Brazil - Tax impact on warranty clauses | KPMG | GLOBAL

Brazil - Tax impact of warranty clauses

Brazil - Tax impact of warranty clauses

Tax impacts of warranty clauses in Brazil.

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Does the seller grant warranties or indemnities to the purchaser when acquiring a company?

Yes. Depending on the size of the deal, the Share Purchase Agreement will be subject to a review by the advisors of both the buyer and the seller in order to verify the impacts that may arise from the deal.    

Does the tax treatment of the warranty depend on its legal classification (e.g. indemnity vs. reduction in the purchase price vs. others)?

Yes. Depending on the wording of the SPA, the warranty may be (usually) classified as a holdback arrangement or as an indemnification and each classification has different tax consequences.    

Is classification of the contractual warranties as a price reduction clause or an indemnity clause relevant in your jurisdiction?

Yes.   

Are mixed clauses included in the SPA (for instance, a warranty drafted partially as a price-reduction clause for the portion corresponding to the purchase price and as an indemnity clause for the amount exceeding the purchase price)?

The usual recommendation is to avoid mixed clauses, since it might attract the tax authorities’ attention to the deal, as the mathematics involved might not be as simple. Also, it increases the risk of a tax assessment resulting from a tax inspection, since it would be harder to explain the logic behind the payments for the tax authorities.  

Is the classification usually mentioned in the SPA?

Yes, it usually is.   

Are there criteria to distinguish between a price reduction clause and an indemnity clause? Could you briefly describe these criteria?

A reduction in the purchase price is commonly written in the SPA and has a direct impact on the goodwill tax benefit calculation for the purchaser (i.e., if there is a price reduction, the amount of the goodwill will be lower and, therefore, the tax benefit arising from the amortization of the goodwill as well).

In case of an indemnification clause, it could be understood as a compensation for a loss or a refund. This clause may bring a tax impact upon the receipt of the amount for the benefiting party since it may be subject to taxes on gross revenues.  

What is the most common type of warranty in your jurisdiction?

Warranties could take the form of a price reduction or an indemnity. However, the price reduction is more often applied in acquisitions because there is a discussion over whether or not an indemnity should be treated as a revenue for its beneficiary, and so, taxes like PIS and COFINS (Brazilian Federal Taxes) would apply on it.  

Is a tax warranty usually provided by way of a separate warranty agreement (different from the SPA)?

No. The warranties are usually a part of the SPA and clearly classified.  

Is it usual / a market practice to negotiate after-tax settlements, i.e. to reduce the price adjustment to a net payment (i.e. indemnity minus the tax effect of the deduction for the acquirer or target) or to guarantee full indemnification (i.e. gross-up payment to guarantee a net indemnity)?

The market price is to guarantee a full indemnification.   

Acquirer

  Corporate Income Tax Personal Income Tax
Price reduction clause If the payment is qualified as a price adjustment, it will not be considered as taxable revenue but as a reduction of the goodwill. Therefore the goodwill tax benefit (possibility of deducting the expenses related to the amortization or depreciation of the goodwill for tax purposes) will be reduced. Nil effect.
Indemnification clause If the payment is qualified as an indemnity, it may be subject to tax. Individual income tax in accordance with a progressive table.

Vendor

  Corporate Income Tax Personal Income Tax
Price reduction clause Decrease on the purchase price may lower the amount of the capital gain. Decrease on the purchase price may lower the amount of the capital gain
Indemnification clause Nil effect. The price adjustment would be treated as a loss but whether it has any tax effect would depend on the individual’s situation.

Target

Price reduction clause Nil effect

Contact

Marcus Vinicius de Oliveira

KPMG in Brazil

Partner – Deal Advisory, M&A Tax

Tel : + 55 11 3940 3277

moliveira@kpmg.com.br
 

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