Tax Aspects Of Investing In Brazil
In addition to the current obstacles imposed upon foreign investments in Brazil such as the country’s recession and the uncertain political scenario, the Brazilian tax enviroment, including particularities in the Brazilian tax rules, and the creative approach of local tax authorities, may be considered as other challenges that foreign investors face on a day-to-day basis.
Learning how taxation works in Brazil and how domestic and international tax rules are interpreted may represent an important tool for foreign companies engaged in cross-border transactions with Brazilian resident companies (in either inbound or outbound investments).
Unlike other countries, one single transaction such as an import of services may be subject to six different taxes in Brazil, which result in an effective taxation that may exceed 50 percent depending on how the parties agree to pay the taxes (with or without gross-up). Taxable bases are determined through the application of mathematical formulas that impose the levy of one tax over another.
Among the taxes levied, only one (the withholding tax – WHT) is eligible to benefit from tax reductions eventually granted in tax treaties to avoid double taxation (DTT). Nevertheless, even in the case of an existing DTT, taxpayers may not enjoy practical effects in terms of tax saving in view of the extremely broad definition of “technical services” under Brazilian tax legislation and the Brazilian tax authorities (RFB’s) unique stance on the articles of the treaty to be applied to service remittances.
According to the RFB’s current understanding, service remittances made to countries with which Brazil has signed a DTT fall under:
(i) Article 12 (“royalties”), if the protocol of the DTT expressly states that technical services and technical assistance are included in the concept of royalties. Article 12 of the DTTs entered into by Brazil allows both countries to tax royalty remittances, usually limiting the right to tax of the country in which the payer is domiciled to 15 percent, which is already the tax rate charged under domestic rules (certain DTTs provide for a 10 percent or 12.5 percent maximum tax rate);
(ii) Article 14 (“independent personal services”), if the rendering of the services relies on the technical qualification of a person or group of people.
Certain DTTs also include legal entities under the scope of this Article, and the outcome is the taxation in Brazil with no tax rate limitation; and (iii) Article 7 (“business profits”), as long as Articles 12 and 14 do not apply.
In this case, no WHT is levied in Brazil on service remittances. The DTTs with Austria, Finland, France, Japan and Sweden are the only ones entered into by Brazil which protocol does not classify technical services and technical assistance under Article 12.
As regards to application of treaty articles, taxpayers must be aware that unlike many other countries, Brazil differentiates “technical services” from “technological services.” In practice, any rendering of service involving any kind of knowledge and irrespective of any transfer of technology may be included in the definition given by the RFB for “technical services” and, therefore, shall fall under Article 12 and be taxed by the WHT. As the RFB’s position is contrary to international practice (as in many countries such services would fall under Article 7), foreign legal entities tend to end up with a double taxation as they often face practical difficulties in their country of residence to offset the WHT withheld in Brazil.
Tax legislation also brings difficulties to Brazilians investing overseas or foreign companies investing abroad through Brazil. Within a short period, Brazil left behind the territorial principle and went towards the opposite side to introduce very atypical Controlled Foreign Corporation (CFC) legislation.
Pursuant to the current CFC rules (in force as of 2015), taxation is imposed at the level of the Brazilian controlling company on the profits accrued by each direct or indirect foreign subsidiary, on an accrual basis and regardless of any distribution. Disregarding the group’s international corporate structure, the profits of all indirect foreign controlled companies are directly included in the taxable basis of the Brazilian investor as such companies are deemed to be “first tier subsidiaries” for Brazilian CFC purposes.
CFC rules apply to the profits of all foreign controlled and affiliate companies, irrespective of the nature of the income derived by them (active or passive), and regardless their country of residence (tax havens or not). Tax havens and the nature of the income are only relevant to allow the Brazilian company to enjoy certain tax benefits under the CFC rules (e.g., tax consolidation, among others).
Brazilian transfer pricing legislation is another subject that causes surprise. Although inspired by OECD guidelines, the Brazilian rules do not take into consideration any analysis of the risks, functions and role performed by the companies, but rather determine the calculation of the benchmarks through the application of mathematical formulas (e.g., predetermined profits margins) and objective methods. There is no adoption of the arm’s length principle.
Among other particularities, the Brazilian legislation determines: (i) Different methods for import and export transactions; and (ii) A very broad concept of related parties (also including in the definition any association made through a consortium, certain exclusivity relationships, among others).
Neither domestic rules nor the DTTs signed by Brazil provide for any correlative adjustment to avoid double taxation that may be caused by mismatched transfer pricing adjustments (i.e., tax adjustments in both countries).
Differences resulting from the Brazilian tax legislation or the RFB’s interpretation of law will have to be discussed more from now on due to the globalization phenomenon that is occurring in terms of tax transparency, tax compliance and global exchange of information. Brazil has very sophisticated legislation that allows the country to control prices, inhibit profit shifting and, more importantly, have full access to all tax information of Brazilian taxpayers and foreign parties trading with Brazilian residentes. At the forefront of tax technology, having introduced the electronic individual income tax return more than 15 years ago, the RFB has required more and more that Brazilian legal entities file, regularly, a large amount of information electronically.
In view of the Public System for Digital Filings (SPED) project, initially introduced in 2007 and implemented in stages throughout the years, Brazilian tax authorities have digital access (sometimes instant) to Brazilian companies’ accounting records, returns for several taxes including Corporate Income Tax, digital invoices, and administrative proceedings, among other data.
The demand for information by the tax authorities will very likely increase from here on in light of the implementation of the OECD/G20’s Base Erosion and Profit Shifting (BEPS) Project (e.g., Action 13 – Transfer Pricing Documentation and Country-by-Country Reporting is expected to be implemented in 2017 relating to the 2016 calendar year) and the expected exchange of information with other countries provided for under the OECD Convention on Mutual Administrative Assistance in Tax Matters (in force as of October 2016 for Brazil).
Keeping up with such endless tax compliance and with the innumerous tax rules in force in Brazil (at federal, state and municipal levels) takes a big toll on companies’ resources and time. Tax compliance may increase with BEPS, but the Brazilian tax environment’s continuous evolution may also come for the good with, e.g., the implementation of the mutual agreement procedure recommended by Action 14 (Making Dispute Resolution Mechanisms More Effective) and a possible interest of Brazil to better adapt its legislation or, at least, its law’s interpretation to the international standards. In the meanwhile, knowing Brazil in anticipation will continue to be an important recommendation when engaging in business in Brazil.
This article was written by Erika Tukiama and Stephanie Jane Makin and published in Wolters Kluwer’s Global Tax Weekly, Issue 212, December 1, 2016
Original article: https://www.cchgroup.com/roles/corporations/internationalsolutions/research/global-tax-weekly-a-closer-look