A new beginning for Brazil
The recent conclusion of the impeachment trial of Dilma Rousseff brings a new wave of optimism to Brazil, but there are huge challenges that the new president will need to tackle fiercely and urgently, say Simone Musa and Adriana Stamato of Trench, Rossi e Watanabe Advogados.
While the political scenario is yet not totally peaceful – the left-wing party which leaves the office after 13 years in power is expected to be a noisy opponent – Michel Temer will have more than two full years to put the country back on track and the market is eager for concrete measures in that direction.
First and most important is to restore confidence in the country's economy, which is shaken after diving into recession for the last two years, the same period in which the debt burden skyrocketed. For sure, this will not be easy and will require unpopular measures to curb public spending and reduce the massive fiscal deficit. While the propagated austerity measures have not yet been announced, tax increases and new rules for public pensions are definitely expected.
Tax reform plans discussed in 2015 included an array of measures such as raising the minimum age for retirement; creating a floor for compulsory contributions to public pensions; restoring the controversial financial tax, which was extinguished eight years ago; increasing the inheritance and donation tax and creating an asset tax. Those plans may return to the agenda, together with other measures such as further limitations on deductibility of the Brazilian instrument known as interest on equity and the increase of withholding taxes on dividends and on interest on equity. The changes required in law will now demand an extra effort to be approved by a Congress which is not yet aligned with the new government, but we can already see Temer working hard towards achieving alignment with the legislation.
One of the biggest changes would be any alteration to the taxation of dividends. Since 1996, dividends in Brazil are no longer subject to withholding income tax, and the proposals submitted to Congress considered raising the rate to 15%. This may imply that corporate ownership of Brazilian subsidiaries should be reviewed and possibly relocated to jurisdictions which have specific double taxation treaties limiting the withholding income tax to a rate below 15%.
The possible increase of withholding taxes on interest on equity may also have an impact on the appetite of Brazilian companies to pay this type of deductible dividend, especially if the payment is cross border and was previously relying on a tax exemption applicable to dividends received by the shareholder. Depending on the holding jurisdiction, the shareholder might already be prevented – under BEPS-inspired anti-hybrid legislation – from applying dividend exemptions over interest on equity deductible in Brazil.
Brazil is also facing its first full and broad experience within the transparency world. The amnesty program for undeclared funds held overseas was kept dormant for many years but was eventually launched at the beginning of 2016. Estimates vary from $20 billion to $50 billion returning to the country by October, which would definitely boost tax revenue and inject new money in the economy.
Besides the economic impact, the amnesty program is also seen as an important test for an area where the tax authorities have invested for a long time through modern information technology systems and a diversified network of exchange of information agreements, which serve as a useful tool in fighting corruption and money laundering.
With the ongoing repatriation of billions of dollars under the amnesty program, IRS technology is being tested within a global environment and its success should reverberate to other areas dealing with cross-border transactions, which require in-depth information and close coordination with foreign authorities.
This will certainly be helped by the recent expansion of the Brazilian exchange of information network. In the past years, Brazil was very keen to enter into additional bilateral and multilateral agreements and several examples such as FATCA and ratification of Tax Information Exchange Agreements with the US show that Brazil acknowledges and supports the increasing importance of tax cooperation.
These changes are impacting taxpayers in Brazil (not only those that are part of the repatriation program) and are being introduced into an environment where appetite is shifting from tax planning to tax compliance. Multinationals are certainly more familiar with the challenge of doing business in a transparent world, especially after BEPS, and should be able to react and adapt more quickly. Local companies which lack international experience will face more difficulties, but will need to move fast – or run the risk of not surviving.
Brazil is doing its homework and trying to quickly implement some of the BEPS initiatives. Even though it is not part of the OECD, the country is a key partner of the international organisation and a member of the G20, and was very active during the discussions of the action plans. Although some of the local policies will likely remain untouched – such as transfer pricing, which is based on a fixed margin approach rather than a typical arm's-length concept – recent initiatives clearly indicate that the country intends to follow international trends, but that the authorities are carefully choosing which proposals they will implement and how they will apply them.
So far, it is clear that scrutiny continues to be a key word. For instance, in 2015 the government tried to pass a provisional measure creating the mandatory disclosure inspired by Action 13 of the Action Plan in Congress. The so called 'DIOR' eventually was not approved in the country, but as other Latin American countries – such as Mexico and Chile – move further in this direction, it seems to just be a matter of time before Brazil becomes aligned.
More recent initiatives include the disclosure of the ultimate ownership, which was introduced by the Brazilian tax authorities via a normative instruction and requires legal entities to submit, in their taxpayer's enrollment, the complete chain of ownership up to the ultimate beneficiaries, as well as the legal representatives of owners. This may allow authorities to take more aggressive actions against tax-oriented structures, as well as to be more prepared to pursue debtors abroad for unpaid taxes.
The corruption investigations shall also continue to play an important role in forcing Brazil into the transparent world. The Car Wash operation completed its second year in March and has no set end date. It set a new standard for prosecution of corporate criminal charges in Brazil, and resulted in irreversible impacts to the political, criminal law and judicial environment, as well as changes to campaign financing legislation. In addition, its unfolding to other operations which investigated irregular funding of cultural incentive programs, misuse of indigene territory, financial frauds to pension funds of public companies, among others, created a kind of 'domino effect', which is compelling companies to strengthen their internal policies and carry out audits and investigations to become clean, before any malpractice surfaces and is eventually publicised.
Voluntary disclosures of tax exposures are also expected to become more frequent, in particular for companies which recently entered into leniency agreements with the police authorities and/or competition regulators. Leniency agreements were introduced by the Brazilian Anti-Corruption Act and have been broadly used to settle bribery charges. However, as they do not cover tax costs, those companies – which include large construction and oil and gas companies – will seek to regularise their tax positions as soon as possible, which will also result in increase in tax collection.
The Zelotes case also shed light on unconventional practices involving taxpayers and judges before the Administrative Tax Appellate Court (CARF). The scandal involved large companies and shut down the Court for almost eight months for a complete remodelling, which resulted in the replacement and resignation of the majority of its judges, including individuals who served for a long time and whose experience and expertise will be missed.
When the CARF reopened, it underwent a facelift that not only changed its appearance but its essence. From a highly reputed Court, known for its technical and balance decisions, it was reborn as a timid and biased court where the majority of decisions handed down are unfavourable to taxpayers. While it may be the case that the tax assessments are more well-grounded and hence supposedly hard to overrule, the market suspects that the increase in the tax administration success rate is in fact a "top down" guideline for a more tax administration-oriented Court, which will be less inclined to rule in favour of taxpayers.
This implies that tax disputes which used to be settled at the administrative level will now be taken at the Judicial level. This also points toward more costly and time consuming litigation, with a lower predictability of the outcome, as Brazilian case law is not based on the common law system where precedents have a greater relevance. The new Brazilian Procedural Code, introduced in 2016, has brought some changes which aim at strengthening the power and importance of precedents, but from a practical standpoint the enforceability of such new rules is hard to gage.
All in all, the elements indicate that, for companies investing in emerging markets such as Brazil, it is a more than ever a time to plan for the medium and long term and anticipate, as much as possible, changes. The shift into a transparent world is a one-way ticket and a specific strategy is needed to be able to operate in this changing environment. Structures need to be revisited to make sure that they will survive the future turbulent period where new rules will be created and paradigms broken.
The good news is that the economy started giving signs of its recovery right after Rousseff's impeachment, and the size of the Brazilian market and its importance to Latin America provides some level of comfort that the necessary measures will come, sooner or later.