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Brazil: Brazilian Federal Revenue Authorities publish new administrative guidance

Tuesday, 07 October 2014   (0 Comments)
Posted by: Author: Durval Portela
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Authors:  Durval Portela, Phillippe Jeffrey and Mark Conomy (PwC Brazil)

On August 14, 2014, the General Tax Coordination Department (COSIT) of the Brazilian Federal Revenue Authorities (RFB) published Tax Ruling No. 224, providing that merger of shares, when carried out at a value which exceeds the book value of the shares (i.e. where a gain is deemed to have been realised) should be subject to capital gains taxation.

The tax ruling issued by the RFB is the latest development in an effort to provide administrative guidance in relation to this complex area of Brazilian law.

The concept of a merger of shares has been subject to considerable judicial debate. The results have been mixed with some decisions finding in favour of the taxpayer (i.e. considering the merger of shares does not constitute an alienation of shares), while others have been decided in favour of the RFB, viewing the merger of shares in a manner akin to alienation and, therefore, subject to capital gains taxation.

The tax ruling issued by the RFB draws a comparison between a merger of shares and a contribution of capital (i.e. the merger of shares constituting a capital contribution in kind), with a substitution of shares in the merged company for shares in the new parent entity. On this basis, any positive difference between the value of the shares received and the value of the shares contributed by the shareholder should be viewed as constituting a capital gain and be subject to capital gains taxation.

Contrary to the position held by the RFB, on May 19, 2014, the Specialised Federal Attorney (Procuradoria Federal Especializada or PFE), legal representative of the Securities and Exchange Commission (Comissão de Valores Mobiliários or CVM), published a legal opinion regarding the treatment of a merger of shares, attempting to provide clarity in relation to whether the merger of shares should be construed as ‘sale of shares.’

The key points addressed by the legal opinion can be summarised as follows:

  • The merger of shares is an operation specifically contemplated by Brazilian legislation. It is a transaction between two entities, in which one company becomes a wholly owned subsidiary of the other. 
  • The merger of shares is a different operation from the merger of entities, considering that in the former operation both companies continue to exist after the operation occurs (each with its own assets and liabilities, as well as distinct equities), whereas in the latter, one company will cease to exist. 
  • Further, the participants of the merger of shares operation are not the individual shareholders themselves, but the companies, who decide whether to implement the merger of shares at a general meeting and carry out all necessary formalities on behalf of the shareholders. Such operation requires approval by the majority of shareholders rather than unanimity with dissenting shareholders provided certain withdrawal rights. 

As such, the legal opinion considers that a merger of shares should not constitute an alienation of shares on the basis that the individual shareholders do not participate in the transaction.

PwC observation:

Despite a favourable legal opinion for taxpayers on this issue, it is important to note that the legal opinion is not binding on the RFB or the CVM and, therefore, the taxation consequences arising from a merger of shares remain subject to considerable debate, especially following the publication of a contradictory tax ruling by the RFB. For these reasons, specific advice considering a taxpayer’s individual circumstances should be sought prior to implementation of such an operation.

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