AgendaBrazilian CFC Rules
1. General Overview
2. ADI 2,588
Recent Court Cases
1.Eagle I and II
2.Camargo Correa
3.Normus
4.Vale
5.Marcopolo
6.Brazil Foods
Brazilian CFC Rules | General Overview
History
Market globalization prompted the Brazilian government to adopt the
worldwide income taxation regime for corporate entities as of January 1st,
1996
Law 9,249/1995, regulated by Normative Instruction (“IN”) 38/1996,
introduced the levy of corporate income tax on foreign profits, earnings
and capital gains for corporate entities headquartered in Brazil
Ernst & Young Terco | Recent Court Cases on Brazilian CFC Legislation4
Law 9,532/1997 brought to the Brazilian legal system criteria to
determine the availability of foreign profits (i.e. in case of branches, at the
moment of their inclusion on the company‟s book and in case of
subsidiaries or affiliates, when they were paid, credited, used, delivered or
remitted to the Brazilian legal entity)
Foreign profits, earnings and capital gains recorded as of October 1st,
1999 have become subject to Social Contribution Tax (CSLL), through
Provisory Measure (“MP”) 1,858-7/1999
Ernst & Young Terco | Recent Court Cases on Brazilian CFC Legislation5
Brazilian CFC Rules | General Overview
Article 74 of MP 2,158-35/2001 introduced an automatic taxation
system whereby foreign profits would be considered available to the
Brazilian company by the end of each calendar year, regardless of actually
distributed or not
Enacted to regulate article 74 of MP 2,158-35/2001 (and to replace IN
38/1996), IN 213/2002 created special cases where foreign profits shall
be considered as available to the Brazilian parent company for tax
purposes
Corporate entities recording foreign source earnings and capital gains
must calculate Income Tax according to taxable profit based on accounting
records
Ernst & Young Terco | Recent Court Cases on Brazilian CFC Legislation6
Brazilian CFC Rules | General Overview
Brazilian CFC Rules | General Overview
Current Scenario
Based on Brazilian domestic anti-deferral rules, profits of a CFC are
subject to Brazilian corporate income taxes (CIT) on December 31 of each
year (at a combined 34% tax rate), regardless of any actual distribution
Relief from double taxation of the CFC„s profits is available since Brazil
allows foreign taxes (income tax of the CFC as well as the dividend WHT)
to be credited against the Brazilian tax on the foreign profits (FTC)
The FTC is capped to the amount of Brazilian corporate income taxes
(34%)
Excess FTC on the tax due on profits of one CFC cannot be credited
against tax due on the profits of another CFC (i.e., no "blending" of the
taxes of the CFCs)
Ernst & Young Terco | Recent Court Cases on Brazilian CFC Legislation7
Brazilian CFC Rules | General Overview
Excess FTC cannot be carried forward, unless the inability to credit the
FTCs results from the Brazilian parent company incurring tax losses
There is a risk that foreign taxes incurred cannot be credited in Brazil if
not claimed within 2 years
Losses of the CFCs cannot be offset with the profits of the Brazilian parent
or with profits of other CFCs (i.e., no "blending" of the profits and losses
of the CFCs)
If the CFC is resident in a country with which Brazil has a tax treaty in
force, annual recognition of the profits based on the Brazilian anti-deferral
rules, might be deferred until actual distribution (under article 7 of the
Double Tax Treaty). This position is the object of much controversy and
litigation between taxpayers and the Brazilian tax authorities.
