Disparity between the US and Brazil’s approach to royalties increases risk of double taxation

TP Week As a result of Brazil’s unique policy to prevent erosion of the tax base, companies often face double taxation.
The pending case before the US Tax Court (Docket 5816-13), 3M Co. et al. v. Commissioner, brings this issue into the spotlight. In this case the US Internal Revenue Service (IRS) claims that 3M should be charging higher royalties for the trademark. 3M claims that it is bound by Brazilian legal requirements. The IRS argues that the amount charged is not at arm’s-length, because there should be a 6% royalty rate over the net sales of manufactured products.
In Brazil, outbound royalty payments are not subject to transfer pricing rules. Instead, there are fixed limits for deductibility and remittance requirements that must be observed. First, all the contracts must be submitted for analysis by the National Industrial Property Institute (INPI) and be registered with the Brazilian Central Bank.
Second, royalties related to the use of patents of invention, manufacturing formulas or processes, and expenses for technical, scientific, administrative or similar assistance are, in most cases, limited to 5% of the net revenue from the sale of products covered by the licence agreement or service provision agreement, but for some of them the limitation is lower, depending on the company’s activity.
Royalties for the use of brands (industrial or trademarks) pertaining to any type of production or activity, when not involving use of a patent, manufacturing formula or process, are limited to 1% of the same revenue.
Technical, scientific, administrative and related fees are also subject to the same requirements for deductibility and remittance of royalties, except for the fact that they can only be deducted in the first five years of the company’s establishment or the application process. Deductions can be, renewed for another five years if it is proved to be necessary.
Brazil and the US do not have a double tax treaty or any alternative dispute resolution mechanism so the outcome of the 3M Case is very important for planning and tax compliance purposes for companies investing in Brazil.