Artigo publicado na Bulletin for International Taxation, 2017 (Volume 71), No. 6.
Autor: João Francisco Bianco Ramon Tomazela Santos
BRAZILIAN ANTI-AVOIDANCE LEGISLATION: RECENT REFINEMENTS AND MAJOR DEVIATIONS FROM INTERNATIONAL PRACTICE
1. Introduction
In 2017, the 71st Congress of the International Fiscal Association (IFA) will be held in Rio de Janeiro, from 27 August to 1 September, covering the following two main subjects: (1) base erosion and profit shifting and the practical consequences for domestic and multilateral laws; and (2) the future of transfer pricing.
This article provides a general overview of the main features of Brazilian anti-avoidance rules, with the objective of drawing attention to recent refinements and major deviations compared to the international practice followed by most countries. The article consists of two sections. Section 2.
provides the historical background on the Brazilian general anti-avoidance rule (GAAR) and the application of the “business purpose doctrine” by administrative courts in analysing tax planning structures. Section 3. considers the specific anti- avoidance rules (SAARs) in the Brazilian tax system, including controlled foreign corporation (CFC) legislation, thin capitalization rulers, transfer pricing rules, the limits on royalty payments and restrictions on the deduction of expenses.
2. The Brazilian GAAR 2.1. Background
In 2001, GAAR was introduced by article 116, sole paragraph, of the Código Tributário Nacional (National Tax Code, CTN),1 under which the tax authorities may disregard transactions carried out with the purpose of concealing taxable events or the nature of the elements of the tax obligation, in accordance with procedures to be established by an ordinary law. Thus, a GAAR was introduced into the Brazilian legal system, but its application requires further regulation by an ordinary law, which must establish the conditions, criteria and procedures to be followed by the tax authorities.
Tax authorities have tried to regulate the application of the Brazilian GAAR in the past, but those attempts have been repealed by the Brazilian Congresso Nacional (National Congress, CN). Consequently, the application in practice of the GAAR is not possible until further regulations have been enacted.
Taking into account the entire Brazilian tax system, it can be said that domestic GAARs have been repealed by the Brazilian CN on, at least, the following four occasions: (1) around 1966, when article 74 of the then projected CTN attempted to introduce an economic interpretation into the Brazilian tax system;
(2) in 2001, when the Lei Complementar (Supplementary Law, LC) 104/20012 tried to enact a very broad GAAR, which had been amended and restricted by the CN; (3) in 2002, when Medida Provisória (Provisional Measure, MP) 66/20023 was approved, but excluding the anti-abuse provisions originally envisaged; and (4) in 2015, when MP 685/20154 attempted to introduce the mandatory disclosure of tax planning in Brazil.5
2.2. The “business purpose doctrine”
Despite the lack of a GAAR that is in force, in recent years the Conselho Administrativo de Recursos Fiscais (Administrative Council of Tax
1 BR: Código Tributário Nacional (National Tax Code, CTN).
2 BR: Lei Complementar (Supplementary Law, LC) 104/2001 of 10 Jan. 2001.
3 BR: Medidas Provisórias (Provisional Measure, MP) 66/2002 of 29 Aug. 2002.
4 BR: MP 685/2015.
5 P. Ayres Barreto, Planejamento Tributário: Limites Normativos pp. 163-164 (Noeses 2016).
Appeals, CARF) has applied the “business purpose doctrine” in its analysis of tax planning structures, even in the absence of a sham, fraud or other flaws in the acts or legal transactions undertaken by taxpayers. The “business purpose doctrine”, which was initially developed in US case law by the US Court of Appeals (USCA) in Gregory v. Helvering (1934),6 has been embraced by several countries as a way of establishing whether a tax savings realized by a taxpayer is legitimate in the relevant domestic tax system.7 Briefly, the “business purpose doctrine” considers the reasons that motivated a taxpayer in undertaking a legal transaction or a corporate restructuring, the validity of which depends on the existence of non-tax reasons in the case in question. In some administrative decisions, it has been argued that the existence of business purpose is an essential condition for the validity of a structure adopted by a taxpayer.8 Consequently, it is necessary to consider whether a transaction has been undertaken with the sole purpose of obtaining a tax advantage, with no other relevant purpose other than a reduction in tax.
In practice, the examination by the administrative courts of the business purpose is undertaken on a case-by-case basis, with no specific consideration of the coverage, extension and application, based on a subjective analysis of the business or economic purposes as envisaged by the taxpayer with regard to the transaction. As a result, these decisions analyse cases of tax planning based on empirical or intuitive criteria, which can only be used as auxiliary elements in characterizing a flaw in an act or a legal transaction but not as a sole justification to requalify a legal transaction undertaken by a taxpayer, such as the lack of non-tax reasons, the corporate links between the parties involved, the status quo ante, i.e. the return to the initial state, and the short term nature of the transaction.