Ernst & Young Terco | Recent Court Cases on Brazilian CFC Legislation8
Brazilian CFC Rules | General Overview
Criticism
Brazilian CFC rules are highly criticized due to:
A company that holds an investment in a controlled or affiliated
foreign company, which is in a profit position, should offer to taxation
in Brazil such profits on December 31 of each year regardless of
whether they were actually distributed or not
Brazilian CFC legislation does not distinguish between: (i) passive or
active income; (ii) tax regime to which the CFC is subject to (high or
low taxed), (iii) type of company (no basket rules)
Ernst & Young Terco | Recent Court Cases on Brazilian CFC Legislation9
Brazilian CFC Rules | General Overview
In case the Brazilian company holds less than 20% of the participation
in a CFC, automatic taxation does not apply – cash basis
CFC capital/operational losses cannot be picked up in the Brazilian
parent
There is no distinction if the CFC is a branch or a separate subsidiary
It notably differs from international standards
Ernst & Young Terco | Recent Court Cases on Brazilian CFC Legislation10
Brazilian CFC Rules | ADI 2,588
Article 74 of MP n° 2.158-35/01 and its sole paragraph also brings an
intense debate regarding their constitutionality since they introduced a
triggering event for corporate income taxes, which seems to be not
consistent with the tax legal system currently in force in Brazil
The Brazilian Supreme Court is currently ruling on the constitutionality of
the provision introduced in the Brazilian legal system by article 74 of MP n°
2158-35/01 and the paragraph 2 of article 43 of the Brazilian Tax Code
(CFC Rules) - ADIn 2,588
Ernst & Young Terco | Recent Court Cases on Brazilian CFC Legislation11
Brazilian CFC Rules | ADI 2,588
The judgment has started in 2001 and so far it is still very difficult to
determine which will probably be the prevailing decision. So far, nine
Ministers from the Supreme Court, from a total of 11 Ministers of which
only ten are able to vote on the constitutionality issue, declared their
opinion on the constitutionality issue:
One Minister (Ellen Gracie) voted for the partial unconstitutionality in
respect to foreign affiliates
Four Ministers (Nelson Jobim, Eros Grau, Carlos Ayres Britto and Cezar
Peluso) voted for the constitutionality and
Ernst & Young Terco | Recent Court Cases on Brazilian CFC Legislation12
Brazilian CFC Rules | ADI 2,588
Four Ministers (Marco Aurélio, Sepúlveda Pertence, Ricardo
Lewandowski and Celso de Mello) voted for the unconstitutionality of
the CFC Rules
Minister Joaquim Barbosa should be next one to vote on the
constitutionality or not of the provisions
Supreme Court Decision on Extraordinary Appeal (RE) 611.586 (Leading
Case):
General repercussion confirmed
Effects of a potential positive ruling
Ernst & Young Terco | Recent Court Cases on Brazilian CFC Legislation13
Ernst & Young Terco | Recent Court Cases on Brazilian CFC Legislation15
Recent Court Cases | Eagle I and II Cases (Ambev)
In January 2005, Brazilian Tax Authorities assessed
Eagle Distribuidora de Bebidas S.A. (“Eagle”) for not
taxing the earnings of Jalua Spain S.L. (“Jalua”) and
Brahmaco, its foreign subsidiaries in Canary Islands
and Gibraltar, in accordance with Article 74 of MP n°
2158-35/2001. Jalua also owns two subsidiaries:
Monthiers (Uruguay) and CCBA (Argentina)
Eagle I refers to calendar years 2000 and 2001
(previous to the CFC rules currently in force), while
Eagle II refers to calendar year 2002
Eagle (Brazil)
Jalua(Canary Islands)
Monthiers (Uruguay)
CCBA (Argentina)
Bramahco (Gibraltar)
Ambev(Brazil)
CBB(Brasil)
Brazil
Abroad
Ernst & Young Terco | Recent Court Cases on Brazilian CFC Legislation16
Recent Court Cases | Eagle I and II Cases (Ambev)
In the case of Eagle I, the Administrative Tax Court has
decided that neither the earnings of Jalua nor of its
subsidiaries are subject to tax in Brazil due to the
application of the provisions of Article 7 of the Brazil-
Spain DTT, which determines that the business profits
of a Contracting State shall be taxable only in that
State
