MODULE 2.11 BRAZIL OPTION

Transcription

1 THE ADVANCED DIPLOMA IN INTERNATIONAL TAXATION June 2018 MODULE 2.11 BRAZIL OPTION SUGGESTED SOLUTIONS

2 PART A Question 1 Part 1 At its first stage, Project B operations represent merely import of services by Brazilian residents. The exporter (service provider) would not have local presence and all activities would be performed abroad. The only connection with Brazil would be the client, source of payments. Therefore, all remittances would be subject to Brazilian taxes on import of services: Municipal services tax (ISS) and federal social contributions PIS, COFINS and CIDE. Because the remittance represents income earned in Brazil, the foreign provider of services will also be subject to income tax under withholding procedures. Not all taxes are cost for the Brazilian counterpart, unless the service agreement prescribes that all price is free from tax at source. ISS: Brazilian federal constitution and federal legislation (LC 116) provides that the rendering of services triggers a Municipal tax that may vary between 2% and 5% of the gross revenue (price of the services). Such tax is also applicable on import of services. The local client is the taxpayer responsible for its payment, so no withholding mechanism applies. The actual rate will depend on city regulations, since ISS is a tax regulated by federal LC 116, but subject to specific local law. Only activities listed by regulations are subject to ISS, but since such list is quite broad, the professional services rendered by Pearl are probably subject to tax. Since ISS is owed by the client in Brazil, it will affect the cost of such services (its value increases the cost with retaining the foreign provider). PIS and COFINS: Social contributions PIS and COFINS are federal taxes traditionally due over gross revenues (Laws 9718, and 10833). Since 2004 (Law 10865), Brazil also impose a 9.25% tax on import of services. There is no need to identify the nature of services in any list, as it happens with ISS. Virtually all kind of services imported by local taxpayers is subject to PIS/COFINS, that will be due at the price payment. Since the local client is the taxpayer, no withholding is needed and the contributions represent cost for the taxpayer (Brazilian client). However, if the taxpayer is under the so called non cumulative regime for such social contributions, and the services imported comply with some requirements (basically, if they are deemed to be an essential cost for the customer operations), the amount paid may be used as a credit to be offset with future PIS and COFINS owed on gross revenues. Therefore, such taxes may or may not be a cost for the importer, depending on its actual tax regime and the nature of such expenses when core business is taking into consideration. CIDE: Federal tax CIDE is a social contribution that is due on remittance of funds for the payment of technical services (Law 10168). There have been some dispute regarding the actual obligation when no transfer of technology is present, but currently CIDE applies to basically all technical and administrative assistance provided by non residents to local companies. The Brazilian customer is the taxpayer and should collect 10% of the price remitted as CIDE to the Federal Government. There is no withholding procedure and CIDE represents a cost to the Brazilian client. IRRF: finally, since the remittance of price represents income earned by Pearl from Brazilian source, it will be subject to federal income tax, under withholding procedures. IRRF is a tax owed by the income earner (Pearl) and therefore does not represent a cost for the Brazilian client, unless a gross up is due because the actual service agreement prescribes that price is free from local taxes in Brazil. IRRF is owed at 15% rate over the price, meaning that actual remittance will be of 85% of the agreed value. Part 2 At Project B second stage a local subsidiary is incorporated, meaning that the relationship with Brazilian clients is going to be a local one. The only foreign operation is one of investment, where Pearl Inc. is the controller of the Brazilian subsidiary Pearl Brazil. Page 2 of 20