6 US: USCA, 19 Mar. 1934, Gregory v. Helvering, 69 F2d 809 (1934) and in the decision of the US Supreme Court (USSC) in US: USSC, 7 Jan. 1935, Gregory v. Helvering,
293 U.S. 465 (1935).
7 H. Ordower, The Culture of Tax Avoidance, Saint Louis U. Leg. Stud. Research Paper No.
2010-06, Saint Louis U. Sch. L. p. 50 (2010) and A.P. Polito, Helvering v.
Gregory All of the Perspectives from Which Learned Hand was Wrong, Leg. Stud.
Research Paper Series. Research Paper No. 14-33, Suffolk U. L. Sch. P. 67 (2014).
8 BR: CARF, 9 July 2013, Decision No. 1402-001.404; BR: CARF, 6 Nov. 2013, Decision No. 1202-001.060f; BR: CARF, 18 Aug. 2016, Decision No. 9101-002.429; and
BR: CARF, 5 Oct. 2016, Decision No. 1401-001.741.
In this sense, if a transaction undertaken by a taxpayer does not have any business or economic purpose other than the obtaining of a tax benefit and it can only be regarded as a way of deriving the lowest possible tax burden or a tax deferral, the Brazilian tax authorities may disregard the transaction.
According to the administrative federal courts, this is the case even without conclusive proof of the existence of a sham, abuse of rights or tax fraud.
Strictly speaking, the “business purpose doctrine” could not be used by itself to disregard or to requalify a legal transaction undertaken by taxpayers in Brazil, as the rejection of MP 66/2002 by the CN provides evidence for the absence of legal grounds regarding its use by the tax authorities. Consequently, despite the administrative case law in the opposite direction, the “business purpose doctrine” can only be used by the tax authorities as an auxiliary element in proving the existence of a sham with regard to the legal transaction undertaken by a taxpayer.
2.3. Current practice
In current administrative case law, the application of the “business purpose doctrine” may be criticized given the lack of the legal framework necessary to regulate its limits, as expressly required by article 116, sole paragraph, of the CTN. It is also important to note that, in the Brazilian tax system, tax planning is lawful and taxpayers can legitimately seek alternatives and structure their businesses in ways that are less burdensome from a tax point of view.
As a result, from a constitutional perspective, taxpayers can choose the legal acts and transactions offered by the private law that are best adapted to their needs. In other words, taxpayers have the right to choose, among several possible alternatives, the legal transactions that appear to be the most effective with regarding to organizing their affairs. Consequently, if the legal system provides different alternatives to achieve the same goal, taxpayers are free to choose that which is most convenient, even if this implies a lower tax burden. As a result, tax savings generated by valid legal transactions are the normal exercise of rights and the free exercise of economic activities, provided that there is appropriate correspondence between form and content, without a sham, abuse of right or fraud.
2.4. Shams and other legal defects regarding tax planning According to article 167 of the Brazilian Código Civil (Civil Code, CC)9 a sham exists where: (1) the legal transaction appears to confer or transfer rights to persons other than those to whom the rights are conferred or transferred; (2) the legal transaction contains an untrue statement, confession, condition or clause; or (3) the legal agreement has been pre- or post-dated.
Consequently, a sham affects the validity of legal transaction where it is undertaken in contradiction to the wishes of the parties, thereby giving rise to untruthfulness in respect of an entirely false transaction, i.e. an absolute sham, or the untruthfulness of a transaction that conceals another reality, i.e. a relative sham. In general, tax planning usually involves relative shams, as they conceal real situations that would otherwise result in higher tax burdens.
In addition to a sham, the tax authorities also argue that there are other defects in legal transactions in their attempts to curb tax planning undertaken by taxpayers, such as abuse of right, which arises when a transaction is carried out in excess of the limits imposed by the economic or social purpose of a right or not in good faith,[10 as well as fraud against imperative law, i.e. fraus legis, which occurs when there is intent to defraud an imperative law by way of devices that give the impression of complying with a law, in its literal sense, but which effectively violate its spirit.11
2.5. Administrative courts versus judicial court interpretations
At the level of the judicial courts, there are few precedents on the limits of tax planning. However, one thing is certain. The “business purpose doctrine” has not attained the same acceptance by judicial courts, as has been in
9 BR: Código Civil (Civil Code, CC), Law 10,406 of 10 Jan. 2002.
10 Id., at art. 187 states that “the holder of a right also commits an illicit act when in its exercise he expressly exceeds the applicable limits of its economic or social purpose, good faith, or civil conduct”. All translations from Portuguese into English are the authors’ unofficial translations, unless otherwise indicated.