Even though Tax Authorities presented an appeal, on
September 13th, 2011, the Superior Board of Tax
Appeals (“SBTA”) could not analyze the matter
because the case did not comply with the essentials
requirements of the procedure
Eagle (Brazil)
Jalua(Canary Islands)
Monthiers (Uruguay)
CCBA (Argentina)
Bramahco (Gibraltar)
Ambev(Brazil)
CBB(Brasil)
Brazil
Abroad
Ernst & Young Terco | Recent Court Cases on Brazilian CFC Legislation17
Recent Court Cases | Eagle I and II Cases (Ambev)
Otherwise, in the second case – Eagle II, the
Administrative Tax Court decided that the profits of
Jalua are not subject to local taxation due to Brazil-
Spain DTT, but the profits of Jalua‟s subsidiaries should
be considered as directly received by Eagle (the
indirect shareholder), which made them subject to
taxation in Brazil under Brazilian CFC rules
Such ruling seems to create a sort of tax transparency
to the extent that only the profits accrued by the direct
foreign subsidiary are protected by the DTT (on an
individual basis)
Eagle (Brazil)
Jalua(Canary Islands)
Monthiers (Uruguay)
CCBA (Argentina)
Bramahco (Gibraltar)
Ambev(Brazil)
CBB(Brasil)
Brazil
Abroad
Ernst & Young Terco | Recent Court Cases on Brazilian CFC Legislation18
Recent Court Cases | Camargo Correa Case
In this case, the Administrative Tax Court has ruled on
the taxation of the profits earned by subsidiaries of a
Brazilian parent, located in Portugal and Luxembourg
Both countries have concluded DTTs with Brazil
The Administrative Tax Court ruled that article 74 of MP
2.158-35/01 actually provides for a deemed profit
distribution, which should qualify as dividend income,
subject to article 10 provision of the Brazil-Portugal DTT
Camargo Correa(Brazil)
Subsidiary(Luxembourg)
Subsidiary (Portugal)
Brazil
Abroad
Ernst & Young Terco | Recent Court Cases on Brazilian CFC Legislation19
Recent Court Cases | Camargo Correa Case
Although the Brazil-Portugal DTT prohibits the taxation
of the non-distributed profits (under article 10,
paragraph 5), the Court understood that the DTT does
not prevent Brazil from taxing the profits earned by the
Brazilian shareholders of the Portuguese company
As to the Luxembourg subsidiary, the Administrative Tax
Court has ruled that it could not benefit from the Brazil-
Luxembourg DTT since it was a Holding 1929 company
(i.e. not subject to treaty benefits)
Camargo Correa(Brazil)
Subsidiary(Luxembourg)
Subsidiary (Portugal)
Brazil
Abroad
Ernst & Young Terco | Recent Court Cases on Brazilian CFC Legislation20
Recent Court Cases | Normus Case
On January 27th, 2011, Administrative Tax Court
decided for the taxation, for Brazilian corporate income
taxes purposes, of profits earned by a subsidiary located
in Hungary.
The decision considered that, since the Brazilian
company has recognized foreign profits for accounting
purposes based on the net equity method of accounting,
its profits, income and capital gain earned abroad should
be taxed in Brazil in the end of each fiscal year, under
Article 25 of Law 9,249/95 and Article 74 of the
Provisional Measure 2,158/01.
Normus Emp. e Partic. Ltda
(Brazil)
VCP Overseas Holdings Kft(Hungary)
Brazil
Abroad
Ernst & Young Terco | Recent Court Cases on Brazilian CFC Legislation21
Recent Court Cases | Normus Case
In the opinion expressed in the administrative decision,
Article 7 of the Double Tax Treaty signed between Brazil
and Hungary only protects profits earned by the foreign
company and not by the Brazilian one, which is why the
positive result (profits) derived from its foreign
subsidiary cannot be excluded from the corporate
income taxes basis.
Normus Emp. e Partic. Ltda
(Brazil)
VCP Overseas Holdings Kft(Hungary)
Brazil
Abroad
Ernst & Young Terco | Recent Court Cases on Brazilian CFC Legislation22
Recent Court Cases | Normus Case
Despite the unfavorable decision, it is worth noting that
one of the counselors, who decided this case,
understood for the non-taxation of the result of the net
equity method of accounting. In addition, this decision
was unanimous with respect to the non-taxation of the
currency exchange results registered over the foreign
investment.
