Brazil: Updates To Brazilian Blacklist And Graylist And New Definition Of Substantive Economic Activity

On September 14, 2016, the Federal Revenue of Brazil ("RFB") published Normative Instruction RFB 1,658/2016, which updates the blacklist (list of tax havens) and the graylist (list of privileged fiscal regimes) and inserts a definition for "substantive economic activity" in Normative Instruction RFB 1,037/2010.

The modifications made by Normative Instruction RFB 1,658/2016 in the text of Normative Instruction RFB 1,037/2010 are described in the topics below. All modifications will become effective as of October 1st, 2016.1

1. Addition of new tax havens to the Brazilian blacklist

03 (three) new tax havens have been added to the Brazilian blacklist. They are: Curaçao (CIT: 22% | WHT: 0%), Sint Maarten (CIT: 34% | WHT: 0%) and Ireland (CIT: 12.5% or 25% | WHT: 20% for non-residents).2

As a reminder, payments of interest, royalties and for technical services are generally subject (along with other applicable taxes) to a Withholding Income Tax ("IRRF") of 15%. However, if these payments are made to a person located in a blacklisted jurisdiction, the applicable IRRF rate is increased to 25%.

2. "Suppression" of tax havens from the Brazilian blacklist

02 (two) tax havens have been "removed" from the Brazilian blacklist. They are: the Netherlands Antilles (dissolved since 2010)3 and St. Kitts and Nevis (the jurisdiction had been repeated in Portuguese and English in the blacklist – now, only the Portuguese name has been maintained).

3. Addition of a new privileged fiscal regime to the Brazilian graylist

As of October 1st, 2016, a new privileged fiscal regime will be added to the Brazilian graylist: it is the regime of Austria applicable to legal entities incorporated as holding companies.

It is important to highlight that although certain privileged fiscal regimes (Denmark and the Netherlands) refer to "legal entities incorporated as holding companies that do not perform substantive economic activities",4 the Austrian regime refers only to "legal entities incorporated as holding companies". Therefore, for purposes of analyzing whether a particular Austrian legal entity is graylisted or not, one must only assess whether it is "incorporated as a holding company". If the legal entity in question is incorporated as a holding company, it is automatically regarded as graylisted.

As a reminder, cross-border payments to graylisted entities are generally not subject to an increased rate of IRRF. However, there are relevant consequences that derive from operations with privileged fiscal regimes and/or structures involving privileged fiscal regimes. They are:

(i) Graylisted entities are automatically regarded as "related parties" for transfer pricing purposes, even if they do not have any relationship with the relevant Brazilian entity.5

(ii) Deductibility of interest for Brazilian legal entities (calculating profits in the Actual Profits Regime of Corporate Income Tax ("IRPJ") and Social Contribution on Net Profits ("CSLL")) that have any form of indebtedness before graylisted entities is subject to a lower threshold for thin capitalization purposes. While the general threshold is a 2:1 debt/equity ratio, the lower threshold is only 0.3:1 (30%).6

(iii) For purposes of the Brazilian Controlled Foreign Company ("CFC") rules, profits earned by graylisted affiliated foreign companies,7 or by affiliated foreign companies directly or indirectly controlled by a graylisted company, are taxable by IRPJ and CSLL at the level of the Brazilian corporate investor on December 31 of the relevant taxable period.8 Furthermore, if a CFC is graylisted, or if it is controlled, directly or indirectly, by a graylisted company, its profits cannot be consolidated with the profits of other CFCs9 and the payment of IRPJ and CSLL on its profits cannot be divided in up to 08 (eight) yearly installments.10

(iv) Also for purposes of the Brazilian CFC rules, the stock ownership of a graylisted entity that holds equity in an affiliated foreign company of a Brazilian legal entity is prima facie attributable to the latter. For example: if a Brazilian company ALPHA holds 20% and if a graylisted entity BETA holds 35% of the corporate stock of a foreign entity GAMMA, Brazilian CFC rules will prima facie regard ALPHA as the "owner" of 55% of the stock of GAMMA (therefore, a controlling entity under Brazilian CFC rules).11 In this situation, ALPHA or BETA would have to prove that the two entities are not related for purposes of CFC rules, for ALPHA to not be regarded as the "owner" of the stock participation of BETA.12

4. New definition of substantive economic activity

Both the Danish and the Dutch privileged fiscal regimes have made reference to "legal entities incorporated as holding companies that do not perform substantive economic activities", but Brazilian Law did not provide a definition to the expression "substantive economic activity" until the publication of Normative Instruction RFB 1,658/2016.

