On August 8, 2013, the Brazilian Federal Revenue Secretariat, through a division named General Coordination of Taxation ("COSIT"), issued an important interpretation that a specific legal provision in Brazil does not violate international tax treaties executed by the country to avoid double taxation.
Based on such specific legal provision (Section 74 of Provisional Measure 2,158-35 of 2001), Brazilian tax authorities consider that the profits derived from the participation in a foreign company become available to the Brazilian entity immediately upon being recorded in the balance sheet of the foreign company at the end of each fiscal year. As a result, these profits become subject to Brazilian corporate income taxes regardless of being actually distributed to the Brazilian entity.
In summary, COSIT used the following arguments to support its interpretation:
- When the participation of a Brazilian entity in a foreign company is valued based on the equity pick-up method, the net worth of the Brazilian entity increases every December 31 whenever the foreign entity has registered profits, even though they have not been distributed to the Brazilian entity yet;
- Since these profits are already recorded and can be distributed to shareholders of the foreign company, they are legally available to the Brazilian entity that holds participation in the relevant foreign company;
- Therefore, the increase in net worth that is subject to Brazilian corporate income taxes belongs to the Brazilian entity, and not to the foreign company;
- The tax treaties to avoid double taxation prevent the income accrued by the foreign company from being taxed in Brazil, and not the gains that belong to the Brazilian entity; and
- The taxes paid abroad can be deducted for purposes of Brazilian corporate income taxes, which avoids double taxation of the same income.
COSIT also clarified that Brazilian taxes will not apply only if the relevant tax treaty expressly creates an exception. The tax treaties that Brazil has executed with Denmark, the Czech Republic, and the Slovak Republic were given as examples, since they expressly provide that: "Non-distributed profits of a corporation of a Contracting State, the capital of which is wholly or partly owned or controlled, directly or indirectly, by one or more residents of the other Contracting State, shall not be taxable in the last-mentioned State."
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