Normus Emp. e Partic. Ltda
(Brazil)
VCP Overseas Holdings Kft(Hungary)
Brazil
Abroad
Ernst & Young Terco | Recent Court Cases on Brazilian CFC Legislation23
Recent Court Cases | Vale Case
On March 29th, 2011, the Federal Judicial Court has
ruled on the taxation, for Brazilian corporate income
taxes purposes, of profits earned by the Vale‟s
subsidiaries located in Belgium, Denmark and
Luxembourg
The Court considered that Article 74 of the MP no
2.518/01 does not offend the concept of “income”
established by Federal Constitution/88, given that the
law may legitimately establish criteria as to determine
when the profit is considered as available for tax
purposes
Vale(Brazil)
Subsidiary(Denmark)
Subsidiary(Luxembourg)
Subsidiary(Belgium)
Brazil
Abroad
Ernst & Young Terco | Recent Court Cases on Brazilian CFC Legislation24
Recent Court Cases | Vale Case
In its appeal, Vale claimed that Article 74 of the MP no
2.518/01 is incompatible with the treaties to avoid
double taxation entered into by Brazil with the States of
domicile of the subsidiary companies, as well as it has
extrapolated the permission granted by Article 43,
heading and paragraph 2, of the Brazilian Tax Code,
which states that “In the hypothesis of income or
earnings arising abroad, the law shall establish the
conditions and the moment at which they will be
considered available, for purposes of the levy of tax
referred to in this article”
Vale(Brazil)
Subsidiary(Denmark)
Subsidiary(Luxembourg)
Subsidiary(Belgium)
Brazil
Abroad
Ernst & Young Terco | Recent Court Cases on Brazilian CFC Legislation25
Recent Court Cases | Vale Case
However, the Court ruled that there is no infringement
of Tax Treaties. In their opinion, in accordance with said
treaty, the State where the parent company is
headquartered can tax not only the income earned
inside its territory, but also the foreign income earned
by subsidiaries located abroad
Vale(Brazil)
Subsidiary(Denmark)
Subsidiary(Luxembourg)
Subsidiary(Belgium)
Brazil
Abroad
Recent Court Cases | Marcopolo Cases
Ernst & Young Terco | Recent Court Cases on Brazilian CFC Legislation26
The Brazilian Tax Authorities ("BTA") assessed
Marcopolo S/A for operations from 2001 to 2007, which
consisted of exporting vehicle chassis and bodies to two
subsidiaries: Marcopolo International Corporation
("MIC"), based in the British Virgin Islands, and Ilmot
International Corporation ("ILMOT"), Uruguay
They were also questioned about some sales to third
parties based in tax havens. These export transaction
were made to MIC and ILMOT - intermediating related
companies, named reinvoincing centers - that marketed
directly to end consumers
Marcopolo (Brazil)
ILMOT (Uruguay)
MIC (British Islands)
Recent Court Cases | Marcopolo Cases
Ernst & Young Terco | Recent Court Cases on Brazilian CFC Legislation27
As a result of this tax assessment, Marcopolo was
charged regarding corporate income taxes, ex-officio fine
for fraud and qualified fine for not providing sufficient
information when requested, as the BTA understood that
the export transactions made by Marcopolo to its
subsidiaries located abroad were a sham and lacked any
real substance. The BTA also affirmed that the
constitution of these trading companies was totally
unnecessary and had the sole purpose of avoiding the
taxation of the income in Brazil since the trading
companies are located in tax havens. Both understanding
were confirmed by the Taxpayers‟ Council at the time
Marcopolo (Brazil)
ILMOT (Uruguay)
MIC (British Islands)
Recent Court Cases | Marcopolo Cases
Ernst & Young Terco | Recent Court Cases on Brazilian CFC Legislation28
This case has a relevant role in the analysis regarding the
economic substance necessary in a foreign corporate
structure for Brazilian tax purposes
In recent decisions as regards as different fiscal years,
the Administrative Tax Court decided that (i) the named
“underpricing” policy cannot be understood as income
omission to the extent that the sales had accounting
records, and (ii) there was no fraud as BTA were not able
to prove the taxpayer‟s intention of sham, reason why the
ex-officio fine was disqualified
Marcopolo (Brazil)
ILMOT (Uruguay)
MIC (British Islands)
Ernst & Young Terco | Recent Court Cases on Brazilian CFC Legislation29
Recent Court Cases | Brazil Foods Case
Although such decision has not been published yet, it seems to be relevant
for CFC purposes from what the press has made available to us
In this Case, the Brazilian parent owned one direct foreign subsidiary (first
tier) and three indirect foreign subsidiaries (second tier) through such first
tier one
Brazilian Tax Authorities (“BTA”) have assessed individual results of all
foreign subsidiaries although Normative Instruction 213/2002 provides
for the vertical consolidation
Ernst & Young Terco | Recent Court Cases on Brazilian CFC Legislation30
Recent Court Cases | Brazil Foods Case
Under article 1, paragraph 6 of Normative Instruction 213/2002, the
profits generated at the level of the foreign subsidiaries should be
consolidated at the level of the first tier foreign subsidiary for the
purposes of determining the profit subject to taxation in Brazil under
Brazilian CFC rules
In this context, the Administrative Tax Court ruled on the need for the
vertical consolidation since only the consolidated result should be subject
to taxation in Brazil under the applicable rules
Ernst & Young Terco | Recent Court Cases on Brazilian CFC Legislation31
Recent Court Cases | Supreme Court Cases
Constitutionality of Article 74 of MP 2158-35/2001
COAMO – RE 611.586
EMPRESA BRASILEIRA DE COMPRESSORES S/A – EMBRACO – RE
541.090