Chilvers
For ambitious companies eager to expand into overseas markets, often the conventional route of organic business development is simply not fast enough. The other option to invest in or buy a business outright is far quicker but often fraught with unforeseen dangers. And even the biggest, most experienced players can get it badly wrong if they go into an M&A with their eyes wide shut.
If you search for good and bad M&As online the Daimler-Benz merger/acquisition with Chrysler back in 1998 is generally at the top of most search engines on how NOT to undertake a big international merger. Despite carrying out all the necessary financial and legal measures to ensure a relatively smooth deal, the merger quickly unravelled because of cultural and organisational differences. Something that neither side had foreseen when both parties had first sat down at the negotiating table.
These days the failed merger of the two car manufacturers is held up as a classic example of the failure of two distinctly different corporate cultures. Daimler-Benz was typically German; reliably conservative, efficient, and safe, while Chrysler was typically American; known to be daring, diverse and creative. Daimler-Benz was hierarchical and authoritarian with a distinct chain of command, while Chrysler was egalitarian and advocated a dynamic team approach. One company put its value in tradition and quality, while the other with innovative designs and competitive pricing.
Lavinia Junqueira and Cauê Rodrigues discussed The Art of Deal Making: Using External Expertise Effectively as part of the Tax chapter.
Describe a typically tax-efficient deal structure in your jurisdiction? Any examples.
The Brazilian tax system has several types of taxes that affect different business models. A key point to invest in Brazil is to choose the right business model, through Brazilian investment funds or Brazilian companies, which may be financial or non-financial and may act as a support or ancillary business to the non-resident company. Choosing the right way to structure your business and the right region to act from may allow you to benefit from privileged tax regimes, tax benefits or simply change the way taxes levy and save you money in direct taxes such as corporate income taxes, turnover taxes, property taxes and transaction taxes, as well as indirect sale taxes on services or products, and taxes on imports of goods and services. It is important to plan ahead to offset tax credits. If you are buying a business in Brazil, structure carefully to benefit from goodwill deductions and prevent succession of tax, labour and civil law debts to the extent possible.
A typical deal structure in Brazil is to buy a Brazilian business through a Brazilian holding company to merge and deduct the goodwill and structure the business as a non-resident investing in Brazil. Utilise the Brazilian company whenever a local presence is needed using to the maximum extent possible the thin capitalisation and transfer pricing rules to minimise the Brazilian taxable profits. Try to apply for regional and federal tax benefits and maximise the use of service companies and intellectual or copyright property companies rather than commercial and industrial businesses, which are heavily taxed. With industrial and commercial businesses, work on the sales and logistics chain to optimise profit margins, tax benefits and levies while maximising the offset of accumulated tax credits.
What elements of a structure or deal could prevent a client from implementing your recommendations? For example, holding companies, trusts, exemptions, withholding tax.
Limitations imposed because of counterparty needs may pre- vent the investor from choosing a certain business model. The need for prior approval to operate in specific sectors may create a timing constraint for the business. Some companies are unable to change a global business model to a Brazilian practice or may try to do so but lack the necessary substance for the new business model to prevail and be sustained. The company has to prepare and keep documentary evidence to support the tax positions and request special tax treatments and lack of compliance to such obligation may jeopardise the benefit. Certain spe- cial tax treatments or benefits are not extended to companies owned by non-residents. Some regional tax benefits impose a sort of cash trap for reinvestment and do not allow distributions of the amount obtained because of the tax discount.
Another major factor that ends up invalidating some tax planning, especially those that involve companies of the same eco- nomic group, located in different jurisdictions, is the withholding income tax levied on the intercompany rendering of services or royalty payments intercompany, that are often essential for the business development. Usually, corporations only analyse the corporate effective tax rates of each jurisdiction where they intend to operate and do not analyse the withholding income tax, other taxes levied on these intercompany relations and any cash trap imposed by the country; factors that could end up encumbering the structure as a whole.
How would you minimise the tax risks on a deal, including historic tax liabilities and ongoing tax optimisation?
It is important to have extra tax substance implemented in all business models and to the goodwill payment and structure for its realisation and deduction. Transactions with related parties need to be carefully implemented to allow deduction of expenses and costs. The materialisation of tax risks into tax liabilities can contribute to the devaluation of the company. Implementing a good tax compliance program in Brazil that allows a foreign investor and Brazilian company to acknowledge and keep track of key drivers in the tax liabilities, tax positions, tax reporting and filing obligations and documentary evidence of tax options, expenses and transactions is important to avoid tax liabilities of non-compliance, avoid accumulation of tax credits and optimise liabilities.
Brazil presents a large bureaucracy for the filing of tax returns and ancillary documentation, often imposing on taxpayers’ sizable fines for noncompliance or insufficient proof of their dutiful practices. The sheer volume of information that must be provided to Brazilian Tax Authorities is overwhelming to most, which often exposes newcomers to failure. Situations in which the taxpayer levies taxes correctly but provides inadequate tax returns are commonplace, especially for poorly advised newcomers.
Preemptive analysis of potential tax liabilities is a large part of our services since even legal structures are susceptible to tax assessment, as Brazilian tax authorities adopt a “substance over form” criteria. Thus, given this scenario, we find it important for all entrepreneurs operating or looking to operate in Brazil to seek the advice of tax specialists to maximise the tax efficiency of local transactions and minimise the ensuing tax risks. The trained eye of professionals knowledgeable in tax law, and with a comprehensive business vision, is the key for successful development of corporations in Brazil.
Top Tips – Tax Traps To Be Avoided In Your Jurisdiction
• Brazilian corporate income tax can be levied under different regimes – “Actual Profit”, “Presumed Profit” and “Simples Nacional”. Each regime implies different rules for defining taxable income and expense deduction. The efficiency of each regime varies in accordance with the company’s activities and income/expense ratio. Companies often incur unnecessary tax expenses when choosing the regime without understanding how each suit them differently.
• Often the most efficient corporate income tax regime is the Simples Nacional, but this is also the most restricted. Not understanding the requirements for making this choice commonly results in assessments.
• A single real estate transaction can be executed to different degrees of tax efficiency in accord- ance with the seller. The ensuing income tax has different treatment for companies and individuals.
• Transactions with companies resident in tax havens and privileged tax regimes often incur in raised tax rates, the most efficient structures often move away from such jurisdictions.