11 Id., at art. 166, item VI, of the CC, which states “a legal transaction is null when … its purpose is to frustrate a mandatory law”.
cases before the administrative courts. This is confirmed by an analysis of a decision of the Superior Tribunal de Justiça (Superior Court of Justice, STJ),12 in which the STJ stated that:
“the economic element, although important for the assessment of the ability-to-pay of the taxpayer, does not prevail over the legal form, except if the tax authorities can prove the existence of a sham, malice or fraud in respect of the legal transaction.”
Consequently, the STJ has expressly rejected the “business purpose doctrine” as adopted in administrative case law, as well as the concept of the prevalence of economic substance over legal form.13 To sum up, the “business purpose doctrine” is still incipient at the level of the judicial courts, in which the decisions given to date adopt a more technical approach in the analysis of tax planning, based on the traditional concepts of a sham, fraud and abuse of right.
3. Brazilian SAARs 3.1. In general
As is widely recognized, SAARs are one of the primary tools used by countries to counter tax avoidance. In general, SAARs are typically enacted in response to abusive tax strategies exploited by taxpayers and harmful tax measures adopted by tax havens. The most important SAARs adopted by Brazil are summarized in sections 3.2. to 3.8.
3.2. CFC rules
According to the Brazilian CFC rules, profits derived by direct and indirect controlled companies domiciled abroad are subject to the imposto de renda das pessoas jurídicas (corporate income tax, IRPJ) and the contribuição social sobre o lucro líquido (social contribution on net profit, CSLL) on 31 December of each calendar year, regardless of the any distributions to the relevant legal entity in Brazil. The new CFC regime introduced by Lei (Law)
12 BR: STJ, 18 Mar. 2010, Special Appeal No. 1,119,405-RS.
13 The same line of reasoning was adopted in BR: STJ, 25 Aug. 2009, Special Appeal No.
946.707-RS.
12,973/201414 uses the expression “the portion of the adjustment of the investment value... equivalent to the profits” to describe the materiality, i.e. the economic substrate, that is to be taxed in Brazil. This wording was adopted to prevent discussion regarding the compatibility of CFC rules with the realization requirement and with the tax treaties that Brazil has concluded with other states.
Based on the wording of this legal provision, the tax authorities argue that the profits of a CFC abroad are a simple reference for the calculation of the income derived by the legal entity in Brazil, given the increase in the value of the equity held in the CFC. However, this is a mere play on words, as IRPJ and the CSLL are levied on the profits derived by the CFC, which are calculated on the basis of the applicable accounting rules in the foreign jurisdiction.
An interesting novelty of Law 12,973/2014 relates to the introduction of a deferred payment regime, under which, following the inclusion of the foreign profits in the tax bases in respect of IRPJ and the CSLL, the legal entity in Brazil can opt for the payment of the amounts due in instalments in proportion to the profits distributed. Under the deferred payment regime, the taxpayer must pay 12.5% of the taxes due in the first year following the relevant tax period. The remaining amount must be paid in proportion to the profits effectively distributed to the Brazilian legal entity up to and including the eighth year following the tax period.
The deferred payment regime was adopted by Brazil to mitigate the harmful effects of the automatic taxation of profits derived abroad on 31 December of each calendar year. The regime, however, avoids leaving the incidence of taxes due in Brazil as it is subordinated to the existence of a realization that would otherwise depend on the will of a taxpayer.
From a tax policy perspective, the CFC rules give rise to a provocative dilemma. On the one hand, the complete elimination of tax deferral by way of the comprehensive CFC rules puts multinational enterprises (MNEs) at a competitive disadvantage, which can result in corporate inversions to jurisdictions with less stringent CFC rules. On the other hand, the taxation of foreign profits only on distribution leaves the decision as to when tax will be
14 BR: Law 12,973/2014 of 13 May 2014.
levied to the sole discretion of the taxpayer, thereby permitting the permanent deferral of profits retained in CFCs abroad. Consequently, with the introduction of the deferred payment regime, the Brazilian legislator sought to adopt a compromise solution, which can be considered to be a midway point between these two alternatives.
A consolidated tax regime was also included in the new CFC rules, under which current profits and losses obtained by CFCs domiciled in different countries may be combined for tax purposes, except in relation to the following five situations:
(1) CFCs located in a country that does not have exchange of information with Brazil for tax purposes;
(2) CFCs located in low-tax jurisdictions or subject to privileged tax regimes;
(3) CFCs subject to a nominal tax rate of less than 20%;
(4) CFCs directly or indirectly controlled by a legal entity subject to the conditions noted in (2) and (3); and
(5) CFCs with active income of less than 80% of their total income.
As a result, up to the calendar year of 2022, the current profits and losses of CFCs located abroad can be computed in a consolidated manner to determine the final amount that is liable to tax in the hands of the parent company in Brazil. It should also be noted that the new Brazilian CFC rules introduced a deemed foreign tax credit of 9% on the profits earned abroad by CFCs that undertake industrial activities.