3 Pearl Brazil is going to be a regular taxpayer in Brazil and pay all taxes owed by its businesses. Its profit after taxes may be remitted abroad as dividends to Pearl HQ. Dividends are tax exempt from income tax in Brazil, even when the beneficiary is a foreign investor. However, since dividend payment demands remittance of funds abroad, a foreign exchange transaction (buying of foreign currency) will occur. In such transactions another federal tax will be due tax on financial operations, foreign exchange ( IOF Exchange ). Currently, IOF Exchange is subject to a zero rate. Therefore, Pearl HQ should not expect any cost related to Brazilian income tax on its dividends flow. Any interest paid by Pearl Brazil is going to be subject to Brazilian income tax at a 15% rate, under the withholding procedure. Besides IRRF, the federal tax on financial transactions (IOF) is also due. If the interest payments is related to a loan with a deadline shorter than 180 days, a 6% IOF will be due by the Brazilian counterpart. If the debt is longer than 180 days, a zero rate is currently applicable. At last, if the interest paid are related to Interest on Net Equity legal option available in Brazil ( Juros sobre Capital Próprio, or JCP ), a 15% income tax is going to be withheld, but no IOF is due. Therefore, the flow of interest is always subject to income tax WHT at 15% rate. Pearl Brazil may expect IOF from zero to 6% depending on the nature and term of payment, but such tax is not owed by the foreign counterpart. Finally, interest paid by Pearl Brazil to Pearl HQ are subject to transfer pricing control in Brazil, but such would never impose a burden in Pearl HQ, but only potentially to Pearl Brazil deductibility from its own Brazilian income tax. Therefore, although no Brazilian income tax will be owned by Pearl HQ on any Brazilian dividends, it should expect a 15% cost on its income from interest from Brazil. Such tax would probably be subject to a foreign tax credit at Bonini, under the reciprocal treatment principal, which allows countries to offset foreign federal income taxes paid at source, even when there is no specific tax convention between the States. Part 3 Capital gains earned by non residents from the disposal of Brazilian assets are subject to income tax under the same rules applicable to Brazilian residents, even if the buyer is also a non resident (Law 10833, art Law 9249, art. 18). Pearl Brazil shares were not acquired under regular capital market operations (shares bought in local stock market), so the regular regime will apply. Therefore, if Pearl HQ sells its participation in Pearl Brazil with profit, it is going to be subject to federal income tax from 15% to 22.5%, depending on the size of such profit. The basis is going to be assessed as the balance between Pearl HQ investment cost versus total price of the deal. Gains are taxed as follows: Gain amount (prices minus cost): Rate of up to R$ 5 million 15% from 5 to R$10 million 17.5% from10 to R$30 million 20% Over R$30 million 22.5% The income tax on capital gains is subject to withholding procedure, meaning that the acquirer is responsible for its deduction from price and payment, even if the acquirer is also non resident (in this case, its legal representative in Brazil). Cost of foreign investments are usually registered at the Brazilian Central Bank. The cost should be considered in foreign currency, not Reais, to avoid taxing exchange variation. If part of the capital was invested in Reais (i.e., in Brazil), the capital gain calculation will follow the proportions of foreign investment (calculation in foreign currency) and national investment (assessment in Brazilian currency). The question does not open details on such proportions, so the assessment would basically follow the assumption that all investment is foreign (registered at Central Bank). Page 3 of 20

4 Brazilian income tax on capital gains may be imposed even if the sale does not occurs at Pearl Brazil s level, but at its controlling company (i.e., the ultimate beneficiaries sell Pearl HQ and all subsidiaries together to the new investor, meaning that the direct control of Pearl Brazil does not change). Any future royalties received by Pearl HQ would be subject to Brazilian income tax under withholding procedures. A 15% income tax will be collect by source, and unless a free of tax price is agreed, Pearl HQ will have to expect such cost. However, the income tax withheld in Brazil may be used as foreign tax credit, even if there is no tax treaty between Brazil and Bonini (reciprocity rule). Federal social contribution CIDE will also be levied at at 10% rate, but that is a cost for the Brazilian counterpart (Pearl Brazil). Part 4 If Bonini is regarded as a low tax jurisdiction or Pearl HQ is regarded as under a privileged tax regime all IRRF (income tax under withholding procedure) will be raised from regular 15% rate to 25% rate. That will affect any interests, royalties and income from services with Brazilian source. The 25% rate will also be applicable to any Brazilian income tax for capital gains. Therefore, any income with Brazilian source will be subject to a higher income tax rate if Bonini is regarded as a low tax jurisdiction, or Pearl HQ as under a privileged tax regime. Provisions similar to those for thin capitalisation are also applicable to interest paid or credited by a Brazilian entity to an individual or legal entity (whether or not a related party) resident or domiciled in a tax haven or in a jurisdiction under a privileged tax regime. In these cases, the interest expense is only deductible for Brazilian income tax purposes if it is viewed as necessary to the company s activities and the total amount of the Brazilian entity s debt with any foreign party resident or domiciled in a tax haven or in a jurisdiction under a privileged tax regime does not exceed 30% of the Brazilian entity's net equity. The Law also provides that amounts paid, credited, delivered, used, or remitted under any title, directly or indirectly, to related or unrelated individuals or legal entities that are resident or domiciled in a tax haven or in a jurisdiction under a privileged tax regime will only be viewed as deductible for Brazilian income tax purposes if all of the following conditions are met: (i) the effective beneficiary of the payment is identified; (ii) there is evidence that the payment beneficiary has operational capacity (i.e. substance); and (iii) there is adequate documentation to support the relevant payments and the corresponding supply of goods, rights, or utilisation of services. Part 5 If Bonini and Brazil enter into a tax convention under the OECD model some Brazilian income tax owed at source may be affected. Project B first stage (question 1): no Brazilian income tax would be not owed, since revenues from the provision of services are regarded as profits subject to article 7 of the treaty. Since there is no local presence, there is no permanent establishment in Brazil and all profit should be taxed at Bonini. ISS, PIS and COFINS would still be owned. Project B second stage (question 2): although article 10 of the model convention authorizes both the source country and the resident state to tax dividends (with limits from 5% to 15%), it would not affected Pearl HQ, since currently there is an exemption for income from dividends of a Brazilian company. Interest paid by Pearl Brazil would also be subject to article 11 provisions, meaning that both Brazil and Bonini may tax it, but Brazilian rate would be limited to 10%. Project B secret stage (question 3): capital gain from the disposal of Pearl Brazil shares should not be subject to Brazilian income tax, since article 13 of the model convention only authorizes the source country to tax gains from the disposal of real estate and assets from local permanent Page 4 of 20

