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Brazilian Federal Revenue Service publishes Normative Ruling No. 1,786/2018 with rules relevant to the oil and gas industry

Oil and Gas; Tax

On January 30, 2018, the Brazilian Federal Revenue Service published Normative Ruling No. 1,786, of January 29, 2018 (“NR No. 1,786”), which regulates depreciation, amortization and depletion of assets admitted to Brazil under Repetro and later transferred to Repetro-Sped, and which amends NR No. 1,778/2017 , and NR No. 1455/2014 .

In the wake of various regulations published by the Federal Revenue Service in recent months, NR No. 1,786 clarifies certain tax treatment relating to E&P activities and relevant definitions for the application of these new tax treatments, in addition to rectifying flaws in other regulations, published recently, that have causing conflicting interpretations in the sector.

Among the key provisions introduced by NR No. 1,786, we highlight section 4, which establishes that the depreciation, amortization or depletion of assets admitted into Brazil under Repetro and later transferred to Repetro-Sped, and which were acquired by related parties under the definitive importation model, are limited to the net book value of the asset (i.e., deducting the depreciated, amortized and depleted amounts).

For the application of the above rule, NR No. 1,786 establishes that parties are related if: (i) the acquirer and the seller are controlled, directly or indirectly, by the same party or parties; (ii) their equity interest demonstrates a parent or affiliate relationship; (iii) if the acquirer is a partner, holder, director or administrator of the seller; or (iv) the acquirer and the seller are associated by a consortium or condominium in any business venture, as defined in Brazilian legislation.

It seems that, by limiting the depreciation, amortization and depletion of the acquired asset to its net book value, the Federal Revenue Service introduced, arguably without any legal basis, a restrictive condition on the deductibility of expenses for corporate income tax (IRPJ/CSLL) purposes, which may lead to controversies. 
Below we indicate the most significant amendments introduced by NR No. 1,786 to NR No. 1,778/2017 and NR No. 1,455/2014:

Amendments to NR No. 1,778

Amendments to the period defined as being the exploration phase. In accordance with the wording of NR No. 1,786, the exploration phase extends to: (i) the termination of the period established in the contract with the National Agency of Petroleum, Natural Gas and Biofuels (ANP); (ii) the time at which the exploration block is fully returned to ANP; or (iii) the filing with ANP of the so-called Declaration of Commerciality, whichever occurs first. The original wording of NR No. 1,778, in its item “(iii)”, established that the exploration phase ended at the “end of the assessment of the commerciality of the area relating to the production field” and not the filing of the “Declaration of Commerciality.

Deductibility of expenses in the production phase. In line with the general rules established in tax laws for deductibility of expenses from the calculation of corporate income taxes (IRPJ/CSLL), NR No. 1,786 introduces a provision clarifying that expenses incurred in the production of O&G may be fully deducted, in each assessment period, from the basis of calculation for corporate income taxes.
Coordinated operations for the extraction and movement of O&G. According to the amendments introduced by NR No. 1,786, the amounts invested in the exploration phase “include 
the set of coordinated operations for the extraction of oil or natural gas from a deposit and preparation for movement of O&G, except expenses related to development activities”. Identical wording was also included in the section dealing with the production phase.

Activities in the development phase. NR No. 1,786 includes “studies necessary and related to the planning and implementation of projects, analysis of reservoirs and production systems and obtaining necessary licenses for the implementation of projects”, among the activities in the development phase for deducting depleted assets from the basis of calculation for corporate income taxes.

Assessment of the total production and the volume of proven reserves. NR No. 1,786 introduces new language to the section in NR No. 1.778 that deals with accelerated depletion (unit of production method), which must be calculated on the basis of the ratio between the total production of the field in the assessment period and the volume of proven reserves in the same field existing on the last day of the prior assessment period. This calculation, as amended, must be made in accordance with the methodology adopted by ANP, which takes into consideration the production and reserves of oil and natural gas jointly. 

Amendments to NR No. 1,455

Percentages for the O&G contractual split. As expected by the industry, NR No. 1,786 corrected from 75% to 70% the percentage relating to the chartering of vessels with floating production or storage and offloading systems, which is now in line with the contractual split rules, effective since January 1, 2018, which was introduced by Law No. 13,586/2017. Notwithstanding this correction, note that Law No. 13,586/2017 grants the Minister of Finance the power, to be supported by economic studies, to raise the current percentages for the O&G contractual split by up to ten percentage points.

Inapplicability of the percentages for the O&G contractual split to maritime support vessels. NR No. 1,786 reproduces a provision established in Law No. 13,586/2017, which stipulates that the percentages for the O&G contractual split do not apply to vessels used in maritime support navigation and prohibits the retroactive application of these percentages to these types of vessels. Please note that the new wording introduced by NR No. 1,786 may be further amended due to a minor formal error that references an incorrect paragraph in NR No. 1,786/2018.

O&G contractual split rules for vessels used in regasification activities. NR No. 1,786 includes references to the section dealing with chartering of vessels related to LNG transportation, handling, transference, storage and regasification in every relevant section of NR No. 1,455 that deals with general rules for O&G contractual split (e.g. exchange rules, renegotiation and readjustment of contractual amounts). This is a formal correction because LNG-related vessels were not referenced in the general O&G contractual split rules in the original wording of NR No. 1,455. 

NR No. 1,786 came into effect on January 30, 2018.

²Regulates the levy of withholding income tax on income paid, credited, employed, delivered or remitted to entities domiciled abroad.

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