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Philippe Jeffrey |
Gustavo Carmona |
On November 12 2013, the Brazilian government published Provisional Measure (MP) No 627 which profoundly changes many aspects of the Brazilian tax system, including the taxation of profits earned by foreign controlled and affiliated companies. These new CFC rules are still subject to further regulations to be issued by the Brazilian IRS. The current rules tax the undistributed profits in Brazil of foreign controlled or affiliated companies, which are considered to be available to the Brazilian parent on December 31 of each calendar year. Such rules have been the subject of much debate at both the administrative and judicial levels and have generated considerable legal uncertainty.
Unlike the current legislation, which does not distinguish between controlled and affiliated companies for CFC purposes, the new rules introduced by the MP provide for distinct tax treatment in each case.
With regards to controlled companies, while much of the debate surrounding current CFC rules revolved around whether both directly and indirectly controlled entities were within their scope, the new rules expressly apply to both directly and indirectly controlled entities individually ("look through approach"). As such, any investment in a controlled foreign entity must be adjusted annually to reflect the change in the investment value corresponding to the profits or losses of the directly and indirectly controlled entity, in proportion to the Brazilian parent's participation in its equity and any positive adjustment equivalent to profits earned abroad must be as subject to corporate income tax (IRPJ) and the social contribution on net income (CSLL) on a yearly basis.
Taxpayers will be allowed to consolidate positive and negative adjustments until 2017 if the controlled entity's profits derive from active income, which excludes income derived from royalties, interest, dividends, shareholdings and other financial operations. To benefit from this consolidation, the controlled entity may not be in one of these situations:
located in a country with which Brazil has not signed a tax information exchange agreement;
subject to a tax regime with a nominal income tax rate below 20%;
located in a low-tax jurisdiction or benefits from a privileged tax regime, or
directly or indirectly controlled by a company located in such jurisdiction or which benefits from the mentioned tax regimes.
If the taxpayer does not opt for the consolidation, losses will only be compensated by the foreign controlled entity with its own future profits for up to five years. Accumulated losses accrued before the new rules take effect may be compensated without time limitations.
Taxpayers may, at their discretion, choose to pay the income taxes due proportionally to the controlled company's results distributed to the Brazilian entity, in periods subsequent to that in which such results were generated. Yet, in the first subsequent year, 25% of such results will be considered distributed to the Brazilian parent and must therefore be taxed. If no further profits are distributed, the remaining 75% will have to be taxed in the fifth subsequent year.
While the previous CFC rules avoided double taxation to a certain degree by means of foreign tax credits granted in Brazil related to the income tax paid on the foreign entity's profits, the new rules expressly extend such credits to withholding income tax paid abroad on the profits distributed to the Brazilian parent, with no time limitation.
With regards to affiliated companies, the new rules do not require adjustments to the Brazilian entity's accounts as is the case with controlled entities but focus on distributed profits. Profits will be considered distributed to the parent when credited or paid or under specific circumstances as defined by the legislation. As such, any profits earned by a Brazilian entity through a foreign affiliate will only be taxable in Brazil on December 31 of the year in which they were actually distributed to the Brazilian entity if the affiliate is:
not subject to a tax regime with a nominal income tax rate below 20%;
not located in a low-tax jurisdiction or benefits from a privileged tax regime;
not directly or indirectly controlled by a company located in such a jurisdiction or benefits from a privileged tax regime; and
generates at least 80% active income.
If such conditions are not met, affiliated companies must follow the same rules applicable to controlled foreign entities.
Such new CFC rules will not apply to directly controlled foreign entities for activities related to the exploration of oil and gas in Brazil.
The new CFC rules will also apply to individuals who detain equity shares in controlled foreign entities. However, such rules only apply if the controlled entity is subject to a tax regime with a nominal income tax rate below 20%, located in a low-tax jurisdiction or benefits from a privileged tax regime or if the individual does not possess the proper documentation, duly registered with the appropriate authorities, which show the controlled entity's other stakeholders.
These rules will enter into effect from January 1 2015, though taxpayers may elect (irrevocably) to adhere to the new rules from January 1 2014. Considering that the rules were introduced by a provisional measure of the executive branch, the Brazilian Congress has up to 120 days to approve them and convert them into law. Certain amendments may be made to the text during this process.
Philippe Jeffrey (philippe.jeffrey@br.pwc.com) and Gustavo Carmona (gustavo.carmona@br.pwc.com)
PwC
Tel: +55 11 3674 2271
Website: www.pwc.com
