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The Brazilian Federal Revenue Service publishes Normative Ruling No. 1,778/2017 relevant for the oil and gas industry


On January 2, 2018, the federal official gazette published Normative Ruling No. 1,778 ("NR No. 1,778"), dated December 29, 2017, which stipulates: (i) the tax treatment of expenses for exploration, development and production of oil and gas ("E&P"); (ii) the registration of such expenses; and (iii) criteria for exhaustion and depletion of assets used in E&P activities.

Broadly speaking, NR No. 1,778 seeks to regulate the provisions in sections 1 and 2 of Law No. 13,586, dated December 28, 2017, which originated from Provisional Measure No. 795/2017, in particular with respect to the tax treatment of expenses relating to E&P activities to determine the basis for calculation of Corporate Income Tax ("IRPJ") and Social Contribution on Net Profits ("CSLL"). Additionally, it establishes the rules regarding the contractual split for the application of Withholding Income Tax ("IRRF") at a zero rate on cross-border payments in respect of the charter or lease of vessels. 

Although the wording of NR No. 1,778 is similar to that of Law 13,586, there are specific aspects that merit our attention.

With respect to expenses incurred in the exploratory phase, NR No. 1,778 maintained the tax treatment established in Law No. 13,586, which provides for the full deduction of such expenses for the purpose of calculating IRPJ and CSLL. NR No. 1,778 also provides the following clarifications: 

i. Expenses incurred in respect of exploration are deemed to include the cost of acquisition and processing of geological and geophysical data, surveys (such as, topographic, aerial, geological and geophysical surveys) and the interpretation of such surveys, drilling for the assessment and identification of areas of deposits and acquisition of related equipment, abandonment of exploratory wells, execution of production tests for the evaluation of discovery and necessary facilities to support exploratory activities, including expenses in relation to infrastructure, services and civil engineering works;

ii. Such expenses must be recorded in sub-accounts for the respective intangible asset, to be identified in accordance with the relevant exploratory blocks;

iii. The exploration phase ends upon: (i) the termination of the period contractually agreed with the National Agency of Petroleum, Natural Gas and Biofuels – ANP; (ii) the return of the total area of the block to ANP; or (iii) the evaluation of the marketability of the area, whichever occurs first.

With respect to expenses incurred in the development phase, NR No. 1,778 replicates the rules for deductibility of expenses related to the depletion of the corresponding assets and of machinery and equipment used in this phase, as established by Law 13,586. 

Furthermore, NR No. 1,778 defines development activities to be a set of actions and investments to enable the production of oil or natural gas and clarifies that: 

i. Development activities may be considered to be activities carried out in the production field relating to the drilling and completion of production and injection wells and construction of facilities for extraction, collection, treatment, storage and transfer of oil and natural gas, including preliminary studies and projects, offshore platforms, pipelines, treatment units for oil and natural gas, wellhead equipment, production pipes, flow lines, tanks and other facilities exclusively for extraction, as well as oil and gas pipelines, including their respective compression and pumping stations, which are directly connected to the delivery of the production flow up to the end of the section that exclusively serves the flow, excluding secondary distribution branches;

ii. The development phase begins upon the submission of the Declaration of Commerciality to ANP and can coexist with the production phase when new investments are made with a view to increasing the production or the recovery factor of the deposit;

iii. The book value of the assets resulting from expenses incurred up to January 1, 2018 will be segregated into two separate sub-accounts for each production field, one for the amounts already deducted and the other for the amounts not yet deducted;

iv. The book value of assets resulting from expenses incurred after January 1, 2018 will be recorded in a specific sub-account for the amounts not yet deducted, as mentioned in item “iii” above (if any), or in another asset account that identifies the production field. 

With respect to the contractual split, NR No. 1,778 amends NR No. 1,455, dated March 6, 2014 (which regulates the incidence of IRRF on cross-border payments) to incorporate the new rules introduced by Law 13,586 on the benefit of the zero IRRF rate in relation to contractual (charter/service) split.

In that regard, special mention should be made as to cross-border payments executed after January 1, 2018 in consideration for charter or lease of vessels with floating systems of production or storage and offloading. Whereas Law No. 13,586 reduces the applicable split charter/service ratio from 85%/15% to 70%/30% for the application of the IRRF at the zero rate, NR No 1,778 introduces a higher ratio of 75%/25% for these types of vessels. Such amendment may relate to the permission granted to the Minister of Finance in section 2, paragraph 8, of Law 13,586 by which he may change the percentage limit of the ratio between charter/lease and services based on economic studies.

Finally, NR No. 1,778 also regulates, by means of an amendment to NR No. 1455/2014, the rules for the calculation of the abovementioned percentages applicable to charter/lease agreements.

NR No. 1,778 came into effect on January 2, 2018.

Attorneys of the practices of Tax.

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