The taxation of profits earned by foreign subsidiaries and affiliated companies of Brazilian multinationals is once again under examination, this time by Brazil’s Federal Supreme Court (Supremo Tribunal Federal, or STF). While the outcome of the high-profile case in question is eagerly awaited, the underlying legal debate is far from new.
The current trial arises from a 2014 ruling by the Superior Court of Justice (Superior Tribunal de Justiça, or STJ), which addressed the issue from the perspective of domestic tax legislation. Now, the STF is expected to determine whether the taxation of such profits complies with Brazil’s constitutional framework and the treaties signed by Brazil to avoid double taxation.
Background to the case
The case originated with a writ of mandamus filed by the mining company Vale do Rio Doce, challenging the automatic taxation of profits earned by its controlled subsidiaries in Belgium, Denmark, and Bermuda.
Under Brazilian law – specifically, Article 74 of Provisional Measure No. 2,158-34/2001 and Regulatory Instruction No. 213/2002 – these profits were subjected to corporate income tax (imposto de renda pessoa jurídica, or IRPJ) and social contribution on net profit (contribuição social sobre o lucro líquido, or CSLL) in Brazil, even if not yet distributed to the Brazilian parent company.
As a result, Article 74 subjects foreign profits to taxation at the end of each fiscal year, even if they are not repatriated. The provision aims to prevent profit retention abroad and, consequently, avoid or indefinitely defer Brazilian taxation.
This automatic taxation model has faced strong legal opposition on two main fronts:
Domestic tax law perspective – under Brazilian income tax principles, taxation should occur only when income is ‘available’ to the taxpayer. Therefore, taxing profits that have not been paid or credited violates the constitutional principle of income availability, which should be derived from the ability-to-pay principle.
International treaty perspective – Brazil has signed several bilateral tax treaties, following the structure of the OECD Model Tax Convention on Income and on Capital, that reserve exclusive taxing rights over profits to the country where the entity is resident (Article 7). As such, if a foreign subsidiary is a separate legal entity, its profits should only be taxed in its country of domicile and this automatic taxation is considered taxation of the foreign entity’s profits, not the Brazilian entity’s profits.
In a case filed by the Brazilian National Confederation of Industry in 2013, the STF assessed the constitutionality of Article 74 of Provisional Measure No. 2,158-34 through Direct Action of Unconstitutionality (Ação Direta de Inconstitucionalidade, or ADI) No. 2588. The court upheld the provision’s constitutionality in relation to controlled entities located in tax havens or jurisdictions with privileged tax regimes.
Conversely, the STF ruled that Article 74 was unconstitutional when applied to affiliated companies not based in tax havens. Importantly, the court did not address the situation of affiliates located in countries without special tax regimes or bilateral tax treaties, nor controlled entities located in jurisdictions that were not tax havens nor under privileged tax regimes. Nor did the STF analyse the issue through the lens of the international tax treaties Brazil has signed to avoid double taxation.
In 2014, in the Vale case, the STJ filled part of that gap by adopting a treaty-based approach. The court held that Brazil may not disregard its international agreements to tax profits that legally belong to subsidiaries protected by such treaties. According to the STJ, these profits fall under the tax jurisdiction of the subsidiary’s country of residence.
Additionally, following the STF’s ruling, the STJ permitted the taxation of profits from subsidiaries located in non-treaty jurisdictions (such as Bermuda), treating such profits as available on the date they are recorded in financial statements. However, the STJ maintained that Brazil cannot tax profits earned by subsidiaries based in countries with which it has tax treaties.
In response to the evolving judicial interpretations, the Brazilian parliament enacted Law No. 12,973/2014, which replaced the prior framework. While preserving the core provisions of Article 74, the new law sought to align the legal framework with the STF’s rulings in ADI 2588.
What is at stake?
The ongoing case before the STF is a continuation of the Vale case. Now, more than a decade later, the STF is re-examining the issue through a constitutional lens and considering Brazil’s commitments under international tax treaties.
In his opinion, Justice André Mendonça defended the primacy of international treaties over domestic law in cases of conflict. He argued that previous decisions supporting the taxation of foreign profits did not fully address the implications of Brazil’s bilateral tax agreements.
Justice Gilmar Mendes disagreed, taking the view that profits earned abroad result in an immediate economic benefit for the Brazilian parent company, even before they are distributed. He also stated that tax treaties should not apply in this context, since the income tax is levied on the Brazilian entity itself.
Once again, the case highlights the two opposing perspectives on the matter. For now, the trial remains on hold following a request for further review by the other justices.
This case represents a defining moment for multinational groups with operations in Brazil. The STF’s decision will clarify the boundaries between Brazil’s domestic anti-deferral tax rules and its obligations under international treaties.
