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Brazilian Tax Reform – Is This Time for Real?

The Brazilian tax system is largely considered one of the most cumbersome and complex systems in the world.  While there have been rumors of reforming the system over the years it appears the latest effort may have some momentum.  On July 21st, Paulo Guedes, Brazilian Minister of Economy, presented a draft bill (Bill No. 3,8877/220) encompassing the unification of federal taxes by creating a federal VAT, known as “Social Contribution on Goods and Services – CBS.  CBS will effectively eliminate both PIS and COFINS, which are Social Security Contribution assessed on gross revenues.  The proposed bill will be discussed and voted on by both legislative houses and if approved will be effective within six months of approval.

This bill is the first, in a phased approach to introducing wider tax reforms.  Other bill under consideration by the federal government include income tax reform, adjustments to the Excise Tax (IPI), reduction of social security taxes due on payroll and introduction of a new tax on digital payments. 

This article will take a brief look at CBS. 

What is CBS?

CBS is levied on imports and local sales of both goods and services, while export transactions would be exempt.  The bill proposes to treat the assignment and licensing of rights, including intangibles, as falling within the definition of imported services, thus subject to CBS.  As opposed to PIS and COFINS, which applies to non-operating revenue, CBS will only apply to revenues from operations.

It is intended to simplify tax on consumption and eliminate the different taxes and special tax regimes for various sectors of the economy, while promoting tax equity and savings to taxpayers.  The biggest benefit may be a reduction in the time companies spend on tax compliance and reduce never ending legal discussions currently taking place regarding the PIS/COFINS system.

Under the proposed bill, some notable special tax regimes will remain in place, including SIMPLES NACIONAL (for micro and small businesses), the Manaus Free Trade Zone exemption, and the exemption for basic food items.

What Is the CBS Tax Rate?

The Brazilian tax rate under the Tax Reform Bill will increase to 12% from the current regular tax rates for PIS and COFINS of 9.25%.  The calculation of the tax base is computed as follows: Gross Revenues excluding amount of ICMS (State VAT), ISS (Municipal Tax) and unconditional discounts.  The gross-up calculation would no longer be available.

Are Tax Credits Available in Calculating CBS?

In calculating CBS taxpayers will be allowed credits, comparable to the noncumulative system of PIS and COFINS, however without the restrictions currently applicable in the PIS/COFINS law.  Under the proposed methodology of calculating CBS, each part of the supply chain may consider credits over the amount paid by the supplier and detailed on an invoice, thus CBS effectively applies to the value added to a product or service provided by the taxpayer.

Other credits such as depreciation and rent expense, among other expense items are not permitted.  Any depreciation of assets placed in service prior to CBS coming into force will be allowed.

The Tax Reform Bill will permit taxpayers to accumulate credits during the quarter in an effort to compensate them with other federal taxes at the end of the quarter.  The five year Statute of Limitations would remain in effect and the value of the credits will not be subject to monetary restatement.

Credits made available by product purchases from companies subject to SIMPLES NACIONAL and from the Manaus Free Trade Zone will be available for use.  However, some products subject to a single level of taxation would not be creditable.  Items such as fuel, natural gas and cigarettes would be required to follow specific CBS calculation methods.

Relief for Tax Professionals?

In what can only be considered good news for tax professionals, the bill aims to significantly reduce the complexity currently involved in preparing tax returns.

What is the Impact on Digital Platforms?

Those digital platforms, acting as intermediaries will be responsible for the collection of CBS levied on the transactions completed through them in the event the seller does not issue an electronic invoice.

The impact will be felt by both digital platforms located abroad and the importer of the goods and services performed by individuals into Brazil.  The parties to the import transaction will be responsible for the payment of CBS.  In addition, the owner of the digital platform will need to register with the Brazilian federal tax administration to fulfill the related tax obligations.

Closing Thoughts

is this effort of tax reform in Brazil real?  The answer will become clearer over the next couple of months.  For U.S. companies with operations in Brazil, it is prudent to closely monitor these developments and plan accordingly.

