Brazil unveils new concepts of low tax jurisdictions and privileged tax regimes

Law 11727/08 extended the application of Brazil’s transfer pricing rules to transactions carried out under privileged tax regimes as from January 2009. Until now, transfer pricing rules only applied to transactions with related or unrelated parties domiciled in low taxation jurisdictions.

Article 24 of Law 9430/96, as amended, defined low taxation jurisdictions as countries or locations:

· that do not tax income or that tax it at rates lower than 20%; and/or

· whose internal legislation imposes secrecy on the shareholding structure of legal entities or their ownership, or on the identification of the beneficial owner of income earned by non-residents.

Law 11727/08 defined privileged tax regimes as those that meet one or more of these requirements:

· do not tax income, or that tax it at rates lower than 20%;

· provide tax advantages to non-residents (individuals or legal entities) conditioned upon the non-performance of substantial economic activities in the relevant jurisdiction, or without requiring the performance of substantial economic activities in the relevant jurisdiction;

· do not tax income earned outside the relevant territory, or tax such income at maximum rates of less than 20%; and/or

· do not allow access to information about the shareholding structure of legal entities, ownership of assets and rights or economic transactions performed.

Further to such legislative change, the Brazilian Federal Revenue Service passed Normative Instruction 1037/10 (IN RFB 1037), later amended by Normative Instruction 1045/10 (IN RFB 1045), which:

· listed the jurisdictions considered low taxation jurisdictions, as well as the regimes that fall under the concept of privileged tax regimes; and

· revoked expressly the former list of low taxation jurisdictions set out in Normative Instruction 188/02.

The new list increased the number of countries/locations defined as low taxation jurisdictions from 53 to 65. Switzerland was included in the list and Malta and the holding companies governed by the Luxembourg Law of 1929 were excluded from it, as they were listed as privileged tax regimes.

Nine regimes were considered privileged tax regimes, among which are highlighted those applicable to:

· SAFIs (Sociedade Anónima Financiera de Inversión) in Uruguay;

· LLCs (limited liability companies) owned by non-US residents and not taxable under the US federal income tax system;

· ETVEs (Entidad de Tenencia de Valores Extranjeros) in Spain; and

· Holding companies in the Netherlands, Denmark and Luxembourg without substantial economic activities in the first two cases.

Switzerland requested a review of its inclusion among the low taxation jurisdictions and the Netherlands requested a review of the inclusion of Dutch holding companies’ regime among the privileged tax regimes. Until such requests are decided, these qualifications shall not apply.

The references to SAFIs, LLCs and ETVEs seem to indicate that the RFB’s intention was to target foreign holding companies owned by non-residents as vehicles to centralise their investments overseas, which are not subject to taxation on earnings from their activities of holding equity stakes if certain legal requirements are met.

However, the scope of the concept of privileged tax regime is broader and, on a case by case basis, may even result in the application of Brazilian transfer pricing rules (that follow rigid mathematical calculations to reach import and export benchmarks, which may not reflect the arm’s-length principle in all cases) jeopardising regular business transactions between independent parties, among other adverse consequences.

The list of low taxation jurisdictions and privileged tax regimes may also have negative impacts on the negotiation of new double taxation agreements with Brazil (for example, with U.S. and Switzerland).

At last, debates may arise as to whether the list of low taxation jurisdictions and privileged tax regimes is all inclusive or not. Based on the position taken by the Federal Revenue Service in relation to the former list of low taxation jurisdictions, we believe the new list will be considered all inclusive.

The matter is still recent and it is possible that some of the critical issues mentioned above will be clarified soon.

Cristiane Magalhães (cmagalhaes@machadoassociados.com.br);

Alexandre Gentil (agentil@machadoassociados.com.br); and

Pedro Lima (plima@machadoassociados.com.br) of Machado Associados