5 establishments. According to article 12, royalties would not be subject to tax at source (Brazil), because there is no permanent establishment of Pearl HQ in Brazil at this stage. Page 5 of 20

6 Question 2 Part 1 Brazilian regulations regarding tax residency only state that companies domiciled in Brazil will be regarded as local taxpayers, disregard of its purpose, nationality or investors (RIR, 124, I + Art. 147, I). The concept of domicile is found at the Brazilian Civil Code (art. 75, IV), which states that entities will be regarded as domiciled where its administration and executive board are located, or where its own statutes indicate statutory seat. Since the question states that Scubahia was established in Salvador and incorporated according with local laws, it is assumed that it is a company domiciled in Brazil and, therefore, a Brazilian taxpayer. The fact that key decision were possibly made by conference call does not surely affirm that the company administration and/or board of directors happen in another place, so domicile is Salvador, Brazil and no further consequence derive from that remote meetings. Part 2 Scubahia own results are the ones realized by the company direct activities, with no subsidiaries involved. According to the question, they consist of local direct sales to third parties, local sales to BR2 and online sales with help of the European team. All total $10,000, are subject to Brazilian income tax. But only the part derived from the sales performed by the European team may be subject to income tax abroad, if the activities performed by such staff is regarded as equivalent to a Permanent Establishment in the country where the sales were performed. The revenues and profit from sale operations is typically subject to article 7 of the Model Convention, meaning that only the residence state (Brazil) is allowed to tax them, unless a permanent establishment is regarded to exist in the source state. Article 5 of the Model Convention defines permanent establishment as a fixed place of business. Although the European team never got a taxpayer id or official licenses to operate, if their business is deem to comply with the convention parameters and a permanent establishment is regarded to exist, the source countries will be allowed to assess income tax on that portion of Scubahia results. Part 3 As the controlling company, Scubahia is subject to CFC (controlled foreign companies) regulations in Brazil. It means that all results realized from its subsidiaries (controlled companies entities under control of the Brazilian party) and affiliates (companies where the Brazilian pary has influence, but not control) will be subject to income tax in Brazil. A foreign company under no direct control may still be regarded as equivalent to CFC if the control by the Brazilian party is exercised through other affiliated enterprises. Current regulations (Law 12973) states that Profits realized by a controlled foreign company (CFC) of a Brazilian company are subject to income taxation on 31 December of each year regardless of any actual distribution by the CFC. Under the regime, qualifying CFCs are taxed on an entity-by-entity basis (that is, individually regardless of the design of the corporate structure outside of Brazil). If proper conditions are met, a tax consolidation of CFCs results can be performed. This consolidation occurs at the level of the Brazilian shareholder, through which the accounting losses of a qualifying CFC may offset taxable income of another CFC. Under regulations issued by the Brazilian tax authorities (Ordinance 1,520/2014), the Brazilian shareholder can elect which non-brazilian entities are subject to tax consolidation. The conditions are: - the foreign results derive from countries with whom Brazil have formal exchange of information channels (including exchange of information clause prescribed by conventions that follow the OECD model); - the foreign results does not derive from privileged tax jurisdictions (i.e., where results are taxed at rates lower than 17%); Page 6 of 20

7 - the foreign results derive from entities that have more than 80% of their results from active businesses; and - the controlling Brazilian company adopt proper controls to identify all results segregated for each entity. Passive income, as interest, royalties and dividends, are not regarded as derived from active businesses and, therefore, are not eligible for consolidation. Qualifying non-cfc entities are subject to tax in Brazil on an actual or deemed dividend distribution to a Brazilian shareholder. A deemed credit of 9% of the CFC income subject to tax in Brazil is available for qualifying entities. The Brazilian corporate income tax on CFC income may be subject to installment payments over a period of eight years (12.5% payment per year), but the deferred tax liability is subject to adjustment based on London Interbank Offered Rate plus the US dollar currency exchange variation. A foreign tax credit is available to Brazilian companies on income taxes paid overseas. In general, the foreign tax credit is limited to the amount of Brazilian income tax on the foreignsource income. Therefore, each business unit have its own result and may or may not be considered as a CFC (controlled) or affiliate (under influence, but not controlled). JV will not be regarded as a CFC because Scubahia has only a 10% participation in it. It could not be regarded as equivalent to a CFC also because the Japanese investors who owns the other 90% are third parties not under Scubahia influence. Therefore, Brazilian income tax will only be due when the corresponding profits (10% of $1,000,000 = $100,000) are distributed as dividends. Since it did not happen, there is no Brazilian income tax due over JV results. Caribbean is fully owned by Scubahia and therefore is a CFC. It means that the $5,000,000 profit are subject to Brazilian income tax on 31 December of 2017, regardless of any actual distribution by the CFC. Since only 10% from the results are derived from active businesses (trading goods), such profits are not subject to consolidation, meaning that Scubahia could not offset possible losses from other subsidiaries. Asia is a CFC and its results will also be subject to Brazilian income tax on Since it is domiciled in a country regarded as a tax haven by Brazilian regulations, because it does not tax income, Asian results are not eligible for consolidation. Pacific is also a CFC, because it is fully controlled by Asian, which is fully controlled by Scubahia. Since its results for 2017 were already distributed as dividends to Asian, they were already considered for Brazilian income tax purposes. They would be taxed in Brazil even if they were not distributed and disregard of its actual active business (import and resell of goods) because Pacific is controlled by a tax haven resident. Latam results derive part from own active business (reselling of goods) and part from its controlled BR2 and BR3. Since Latam is fully owned by Scubahia, it is a CFC and will be subject to Brazilian income tax in However, the results deriving from BR2 and BR3 are excluded from income tax at Scubahia because they relate to profits already taxed in Brazil (where both Br2 and BR3 are established). Finally, since Latam is located in a country that has a Double Tax Treaty with Brazil that follows the OECD Model Convention, most of is results derive from its own active businesses and there is no privileged tax regime, Latam results are eligible for tax consolidation. BR3 is a CFC. However, since it is incorporated in Brazil, its results were already subject to income tax in Brazil and will not be considered again for Scubahia tax assessment. Page 7 of 20