Implementing a Tax Efficient Supply Chain Management Platform to Address Global Business and Tax Disrupters Impact on Operational Structures and Supply Chains

Global business and tax disrupters, such as COVID-19, Trade Wars, and changes to global tax laws are requiring MNEs to evaluate the impact of such disrupters on both their organizational structures and supply chains.

The main objective of global supply chain management is to achieve the greatest value possible at the lowest cost possible.  It is important to remember tax represents 20% of the costs incurred in the global supply chain.  Tax, in some form, is imbedded in virtually every transaction.   To fully appreciate the planning opportunities available by implementing a Tax Efficient Supply Chaim Management Platform (TESCMP), one must first appreciate the components of a globally integrated supply chain.  The globally integrated supply chain starts with Global Suppliers and ends with Global Customers, in between is the processes of Global Logistics, Purchasing, Operations and Market Channels. 

Global Logistics –  Is the part of global supply chain management that plans, implements and controls the efficient and effective forward and reverse flow and storage of goods, services, and related information between the worldwide point of origin and the worldwide point of consumption to meet global customer’s requirements.

Global Purchasing –  Tales place in the inbound or upstream portion of the global supply chain, it involves buying something (such as raw materials, component parts, work in process, products or services), and it should be strategically and tactically integrated with the elements of the production cycle for MNEs.

Global Operations – is the mechanism utilized by an enterprise to implement the MNE’s corporate strategy and facilitate the enterprise being market driven.  It involves the worldwide management of make-or-by decisions in global supply chains, global production and manufacturing, competitive priorities in such supply chains, total cost analyses in global supply chains, process-based quality standards, guidelines within the supply chain operations reference model, and decisions on the usage of operational providers within the realm of global operations across the supply chain.

Global Market Channels – involves the part of the global supply chain management that includes all activities related to sales, service, and the development of relationships, preferably long-term relationships with customers.  A critical component of market channels is the last mile of the supply chain.

Organizations face increasing pressure to avoid future disruption while reducing costs within the supply chain.  These pressures permeate though out each part of the supply chain.  Some of the more common items include:

  • Jurisdictional selection and physical location of the MNE’s logistics, purchasing, and operations;
  • Choice of suppliers and their physical location, focusing on manufacturing and distribution locations;
  • Examine when, within the supply chain, goods are branded and therefore value is added.  This exercise determines the situs of taxability and the value of goods for both income and property tax purposes.
  • The ability to attach value to certain intellectual property may impact customs and duties charged on the importation of goods.

Implementing TESCMP

TESCMP is an approach of overlaying tax strategies, transfer pricing, global mobility, indirect taxes and trade and customs to a company’s business processes.  The first step in implementing TESCMP is to map transactions flows and sort the activities within each process as high value versus routine functions. High-value functions drive companies’ strategic decisions; they determine what products to produce, which markets to enter and how best to execute the corporate strategy. High-value functions entail risk and should concomitantly earn higher returns.

It is people, however, who execute functions and manage risks. By redeploying decision-makers — and the functions and risks that they manage – to centralized and possibly tax-favored jurisdictions, companies may realize material operational and tax benefits through efficiencies and by earning a greater proportion of their profits in a tax-efficient location. Routine activities, deriving a smaller amount of taxable profits, might remain in higher-tax jurisdictions or re-locate elsewhere as business needs dictate. In an environment of hyper change where supply chains need to be nimble in order to avoid disruption, it is important to remember tax represents 20% of the costs incurred, thus planning for this cost is important to drive both operational and financial success.

USMCA and the Automobile Parts Industry

USMCA and the Automobile Parts Industry

In a recent study of census data, WorldCity reported trade between the U.S. and Mexico totaled $615 billion during 2019, and $612 billion between the U.S. and Canada.  Two-way trade between Canada and Mexico totaled $44 billion in 2019. 

For the period January to April, Mexico ranked No. 1 in total trade value with the U.S. at $176.13 billion. Mexico had exports of $72.81 billion and imports $103.33 billion in imports.  Canada ranked No. 2, with a total trade value of $173.84 billion.  Canada had exports of $84.01 billion and imports of $89.83 billion

This trend is expected to grow as Canada, Mexico, and the U.S. recently enacted USMCA.  The USMCA significantly rewrites the rules for trade in agriculture, manufacturing and services amongst Canada, Mexico, and the U.S.

