Brazil: Transfer of a going concern – what you need to know
Transfer of a going concern (TOGC) is commonly used in Brazil in asset deals and in internal reorganizations, such as carveouts. However, TOGC requires thoughtful planning as there are some important aspects to consider. We highlight some of those aspects below.
Brazilian legislation defines a going concern as a group of tangible and/or intangible assets intended for the performance of a business activity – ie, business units or the like.
There are several ways to implement the transfer of a going concern in Brazil, including a direct asset sale, drop down or other corporate restructuring modalities. Deciding on the best transfer alternative will depend on the specific case.
The main issues outlined below must be considered when planning a TGOC:
Potential exposure to liabilities: Unlike other jurisdictions, TOGC may cause the acquiring entity to be responsible for liabilities of the target company, which are not related to the business transferred. For example:
- Liabilities resulting from tax, employees and commercial contracts can be attributed to the acquiring entity if the purchase transaction is considered a TOGC in the country.
- Liabilities resulting from environmental issues can be attributed to the acquiring entity if the assets transferred include contaminated land or assets that caused a contamination.
The extent of those liabilities will depend on certain factors, such as if the transferring entity will:
- Continue to perform activities after the transaction.
- Have enough assets to meet its obligations after the transaction.
Under tax law, TOGC implemented under a direct asset sale or drop-down results in joint and several liability to the buyer, provided the seller ceases the exploitation of such going concern, except in very specific cases involving bankruptcy reorganizations (which is not the focus of this analysis). However, if the seller continues to exploit the same business or begins the same or a new business within six months from the sale event, the buyer is subsidiarily liable.
In a third-party transaction, the parties must consider the risks involved in a TOGC just as it would do in a stock deal. It is usually recommended that a buyer conduct due diligence to identify potential non-materialized and materialized legal and tax risks.
The parties can include representations, warranties, and indemnity provisions to address their liabilities in the related TOGC agreement. Such contractual provisions will serve as the basis for refunds and adjustments between the parties but will not affect regulatory authorities or relevant third parties.
Issues that can affect a transaction’s timing: The following key issues must be carefully mapped and discussed, as they may affect implementation timing:
- The TOGC’s chosen structure
- Obligations, contracts, licenses to operate, governmental authorizations and other business elements of the target company that will have to be altered to accommodate the acquiring entity as the new owner
- If the target company performs regulated activities in Brazil (such as in telecom, banking or energy), then any need for regulatory authorities’ prior consents or notices
- Need for notification of company’s creditors and/or waiting periods for creditors opposition. For example, if the sale of a business unit will cause the transferring entity to have insufficient assets to meet its obligations, the transaction's effectiveness will depend on the creditors' approval (which can be express or tacit) or their payment
- Contractual provisions preventing or imposing conditions for the transfer
- Need for prior incorporation of newcos to receive the assets and conduct business in the country directly – for example, in spinoff structures or if the buyer of assets is a foreign entity.
VAT considerations: One of the interesting benefits of a TOGC is the possibility of avoiding Brazilian VAT (ICMS). Under ICMS rules, a TOGC is exempt from ICMS. However, there are certain conditions which must be fulfilled to qualify for such exemption:
- The transfer must be of the whole establishment (ie, a factory, a distribution center) This usually is represented by a branch registered with the state tax authorities (state tax registration). The easier way to understand this requirement is that the state tax registration must be transferred as a whole.
- The inventory (goods) and fixed assets must remain in the establishment. Otherwise, the movement of inventory and fixed assets may trigger ICMS and no TOGC exemption will be achieved.
Accordingly, unlike in other jurisdictions, it is not possible in Brazil to do a TOGC for part of an establishment. For example, if the transaction involves the sale of a production line in a factory, where other lines will be retained by the seller, a TOGC is not possible. In this situation, the seller will have to perform an asset sale subject to ICMS, even if there is no physical movement of inventory and fixed assets (ie, by means of a carve out of the establishment).
Nevertheless, the buyer should be able to recover the ICMS charged on the transfer of inventory, but depending on the inventory rotation, there could be a cashflow disadvantage. Usually, the sale of fixed assets is either exempt from ICMS or subject to a lower effective tax rate (varies by State). Goodwill and intangibles (ie, client lists, IP rights) are not subject to ICMS.
Learn more about this process by contacting either of the authors or your usual DLA Piper contact.
Alex Jorge is co-head of Tax at independent Brazilian law firm Campos Mello Advogados and the firm’s co-practice group leader for Latin America. Reach Alex at firstname.lastname@example.org. Rafaella Chiachio is a partner in the Corporate practice of Campos Mello. You may reach Rafaella at email@example.com.
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