8 BR2 is also a CFC, because Scubahia controls it through Latam and its own share participation. However, just like BR3, since it is incorporated in Brazil, there is no tax exposure on Scubahia as CFC concerns. Part 4 A negative result (loss) from one CFC may be offset with future positive results from the same entity. There is no authorization to offset such foreign loss with local positive results of the controlling entity. Such losses would not trigger Brazilian income tax under the CFC regime at the year when realized, and would reduce future Brazilian income tax exposure for that same CFC. This would not affect JV because it is not a CFC and would only be subject to Brazilian income tax when dividends are distributed, and such dividends would naturally be net of losses. BR2 and BR3 are not subject to CFC because they are companies already taxed in Brazil. So a negative result (loss) would only have this effect (offset with future profits of the same entity) for Caribbean, Asian, Pacific and Latam. If the CFC is eligible for the consolidation option, its negative result would enable Scubahia to offset the corresponding amount from other CFCs profits. As explained before, only Latam is eligible for consolidation, and therefore its profits could only be offset against its own profits, meaning the consolidation would not have practical effects. Page 8 of 20

9 PART B Question 3 Part 1 Treaty shopping is the practice of structuring a multinational business to take advantage of more favourable tax treaties available in certain jurisdictions. It generally refers to a situation where a taxpayer, who is resident in one state ( resident country) and who earns income or capital gains from another state ( source country), is able to benefit from a tax treaty between the source country and yet another country ( third country). Usually, the business that resides in a home country that doesn't have a tax treaty with the source country from which it receives income establish an operation in a second source country that does have a favourable tax treaty in order to minimize its tax liability (with the residence country). Treaty Shopping is not a direct violation of the Treaty rules, but an abuse on its application by someone who would not be originally thought as a beneficiary of its provisions. Countries attack this issues in different ways. Mostly, they include in their tax treaties or local regulation specific rules that limit the benefits under the treaty in certain circumstances. These rules are typically called limitation on benefits or LOB provisions. Domestic law anti-treaty shopping rules are often implemented by providing that only beneficial owners of the payments are entitled to treaty benefits. The OECD Model Convention and the OECD Commentaries on the Model Convention does not have an official description of the beneficial owners concept, although its articles 10, 11 and 12 do use the term. There have been some possibilities explored by international scholars as how to define it (using a common law approach, defining it as a tax concept solely, referring to domestic law, using the specific convention in context or, lastly, focusing on the treaty shopping avoidance). Basically, those options diverge from reference to domestic law or the construction of an international tax concept of beneficial owner. It is anyway targeted on avoiding abuses that may arise, as it happened in treaty shopping. Part 2 In Brazil, Law has firstly mention beneficial owner when determined that would also be regarded as tax heaven any jurisdiction which regulations do not allow access to corporate control composition or do not identify actual beneficiaries of income attributed to non residents. Law then brought a concept of beneficial owner ( efetivo beneficiário ), when restricting deductibility of expenses incurred in favor of residents of jurisdictions regarded as tax heavens. Basically, it states that the beneficial owner the individual or entity that was not constitute with the sole purpose of avoiding taxes and that realize income in its own name and not as agent of a third party. There are two main factors: first, the beneficial owner concept was created to avoid abusive tax planning, meaning that a real business purpose different than tax avoidance has to be present. Secondly, the income have to be realized in its own name, and not as a proxy or agent for third parties. The Brazilian conventions with South Africa, Belgium, Canada, Chile, China, South Korea, Equator, Philippines, Finland, Netherlands, Hungary, India, Israel, Italy, Mexico, Norway, Portugal, The Czech Republic and Ukraine all contain beneficial owner clauses on its articles 10 (dividends), 11 (interest) and 12 (royalties). Part 3 Aggressive tax planning consists in taking advantage of the technicalities of a tax system or of mismatches between two or more tax systems for the purpose of reducing tax liability. Aggressive tax planning can take a multitude of forms. OECD-G20 base erosion and profit shifting (BEPS) project refers to tax avoidance strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations. Action 6 of the BEPS initiative identifies treaty abuse, and in particular treaty shopping, as one of the most important sources of concerns. Page 9 of 20

