Recent Court Cases on Brazilian CFC Legislation. Jérôme van Standen November 2012

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1 Recent Court Cases on Brazilian CFC Legislation Jérôme van Standen November 2012

2 Agenda Brazilian CFC Rules 1. General Overview 2. ADI 2,588 Recent Court Cases 1.Eagle I and II 2.Camargo Correa 3.Normus 4.Vale 5.Marcopolo 6.Brazil Foods

3 Brazilian CFC Rules General Overview

4 4 Brazilian CFC Rules General Overview History Market globalization prompted the Brazilian government to adopt the worldwide income taxation regime for corporate entities as of January 1 st, 1996 Law 9,249/1995, regulated by Normative Instruction ( IN ) 38/1996, introduced the levy of corporate income tax on foreign profits, earnings and capital gains for corporate entities headquartered in Brazil

5 5 Brazilian CFC Rules General Overview Law 9,532/1997 brought to the Brazilian legal system criteria to determine the availability of foreign profits (i.e. in case of branches, at the moment of their inclusion on the company s book and in case of subsidiaries or affiliates, when they were paid, credited, used, delivered or remitted to the Brazilian legal entity) Foreign profits, earnings and capital gains recorded as of October 1 st, 1999 have become subject to Social Contribution Tax (CSLL), through Provisory Measure ( MP ) 1,858-7/1999

6 6 Brazilian CFC Rules General Overview Article 74 of MP 2,158-35/2001 introduced an automatic taxation system whereby foreign profits would be considered available to the Brazilian company by the end of each calendar year, regardless of actually distributed or not Enacted to regulate article 74 of MP 2,158-35/2001 (and to replace IN 38/1996), IN 213/2002 created special cases where foreign profits shall be considered as available to the Brazilian parent company for tax purposes Corporate entities recording foreign source earnings and capital gains must calculate Income Tax according to taxable profit based on accounting records

7 7 Brazilian CFC Rules General Overview Current Scenario Based on Brazilian domestic anti-deferral rules, profits of a CFC are subject to Brazilian corporate income taxes (CIT) on December 31 of each year (at a combined 34% tax rate), regardless of any actual distribution Relief from double taxation of the CFC s profits is available since Brazil allows foreign taxes (income tax of the CFC as well as the dividend WHT) to be credited against the Brazilian tax on the foreign profits (FTC) The FTC is capped to the amount of Brazilian corporate income taxes (34%) Excess FTC on the tax due on profits of one CFC cannot be credited against tax due on the profits of another CFC (i.e., no "blending" of the taxes of the CFCs)

8 8 Brazilian CFC Rules General Overview Excess FTC cannot be carried forward, unless the inability to credit the FTCs results from the Brazilian parent company incurring tax losses There is a risk that foreign taxes incurred cannot be credited in Brazil if not claimed within 2 years Losses of the CFCs cannot be offset with the profits of the Brazilian parent or with profits of other CFCs (i.e., no "blending" of the profits and losses of the CFCs) If the CFC is resident in a country with which Brazil has a tax treaty in force, annual recognition of the profits based on the Brazilian anti-deferral rules, might be deferred until actual distribution (under article 7 of the Double Tax Treaty). This position is the object of much controversy and litigation between taxpayers and the Brazilian tax authorities.

9 9 Brazilian CFC Rules General Overview Criticism Brazilian CFC rules are highly criticized due to: A company that holds an investment in a controlled or affiliated foreign company, which is in a profit position, should offer to taxation in Brazil such profits on December 31 of each year regardless of whether they were actually distributed or not Brazilian CFC legislation does not distinguish between: (i) passive or active income; (ii) tax regime to which the CFC is subject to (high or low taxed), (iii) type of company (no basket rules)

10 10 Brazilian CFC Rules General Overview In case the Brazilian company holds less than 20% of the participation in a CFC, automatic taxation does not apply cash basis CFC capital/operational losses cannot be picked up in the Brazilian parent There is no distinction if the CFC is a branch or a separate subsidiary It notably differs from international standards

11 11 Brazilian CFC Rules ADI 2,588 Article 74 of MP n /01 and its sole paragraph also brings an intense debate regarding their constitutionality since they introduced a triggering event for corporate income taxes, which seems to be not consistent with the tax legal system currently in force in Brazil The Brazilian Supreme Court is currently ruling on the constitutionality of the provision introduced in the Brazilian legal system by article 74 of MP n /01 and the paragraph 2 of article 43 of the Brazilian Tax Code (CFC Rules) - ADIn 2,588

12 12 Brazilian CFC Rules ADI 2,588 The judgment has started in 2001 and so far it is still very difficult to determine which will probably be the prevailing decision. So far, nine Ministers from the Supreme Court, from a total of 11 Ministers of which only ten are able to vote on the constitutionality issue, declared their opinion on the constitutionality issue: One Minister (Ellen Gracie) voted for the partial unconstitutionality in respect to foreign affiliates Four Ministers (Nelson Jobim, Eros Grau, Carlos Ayres Britto and Cezar Peluso) voted for the constitutionality and