In general, despite the improvements introduced by the new Brazilian CFC rules, Law 12,973/2014, as with the previous legislation, retains an excessively rigid and distortive system in respect of taxation of foreign profits. This departs from the international standard and restricts the competitiveness of Brazilian MNEs engaged in cross-border activities.
Indeed, Law 12,973/2014 favours a tax policy that focuses only on increasing tax revenue, i.e. the “full-income inclusion CFC systems”, in a way that violates the ability-to-pay principle and harms economic development. In seeking a temporary increase in the tax revenue in the short term, Brazil has ignored the future effects that over-inclusive CFC rules could have by reducing the competitiveness of domestic companies in the international scenario and the attractiveness of Brazil as a location for headquarters companies. This may affect economic growth and, therefore, tax revenue in the long run.
In addition, over-inclusive CFC rules could stimulate corporate inversions on the part of Brazilian MNEs, as can be seen in the United States over the past years. Clearly, CFC rules only apply to profits diverted downwards in a corporate organizational structure, i.e. from parent companies to CFCs located in lower levels of a corporate holding structure, as they require corporate control.
Consequently, with the transfer of the control of CFCs to another company abroad, which is not controlled by the parent company headquartered in Brazil, the worldwide taxation provided for in Law 12,973/2014 can be avoided.
The distinction between active and passive income, as a requirement for taxpayers to access the special taxation regimes introduced by the tax legislator, is a further innovation introduced by Law 12,973/2014, compared to the repealed legislation. However, the distinction between active income and passive income does not align the Brazilian CFC rules with international standards, as Brazil has not adopted the transactional approach, in which only tainted income is subject to automatic taxation. Rather, the CFC regime adopted by Brazil still taxes all of the profits earned by a controlled company abroad, so that the distinction between active and passive income is only relevant in accessing special taxation regimes.
Finally, the ongoing debate regarding the compatibility of the Brazilian CFC rules with tax treaties should be noted. Specifically, the STJ, in National Treasury v. Companhia Vale do Rio Doce (2014),15 held that article 7 of the Belgium-Brazil Income Tax Treaty (1972),16 the Brazil-Denmark Income Tax
15 BR: STJ, 24 Apr. 2014, Special Appeal No. 1.325.709/RJ, National Treasury v.
Companhia Vale do Rio Doce, Tax Treaty Case Law IBFD.
16Convention between the Kingdom of Belgium and the Federal Republic of Brazil for the Avoidance of Double Taxation and the Settlement of Certain Other Questions with Respect to Taxes on Income [unofficial translation] (23 June 1972), Treaties IBFD.
Treaty (1974)17 and the Brazil-Luxembourg Income and Capital Tax Treaty (1978)18 prevents the application of Brazilian CFC legislation. The decision is a very important precedent for the taxpayers, as it recognizes that article 7 of such tax treaties has an objective scope, rather than a subjective scope, thereby protecting the profits of an enterprise resident in a contracting state.
Consequently, even if it is assumed that tax treaties do not limit the right of a contracting state to tax its residents, it is clear that one contracting state cannot tax the business profits earned by a company resident in the other contracting state, irrespective of who is the taxpayer liable for the payment of the tax due.19
3.3. Thin capitalization rules
Law 12,249/201020 introduced thin capitalization rules into the Brazil tax legislation to limit the deduction of interest paid or credited by a Brazilian source either to individuals or legal entities domiciled abroad that are considered to be related parties, domiciled in lowtax jurisdictions or subject to privileged tax regimes. According to article 24 of Law 12,249/2010, interest paid or credited by Brazilian companies to related parties domiciled abroad is only deductible in respect of IRPJ and the CSLL if the following three limits are met:
(1) if the creditor holds directly an equity participation in the Brazilian company, the indebtedness cannot be greater than twice the participation of the related party in the net worth of the Brazilian company, i.e. a stand-alone test;
17Convention between the Government of the Kingdom of Denmark and the Government of the Federative Republic of Brazil for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income (27 Aug. 1974), Treaties IBFD.
18 Convention between the Federative Republic of Brazil and the Grand Duchy of Luxembourg for the Avoidance of Double Taxation with Respect to Taxes on Income and Capital [unofficial translation] (80020Nov. 1978), Treaties IBFD.
19 L.E. Schoueri, The Objective Scope of Article 7 and the Treaty Protection to Deemed Distributed Dividends, Kluwer Intl. Tax Blog (27 Apr. 2015), available at www.kluwertaxlawblog.com/blog/2015/04/27/the-objective-scope-of-article-7-and- the-treaty-protection-to-deemed-distributed-dividends.
