Global Tax 50 2016: Operation Zealots

Operation Zealots is a new entry this year

Operação Zelotes, or Operation Zealots, was a two-year police investigation into court corruption in Brazil that resulted a complete closure and overhaul of the tax courts, with the ramifications still being felt today. While the police investigation ran from 2013 to 2015, its aftermath has been felt most keenly by taxpayers in 2016. Since the courts reopened, they are far more likely to find in favour of the tax authorities.

More than 70 companies – some of which were named in 2015 – were investigated under the suspicion that they had paid bribes to Brazil's Administrative Council of Tax Appeals (Conselho Administritivo de Recursos Fiscais, or Carf) to reduce, or avoid, fines for tax evasion.

A spokesperson for the Ministry of Finance told International Tax Review earlier this year that "the Carf is investing in the restructuring and improvement of its work processes, with a focus on governance, integrity and transparency".

After the investigation was concluded, the Ministry of Finance, in June 2015, reduced the number of Carf courts from 36 to 13 and reduced the number of judges from 216 to 160. Judges were also offered a salary ($3,600) for the first time.

Half of the judges in Brazil's tax courts are appointed by the tax authorities, with the other half appointed by taxpayers. Once these changes were confirmed, the majority of taxpayer-nominated judges resigned. This was because practicing attorneys are not allowed to be appointed as judges due to the potential for conflicts of interest, leading to a very different makeup of judges at the Carf.

"As of December last year they had to replace the judges as appointed by taxpayers," said Francisco Moreira, a tax partner at CBSG. "So what we began to see was a number of law professors, accounting professors, or independent consultants. The profile of the judges has changed significantly."

This has contributed to a dramatic change in fortune for companies trying to defend their tax cases at Carf courts. A study by FGV Direito SP, a law school in São Paulo, reviewed 1,409 decisions from December 2015 to June 30 2016. During that period, the courts found in favour of the authorities 68% of the time.

While some of this change was a result of lower levels of corruption, advisers and companies feel that previously winnable cases are no longer going their way due to a variety of factors, including the different makeup and lower levels of experience in the revamped judiciary, and public pressure to see companies punished tax-wise due to anger at the scale of corruption uncovered by Operation Zealots.

One area where the operation's effect has been felt particularly keenly is in transfer pricing, specifically in the use of the PRL60 method, on Brazil's resale price method, which stems from a 2002 normative instruction. PRL60 imposed a fixed margin of 60% rather than allowing for market margins, and created a larger liability for taxpayers. Since December 2015, the Carf has found more often on the side of an adjustment based on the normative instruction – i.e. in favour of the tax authorities.

For now, taxpayers can only hope that the swing in favour of the tax authorities is temporary, and as a result of public pressure on decisions in the wake of widespread corruption being uncovered.

"This is just the beginning and they [the judges] need to provide the message to society that they are independent and not biased toward taxpayers," said Moreira. "After the dust settles down, the judges will begin to take only technical aspects in favour and not the necessity of providing a message to society."