13 13 Brazilian CFC Rules ADI 2,588 Four Ministers (Marco Aurélio, Sepúlveda Pertence, Ricardo Lewandowski and Celso de Mello) voted for the unconstitutionality of the CFC Rules Minister Joaquim Barbosa should be next one to vote on the constitutionality or not of the provisions Supreme Court Decision on Extraordinary Appeal (RE) (Leading Case): General repercussion confirmed Effects of a potential positive ruling

14 Recent Court Cases

15 15 Recent Court Cases Eagle I and II Cases (Ambev) In January 2005, Brazilian Tax Authorities assessed Brazil Abroad Ambev (Brazil) Bramahco (Gibraltar) Monthiers (Uruguay) Eagle (Brazil) CBB (Brasil) Jalua (Canary Islands) CCBA (Argentina) Eagle Distribuidora de Bebidas S.A. ( Eagle ) for not taxing the earnings of Jalua Spain S.L. ( Jalua ) and Brahmaco, its foreign subsidiaries in Canary Islands and Gibraltar, in accordance with Article 74 of MP n /2001. Jalua also owns two subsidiaries: Monthiers (Uruguay) and CCBA (Argentina) Eagle I refers to calendar years 2000 and 2001 (previous to the CFC rules currently in force), while Eagle II refers to calendar year 2002

16 16 Recent Court Cases Eagle I and II Cases (Ambev) In the case of Eagle I, the Administrative Tax Court has Brazil Abroad Ambev (Brazil) Bramahco (Gibraltar) Monthiers (Uruguay) Eagle (Brazil) CBB (Brasil) Jalua (Canary Islands) CCBA (Argentina) decided that neither the earnings of Jalua nor of its subsidiaries are subject to tax in Brazil due to the application of the provisions of Article 7 of the Brazil- Spain DTT, which determines that the business profits of a Contracting State shall be taxable only in that State Even though Tax Authorities presented an appeal, on September 13 th, 2011, the Superior Board of Tax Appeals ( SBTA ) could not analyze the matter because the case did not comply with the essentials requirements of the procedure

17 17 Recent Court Cases Eagle I and II Cases (Ambev) Otherwise, in the second case Eagle II, the Brazil Abroad Ambev (Brazil) Bramahco (Gibraltar) Monthiers (Uruguay) Eagle (Brazil) CBB (Brasil) Jalua (Canary Islands) CCBA (Argentina) Administrative Tax Court decided that the profits of Jalua are not subject to local taxation due to Brazil- Spain DTT, but the profits of Jalua s subsidiaries should be considered as directly received by Eagle (the indirect shareholder), which made them subject to taxation in Brazil under Brazilian CFC rules Such ruling seems to create a sort of tax transparency to the extent that only the profits accrued by the direct foreign subsidiary are protected by the DTT (on an individual basis)

18 18 Recent Court Cases Camargo Correa Case In this case, the Administrative Tax Court has ruled on Brazil Abroad Subsidiary (Portugal) Camargo Correa (Brazil) Subsidiary (Luxembourg) the taxation of the profits earned by subsidiaries of a Brazilian parent, located in Portugal and Luxembourg Both countries have concluded DTTs with Brazil The Administrative Tax Court ruled that article 74 of MP /01 actually provides for a deemed profit distribution, which should qualify as dividend income, subject to article 10 provision of the Brazil-Portugal DTT

19 19 Recent Court Cases Camargo Correa Case Although the Brazil-Portugal DTT prohibits the taxation Brazil Abroad Subsidiary (Portugal) Camargo Correa (Brazil) Subsidiary (Luxembourg) of the non-distributed profits (under article 10, paragraph 5), the Court understood that the DTT does not prevent Brazil from taxing the profits earned by the Brazilian shareholders of the Portuguese company As to the Luxembourg subsidiary, the Administrative Tax Court has ruled that it could not benefit from the Brazil- Luxembourg DTT since it was a Holding 1929 company (i.e. not subject to treaty benefits)

20 20 Recent Court Cases Normus Case On January 27 th, 2011, Administrative Tax Court Brazil Abroad Normus Emp. e Partic. Ltda (Brazil) VCP Overseas Holdings Kft (Hungary) decided for the taxation, for Brazilian corporate income taxes purposes, of profits earned by a subsidiary located in Hungary. The decision considered that, since the Brazilian company has recognized foreign profits for accounting purposes based on the net equity method of accounting, its profits, income and capital gain earned abroad should be taxed in Brazil in the end of each fiscal year, under Article 25 of Law 9,249/95 and Article 74 of the Provisional Measure 2,158/01.

21 21 Recent Court Cases Normus Case In the opinion expressed in the administrative decision, Brazil Abroad Normus Emp. e Partic. Ltda (Brazil) VCP Overseas Holdings Kft (Hungary) Article 7 of the Double Tax Treaty signed between Brazil and Hungary only protects profits earned by the foreign company and not by the Brazilian one, which is why the positive result (profits) derived from its foreign subsidiary cannot be excluded from the corporate income taxes basis.

