I. Introduction
Although internationally adopted, the expression “tax haven” has not been used in the Brazilian applicable legislation. Brazilian regulatory authorities do not like offshore jurisdictions, considered as “tax havens”, because they believe that these jurisdictions have been misused in general with the specific purpose of (i) avoiding the payment of local taxes and/or (ii) not disclosing the identity of the true beneficiaries of the assets (which could be Brazilian residents pretending to be foreign investors just to avoid the reporting and other compliance requirements) and many times to facilitate transactions which would be regarded as questionable or illegal in the jurisdiction of domicile of the true beneficiaries. The fact is that the traditional offshore jurisdictions, the so-called “tax haven jurisdictions”, have a bad image in many countries and not only in Brazil.
II. Definitions adopted in Brazil
Brazilian tax legislation contemplates the concept of “favored taxation country or dependency” (país ou dependência com tributação favorecida) instead of tax haven or fiscal paradise (paraíso fiscal), and also defines the expressions “privileged fiscal regime” (regime fiscal privilegiado) and “related party” (parte vinculada).
Favored taxation country or dependency means any country or dependency of a country that does not impose tax on income or, when imposes, it is a low-tax country, in which the applicable income tax rate is equivalent to any percentage varying between zero and 20% (maximum). This first definition is contained in article 24 of Law 9.430, of December 27, 1996, which introduced transfer pricing regulations in Brazil.
Privileged fiscal regime means any jurisdiction that met one or more of the following requirements:
- it does not tax income or where the maximum applicable tax income rate is below 20%;
- it grants fiscal advantages to a non-resident individual or legal entity:
- without requiring that substantial economic activity be made in the country or dependency; or
- conditioned to the non-exercise of substantial economic activity in the country or dependency;
- it does not tax the earnings obtained outside its territory or imposes a maximum applicable rate below 20% to such earnings;
- it does not permit access to information regarding the capital stock structure, ownership of assets or rights or to the economic transaction entered into between the parties.
All the above-mentioned percentages may be reduced or changed at any time by the Executive Branch.
This second definition is provided for in article 23 of Law No. 11.727, of June 23, 2008, which approved new wording for articles 24-A and 24-B of Law 9.430/96. Article 30 of Law 11.941/2009, clarified that it is not necessary to attend simultaneously and cumulatively all the requirements listed above and that it is sufficient to attend only one for a country or dependency to be treated as a privileged fiscal regime.
For corporate purposes, “related party” is defined by Law No. 6.404, of December 15, 1976, as subsequently amended (the Brazilian Corporation Law – BCL) and its meaning includes any individual or legal entity resident or domiciled abroad (outside Brazil) whose capital stock characterizes its controller or affiliate. For tax purposes, the definition of “related party” is contained in article 23 of Law No. 9.430/1996.
The terms “controller” and “affiliate” are defined by the BCL.
Affiliate (coligada) is a company in which the investor has a significant influence over it (article 243, § 1 of the BCL, as amended by Law No. 11.941, of May 27, 2009).
One company will have significant influence over another when it holds or exercises the power to participate in decisions on financial or operational policies of the affiliate (article 243, § 4 of the BCL, added by Law 11.941/2009).
Significant influence is presumed to exist when one company holds at least 20% of the voting stock of another, but does not control it (article 243, § 5 of the BCL, added by Law 11.941/2009).
Controlled company (controlada) is a company in which another company, known as the controller (controladora), either directly or through other controlled companies, has the rights of a partner in the first company which permanently grants to the controller prevalence in voting the first company´s corporate decisions and the power to elect the majority of its management (article 243, § 2 of the BCL).
The following entities will be deemed to be related to the Brazilian company, for tax purposes:
- the parent company, when domiciled abroad;
- an offshore branch (filial) or dependency (sucursal);
- any individual or legal entity resident or domiciled abroad who/which is its controller or affiliate, as defined by the BCL;
- any legal entity domiciled abroad which may be deemed as its controlled company or affiliate, pursuant to the BCL;
- any legal entity domiciled abroad when both such non-resident company and the Brazilian company are under the same corporate control or common administration or when at least 10% of the capital stock of each one belongs to the same individual or legal entity;
- any individual or legal entity resident or domiciled abroad who/which, jointly with the Brazilian company, holds an equity participation in a third company and the aggregate sum of the participations characterizes them as controllers or affiliates, as defined by the BCL;
- any individual or legal entity resident or domiciled abroad who/which is an associate of the Brazilian company in any undertaking through the formation of a consortium or condominium;
- any individual resident abroad who is a relative or collateral of any kind (relative in-law) up to the third degree, spouse or companion of any of the Brazilian company´s directors or of its direct or indirect controlling partner or shareholder;
- any individual or legal entity resident or domiciled abroad who/which is its exclusive agent, distributor or grantee (concessionário) for the purchase and sale of goods, services or rights; and
- any individual or legal entity resident or domiciled abroad to whom/which the Brazilian company is the exclusive agent, distributor or grantee for the purchase and sale of goods, services or rights.
