Brazil: Decision reached on new Brazilian CFC rules
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Brazil: Decision reached on new Brazilian CFC rules


Alvaro Pereira

Mark Conomy

Brazil's Federal Court of Curitiba has released a decision on the application of the new Brazilian controlled foreign corporation (CFC) rules on May 6 2016. The single court judgment, in relation to Process No. 5005596-52.2015.4.04.7000/PR, outlines that a Brazilian taxpayer may remove from the calculation of its corporate income tax (IRPJ) and social contributions (CSLL), results of its controlled foreign subsidiaries located in Argentina and Chile, until those results are effectively made available to the Brazilian controller.

The decision represents the first time the issue of controlled subsidiary results has been considered under the recently amended CFC rules introduced in May 2014 by Law No. 12,973/2014, which applies from January 1 2015 unless adopted earlier.

By way of background, pursuant to the new Brazilian CFC rules, Brazilian taxpayers are generally required to submit tax profits earned in a calendar year (regardless of distribution) by CFCs, as well as affiliates, in certain circumstances. Pursuant to the new law, the investment in each directly and/or indirectly controlled foreign entity should be managed in individual sub-accounts and should be adjusted annually to reflect the change in the investment value corresponding to the profits or losses of the entity, in proportion to the Brazilian entity's participation. Any accounting profit (before taxes and excluding foreign exchange) of the foreign entity must be added to the calculation base of IRPJ and CSLL in Brazil.

Turning to the present case, the taxpayer argued that the taxation of undistributed profits prior to the effective distribution is illegal, except where the entities are located in tax havens. Further, the present circumstances of Brazil's DTAs with Chile and Argentina should prevail over the domestic law to prevent taxation of such profits in Brazil. The Brazilian Administration considered that the previous jurisprudence provides that such law should only be unconstitutional to the extent that it applies to affiliates (e.g. non-controlling interests) not located in tax havens. In relation to the discussion of the DTAs, the tax authorities argued that the law does not seek to tax the profits of the relevant subsidiary, but rather the profits of the Brazilian controller earned through the foreign subsidiary (i.e. the adjustment being made in Brazil).

The Federal Court of Curitiba's judge considered that the relevant article of the new CFC law is unconstitutional on the basis that it creates a hypothetical situation requiring taxation of a different economic base than that contemplated by the Constitution. There may be restrictions on the ability of the foreign entity to distribute the profits and therefore the mere adjustment of the value of the investment in the foreign entity does not appear to supply the legal availability of the underlying profits. The judge also considered that both of the relevant subsidiaries, in the present case, are located in jurisdictions that have signed a DTA with Brazil, which include a clause stating that profits can only be taxed in the State in which the entity is located, except where the entity has a permanent establishment in the other State (i.e. the article referring to business profits). The foreign entities did not have a permanent establishment in Brazil.

For these reasons outlined above, the judge concluded that the request of the taxpayer should proceed and the profits removed from the calculation of the Brazilian entity's IRPJ and CSLL. An appeal has already been filed by representatives of the Brazilian Administration.

The decision represents a welcome development for taxpayers in terms of how the new law should be applied, as well as the interaction of the law with executed DTAs. However, as the decision has yet to be ratified by a superior court and the amended law remains relatively untested, taxpayers should continue to carefully monitor the developments of the issue in the courts.

Alvaro Pereira ( and Mark Conomy (



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