20 BR: Law 12,249/2010 of 11 June 2010.
(2) if the creditor does not hold an equity participation in the Brazilian company, the indebtedness cannot be greater than twice the total net worth of the Brazilian company, i.e. a stand-alone test; and
(3) in addition to the two limits referred to in (1) and (2), there is a global limit on deductibility that encompasses all of the indebtedness with related parties, which cannot be greater than twice the total amount of the equity participation held by all of the related parties in the net worth of the Brazilian company, i.e. an overall test.
In practice, if these individual or global limits are not satisfied by the Brazilian company, i.e. the borrower, the excess amount of interest is considered to be a non-deductible expense for tax purposes.
In addition, article 25 of Law 12,249/2010 establishes a lower debt/equity ratio in respect of the financial transactions carried out with individuals or legal entities located in low-tax jurisdictions or subject to privileged tax regimes. In this case, the indebtedness cannot exceed 30% of the net worth of the legal entity resident of Brazil.
Table 1 summarizes the most relevant aspects of the Brazilian thin capitalization rules.
Table 1: Key aspects of the Brazilian thin capitalization rules Location of the
lender Regular jurisdictions Low-tax jurisdictions or privileged tax regime
Lender Direct
shareholder
Foreign related party without
equity participation
Any individual or legal entity Debt/equity
ratio 2:1 0.3:1
Stand-alone test Direct shareholder debt
versus
Related-party debt versus.
debtor’s total net
Total debt versus debtor’s total net equity
Location of the
lender Regular jurisdictions Low-tax jurisdictions or privileged tax regime shareholder’s
net equity ownership
equity
Overall test
Total direct shareholder debt
versus total related party’s
net equity ownership
Total related- party debt versus debtor’s total net equity
Total debt versus debtor’s total net equity
Under the Brazilian thin capitalization rules, a taxpayer is not permitted to prove that the volume of its financial transactions is in accordance with the arm’s length principle. Consequently, if a company’s debt exceeds one of the fixed ratios, the deduction of the excess interest expense is disallowed, but without recharacterizing these amounts as dividend distributions.
In contrast to other countries, the Brazilian thin capitalization rules also apply to financial institutions and assimilated entities. The only exception is for “on-lending transactions”, which are defined as credit transactions in which the financial institution transfers the risk of foreign exchange variation to the individual or legal entity in Brazil, based on the same index used for the external funding and without charging any additional remuneration in respect of the provision of the intermediary services, in addition to a standard commission.
The compatibility of the thin capitalization rules with tax treaties21 concluded by Brazil is a controversial topic. This has given rise to at least three controversies.
First, as the concept of “related parties” provided for in domestic law22 is broader than that of “associated enterprises” used in article 9 of tax
21 For an in-depth analysis of the subject, see A. Fross, Debt-equity Ratios, Earning Stripping Rules and the Arm’s Length Principle, in International Group Financing and Taxes, Series on Intl. Tax L. pp. 33-53 (C. Massoner, A. Storck & B. Stürzlinger eds., Linde 2012).
22 BR: Law 9,430/1996 of 27 Dec. 1996, art. 23.
treaties based on the OECD Model,23 this treaty provision could restrict the subjective scope of the Brazilian thin capitalization rules.Consequently, article 24 of Law 12,249/2010 should not be applied to control financial transactions carried out by Brazilian companies with related parties located in treaty states that do not fall within the concept of “associated enterprises”.
Second, article 9(1) of tax treaties based on the OECD Model permits the adjustment of profits where the conditions of commercial or financial transactions entered into between the “associated enterprises” differ from the arm’s length standard. However, the Brazilian thin capitalization rules are based on a fixed debt/equity ratio, which may or may not comply with the volume of debt-financing to be found under the arm’s length standard.24 This implies that profit adjustments that exceed the arm’s length amount may be incompatible with tax treaties concluded by Brazil, especially as Law 12,249/2010 does not permit a taxpayer to demonstrate that its volume of debtfinancing reflects arm’s length conditions. In order to comply with the tax treaties that Brazil has concluded, Law 12,249/2010 should have permitted taxpayers to prove that their volumes of debt-financing are appropriate or in accordance with normal market conditions for their economic activities.
Third, the application of Law 12,249/2010 exclusively to financial transactions carried out with non-residents may violate the nondiscrimination clause in article 24(4) of tax treaties concluded by Brazil.25 This treaty provision states that payments made to a resident of the other contracting state must be deductible under the same conditions imposed on payments made to
23OECD Model Tax Convention on Income and on Capital (26 July 2014), Models IBFD.
24 Art. 9(1) OECD Model (2014) is also relevant for the volume of the loan. In this sense, see OECD Model Tax Convention on Income and on Capital: Commentary on Article 9(1) para. 3 (26 July 2014), Models IBFD, which reads as follows: “The Article is relevant not only in determining whether the rate of interest provided for in a loan contract is an arm’s length rate, but also whether a prima facie loan can be regarded as a loan or should be regarded as some other kind of payment, in particular a contribution to equity capital”.
