Taxation of Management Fees in Latin America

Latin American subsidiaries of US companies are caught in a bind. Parent companies in the US are being required by transfer pricing rules to charge foreign subs for services, but Latin American tax authorities often don't accept the service fees as deductible business expenses.

A recent article in Practical Latin American Tax Strategies, published by WorldTrade Executive reviews the tax deduction for management services in the major countries and provides some suggestions for ways to meet the deductibility tests. The article was prepared by some of the members of the Latin Tax practice at PricewaterhouseCoopers.

For example, for Brazil the authors note the following:

Expenses recognized by a Brazilian entity are deductible for tax computation purposes if:
1. actually incurred;
2. ordinary and necessary to conduct the business activities of the company; and
3. properly and adequately documented.

In the context of service fees, expenses will only be considered as actually incurred when the services (and related benefits) have been in fact received by the Brazilian Affiliate. In prior decisions, the Brazilian tax authorities and local courts have repeatedly ruled against the deductibility of expenses deriving from intercompany service agreements (particularly those related to cost sharing agreements) due to the lack of proof that the services and related benefits had actually been received by the Brazilian entity. It is indisputable from these cases that the mere documentation that the services were contracted, assumed and paid was not considered as sufficient proof.

Moreover, it should be noted that sufficient documentation is essential to substantiate any claims that the expenses are ordinary and necessary for the maintenance of the company’s activities and source of income, especially in the case of international intercompany service agreements.

For deductibility purposes, the Brazilian Affiliate will have to prove that it actually received an identifiable benefit from each of the charged services listed in the corresponding agreements. In this regard, Brazilian tax authorities may question expenses related to services provided to all beneficiaries of the group (such as the “Allocated Services”), if such expenses only result in benefits for certain Affiliates and do not clearly include the Brazilian Affiliate. That service fees paid to related companies abroad are often subject to special scrutiny by the tax authorities.

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