Brazil
Nelio Weiss and Philippe Jeffrey
PricewaterhouseCoopers
São Paulo
Nelio Weiss and Philippe Jeffrey of PricewaterhouseCoopers explain how taxpayers are faced with new court decisions at the same time as trying to deal with the effects of the economic downturn and new legislation
Despite growing vigorously in the first semester of 2008, the Brazilian economy suffered the effects of the world financial crisis, which had its peak in the last quarter of the year. The Brazilian GDP ended 2008 with an increase of 5.1%.
The initial effects of the crisis were felt in the Brazilian stock market, which plunged about 50% in comparison to its historic peak in May 2008, mainly due to the aversion to risk and outflow of international investments. The Brazilian economy was affected subsequently by a decrease in the country's export revenues and a contraction of domestic demand due to the internal liquidity squeeze provoked by the collapse of international credit, the fall of commodities prices and recession in developed economies. Facing this instability, the government and companies were nudged to act energetically and positively to mitigate the crisis's effects.
Aiming at increasing financial liquidity, the Brazilian Central Bank – BACEN extended credit to the banking system, injected new resources into three large federal banks and reduced official interest rates. Simultaneously, to sustain internal consumption levels, particularly in the economic sectors most affected by the crisis such as the automotive and construction industries, the government adjusted Brazil's well known heavy tax burden (about 37% of the GDP in 2008), adopting a whole set of tax incentives to stimulate domestic demand.
In its turn, the majority of Brazilian companies that planned new investments for 2009 to increase productivity, altered their business plans to more defensive strategies directed at cost reduction, reallocation of economic resources to profitable activities and realistic cash flow administration. As a result, major investments were put on hold and companies reduced their work force substantially.
After the initial shock, the Brazilian economic indicators for 2009 already suggest a recovery. Indeed, specialists predicted that the Brazilian economy would be one of the first to recover fully from the global financial crisis, either late this year or at the beginning of 2010. In this sense, the credit market is being normalised, domestic demand, especially in certain sectors such as automotive, is already at pre-crisis level and companies are resuming investments, Brazilian exports are growing again and there are elements suggesting that the unemployment rate is stabilising. Although the Brazilian economy seems to be in good shape, the government still has important issues to address to optimise sustainable growth, such as tax and institutional reforms, spending cuts and heavy investments in infrastructure. However, no significant changes should be expected as Brazil will prepare for a presidential election in 2010.
Jurisprudence
Tax treatment of cost-sharing agreements
On August 14 2008, Decision 23 was issued by the Brazilian tax authorities, reiterating their position in regard to expenses paid or incurred by a legal entity domiciled in Brazil to its related entity abroad, under a cost sharing agreement. In this context, the ruling set forth that such expenses may not be considered deductible for Brazilian Corporate Income Tax (IRPJ) and Social Contribution on Net Income (CSLL) purposes, once they refer to a permanent establishment located outside the country, and, thus, are not directly related to the calculation basis of these taxes in Brazil. The ruling mentions that the transaction is consequently not subject to Brazilian transfer pricing regulations.
The ruling also sets forth that even though the amount paid cannot be tax deductible, the payment to the foreign entity remains subject to withholding income tax and CIDE (a federal contribution) at the rates of 15% and 10%, respectively.
Although private letter rulings are not binding for all taxpayers (only the taxpayer to whom it was issued), it indicates and reinforces the view of the authorities on this matter.
Taxpayer's council decision on controlled foreign corporation rules
A Brazilian administrative court issued an unfavourable decision to taxpayers recently in regard to the taxation of income accrued by subsidiaries abroad. The decision said that the protection granted by the Brazil-Spain tax treaty (which provides that dividends paid from Spain to Brazil should not be taxable in Brazil) applies only to the operational income accrued directly by the foreign subsidiary and not by its indirect subsidiaries.
This decision may affect holding structures abroad, also in light of other tax treaties entered into by Brazil. Nevertheless, it is still subject to appeal and is not yet a definitive decision.
Additionally, the majority of decisions issued in this regard by the Council have been favourable to the taxpayer, determining that the exemption granted by the tax treaties also applies the income accrued by indirect subsidiaries.
Favourable court decision – Service vs Article 7 Tax Treaty
A Brazilian court of second instance in the State of Rio Grande do Sul issued an important decision recently on the non-application of withholding income tax on remittance for services to beneficiaries located in a tax treaty country.
The court ruled out that remittance for technical services (not involving a transfer of technology or know-how) to residents of Canada and Germany could not be subject to the Brazilian withholding tax because of the application of the article 7 (business profits) included in the Brazil-Canada and Brazil-Germany tax treaties (the latter was in force until the end of 2005), which states that Brazil would only have taxing rights if the foreign entity had a permanent establishment in the country.
The decision is an important precedent as it is well known that the Brazilian tax authorities do not apply the business profits principle to exempt income not subject to withholding under a specific article of a treaty (that is, income other than dividends, interest or royalties).
It is important to note that this decision is not final and may still be subject to further appeal by the Brazilian authorities.
Tax treaties
Income tax treaty between Brazil and Russia
The tax treaty for the avoidance of double taxation and the prevention of fiscal evasion concluded between Brazil and Russia on November 22 2004 is expected to be effective from January 1 2010.