10 In order to provide the clarification required by Action 6, it has been decided to (1) state clearly that States that enter into a tax treaty intend to eliminate double taxation without creating opportunities for tax evasion and avoidance. It was also recommended that (2) all treaties contains a specific Limitation of Benefits (LOB) clause. Finally, BEPS action 6 recommends that, (3) beyond LOB, in order to address other forms of treaty abuse, including treaty shopping situations that would not be covered by the LOB rule, a more general anti-abuse rule based on the principal purposes of transactions or arrangements (the principal purposes test or PPT rule) will be included in the OECD Model Tax Convention. Under this last rule, if one of the principal purposes of transactions or arrangements is to obtain treaty benefits, these benefits would be denied unless it is established that granting these benefits would be in accordance with the object and purpose of the provisions of the treaty. No Brazil convention has a clear statement that it intend to avoid creating opportunities for nontaxation or reduced taxation through tax evasion or avoidance. Brazil already have a LOB clause in its treaties with South Africa, Israel, Peru, Trinidad and Tobago, Turkey and Venezuela. The PPT rule resembles the Brazilian general anti avoidance rule (art. 116 of Brazilian Tax Code CTN), which authorizes tax administration to requalify transactions when an underlying purpose is hidden for the purpose of avoiding taxes. Page 10 of 20

11 Question 4 Part 1 This question is aiming at determining when the Convention already signed will be fully applicable and if something during its conversion may affect its effects. Brazilian Federal Constitution gives powers to the Federal government to celebrate international conventions. The President is the person authorized to sign such treaties. However, even after signed the convention is only applicable when internal procedures are followed. The President s signature only shows acceptance of the agreed terms and willingness to adopt it. Congress acceptance of such terms is necessary and, if approved in a referendum, is published as a legislative decree. Following Congress approval, the President will definitively confirm its intention by a ratification instrument, which will be exchanged for a similar one issued by the counterpart. This procedure set the moment when the convention is deemed as valid for international purposes (consensus). Finally, in order to be fully applicable in Brazil, the convention has to be promulgated by a decree enacted by the President and published at official media. This final stage gives internal publicity to the agreement, but is essential for its effectiveness. These stages must be fulfilled in the corresponding order. There is no ratification without consensus. However, once the consensus is achieved, Congress can not overrule it. Although there are procedures for fully effectiveness of the Treaty (articles 21, 84 and 49 of the Brazilian Federal Constitution), none of them could modify the terms and conditions agreed with foreign authorities. Therefore, the interested party may have to wait until internal formalities are fulfilled, but they should not mean that the tax incentives are subject to new limits. Part 2 Although there has been some dispute, current case law and most scholars agree that once ratified the international convention is not subject to modifications by internal law. The most acceptable interpretation is that the Federal Constitution has created a system ( monista ) when referring to rights and warranties, meaning that the international convention is valid until the proper international mechanism of revocation or modification is applied. No future internal laws could limit the treaty application, because it is the result of the special powers entitles to the President and the Congress. Tax Code article 98 also establish that tax treaties are hierarchically above internal law. Even though it is subject to a legislative decree and an executive decree to be fully effective, it is never actually transformed in local law, and its future modification will depend on another international convention. Part 3 Once all procedures for internal ratification are finalized, the international convention is fully applicable and can not be limited by State or Municipal regulations. Although signed by the President, his role is as an authority representing the Brazilian Republic, not the internal Federal Government. The limitations imposed on the Federal Union to create tax exemptions for State and Municipal taxes (art. 151, Federal Constitution) are applicable only for the Federal Union as in regard to internal public policy. When representing the country the Federal authorities act as an international agent and is authorized to create incentives that may affect State and Municipal taxes, as it was confirmed the the Brazilian Supreme Court (RE GATT convention). Page 11 of 20