On May 30, 2016, RFB released Public Consultation 007/2016, which proposed a definition for the expression "substantive economic activity". The definition proposed by RFB at the time was the following:

"Art. 1st For purposes of the identification of privileged fiscal regimes in Art. 2nd of Normative Instruction 1,037, of June 04, 2010, a legal entity legally incorporated as a holding company performs a substantive economic activity when it possesses, in its country of residence, operational capability and adequate installations for the performance of management and effective decision-making with regard:

I – To the development of activities with the purpose of obtaining income derived from the assets at its disposal; or

II – To the management of corporate participations with the purpose of obtaining income derived from the distribution of profit and capital gains."

[Free translation – Highlights not present in the original text]

Many elements of the definition proposed in Public Consultation 007/2016 were maintained by Normative Instruction RFB 1,037/2010, which shows that RFB did not take into account several pleas of commentators and practitioners for an objective definition of "substantive economic activity". The new definition, as established by Article 1st of Normative Instruction RFB 1,658/2016, is the following:

"Art. 1st [...]

Sole Paragraph. For purposes of the identification of privileged fiscal regimes in items III and IV of Art. 2nd [of Normative Instruction 1,037, of June 04, 2010], a legal entity which performs the activity of a holding company performs a substantive economic activity when it possesses, in its country of residence, appropriate operational capability for its goals, evidenced, among other factors, by the existence of a sufficient number of qualified personnel of its own and of adequate installations for the performance of management and effective decision-making with regard:

I – To the development of activities with the purpose of obtaining income derived from the assets at its disposal; or

II – To the management of corporate participations with the purpose of obtaining income derived from the distribution of profit and capital gains."

[Free translation – Highlights not present in the original text]

The new definition of "substantive economic activity", therefore, further expands the definition in Public Consultation 007/2016, mainly by making reference to "other factors" that may potentially assist the taxpayer in proving operational capability, as well as to a "sufficient number of qualified personnel of its own". Our opinion is that the new definition of "substantive economic activity" is, to a certain extent, a non-definition: it summarizes several features of "business purpose" and "economic substance" that have been used by tax authorities in arguing cases before the Administrative Court of Tax Appeals ("CARF") and the Judicial Courts, and it does not provide legal certainty for Brazilian taxpayers wishing to plan their multinational activities (or for Danish and Dutch entities wishing to do business in Brazil).

For further comments on the application of the new Normative Instruction RFB 1,658/2016, please do not hesitate to contact our firm.

Update: On September 19, 2016, RFB rectified the terms of Normative Instruction RFB 1,658/2016, which now state that the modifications to the Brazilian blacklist and graylist are effective as of October 1st, 2016 (instead of August 1st, 2016).

Footnotes

1 See Article 3rd of Normative Instruction RFB 1,658/2016.

2 See PwC. Worldwide Tax Summaries Online. 2016/2017 edition. Available at: http://taxsummaries.pwc.com/uk/taxsummaries/wwts.nsf/ID/PPAA-85RDKF.

3 Aruba, Curaçao and Sint Maarten (formerly jurisdictions within the Netherlands Antilles) are all listed as tax havens in the Brazilian blacklist. See Article 1st, items V, LXVI and LXVII, of Normative Instruction RFB 1,037/2010.

4 See Article 2nd, items III and IV, of Normative Instruction RFB 1,037/2010.

5 See Article 24-A of Law 9,430/1996.

6 See Article 25 of Law 12,249/2010.

7 An "affiliated company" is defined by Brazilian Law as a company over which the relevant company has or exerts a significant influence (a power to participate in decisions of its financial and operational policies, without control). Also pursuant to Brazilian Law, a "significant influence" is considered as present if the relevant company owns 20% or more of the voting stock of the invested company, without control. See Article 243, §§ 1st, 4th and 5th, of Law 6,404/1976. Profits of affiliated foreign companies are generally only taxed upon their distribution as dividends. See Article 81 of Law 12,973/2014.

8 This is an exception to the general rule for affiliated foreign companies, which is taxation upon the distribution of dividends. See Article 81, items II and III, of Law 12,973/2014.

9 See Article 78, items II and III, of Law 12,973/2014.

10 See Article 91, items II and III, of Law 12,973/2014.

11 See Article 83, sole paragraph, item VI, of Law 12,973/2014.

12 See Article 15, § 2nd, of Normative Instruction RFB 1,520/2014.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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