25 Brazil has included art. 24(4) in the tax treaties that it has concluded with Belgium, Chile, China, Israel, Korea (Rep.), Mexico, Peru, Portugal, South Africa, Turkey and Ukraine. However, some of these tax treaties have saving clauses, which expressly permit the application of thin capitalization rules, i.e. the tax treaties with Israel, Peru, Portugal, South Africa and Turkey.
residents.26 The problem is that interest paid to individuals or legal entities domiciled in Brazil falls outside the scope of the Brazilian thin capitalization, as being deductible from the taxable profits of the payer in Brazil. Consequently, as interest expenses must be deductible under the same conditions if the creditor is resident in a treaty state, the non-discrimination clause may prevent the application of the Brazilian thin capitalization rules.
Looking ahead, this leaves the question of whether Brazil should adopt the interest barrier rules as proposed in Action 4 of the OECD/G20 Base Erosion and Profit Shifting (BEPS) initiative, in addition to or in replacement of its thin capitalization rules. Ideally, Brazil should not adopt interest barrier rules based on a percentage, i.e. 10% to 30%, in excess of earnings before interest, tax, depreciation and amortization (EBITDA), as the general application of these rules, as a standard profit adjustm ent, may be incompatible with the ability- topay principle and the concept of net income. Interest revenue is the income of the creditor, which experiences an increase in its abilityto-pay. Conversely, the debtor’s ability-to-pay is reduced by the interest payment,27 which implies that a legal provision that restricts the deduction of interest expenses would breach the concept of income and the ability-to-pay principle.
In addition, with regard to tax treaties, interest barriers rules that target a certain group of taxpayers, i.e. the companies in the same corporate group, and establish a particular profits adjustment, i.e. not a general rule for the determination of the taxable profit, encounter the same objections raised previously in relation to thin capitalization rules.
26 Art. 24(4) OECD Model (2014) reads as follows: “Except where the provisions of paragraph 1 of Article 9, paragraph 6 of Article 11, or paragraph 4 of Article 12, apply, interest, royalties and other disbursements paid by an enterprise of a Contracting State to a resident of the other Contracting State shall, for the purpose of determining the taxable profits of such enterprise, be deductible under the same conditions as if they had been paid to a resident of the first-mentioned State. Similarly, any debts of an enterprise of a Contracting State to a resident of the other Contracting State shall, for the purpose of determining the taxable capital of such enterprise, be deductible under the same conditions as if they had been contracted to a resident of the first-mentioned State”.
27 E.C.C.M. Kemmeren, Principle of Origin in Tax Conventions – A Rethinking of Models p.
433 (Pijnenburg 2001).
Finally, from a tax policy perspective, interest barrier rules may have harmful effects on economic developing, as their scope is not welltargeted.
In addition to increasing the cost of capital, interest limitation rules based on the EBITDA could adversely affect loss-making, start-up companies and cyclical industries, thereby aggravating the economic crises that Brazil at the time of the writing of this article was experiencing.
3.4. Transfer pricing rules
Brazil introduced transfer pricing rules in 1996 by way of Law 9,430/1996 to control the artificial transfer of profits to related parties abroad and to individuals or companies located in low-tax jurisdictions or subject to privileged tax regimes. Broadly, these rules establish a set of methods to determine the maximum deductible price for import transactions and the minimum taxable revenue for export transactions.
Consequently, in relation to import transactions, the Brazilian transfer pricing rules basically state that the costs incurred by Brazilian companies in respect of their imports that exceed certain specified parameters are not deductible for tax purposes. With regard to export transactions, transfer pricing rules establish that, if Brazilian companies charge less for their exports than certain specified parameters, the difference between the revenue recorded in the accounting books and the minimum revenue established by the method is subject to IRPJ and the CSLL in Brazil.
The Brazilian transfer pricing rules are unique, in that they depart from the international standard found in the OECD Transfer Pricing Guidelines.28 The main differences are the following:
– Brazil has not adopted the arm’s length standard in full, in primarily opting for the use of predetermined profit margins, subject to some exceptions.
28 OECD, Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD 2010), International Organizations’ Documentation IBFD.
- Brazil does not adopt the “best method rule”, according to which taxpayers should adopt the transfer pricing method that provides the most reliable arm’s length result. Under the Brazilian transfer pricing rules, taxpayers may choose any method admitted under the law.
- Brazil does not apply transfer pricing rules to royalties, fees for technical assistance and scientific and administrative fees.
These are subject to quantitative restrictions in respect of the deduction of expenses and to a withholding tax on the remittance of the income to the beneficiary abroad.
- Brazil does not permit the application of transactional profit methods, i.e. the profit split method and the transactional net margin method (TNMM).
– Brazil does not provide for correlative and secondary adjustments.
– Brazil does enter into advance pricing agreements (APAs).