The treaty, which is mainly based on the OECD model, sets forth standard regulations on permanent establishment and business profits issues and limits withholding tax rates on remittances. Yet, article 22 of the tax treaty, which grants taxing rights to the source country with respect to "other income", still demonstrates a clear protection of exclusive source-based taxation rights, which diverges from the OECD model convention.
Like most recent treaties concluded by Brazil, the treaty with Russia also includes a specific article about limitation of benefits and expressly sets forth that the provisions of the convention do not prevent a contracting state from applying the provisions of its tax law regarding thin capitalisation, as well as controlled foreign corporations (CFCs).
The regulations of the treaty limit withholding tax rates on interests and royalties to 15% and on dividends to 10% if the shareholder is holding at least 20% of the total capital of the company paying the dividends, or 15% in all other cases. Under Brazilian domestic tax law, dividend payments are not subject to income tax withholding.
The protocol of the treaty also sets forth that payments of interest on capital (as allowed by the Brazilian tax legislation), will be considered interest for the purposes of article 11 of the treaty and that payments of any kind received as consideration for the rendering of technical services and technical assistance should be covered by the application of the article 12 (Royalties). Lastly, it is also understood that payments of any kind concerning any transactions with respect to computer software shall be taxable by a contracting state in accordance with its domestic legislation.
New low-taxed jurisdictions list
On June 23 2008, the Brazilian Congress enacted new legislation which introduced, among other provisions, a broader definition of low-tax jurisdictions that entered into force as of January 1 2009. It is initially understood that the new definition of low-tax jurisdictions will have the effect of increasing the transactions subject to transfer pricing.
Yet, it is still unclear at this time to what extent the provisions will affect cross-border payments from Brazilian residents to beneficiaries located in tax havens (that is, potential increase of the withholding income tax rate applicable on interest, royalties and service payments, as well as capital gains). Brazilian tax authorities are still expected to issue an updated blacklist of low-tax jurisdictions.
Authorities amend transfer pricing legislation
For a fourth consecutive year and with the objective to minimise the effect for Brazilian exporting companies of the appreciation of the local currency in relation to foreign currencies (specifically the US dollar and the Euro, mainly during the first semester of 2008), the Brazilian authorities issued ordinance 310 and normative instruction 898 on December 29 2008, which amended transfer pricing legislation.
The legislation provided that Brazilian exporting companies were allowed to increase their export revenues only for calendar year 2008 (for transfer pricing calculation purposes) using the ratio of 1:20.
Consolidation of zero rate withholding tax provisions
Decree 6,761/2009 was enacted on February 6 2009, with the objective of consolidating existing provisions concerning the reduction of withholding income tax (to 0%) on amounts paid or credited to beneficiaries resident or domiciled abroad, relating to expenses such as market research, commissions, rent and lease of booths and space for exhibitions, fairs and similar events abroad, as well as services destined to promote Brazilian products and tourism destinations. Further regulations shall be issued to complement the rules stated in the decree.
Transitional tax regime
On December 28, 2007, new legislation altered and revoked several provisions of the Brazilian Corporate Act and also introduced new rules to adapt Brazilian accounting practices to international accounting standards as of January 1 2008.
Provisional Measure (PM) 449, enacted on December 4 2008, and converted into Law 11,941 on May 27 2009, guaranteed fiscal neutrality, that is, no adverse tax consequences should be triggered from the adoption of the referred new accounting criteria in connection with the recognition of revenues, costs and expenses computed on the assessment of net profits. To achieve this result, Brazilian taxpayers have the option to elect for a transitional tax regime (Regime Tributário de Transição – RTT), under which, for tax purposes only, taxpayers can calculate corporate income tax (IRPJ) and follow the applicable accounting criteria before the enactment of the new Corporate Act. The transitional tax regime is optional for the 2008 and 2009 calendar-years (mandatory as from 2010) and shall be in force until a new law is enacted setting forth the tax effects (if any) stemming from the new methods and accounting criteria. The option of the RTT for IRPJ also binds social contribution on net income (CSLL), PIS and COFINS (federal social contributions).
Tax measures for economic growth
Provisional Measure 451, enacted on December 16 2009, institutes the thresholds of monthly salaries for the calculation of individuals' income tax for the calendar-years 2009 and 2010. The new legislation also introduced two new intermediary income tax brackets (7.5% and 22.5%), with the intention of reducing the tax burden of middle-class individual taxpayers.
With the intention of controlling the fluctuation of the Brazilian currency, caused by the global financial crisis, Brazilian authorities published on October 23 2008, Decree 6,613 setting forth additional changes to the Tax on Financial Transactions (IOF). The main changes set forth by the decree which should have a particular impact on international transactions are the IOF rate reductions in connection with foreign exchange transactions. In addition, Decree 6,691, issued on December 11 2008, established a reduction of the IOF rate on credit transactions for individual taxpayers.
Finally, Decrees 6,687/2008 and 6,890/2009 introduced temporary rate reductions of the excise tax (IPI) levied on sales of vehicles, construction materials and home appliances. Such measures had already the effect of lowering the prices of such products, thus reducing the contraction on domestic demand.
Nélio Weiss (nelio.weiss@br.pwc.com) is an international tax partner with PricewaterhouseCoopers in São Paulo, Brazil and is responsible for the international tax services practice in South and Central America
Philippe Jeffrey (philippe.jeffrey@br.pwc.com) is an international tax senior manager with PricewaterhouseCoopers based in São Paulo, Brazil