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13.2. Thin-capitalization and other Restrictions to Interest Deduction

Under thin-capitalization rules, interest expense arising from a financial arrangement with a related party is deductible only if the debt-to-net equity ratio of the Brazilian borrower does not exceed 2:1. In addition, interest expense arising from a financing arrangement executed with a party established in a low-tax jurisdiction or benefiting from a preferential tax regime is deductible only if the Brazilian borrower’s  debt-to-net equity ratio does not exceed 0.3:1.

Thin capitalization rules were introduced in Brazil on 16 December 2009, by Provisional Measure (PM) 472, which was converted into Law 12,249/2010 on 14 June 2010,The Law establishes that interest paid or credited by a Brazilian entity to a related party (an individual or legal entity), resident or domiciled abroad, not constituted in a tax haven or in a jurisdiction with a privileged tax regime, maybe deducted only for income tax purposes if the interest expense is viewed as necessary for the activities of the local entity and the following requirements are met:

  • a. The amount of debt granted by the foreign related party (which holds a participation in the Brazilian entity) does not exceed twice the amount of its participation in the net equity of the Brazilian entity;
  • b. The amount of debt granted by a foreign related party (which does not hold a participation in the Brazilian entity) does not exceed twice the amount of the net equity of the Brazilian entity;
  • c. The total amount of debt granted by foreign related parties in (a) and (b) does not exceed twice the sum of participation of all related parties in the net equity of the Brazilian entity;
  • d. If debt is granted only by related parties that do not hold a participation in the Brazilian entity, the total amount of debt granted by all of these related parties does not exceed twice the amount of the Brazilian entity’s net equity.
  • e. If one of these 2:1 ratios is exceeded, the portion of interest related to the excess debt amount will not be deductible for Brazilian income tax purposes.