Cost sharing agreements: What can be expected from the possible replacement of PIS and COFINS in the context of Brazilian tax reforms?
An important aspect to be considered for adequate comprehension of the tax reflection of cost sharing agreements, both regarding the current incidence of PIS and COFINS[1] and their possible replacement with another levy falling on revenue, is the business justification for implementing a cost sharing structure.
Cost sharing is an arrangement frequently used by business groups, both domestic and international, to apportion costs incurred in the common interest of the members of the group, with the specific goals of achieving: (i) rationalization of costs; (ii) efficiency of management; (iii) increased productivity; (iv) savings; and (v) optimization of results.
These justifications are based on the interest of a business group in harmonizing and improving its internal control activity, especially to enable meeting the complex compliance challenges of the modern business environment. How can this be achieved?
On the one hand, each company can use its own internal control team, thus incurring the same costs to a great extent. This overlap of control costs is clearly redundant and would complicate the desire for internal harmonization and enhanced control.
On the other hand, one of the companies, namely that with the most qualified and experienced internal control team, relying on the best infrastructure, can assume the centralization of all the costs by performing the services for all the members of the group. Which model is more reasonable, efficient and economic?
The second option is obviously more rational and less costly, whereby a single company centralizes the control activities to the benefit of all the group’s members, with the expenses being apportioned among them and reimbursed to the centralizing member.
However, several questions arise here: How can the flow of resources between the companies operate? Do the reimbursed costs constitute revenue on one side and expense on the other? What “tax regime” should be attributed to those monetary transfers?
It is first important to stress that a cost sharing agreement, as the name indicates, implies the sharing of costs, without any profit margin or revenue markup on the amounts transferred within the group. The only thing that happens is simple reimbursement of costs.
As should be evident, the acquisition of wealth is a fundamental condition to legitimize the imposition of any tax or other fiscal levy (e.g., contribution). There can be no legitimate taxation without an increase in wealth.
In the case of the PIS and COFINS contributions, this element of wealth is based on Article 195 of the Federal Constitution, according to which: “Social security[2] shall be financed by society as a whole, directly and indirectly, under the terms of the law, with resources from the budgets of the Federal, State, Federal District and Municipal Governments, and from the following social contributions: I – from the employer, company or entity legally equated as such, applicable on: a) the wages and other earnings of work paid or credited, under any title, to individuals that render service thereto, even if without an employment relationship; b) the revenue or turnover; (…) IV – the importer of goods or services from abroad, or entity legally equated as such.
Hence, there are two situations with constitutionally distinct materialities, which presuppose as the element for ascertainment of wealth the revenue or turnover received in the case of domestic transactions, or the payment of the price for an imported service (or good) in the case of international transactions.
Hence, it is obvious that since in a cost sharing agreement what occurs is only reimbursement of costs, in the final analysis only representing recomposition of net worth, there is no ingress of revenue or payment for a service rendered. In short, reimbursement and payment received are distinct concepts.
In this context, the incidence of PIS and COFINS is not legitimate on the simple transfer of capital to recompose the costs incurred by the company of the group that centralizes the costs for certain activities in benefit of the other members, not for the purpose of lowering the tax burden, but rather to achieve greater management efficiency, increase productivity, obtain savings and optimize results.
However, the cost sharing agreement under Brazilian law is classified as an atypical contract, so there is no rule that regulates the fiscal effects, leaving the arrangement in a gray area.
The tax aspects of cost sharing agreements have therefore been developed over the years by the Federal Revenue Service, through consultation solutions[3], which can be represented on a timeline with the following sequence: (i) Consultation Solution 8/2012, which established the requirements that must be met for classification of a contract as a cost sharing agreement; (ii) Divergence Solution 23/2013, which analyzed these requirements and recognized the nature of reimbursement/recomposition of net worth of the money transferred, thus ruling out taxation, including PIS and COFINS, in the domestic ambit; and (iii) Consultation Solution 276/2019, which in the case of international transactions, held for the incidence of taxation, including PIS and COFINS, based on the characterization of importation of technical services.