- Brazil uses safe harbours that prevent the application of the methods to determine the parameter price if the taxpayer complies with these methods.
Brazilian transfer pricing practice is an alternative for the protection of tax revenue against base erosion and profit shifting. The recent proposals presented in Actions 8, 9 and 10 of the OECD/G20 BEPS initiative to ensure that transfer pricing outcomes are in line with value creation indicate that current transfer pricing rules based on the arm’s length standard cannot deal with the changes in the global corporative business environment. In the view of the Brazilian tax authorities, it is difficult to realize significant results with the application of a functional analysis to transfer pricing, while predetermined profit margins, at least, ensure a minimum level of taxation in Brazil.
In addition, the arm’s length standard as adopted by the OECD may be too complex and costly to be applied consistently by developing countries.
Consequently, the adoption of a more straightforward mechanism, such as the predetermined profit margins, permits developing countries to counter the manipulation of profits between related parties.
Finally, despite the risk of economic double taxation, predetermined profit margins may bring about greater certainty for taxpayers, as it is possible to know in advance that, once the methods are applied, the amount to be taxed will not give rise to significant litigation.
With regard to import transactions, the Brazilian transfer pricing rules provide for four methods in respect of the assessment of the maximum costs that can be deducted by taxpayers. These are summarized in Table 2.
Table 2: Import transactions: methods for the assessment of the maximum costs deductible by taxpayers
Method Definition
Compared independent prices (PIC)
The average prices of identical or similar goods, services, or rights in the Brazilian or any other market, in purchase and sale transactions and under
similar payment conditions.
Cost plus profit (CPL)
The average cost of production of identical or similar goods, services, or rights in the country where they have been originally produced, plus the
taxes charged by such country on the exportation, plus a profit margin of 20% of the cost, before the
addition of tax.
Resale price less profit (PRL)
The average resale price of the goods or rights less unconditional discounts granted, taxes levied on the
sales, commissions paid, and a profit margin that may vary between 20% and 40%, depending on the
economic sector.
Quotation price on imports (PCI)
The daily average values of the quotation of commodities subject to public prices on internationally recognized commodities exchanges
and futures.
Except for the import of commodities, in respect of which the application of the PCI is mandatory, taxpayers are free to calculate the standard price on imports according to any of the methods described in Table 2, but the chosen method must be applied consistently throughout the calendar year to each type of product or service imported. If the import price effectively applied exceeds the highest standard price calculated according to the method chosen, any excess is not deductible for corporate tax purposes.
With regard to export transactions, the Brazilian transfer pricing rules state that specified methods must be used to assess the minimum revenue to be taxed in Brazil. These methods are set out in Table 3.
Table 3: Export transactions: methods for assessing the minimum revenue to be taxed
Method Definition
Export sales price (PVEx)
The arithmetical average of the sales price on exports of the company itself to other customers or by other Brazilian companies providing similar
services, goods and intangible rights in the same tax year, under similar payment conditions.
Production or acquisition cost plus taxes and profit (CAP)
The arithmetical average of production costs of the services, goods and intangible rights exported, plus taxes imposed in Brazil and a profit margin of
15% on the cost plus taxes.
Wholesale price in the destination country, less profit (PVA)
The arithmetical average of the sales price of identical or similar goods in the destination country wholesale market, under similar payment conditions, less taxes imposed in that country and
a 15% profit margin on the wholesale price.
Retail price in the destination country, less profit (PVV).
The arithmetical average of the sales price of identical or similar goods in the destination country retail market, under similar payment conditions, less taxes imposed in that country and
a 30% profit margin on the retail price.
Quotation price on exports (PECEX)
The daily average values of the quotation of commodities subject to public prices on internationally recognized commodities exchanges
and futures.
In summary, the Brazilian transfer pricing rules are simpler than the OECD Transfer Pricing Guidelines, as well as more effective in countering base erosion and profit shifting. The problem is that predetermined profit margins can easily result in double taxation, as the other country may well not make a correlative adjustment where the profit allocated to the company located in Brazil does not reflect the arm’s length principle.
In addition, transfer pricing rules based on predetermined profit margins often over-tax some transactions and under-tax others. This is because the markup required by the method may be higher or lower than the profits derived by taxpayers.
Finally, in an international setting, the Brazilian transfer pricing rules may permit the diversion of profits to foreign jurisdictions, thereby facilitating double non-taxation. Such a situation could arise where the extra profit margin allocated to the counterparty abroad is treated as an informal capital contribution in the foreign jurisdiction that is not taxed under the domestic law. In turn, this suggests that the realization of an international consensus on the future of transfer pricing would appear to be unlikely in the short term.