12 Part C Question 5 Part 1 Since Palm Heart is entering into a loan agreement with its controlling foreign parent company, Exotic Foods, the interest expenses arising from such agreement will have its deduction from Brazilian income tax basis limited by local thin capitalization rules, as well as transfer pricing methods. The Brazilian thin capitalisation rules establish that interest paid or credited by a Brazilian entity to a related party (individual or legal entity), resident or domiciled abroad, not constituted in a tax haven or in a jurisdiction with a privileged tax regime, may only be deducted for income tax purposes if the interest expense is viewed as necessary for the activities of the local entity and the following requirements are met: i) the amount of debt granted by the foreign-related party (which has participation in the Brazilian entity) does not exceed twice the amount of its participation in the net equity of the Brazilian entity ii) the amount of debt granted by a foreign-related party (which does not have participation in the Brazilian entity) does not exceed twice the amount of the net equity of the Brazilian entity iii) the total amount of debt granted by foreign-related parties as per (i) and (ii) does not exceed twice the sum of participation of all related parties in the net equity of the Brazilian entity, and iv) in case debt is only granted by related parties that do not have a participation in the Brazilian entity, the total amount of debt granted by all of these related parties does not exceed twice the amount of the Brazilian entity s net equity. Consequently, if one of the mentioned 2:1 ratios is exceeded, the portion of interest related to the excess debt amount will not be deductible for Brazilian income tax purposes. Similar provisions are also applicable to interest paid or credited by a Brazilian entity to an individual or legal entity (whether or not a related party) resident or domiciled in a tax haven or in a jurisdiction subject to a privileged tax regime. In these cases, the ratio reduces to 30% of the Brazilian entity's net equity (0.3:1 ratio). The Brazilian transfer pricing rules apply to import and export transactions of goods, services, and rights between related parties (the legislation provides a broad list of the parties considered as related for transfer pricing purposes). Under such rules, the price determined between related parties shall be acceptable, for Brazilian tax purposes, if it is in accordance with one of the transfer pricing methods established by the legislation (no profit methods are available). Since there is no best method approach, taxpayers can choose the least onerous alternative for each good, service, or right on an annual basis). Moreover, all transactions with both tax havens and those subject to privileged tax regimes are subject to transfer pricing rules, whether involving related parties or not. Brazilian transfer pricing rules are applicable to interest derived from/charged to inter-company loans and/or with entities situated in low tax jurisdictions, and such interest must comply with the rates established below, in addition to a spread determined by the Ministry of Finance, in order to be acceptable for tax deductibility purposes: i) In case of transaction in US dollars, subject to a fixed interest rate: Rate of Brazilian sovereign bonds issued in US dollars in foreign markets. ii) In case of transaction in Brazilian reais, subject to a fixed interest rate: Rate of Brazilian sovereign bonds issued in Brazilian reais in foreign markets. iii) In all other cases (e.g. euros): LIBOR for the period of six months. Page 12 of 20

13 The additional spread is currently set at 3.5% per year, applicable to interest due to foreign related parties or to low tax jurisdictions, and 2.5% per year, in case of interest charged by the Brazilian entity. For transactions covered in item (iii) above, in currencies for which there is no specific LIBOR, the LIBOR for deposits in US dollars shall be the one to be considered. Part 2 Palm Heart s main activity is to extract, process and export food products to foreign companies controlled by Exotic Foods, which in turn distributes it in local markets. Since Pam Heart and its foreign clients are all controlled by the same parent company, Exotic Foods, such export revenues will need to comply with Brazilian Transfer Pricing rules. The Brazilian transfer pricing rules apply to import and export transactions of goods, services, and rights between related parties (the legislation provides a broad list of the parties considered as related for transfer pricing purposes). Under such rules, the price determined between related parties shall be acceptable, for Brazilian tax purposes, if it is in accordance with one of the transfer pricing methods established by the legislation (no profit methods are available). Since there is no best method approach, taxpayers can choose the least onerous alternative for each good, service, or right on an annual basis). Moreover, all transactions with both tax havens and those subject to privileged tax regimes are subject to transfer pricing rules, whether involving related parties or not. The adequacy of the price performed between related parties in any operations involving goods, services, and rights shall be supported by the application of one of the following transfer pricing methods, as determined in the Brazilian transfer pricing rules (the company may choose the most convenient method as there is no best method rule). The transfer pricing methods available for documenting the export transactions are: a) Export sales price (PVEx). b) Wholesale price in the country of destination less profit (PVA). c) Retail price in the country of destination less profit (PVV) d) Acquisition or production cost plus taxes and profit (CAP). e) Export of quoted commodities (PECEX) - applicable only to commodities. Relief of proof rules for inter-company export transactions is available. Exports of commodities, quoted in commodities exchange markets, must be tested by the use of specific methods called PCI and PECEX, respectively. Based on these methods, taxpayers shall compare the transaction amounts with the daily average quote for each product. Considering that Palm Heart has also been selling intellectual rights and services related to assistance on how to implement a faster and cheaper way of harvesting, such royalties and services would also be subject to transfer pricing as export revenues from related parties. Part 3 Since both Brazil and the source countries are taxing Palm Heart s revenues, the application of transfer pricing adjustments are causing an effective double taxation issue. In such cases, at least for the countries that have a Tax Convention with Brazil that follows the OECD Model, the taxpayer may provoke the authorities to search for a solution that minimizes that effect. Such situations are typically addressed by article 25 of the Model Convention, which states that Where a person considers that the actions of one or both of the Contracting States result or will result for him in taxation not in accordance with the provisions of this Convention, he may, irrespective of the remedies provided by the domestic law of those States, present his case to the competent authority of either Contracting State. Page 13 of 20