22 22 Recent Court Cases Normus Case Despite the unfavorable decision, it is worth noting that Brazil Abroad Normus Emp. e Partic. Ltda (Brazil) VCP Overseas Holdings Kft (Hungary) one of the counselors, who decided this case, understood for the non-taxation of the result of the net equity method of accounting. In addition, this decision was unanimous with respect to the non-taxation of the currency exchange results registered over the foreign investment.

23 23 Recent Court Cases Vale Case On March 29 th, 2011, the Federal Judicial Court has Brazil Abroad Subsidiary (Belgium) Vale (Brazil) Subsidiary (Luxembourg) Subsidiary (Denmark) ruled on the taxation, for Brazilian corporate income taxes purposes, of profits earned by the Vale s subsidiaries located in Belgium, Denmark and Luxembourg The Court considered that Article 74 of the MP no 2.518/01 does not offend the concept of income established by Federal Constitution/88, given that the law may legitimately establish criteria as to determine when the profit is considered as available for tax purposes

24 24 Recent Court Cases Vale Case In its appeal, Vale claimed that Article 74 of the MP n o Brazil Abroad Subsidiary (Belgium) Vale (Brazil) Subsidiary (Luxembourg) Subsidiary (Denmark) 2.518/01 is incompatible with the treaties to avoid double taxation entered into by Brazil with the States of domicile of the subsidiary companies, as well as it has extrapolated the permission granted by Article 43, heading and paragraph 2, of the Brazilian Tax Code, which states that In the hypothesis of income or earnings arising abroad, the law shall establish the conditions and the moment at which they will be considered available, for purposes of the levy of tax referred to in this article

25 25 Recent Court Cases Vale Case However, the Court ruled that there is no infringement Brazil Abroad Subsidiary (Belgium) Vale (Brazil) Subsidiary (Denmark) of Tax Treaties. In their opinion, in accordance with said treaty, the State where the parent company is headquartered can tax not only the income earned inside its territory, but also the foreign income earned by subsidiaries located abroad Subsidiary (Luxembourg)

26 26 Recent Court Cases Marcopolo Cases The Brazilian Tax Authorities ("BTA") assessed MIC (British Islands) Marcopolo (Brazil) ILMOT (Uruguay) Marcopolo S/A for operations from 2001 to 2007, which consisted of exporting vehicle chassis and bodies to two subsidiaries: Marcopolo International Corporation ("MIC"), based in the British Virgin Islands, and Ilmot International Corporation ("ILMOT"), Uruguay They were also questioned about some sales to third parties based in tax havens. These export transaction were made to MIC and ILMOT - intermediating related companies, named reinvoincing centers - that marketed directly to end consumers

27 27 Recent Court Cases Marcopolo Cases As a result of this tax assessment, Marcopolo was MIC (British Islands) Marcopolo (Brazil) ILMOT (Uruguay) charged regarding corporate income taxes, ex-officio fine for fraud and qualified fine for not providing sufficient information when requested, as the BTA understood that the export transactions made by Marcopolo to its subsidiaries located abroad were a sham and lacked any real substance. The BTA also affirmed that the constitution of these trading companies was totally unnecessary and had the sole purpose of avoiding the taxation of the income in Brazil since the trading companies are located in tax havens. Both understanding were confirmed by the Taxpayers Council at the time

28 28 Recent Court Cases Marcopolo Cases This case has a relevant role in the analysis regarding the MIC (British Islands) Marcopolo (Brazil) ILMOT (Uruguay) economic substance necessary in a foreign corporate structure for Brazilian tax purposes In recent decisions as regards as different fiscal years, the Administrative Tax Court decided that (i) the named underpricing policy cannot be understood as income omission to the extent that the sales had accounting records, and (ii) there was no fraud as BTA were not able to prove the taxpayer s intention of sham, reason why the ex-officio fine was disqualified

29 29 Recent Court Cases Brazil Foods Case Although such decision has not been published yet, it seems to be relevant for CFC purposes from what the press has made available to us In this Case, the Brazilian parent owned one direct foreign subsidiary (first tier) and three indirect foreign subsidiaries (second tier) through such first tier one Brazilian Tax Authorities ( BTA ) have assessed individual results of all foreign subsidiaries although Normative Instruction 213/2002 provides for the vertical consolidation

30 30 Recent Court Cases Brazil Foods Case Under article 1, paragraph 6 of Normative Instruction 213/2002, the profits generated at the level of the foreign subsidiaries should be consolidated at the level of the first tier foreign subsidiary for the purposes of determining the profit subject to taxation in Brazil under Brazilian CFC rules In this context, the Administrative Tax Court ruled on the need for the vertical consolidation since only the consolidated result should be subject to taxation in Brazil under the applicable rules

31 31 Recent Court Cases Supreme Court Cases Constitutionality of Article 74 of MP /2001 COAMO RE EMPRESA BRASILEIRA DE COMPRESSORES S/A EMBRACO RE

32 Thank you!