3.5. Royalties
Under Brazilian tax legislation, the concept of royalty has a very wide meaning, in encompassing any income derived from the use, enjoyment and exploitation of rights. The Brazilian concept of royalties, therefore, includes:
(1) the right to extract or collect vegetables, including foresting, resources; (2) the right to search for and extract mineral resources; (3) the use or exploitation of inventions, manufacturing processes and formulas and industry and trademarks; and (4) the exploitation of copyright, except when realized by the author or the creator of the right or property.29
As noted in section 3.4., Brazil does not apply transfer pricing rules to royalties paid in consideration for the use of trademarks, patents, the
29 BR: Law 4,506/1964 of 30 Nov. 1964, art. 22.
provision of technical assistance and knowledge, the transfer of know-how, and for administrative assistance. However, the deduction of such expenses for tax purposes is subject to specific limits and conditions, which are intended to counter base erosion and profit shifting.
These rules have been in place since the 1950s, long before the OECD/G20 BEPS initiative was started. The deduction of royalties is limited to 1% to 5% of the net sales price of the product or services connected to the patent, provision of technology or technical assistance. The limit varies according to the business activity and with the importance of the product or service in question for the Brazilian economy, as determined by the Portaria do Ministro das Finanças (Finance Ministry Ordinance, PMF) 436/1958.30 The deduction of royalties paid for the use of trademarks is limited to 1% of the net sales price of the products, or the services, bearing the trademark.
Finally, Brazilian tax legislation provides that royalties paid to partners, whether individuals or legal entities, or managers are not deductible for tax purposes.31
3.6. Restrictions on the deduction of expenses
Article 26 of Law 12,249/2010 establishes that the amounts paid, credited, delivered, employed or remitted on any account, either directly or indirectly, to individuals or legal entities resident or incorporated in low-tax jurisdictions or subject to privileged tax regimes are not deductible for tax purposes. This applies, except if the following three cumulative conditions are satisfied: (1) identification of the beneficial owner of the non-resident entity that receives the amount remitted; (2) presentation of proof of the operational capacity of the non-resident to perform the transaction; and (3) presentation of documents that confirm the payment of the price in question and that acknowledges the receipt of the goods, rights or the use of the services. For these purposes, the term “beneficial” owner means an individual or a legal entity not
30 BR: Portaria do Ministro das Finanças (Finance Ministry Ordinance, PMF) 436/1958 of 30 Dec. 1958.
31 Art. 71, sole para. (d) Law 4,506/1964.
incorporated for the sole or specific purpose of saving tax, which derives such amounts on its own account and not as agent, fiduciary or delegate on behalf of third parties.
3.7. Withholding tax on payments to individuals or legal entities in low-tax jurisdictions
In general, Brazilian tax legislation provides for a standard tax rate of 15% for the withholding tax levied on income and capital gains paid to non- residents. However, where the beneficiary is resident in a low-tax jurisdiction, the withholding tax is set at a rate of 25%, which is withheld from the income or the gains remitted to the beneficiary.32
3.8. Change of residence
Under article 27 of Law 12,249/2010, the transfer of the tax residence of an individual resident and domiciled in Brazil to a low-tax jurisdiction or a privileged tax regime only has effect if the taxpayer can demonstrate that:
– he or she effectively resides in the foreign country or jurisdiction; and
– he or she is subject to a comprehensive tax on income from labour or capital, as well as the effective payment of any tax due.
The law states that individuals who have effectively stayed in the country or jurisdiction in question for more than 183 consecutive days in a 12- month period and individuals who can prove that the habitual residence of their family and most of their assets are located in the country or jurisdiction comply with condition (1). Apart from this rule, Brazil has no exit taxes.
32 BR: Law 9,779/1999 of 19 Jan. 1999, art. 8 and BR: Law 10,833/2003 of 29 Dec.
2003, art. 47.
4. Conclusions
The Brazilian anti-avoidance legislation follows the latest trends and international developments, but with several adaptations and adjustments to protect tax revenue and the interests of the tax authorities. In general, the Brazilian anti-avoidance rules can be regarded as being excessively stringent and over-focusing on increasing tax revenue and the protection of the tax base to the detriment of other tax policy objectives, such as efficiency, fairness and neutrality. Brazilian tax rules also create economic distortions and affect the competitiveness of Brazilian companies, even when the legal transactions undertaken by taxpayers are not intended to give rise to tax savings.
The merits of Brazilian anti-avoidance rules lie in their effectiveness, practicability, reduction in administrative costs and enforceability.
However, Brazil’s tax practices on economic development could adversely affect entrepreneurs.
Perhaps the appropriate solution to the phenomenon of base erosion and profit shifting is located halfway between Brazilian practice and the international standard. Practical rules that are easy to apply and enforce, voluntary compliance, and an enhanced relationship between taxpayers and the tax authorities would appear to be crucial elements in developing an effective and a fair and simple system in the era following the OECD/G20 BEPS initiative.
Whether countries will achieve this remains to be seen.
