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5.5. Qualification of Specific Income Categories for Tax Purposes

Interest on Net Equity

Since January 1996 companies have been able to pay interest to shareholders/quota holders,calculated on the company’s net equity. This interest, which may not exceed 50% of the annual profits or retained earnings, is deductible for income tax and corporate social contribution purposes, and is generally subject to 15%WHT (both for beneficiaries resident in Brazil or abroad), rising to 25% if the non-resident beneficiary is resident/domiciled in a low-tax jurisdiction, according to Brazilian legislation. It is calculated on a pro rata temporis basis and up to a given rate known as the long-term interest rate (TJLP). If the beneficiary is a corporate entity subject to normal income tax in Brazil,the tax withheld at source may be taken as a tax credit against the normal CIT due. Alternatively,this tax credit can be offset against income tax due at source on interest payments. This interest is not subject to further tax if the beneficiary is a Brazilian resident individual.

Royalties and Service Fees

For tax deduction purposes, royalties, license fees, technical assistance and similar charges,together with the amortization of patent costs,may not exceed, in the aggregate, specified percentages of net sales revenue from the related products.Except in cases covered by specific tax incentives,the highest total deductible charge permitted for certain industries is 5%. The maximum payment for the use of trademarks and trade names is 1% of the corresponding net sales.

Formal agreements must be registered with the National Institute of Industrial Property (Institu to Nacional de Propriedade Industrial - INPI) in support of all such charges.Royalties paid in remuneration of license agreements without INPI approval are not deductible for tax purposes.

Registration with the Central Bank of Brazil is also necessary for the remittance of foreign currency.

Royalties payable to a foreign company with a direct or indirect controlling interest in a Brazilian company are deductible for tax purposes, provided the contract has been duly registered with the INPI.

There is no withholding tax on royalties and service fees etc., paid to resident parties. However,payments of royalties and technical assistance service fees to foreign recipients are subject to 15% WHT, rising to 25% if the non-resident beneficiary is resident/domiciled in a low-tax jurisdiction, as defined by Brazilian legislation. In addition, remittances of royalties and service fees are subject to the Contribution for Intervention in the Economic Domain (CIDE), at the rate of 10%on the amounts credited/paid. CIDE is levied on the local entity’s cost and is not therefore creditable to non-residents.

Depending on the nature of the remittance to the foreign beneficiary, the respective payment/credit may fall under one of the services subject to the Municipal Services Tax - ISS. Under the prevailing legislation, ISS is not levied on the licensing of patents and copyright. Nevertheless,as stated in Complementary Law 116/2003,licenses to use/exploit trademarks and software have been subject to ISS since August 2003. The Brazilian entity is responsible (on behalf of then on-resident) for withholding and paying the tax to the municipal authorities, at rates ranging from 2% to 5%.

In general, remittances of royalties are not subject to the PIS and COFINS taxes, as these social contributions apply to the import of goods and services (since May 2004). Nevertheless,once characterized as a service for ISS purposes,the federal tax authorities may also require the payment of the PIS and COFINS taxes, at the rates of 1.65% and 7.6% respectively.Lastly, remittances of royalties/technical assistance service fees abroad (i.e. foreign exchange transactions) are currently subject to the Tax on Financial Transactions – IOF, at the rate of 0.38%.

It should be noted that operations involving royalty agreements are not subject to transfer pricing rules if the related contract has been registered with the Central Bank and the INPI. For information about service fees paid to associated foreign companies, please refer to Sec. 13.4.