Royalties limitations as a barrier to foreign investments in Brazil
Jabuticaba is a purplish-black, white-pulped fruit that is native to certain Brazilian regions. Although it is found also in other South American countries, the word jabuticaba, in popular language, became a synonym for things that exist only in Brazil. Not always good ones.
One of these jabuticabas is a strong limitation to the payment of royalties for the use of patents and trademarks and for technical, scientific, administrative or similar services. The new Brazilian President has promised in his government plan to pursue economic liberalism and to reduce State controls, as well as taxation. Removing limitations to the payments of those royalties would be an important step in that direction and a welcome gesture to foreign investments.
A law passed in 1962 – and amended in 1979 – to regulate foreign investments in Brazil limits the amount of royalties for exploitation of invention patents and of industry or commerce trademarks (together with compensation for technical, scientific, administrative or similar assistance services) that can be deducted from the Brazilian taxable income of the paying company to up to 5% of the net revenue generated by the manufacture or sale of a product.
The law further determines that the actual percentages shall be established and periodically revised by the Finance Minister, based on the products’ essentiality and observing the 5% cap. An even older regulation passed in 1958 – with few updates in 1959, 1970, and 1994 – limits the deductibility of royalties to percentages varying from 1% to 5%, with most products being considered as “non-essential” and thus subject to the 1% rate.
There are also several other requirements and restrictions to the tax deductibility of such payments for Brazilian companies, in addition to the 5% cap, such as mandatory registration of the agreements with the Central Bank of Brazil and non-deductibility of certain payments to related parties.
The rules above are of a tax nature. Does this mean that higher amounts of royalties can be paid, although the excess is non-deductible for tax purposes? Not exactly. The foreign investments law from 1962 further states that the amount of royalties paid in excess of the tax-deductible limits is deemed as profit distribution for legal and tax purposes. Although profit distribution (even to foreign shareholders) is currently exempt from taxation in Brazil, the company may only distribute profits after having paid all corporate taxes and provided that the company has net profits in the current fiscal year, accumulated profits from previous years or certain capital reserves in its balance sheet.
Remittance of royalties outside Brazil in excess of the applicable percentages (1% in most cases) might have administrative and criminal implications, in addition to not being deductible for tax purposes. In the Central Bank and the Public Prosecutor’s views, this could be deemed as a foreign exchange evasion, subjecting the company and responsible officers to fines and imprisonment.
In a nutshell, the rules discussed above intend not only to limit its tax deductibility but in fact to prohibit the payment of royalties in excess of a percentage (1% in most cases) of the revenues generated by the manufacture or sale of the relevant product in Brazil.
There may have been a reason in the past for such limitation, when Brazil’s industrialization was incipient and foreign exchange controls were common also in other countries as a means to protect local economies. Presently, however, the only effect of restrictions of this kind is to make Brazil less attractive to foreign investments.