|July 6, 2011|
Previously published on May 2011
The Brazilian Federal Revenue Service (Receita Federal do Brasil - RFB) issued the Normative Ruling RFB 1.154/2011, on May 12, 2011 (published on May 13, 2011). Such piece of legislation intends to regulate local Thin Capitalization rules (Thin Cap Rules) that were relatively recently passed by the Brazilian Congress under the Law 12.249, of June 11, 2010.
In broad terms, Thin Cap Rules (worldwide) apply where there is an excessive debt over equity ratio among related parties. More specifically, Brazilian Thin Cap Rules set up limits (based on a debt/equity over net worth ratio or debt/net worth ratio) for the deductibility of interest expenses paid either to:
i) a foreign related party not located in a jurisdiction with a favorable tax treatment or a privileged tax regime (Tax Havens). In general terms, the debt may not exceed twice the net worth of the local entity (lenders with non-direct equity participation) or twice the equity participation of the foreign party on the net worth of the local entity (lenders with direct equity participation); or
ii) a foreign party located in a jurisdiction with a favorable tax treatment or a privileged tax regime (Tax Havens). The debt may not exceed 30% of the net worth of the local entity.
The main aspects of Normative Ruling RFB 1.154/2011 regarding Thin Cap Rules are the following:
- A formula to calculate the excess of interest expenses (non-deductible) based on the monthly weighted average debt of the local entity on the relevant transactions.
- Clarification regarding the inapplicability of Thin Cap Rules to debt transactions with local lenders, even when the guarantor or intervening party is a foreign. related party or a foreign party placed in a Tax Haven. Exception is made to an event of default, to which Thin Cap Rules shall apply for interest accrued as from the date the foreign party assumed the payment of the debt.
- Explanation regarding the calculation of limits for interest deduction.
- Enlightenment of certain aspects regarding the definition of a related party.
In our view, Normative Ruling RFB nr. 1.154/2011 shall be a key regulation in order to elucidate some unclear issues of the Thin Cap Rules brought by Law 12.249/2010. Such rules may affect many Brazilian entities and might be particularly relevant for local taxpayers (legal entities) with substantial debt financing received from foreign sources.