The USMCA will directly benefit the automotive industry as one of the key components is a requirement 75% of a vehicle’s components are to be made in Canada, Mexico, and the U.S., to receive tariff free access to the three countries.  Another significant rule change is requiring that 40-45% of an automobile’s content must be made by workers earning at least $16 per hour.

USMCA is having a direct influence on discussions automobile parts manufacturers are having regarding nearshoring operations back to North America.  As mentioned in our article titled, “Repositioning of Auto Parts Operations from China to Mexico,” there are many reasons to nearshore the manufacturing from China.  Many companies point to being closer to their customer base, reduce tariff liabilities and security requirements.  It is not surprising to see Canadian, American, and other foreign companies look to take advantage of operating in Mexico and benefitting from the USMCA.

The Mexican benefactors to the repositioning of auto parts operations includes those regions along the U.S.- Mexico border, such as Tamaulipas, Nuevo Leon, Coahuila, Chihuahua, Baja California Norte.  These regions are home to hundreds of maquiladoras owned by U.S., foreign, and Mexican companies.  Maquiladoras provide jobs to thousands of workers and vital supplies to automobile assemblers.  On the U.S. side of the border, Texas, New Mexico, Arizona. and California benefit from increased maquiladora activity as these states are closely tied to Mexico and its economy.

In normal times, Mexican, Canadian, and American companies could expect a huge boost in business activity from the positive impact of the USMCA.   The COVID-19 pandemic is a major disruptor to business operations in all industries.  However, the combination of the pandemic and the USMCA may greatly enhance the prospect of more automobile part manufacturers looking to nearshore back to the North America.  Mexico, through the maquiladora program is open for business!

Repositioning of Auto Parts Operations from China to Mexico

Covid-19 has impacted global business in an unprecedented fashion.  There are virtually few industries immune to the impact, especially when you consider their position in the global supply chain.  As with any disruption of normal business operating processes, Covid-19 has created both winners and losers.  In pondering who the winners and losers are it becomes clearer when we consider an example, the automotive parts industry.      

The Chinese business model of producing quality products at a reduced cost has been very seductive to a countless number of industries, resulting in manufacturing jobs leaving the U.S. and relocating to China.  The automotive parts industry embraced this business model, however Covid-19 and the resulting disruption to their supply chains is likely resulting in a reevaluation of this position.  So, while it is likely China will experience a reduction in its manufacturing base over time, the question is who will benefit from the repositioning of manufacturing assets.  While there are several candidates to consider, we need to look no further than our neighbor to the south, Mexico.

Mexico has been a direct competitor to China in the auto parts industry for several decades.  The attractiveness of Mexico, as a center to place manufacturing and assembly activities is based on factors including lower wages and logistics costs, infrastructure and the favorable trade agreement with the U.S. and Canada (USMCA).

To appreciate the size of the auto parts industry in Mexico, we can look at recent data provided by the National Auto Parts Industry Association.  In a pre Covid-19 forecast, the value of auto parts manufactured in Mexico during 2020 was expected to exceed USD100 billion.  What will the actual results show once the full impact of the repositioning of manufacturing assets from China to Mexico becomes clearer? 

There are over 30,000 parts in a typical automobile.  Many of those parts including wire harnesses, seats and their parts, motors, gearboxes, die-cut parts, axles, braking mechanisms, lighting appliances, airbags, seat belts and many other components are manufactured or assembled in Mexico.  It is important to note that 80 percent of this production will be consumed in the U.S. marketplace.  Thus, it is a natural extension for Mexico to gain more auto parts manufacturing and assembly operations as the result of Covid-19 and the repositioning of manufacturing or assembly assets from China.

For U.S. auto parts manufacturers with current facilities in China, the repositioning of these assets to Mexico is typically undertaken by utilizing the Mexican maquiladora or IMMEX program. It is important to understand both the benefits and operations of a maquiladora.

