Deduction Of Royalties In Intragroup Transactions

We refer to the wrongful decision of the highest level of Brazil's tax administrative court1 (CSRF, Decision 9101-001.908 of May 13, 2014) against the deductibility for income tax purposes (IRPJ)2 of any royalties3 whatsoever (e.g. copyright royalties regarding software, books, songs, movie, magazine and cartoon characters) paid by a Brazilian company to its partners (individuals or legal entities, foreigners or not, with any shares), with the exception of royalties for patents and trademarks (forgetting that know-how is also included) regarding agreements signed from 1992 on with its foreign parent company. The case refers to software royalties. Nowadays intellectual property licensing agreements (e.g. patent, trademark, know-how) - import of technology - are still subject to strict regulations regarding necessary clauses of the agreements and, specially, the amount to be paid/remitted/deducted for tax purposes (limited to royalties of 5% instead of other transfer pricing rules methods), involving the Brazilian Patent and Trademark Office (INPI), the Central Bank of Brazil (Bacen) and the Brazilian IRS (RFB). Copyright royalties on the other hand are not subject to such restrictions and shall comply with Brazilian transfer pricing rules, although we are not aware of tax assessments in this regard. In order to understand and proceed with the adequate interpretation of Brazilian regulatory tax legislation regarding royalties for intellectual property rights it is necessary to understand the historic perspective of its enactment since royalties for intellectual property rights were one of the first instruments of abusive international tax planning in Brazil. In the 1950's Brazil taxed heavily a company's profit and its dividends with a joint taxation (income tax, compulsory loan, additional income tax and withholding income tax) that could reach 50% or more of such amounts. Royalties on the other hand were deductible without limitation and taxed by withholding income tax of 25%. There was also a shortage of dollars due to dividends remittances restrictions in several countries. Thus it was better to pay royalties than dividends. Corporate groups always look to the whole taxation of its transactions and since royalties had a lower taxation, abusive royalty rates of 10%, 15% or more were established in intragroup transactions regarding patents, trademarks and know-how (technical assistance). The problematic was limited to the transactions...