Brazil: Impact of contingent consideration on tax amortisation of goodwill

In the context of M&A transactions in Brazil, the tax amortisation of the goodwill paid for the acquisition of equity stake in a Brazilian company stands out not only as one of the most discussed “tax incentives”, but also as the source of the most numerous tax assessments and involving the highest amounts under discussion in administrative courts.

One of the relevant topics is the tax treatment of contingent considerations and any other type of price adjustments and their effects on the tax amortisation of goodwill.

Law 12973/14, which intended to adapt the tax rules to the IFRS, introduced significant changes to the rules on the tax amortisation of goodwill in a manner to align them with IFRS 3 on business combinations.

According to current Brazilian tax rules, the goodwill paid by Brazilian companies for the acquisition of equity stake in other Brazilian companies (i) is generally part of the acquisition costs for the purposes of ascertaining the taxable capital gain upon a future sale of the investment, or (ii) may be deducted from the corporate income tax (IRPJ) and contribution on net profit (CSLL) calculation after the merger of the Brazilian investor into the target company, or vice versa, at a monthly ratio of 1/60 (i.e. a 5-year period).

Although IFRS 3 sets outs that the goodwill must be determined within a year of the business combination, M&A transactions regularly result in price adjustments for the following years, arising from earn-out payments or contingencies. Brazilian tax rules generally establish that tax effects of contingent considerations should be considered in the calculation of IRPJ and CSLL when the event that leads to the price adjustment occurs, regardless of the accounting procedures. However, such rules do not expressly regulate how these price adjustments should affect the tax amortisation of goodwill in different scenarios, i.e. if the merger has already been implemented and the goodwill is still being amortised for tax purposes (within the 5-year period after the merger) or when the goodwill has already been fully amortised for tax purposes.

In a ruling issued in 2016, Brazilian tax authorities analysed a case involving the tax legislation previously in force and concluded that a reduction in the price of the transaction arising from a breach of representation affects the consideration paid for the investment, and thus should impact the goodwill to be amortised for tax purposes. In this case, considering the goodwill was still being amortised by the surviving company of the merger, the tax authorities understood the amortisation expenses to be excluded from the IRPJ/CSLL calculation should be accordingly reduced as of that date, with no need to adjust the calculation of the taxes paid in the past. We are not aware of any other administrative or judicial decisions on the matter.

The same rationale could, in principle, be applied to the rules currently in force. However, questions remain open for several situations. What should be done if the goodwill has already been amortised? Could an increase in price be considered as a deductible expense immediately upon payment? How should the price reduction be reflected in the tax calculation?

These are common questions that may arise in the aftermath of M&A transactions in Brazil that require a careful analysis of the details, including timing of the payment and status of amortisation, to identify alternatives of tax treatment and the grounds to support them.

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