Benefits of Utilizing a Maquiladora

  1. Ability to better compete in world markets by combining advanced U.S. technology with a qualified and cost competitive Mexican labor force and technical staff;

  2. Ability to continue to employ U.S. personnel in U.S. facilities in administration, warehousing, product finishing, etc.;

  3. Ability to own 100% of and efficiently control and administer a Mexican entity and operations;

  4. Ability to utilize U.S. technical and administrative personnel in Mexico operations (up to 10% may be non-Mexican and may obtain the required working visas), while providing U.S. personnel the ability to live in the U.S.;

  5. Ability to acquire, through a Mexican entity, fee simple ownership of land and buildings for industrial operations typically along Mexico’s border with the U.S.  Typical sites include Empaime, Guaymas, Hermosillo, Guanajuat, Monterrey, Queretaro, Saltillo, and Tijuana;

  6. Ability to import NAFTA origin raw materials, components, machinery, and equipment on a duty-free or NAFTA duty-rate basis;

  7. Ability to defer duties on imported raw materials until after the exportation of finished or semi-finished products, and the ability to take advantage of preferential duty rates under applicable Mexican Sectorial Programs;

  8. Ability to avoid non-tariff barriers;

  9. Ability to take advantage of preferential U.S. Customs and Border Protection programs which allow U.S. companies to import finished products and semi-finished products duty free or based on the value added in Mexico;

  10. State of the art infrastructure for the efficient cross-border transfer of goods, and simplified U.S. and Mexican customs clearance procedures;

  11. Ability to sell products in the Mexican market;

  12. Proximity to the U.S. market; and

  13. Access to Mexican and other Latin American markets.

The Maquiladora (IMMEX) Program

A maquiladora is an import/export program granted by the Department of Economy under the Decree for the Promotion of the Manufacturing, Maquiladora and Export Services Industries (IMMEX Decree) to a Mexican company that allows it to import, on a temporary basis, assets generally owned by its foreign maquila principal (FMP) to be manufactured and returned/exported. Raw materials temporarily imported under such regime are exempted of paying duties (IGI) upon its importation. In addition, the company must obtain a VAT Certification granted by the Service Tax Administration (SAT) in Mexico to avoid the payment of value added tax (16%) upon the temporary importation of machinery, equipment, and raw materials. Some IMMEX also obtain a PROSEC program which allows for the temporary importation of certain raw materials under preferential duties for the manufacturing of a specific sectorial product.

 The IMMEX Decree provides that companies may file for one program authorization (an “IMMEX Program”) to carry out export-related operations under one of several different IMMEX Programs.  The five programs include 1) Holding (Controladora de empresas); 2) Industrial; 3) Services; 4) Shelter; and 5) Third party company (Terciarización).  These programs are intended to allow Mexican companies greater flexibility to be more innovative and competitive in a globalized economy.

 Under the IMMEX degree, a U.S. company will qualify to operate under maquiladora status only if it has a corporate presence in Mexico.  The typical structure utilized by a U.S. parent company in the establishment of a maquiladora company is to form an S.A. de C.V. or an S. de R.L. de C.V.  The U.S. parent company can own 100% of the maquiladora. 

From an operations perspective, the U.S. parent company furnishes the machinery, equipment, raw materials, components, and supplies in consignment, pursuant to the terms of a bailment contract, for assembly or manufacture by the maquiladora. The U.S. parent company retains the title to all said materials, supplies, and equipment, as well as the semi-finished or finished products.  The maquiladora charges the parent company and invoices the parent company periodically a service fee for these assembly or manufacturing services based on its costs, plus a markup on an “arms-length” basis, in compliance with Mexican transfer pricing rules.  The U.S parent company funds the maquiladora operations by advancing funds for capital and operating expenses to the maquiladora on an as needed basis, in addition to funds paid for the service fees from time to time.  An inter-company payable in favor of the parent company usually accumulates; however, this may need to be capitalized periodically to avoid a potential phantom Mexican income tax on inflationary gains.

Next Steps

Before embarking on relocating auto parts manufacturing or assembly from China or the U.S. to Mexico, it is important to spend up-front time understanding the cost-benefit of utilizing the maquiladora program.  The best path forward is to engage a team of seasoned professionals to assist you from a legal, tax and supply chain perspective.  The team at Global Tax Focus LLC and our Global Collaboration Partners are available to assist you in evaluating the possibilities of doing business in Mexico.  Please reach out to us to schedule a time to speak to our team.