14 Question 6 Part 1 Brazilian legislation tries to identify a link of permanency to identify an individual as tax resident of the country. To ease such compliance, objective limits were drawn. Therefore, an individual is considered to be a resident for Brazilian tax purposes if he/she falls into one or more of the following situations: - Brazilian citizens living in Brazil - Brazilian residents living abroad for the first 12 months subsequent to their departure, in cases where no tax clearance certificate was filed - naturalized foreign nationals - foreign national holders of permanent visas and holders of temporary work visas under an employment contract with a Brazilian entity as of the date of entry to Brazil with such visa - holders of temporary visas without an employment contract with a Brazilian entity after completing 183 days of actual physical presence in Brazil within any 12-month period. A foreign national who enters Brazil with a permanent visa is considered to be a resident for tax purposes from the day of arrival and therefore, is subject to tax on his/her worldwide income. The holder of a temporary work visa is also considered to be a resident for tax purposes from the day of arrival if he/she has an employment relationship with a Brazilian entity. If there is no employment relationship with a Brazilian entity, the holder of a temporary work visa will be considered a resident for tax purposes after the 183 day of physical presence in Brazil within a 12-month period, beginning on the date of arrival or on obtaining a permanent visa, if this precedes the 183 days of physical presence. Upon leaving Brazil, taxpayers must break tax residency. In order to break tax residency in Brazil an individual must obtain a tax clearance. The tax clearance process involves the preparation and filing of a final tax return covering the period from 1 January to the date of departure. Any returns or balances outstanding from prior years must also be filed and paid. As a result of a failure to file in the tax clearance process, the individual will be regarded as a resident for income tax purposes during the first 12 months of absence and continue to be taxed on worldwide income. Individuals eligible for filing the annual exempt Brazilian tax return include: - holders of a CPF card, whether resident in Brazil or not, that were not required to file an annual income tax return in Brazil - any individual that has income of less than R$ ,70 This includes employment income as well as retirement plan distributions, pension income, and income from rental property - an individual listed as a dependent in the annual income tax return of another taxpayer and holder of a CPF number - a Brazilian citizen that lives outside Brazil that has filed a tax clearance process upon departure but wants to keep their CPF number in active status - an individual that lives abroad (Brazilian or foreign) that holds assets in Brazil or simply wants to keep the CPF regular and active. Therefore, the family situation is as follows: Stanley: not a Brazilian tax resident. Although he have never filed a notice of leave, since he left Brazil two years ago, with no further link to the country, he will not be considered a current tax resident. Maria: Brazilian tax resident. Even though she filed a notice of leave two years ago, she have come back to work in Brazil and isat the country for the last 13 months. She may have a tax exemption derived from her salary from U.S. federal government, but she is deemed as tax resident since she has enough link to the country. Page 14 of 20

15 Leonardo: probably not a Brazilian tax resident, since he lives abroad for the last three years. He may obtain residency status if his trips to Brazil last more than 183 days in any 12-month period. Lucas: Brazilian tax resident. Although probably a resident of the Caribbean country, with only foreign source income, he is deemed as a Brazilian tax resident because he is back in Brazil for seven months. João: not a Brazilian tax resident. Since he is living abroad for the last five years, he is not considered to have a strong link to the country, despite his income with local source. Part 2 Resident taxpayers are subject to pay income tax in Brazil on their worldwide (global) income, on a monthly cash basis. That would include not only salary, but capital gains and any other kind of revenue. Resident taxpayers are subject to withholding tax system on their Brazilian-sourced income based on a progressive tax table. They are also subject to the Brazilian monthly income tax on the sum of their offshore income (wages, compensation, interests, dividends, rental income, capital gains, and so on) and to file annual Brazilian income tax returns. Resident taxpayers are required to pay monthly income tax (a process called Carnê-Leão) on their income that was not subject to withholding tax by other local source. Generally, it means offshore income and rental income received from other individuals. This tax is also calculated based on a progressive tax table that has three rates: 0 percent, 7,5%, 15 percent, 22,5% and 27.5 percent. The payment has to be effected up to the last business day of the following month. However, dividends are tax exempt from income tax in Brazil, even when the beneficiary is a foreign investor. No family member will be exposed to Brazilian income tax on dividends arising from South Star. However, since dividend payment to foreigners demands remittance of funds abroad, a foreign exchange transaction (buying of foreign currency) will occur. In such transactions another federal tax will be due tax on financial operations, foreign exchange ( IOF Exchange ). Currently, IOF Exchange is subject to a zero rate. Therefore, Pearl HQ should not expect any cost related to Brazilian income tax on its dividends flow. A corporation is resident in Brazil if it is incorporated in Brazil. Since South Star is incorporated in Brazil, it is a Brazilian company and also a Brazilian asset for purposes of capital gain taxation. All family members will be subject to the same Brazilian income tax on capital gains from the disposal of South Star shares, because capital gains earned by non residents from the disposal of Brazilian assets are subject to income tax under the same rules applicable to Brazilian residents, even if the buyer is also a non resident (Law 10833, art Law 9249, art. 18). There is no information that South Star shares were acquired under regular capital market operations (shares bought in local stock market), so the regular regime will probably apply. Any profit from South Star shares sale is going to be subject to federal income tax from 15% to 22.5%, depending on the size of such profit. The basis is going to be assessed as the balance between investment cost of every individual versus his/her share of the price of the deal. Gains are taxed as follows: Gain amount (prices minus cost): Rate of up to R$ 5 million 15% from 5 to R$10 million 17.5% from10 to R$30 million 20% Over R$30 million 22.5% Page 15 of 20

