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Brazil: Taxation of profits earned abroad on accrual basis


Cristiane Magalhaes and Tatiana Villani, of Machado Associados, explore Brazil’s peculiar rules regarding the taxation of profits earned abroad.

At present, Brazil has the following rules regarding foreign profit taxation:

- Pursuant to article 74 of the Provisional Measure no. 2158-35/2001 (MP 2158), profits earned by foreign controlled and/or affiliate companies of a Brazilian company shall be subject to income tax (IRPJ) and social contribution on net profits (CSLL) in Brazil on accrual basis, that is, on December 31 of each year, regardless of their actual distribution and/or their origin (passive or active income, originated in tax haven or treaty countries);

- Regulation issued by the Brazilian Federal Revenue Service imposes taxation on the revenues booked by the Brazilian company, arising from the application of the equity pick up method on its foreign investments, instead of taxing the profits earned by such investments. Such provision has no legal grounds;

- Taxes paid abroad may be offset against the IRPJ and CSLL due in Brazil, provided certain limits and conditions are met;

- Losses incurred by the foreign subsidiaries/affiliates shall not be used to offset profits earned in Brazil by the Brazilian shareholder. Such losses may only offset profits ascertained by the same foreign subsidiary/affiliate in subsequent years.

There are several debates about the legitimacy of these rules, especially in what concerns the accrual basis taxation mechanism introduced by article 74 of MP 2158, which can subject to tax fictitious income (that is, profits generated by foreign invested companies that are not properly made available to the Brazilian investors, neither from the economic, nor from the legal perspectives), and, as such, offends Constitutional concepts and principles.

This matter is of course crucial in the current economic context, in which there is a clear movement of internationalisation of Brazilian companies for reaching (and surviving in) the global market.

In this scenario, there was high expectation that Brazilian Supreme Court (local acronym STF) would finally settle the debate on the legitimacy of article 74 of MP 2158 when finalising the judgment of Direct Action of Unconstitutionality 2588 (ADI 2588), filed by the National Confederation of Industry more than 11 years ago. However, this was not the case.

Judgment of ADI 2588 was initiated and interrupted several times in the last 11 years, and the score was quite tight: there were four votes against taxpayers, four votes in favour of taxpayers, and one vote partially in favour of taxpayers in what concerned profits from foreign affiliated companies. The only one vote missing (from the current STF’s President) was expected to decide the case for good, be it against or in favour of taxpayers.

Surprisingly, in a recent plenary session, instead of following one or the other reasoning of the 10 existing votes of ADI 2588, STF’s President brought a new interpretation to article 74 of MP 2158, influenced by international standards (mostly, by controlled foreign companies (CFC) rules). In his view, the accrual basis taxation is compatible with the Constitution only for profits generated by foreign invested companies domiciled in tax havens.

STF President’s vote has not been published yet, and there are already debates about some of its aspects and effects, especially: (a) the concept of tax haven adopted in the vote (as it is not properly defined in the legislation that governs the matter); (b) the legitimacy of a STF’s decision introducing CFC rules concepts.

Irrespective of such debates, the fact is that, adding all the 10 votes issued in ADI 2588, the conclusion of STF with regard to the accrual basis taxation of profits earned abroad is the following:

(i) affiliated companies located outside tax haven jurisdictions: unconstitutional;

(ii) affiliated companies located in tax haven jurisdictions: no majority was reached (thus, definition is still pending);

(iii) controlled companies located outside tax haven jurisdictions: no majority was reached (thus, definition is still pending); and

(iv) controlled companies located in tax haven jurisdictions: constitutional.

Criticisms are being made on the fact that the decision reached in ADI 2588 does not represent the opinion of STF’s current composition, as votes from former judges have been considered. Besides, it is evident that it does not completely solve all the situations and issues related to the taxation on an accrual basis of profits earned abroad, including tax treaty aspects. As such, such decision has in fact limited practical effects.

Hopefully, such important matters shall soon be settled in future decisions to be granted in other pending cases before STF.

Cristiane Magalhães ( and Tatiana Villani ( are specialists in Brazilian direct taxes and members of Machado Associados, principal Corporate Tax correspondent for Brazil.

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