Final U.S. Anti-hybrid Provisions – The Impact To Multinational Groups with an Italian Subsidiary and Italian Groups with a U.S. Subsidiary

On April 7, 2020 the U.S. Treasury Department and Internal Revenue Service issued final regulations implementing the anti-hybrid provisions enacted by the Tax Cuts and Jobs Act (TCJA).  These rules apply with respect to notional interest deductions (NID) taken as from the fiscal year beginning on or after December 31, 2018.

These final regulations are of interest to multinational groups with an Italian subsidiary and Italian groups with a U.S. subsidiary.  The rules are focused on hybrid dividends, hybrid transactions and other transactions with hybrid entities. The U.S. rules are comparable to the hybrid mismatch rules as outlined under the OECD’s BEPS project.  The U.S. rules provide that deductions related to equity are considered a “hybrid deduction.”  The impact of these regulations on the Italian NID regime will likely result in a higher tax burden for U.S. companies while reducing the overall tax benefit available under the Italian NID regime.  This is due to the deductibility or inclusion in taxable income of payments made between Italian and U.S. related parties.

The Italian NID Regime

On December 24, 2019, the Italian Parliament approved the Budget Law for 2020, which contained a package of tax increases and decreases with varying effective dates.  One important enacted law reinstated the NID system that was repealed by the 2019 Budget Law. The NID rate provided for by the Budget Law for 2020 is 1.3%.  Under this regime, Italian resident companies and permanent establishments of non-resident companies may deduct notional interest from their corporate income taxable base. The NID is calculated according to the equity increase (ie, new equity rate) from the end of fiscal year, multiplied by a rate determined annually.    

Impact of the New Regulations to U.S. Groups with an Italian Subsidiary

Under U.S. tax law, a U.S. company is allowed a full “dividend received deduction”(DRD) for the foreign source portion of dividends received by the U.S. corporation from a foreign corporation in which the U.S. corporation is at least a 10 percent shareholder (CFC).  The rules disallow the DRD for any amount of the dividend received from a CFC for which the CFC receives a deduction or other foreign income tax benefit.

Starting with fiscal years beginning on or after December 20, 2018, the U.S. shareholder of the CFC must track all hybrid deductions claimed by the CFC.  The U.S. shareholder is allowed a DRD only to the extent that the DRD exceeds the total of the hybrid deductions tracked.  The result of the new regulations to U.S. group with an Italian subsidiary is the partial taxation of the dividend received.

Impact of the New Regulations to Italian Groups with a U.S. Subsidiary

Under U.S. law, certain deductions for related party payments made in connection with a hybrid transaction or made by or to a hybrid entity is disallowed.  In addition, the law addresses cases in which income attributable to an intercompany payment is either directly or indirectly offset by a hybrid deduction.  This limitation typically applies where the Italian company is receiving payments as a shareholder of the U.S. company or if the transaction is between brother-sister companies owned by a non-US Parent entity, including an Italian entity.

Multinational groups with an Italian subsidiary and Italian groups with a U.S. subsidiary should consider evaluating the new U.S. anti-hybrid provisions to avoid any surprises.

For additional information, please reach out to us.

U.S. Exports in the Post Covid-19 World

The impact of the COVID19 pandemic on global supply chains will play out throughout the world well into the foreseeable future.  In the U.S. the stark reality of relying on China as an integral manufacturer of many products that Americans gave little thought to prior to COVID19, has resulted in a groundswell cry to reevaluate this relationship moving forward.  From the C-Suite of large multinational corporations to closely held business owners the question of whether to move some manufacturing operations back to the U.S. is currently underway.  While it is impossible to move a foreign manufacturing facility overnight, some operations can be peeled back to the U.S. in short order.  This will likely result in the opportunity to export these products from the U.S., thus revisiting the vitality of the Interest Charge Domestic International Sales Corporation (IC-DISC) may be in order, especially for closely held businesses. 

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