The conclusion that can be reached from these expressions by the Federal Revenue Service is that the following requirements must be satisfied for a cost sharing agreement to meet its professed objectives: (i) the agreement must be in writing; (ii) the services performed by the cost-centralizing company cannot be part of its core business purpose; (iii) the criteria for apportionment of the costs must be objective and reasonable; (iv) the apportionment of costs must be fairly based on the services received by each company in comparison with the overall cost incurred by the group (generic reasonableness); (v) there must be no margin or markup; and (vi) there must be benefit to all the companies (mutual benefit – the arrangement cannot benefit one company of the group and not the centralizing member, for instance).
However, in practice, these requirements, especially regarding the reasonableness and objectivity of the apportionment criteria, can have varied interpretations by the tax authorities, as shown by the consultation solutions mentioned previously.
What can be said in general, in the case of domestic cost sharing agreements, is that in the majority of cases the Federal Revenue Service has been recognizing the non-application of PIS and COFINS, as well as other fiscal levies, on the flows of resources, holding they are not classified as revenues, but rather inflows for recomposition of net worth. As a natural corollary, there are no expenses that generate offsetting PIS and COFINS credits, other than what can be allocated to a member company in the agreement itself as arising from the costs incurred by the centralizer.
On the other hand, the same logic has not been applied to international cost sharing agreements, since the Federal Revenue Service insists on imposing fiscal levies, including PIS and COFINS, on the amounts reimbursed to centralizing companies located outside the country.
For this reason, many multinational groups decide not to implement international cost sharing structures in Brazil, based on the uncertainties about the fiscal regime applicable in the country.
The Administrative Tax Appeals Council (CARF) has also been following the trend of recognizing the freedom from taxation on the reimbursement/recomposition of net worth in domestic situations and not recognizing this immunity in the international arena, as can be noted from Decision no. 1401-004.049, by the 4th Chamber, 1st Ordinary Panel, of December 10, 2019, and more recently in Decision no. 1401-004.270 by the 4th Chamber, 1st Ordinary Panel, of March 11, 2020.
In the judicial sphere, an emblematic case was judged by the 4th Specialized Panel of the Federal Court of Appeals for the 2nd Region (TRF-2)[4], in which Luiz Antonio Soares was the reporting judge (decided on October 29, 2019), recognizing the assessment of another CIDE (Contribution for Intervention in the Economic System) over cost sharing agreements. More important was the decision by the Federal Supreme Court in an extraordinary appeal involving the incidence of CIDE, with the following headnote: “Extraordinary Appeal. Tax and Constitutional Law. Contribution for Intervention in the Economic System on remittances abroad. Laws 10,168/2000 and 10,332/2001. Constitutional profile and parameters for the exercise of competence of the Federal Government. Relevance of the matter and transcendence of interests. Theme 914. Existence of general repercussion.” (Extraordinary Appeal no. 928943 RG, Reporting Justice Luiz Fux, Court sitting en banc, judged on September 1, 2016, published on September 13, 2016.
Finally, there is doubt about possible changes in the rules and interpretations mentioned above regarding domestic and international cost sharing arrangements in the event that some other levy replaces PIS and COFINS as part of the tax reform under discussion in Congress.
Based on the foregoing, if a future legal framework constructed based on the proposals for tax reform currently under debate does not specifically define the tax status of cost sharing agreements, so that the levy(ies) that might replace PIS and COFINS continue to rely on the current constitutional and legal base for their legitimacy, namely: (i) the revenue in domestic situations; and (ii) the price of the services in international arrangements, the criteria established by the positions of the Federal Revenue Service, along with the administrative and judicial jurisprudence, will continue serving as guidance for drafting cost sharing agreements and gauging the risk resulting from implementation of those structures in Brazil.
André Gomes de Oliveira
Secretary-General of the Brazilian Association of Financial Law (ABDF), Brazilian IFA Branch
Senior Partner with Castro Barros Advogados
[1] PIS means the Contribution to the Social Integration Program, while COFINS stands for the Contribution to Finance Social Security (not to be confused with social security contributions on payroll). Contributions (contribuições) are taxes whose revenues are reserved for specific uses instead of going into the general fund.
[2] In the sense of well-being of society as a whole, not just the pension system.
[3] Consultation solutions are responses to formal queries posed by taxpayers regarding the interpretation of tax rules. The solutions are binding on the company or person posing the question and are published to provide guidance to other taxpayers
[4] Case no. 0178161-04.2016.4.02.5101/RJ.