16 In case of non residents, the income tax on capital gains is subject to withholding procedure, meaning that the acquirer is responsible for its deduction from price and payment, even if the acquirer is also non resident (in this case, its legal representative in Brazil). Part 3 Resident taxpayers are subject to pay income tax in Brazil on their worldwide (global) income, on a monthly cash basis. Investment income from sources outside Brazil is subject to tax at ordinary rates and the tax is required to be paid by the last day of the month following the month of receipt of the income. This income is included in the monthly Carnê-Leão and the corresponding taxes paid. A foreign tax credit mechanism exists in Brazil whereby taxpayers may receive a unilateral credit against Brazilian income tax for foreign taxes paid on non-brazilian-sourced income. The foreign tax credit is allowed for taxes levied in countries with which Brazil has an income tax treaty in effect or for taxes levied by countries whose legislation grants reciprocal treatment to Brazilian-source income and taxes. The foreign tax credit may not exceed the difference between the Brazilian income tax calculated without the foreign income and the Brazilian income tax calculated on a taxable base that includes foreign income. Brazil currently has tax treaties with 32 countries for the purpose of reducing or eliminating double taxation. Page 16 of 20

17 Question 7 Part 1 Brazilian legislation tries to identify a link of permanency to identify an individual as tax resident of the country. To ease such compliance, objective limits were drawn. Therefore, an individual is considered to be a resident for Brazilian tax purposes if he/she falls into one or more of the following situations: - Brazilian citizens living in Brazil - Brazilian residents living abroad for the first 12 months subsequent to their departure, in cases where no tax clearance certificate was filed - naturalized foreign nationals - foreign national holders of permanent visas and holders of temporary work visas under an employment contract with a Brazilian entity as of the date of entry to Brazil with such visa - holders of temporary visas without an employment contract with a Brazilian entity after completing 183 days of actual physical presence in Brazil within any 12-month period. Since Mr. Silva has two domiciles, businesses in both countries and file his tax return in Brazil, he is probably deemed as a Brazilian tax resident, even though the question did not clarify how many days each year he spends in Brazil. As a resident taxpayer he is subject to pay income tax in Brazil on his worldwide (global) income, on a monthly cash basis. Investment income from sources outside Brazil is subject to tax at ordinary rates and the tax is required to be paid by the last day of the month following the month of receipt of the income. This income is included in the monthly Carnê-Leão and the corresponding taxes paid. A foreign tax credit mechanism exists in Brazil whereby taxpayers may receive a unilateral credit against Brazilian income tax for foreign taxes paid on non-brazilian-sourced income. The foreign tax credit is allowed for taxes levied in countries with which Brazil has an income tax treaty in effect or for taxes levied by countries whose legislation grants reciprocal treatment to Brazilian-source income and taxes. The foreign tax credit may not exceed the difference between the Brazilian income tax calculated without the foreign income and the Brazilian income tax calculated on a taxable base that includes foreign income. Therefore, Mr. Silva has an important tax exposure in Brazil, related to all income with foreign source for the last five years. He would be liable for the tax assessed according to the regular tax rates over any income, plus interest and penalties for late payment. Part 2 Traditionally, countries do not have the power to enforce their tax collection on assets located abroad (the so called revenue rule ). Considering that the power to tax derives from the State sovereignty, and this is limited by the country s borders, the collection of tax abroad usually depended on international cooperation. Brazil does not have treaty language that allows local authorities to work with the taxing authorities in other countries to collect Brazilian taxes owed by Brazilian tax residents or their property located in those countries and to allow those countries to have Brazilian tax authorities collect from local residents or property located in Brazil. Therefore, currently it is not possible that Mr. Silva s apartment in New York is subject to Brazilian tax collection procedure. However, since FATCA was implemented and the countries have signed a TIEA, future developments may authorize such international constrictive acts. Part 3 Page 17 of 20

18 There are no trusts regulated by Brazil. However, the foreign trusts would probably be regarded as an entity segregated from any related party settlor, trustee and beneficiaries. When setting a trust, all Mr. Silva s assets allocated to the trust will be regarded as leaving his ownership rights. Assuming all taxes owed over such assets (and the income that has allowed its acquisition) were duly paid, there is no Brazilian tax cost on such transfer (from settlor to trust) maybe IOF on tax currency exchanges, if that is the case. There is no clear regulations on how to declare the trust rights on the settlor and beneficiaries tax returns in Brazil, but it seem correct to affirm that if any of the children is a Brazilian tax resident the future income deriving from the trust would be treated as inheritance equivalent, which would be graced with an income tax exemption, but subject to state inheritance tax (ITCMD) at the state of residency of the beneficiary. Considering that such income is foreign sourced, there is relevant case law affirming that no state inheritance tax would be owed by the beneficiary, but most states would try to collect such tax according to their local law. If the beneficiaries receive more assets/income from the trust that the settlor has originally transferred, such surplus might be regarded as additional income to which the inheritance income tax exemption would not apply. Furthermore, if such incomes deriving from the trust are paid in Brazil, a possible IOF would be triggered by the currency exchange transactions. Page 18 of 20