Under Brazilian law the consortium and the condominium are not legal entities but different forms of joint ventures. The condominium is basically the common ownership of an asset which is governed by articles 1.314 to 1.358 of the Brazilian Civil Code (Law No. 10.406, of January 10, 2002). The consortium is a contract governed by articles 278 and 279 of the BCL and must be registered at the Commercial Registry of the place where its head office is located.
III. The Need to Identify the Ultimate Beneficial Owner
According to the current Brazilian law and regulations, the Brazilian representatives of foreign investors are required to identify the ultimate beneficial owner (the final client) owing responsible for every transaction carried out at the Brazilian financial and capital markets1.
Law No. 8,021 of April 12, 1990 expressly establishes that no payment or redemption regarding any security or investment shall be made out to any unidentified beneficiary and neither securities nor payments shall be issued or paid in bearer form. Therefore, the disclosing of the identity of the beneficiary is a legal mandatory requirement in Brazil. Furthermore, the BCL expressly states that shares and debentures must be issued in registered form.
IV. List of Favored Taxation and Privileged Fiscal Regimes Countries and Dependencies
On June 4, 2010, the Secretary of the Brazilian Federal Revenue Office (Receita Federal do Brasil – RFB) issued RFB Normative Instruction No. 1037, which contains an updated list of favored taxation countries. This list remains in full force and effect and is valid as of June 7, 2010, date of its publication in the Official Gazette of the Union (Diário Oficial da União – DOU).
For the purpose of this list (which is deemed to be a “black-list”), the Brazilian tax authorities included the countries or dependencies that, according to the Brazilian Government, do not impose tax on income or, in which the applicable income tax rate is equivalent to any percentage varying between zero and 20% (maximum), as well as whose national legislation does not allow access to the information regarding the capital stock structure or ownership of the legal entities organized under the laws of any such jurisdiction. The current list comprises the following jurisdictions: (i) Andorra; (ii) Anguilla; (iii) Antigua and Barbuda; (iv) Netherlands Antilles; (v) Aruba; (vi) Ascension Island; (vii) The Commonwealth of The Bahamas; (viii) Bahrein; (ix) Barbados. (x) Belize; (xi) The Bermuda Islands; (xii) Brunei; (xiii) Campione d`Italia; (xiv) Channel Islands (Alderney, Guernsey, Jersey and Sark); (xv) Cayman Islands; (xvi) Cyprus; (xvii) Singapore; (xviii) Cook Islands; (xix) Costa Rica; (xx) Djibouti; (xxi) Dominica; (xxii) United Arab Emirates; (xxiii) Gibraltar; (xxiv) Granada; (xxv) Hong Kong; (xxvi) Kiribati; (xxvii) Labuan; (xxviii) Lebanon; (xxix) Liberia; (xxx) Liechtenstein;; (xxxi) Macau; (xxxii) Madeira Island; (xxxiii) Maldives; (xxxiv) Isle of Man; (xxxv) Marshall Islands; (xxxvi) Mauritius Island; (xxxvii) Monaco; (xxxviii) Montserrat Island; (xxxix) Nauru; (xl) Niue Island; (xl) Norfolk Island (xlii) Panama; (xliii) Pitcairn Islands; (xliv) French Polynesia; (xlv) Qeshm Island; (xlvi) American Samoa; (xlvii) Eastern Samoa; (xlviii) San Marino; (xlix) Saint Helena Island; (l) Saint Lucia; (li) The Federation of Saint Kitts and Nevis; (lii) Saint-Pierre and Miquelon Island; (liii) Saint Vincent and the Grenadines; (liv) Seychelles; (lv) Solomon Islands; (lvi) The Kingdom of Swaziland; (lvii) Switzerland2; (lviii) The Sultanate of Oman; (lix) Tonga; (lx) Tristan da Cunha; (lxi) Turks and Caicos Islands; (lxii) Vanuatu; (lxiii) U.S. Virgin Islands; (lxiv) British Virgin Islands.
The main consequence is that the listed countries and dependencies are subject to a higher withholding income tax rate on the remittance abroad of capital gains and of the remuneration due for rendering of services, which is equivalent to 25%. For countries in jurisdictions which do not fall into this category, the applicable rate is only 15%3.
For the first time the RFB has identified the entities which are subject to the concept of “privileged fiscal regime” and must obey the Brazilian transfer pricing rules. These rules basically require the adjustment of the revenues and expenses in transactions entered into between related parties, when there is over-invoicing or under-invoicing related to import and export operations, in order to avoid that part of the profit of the Brazilian company that normally would be taxed in Brazil if the transaction was structured otherwise be transferred to another foreign company based in a favored taxation country or dependency or is deemed to be subject to a privileged fiscal regime with the sole and exclusive purpose of saving the corresponding Brazilian tax. The same principle also applies if the transaction involves an unrelated company, i.e. a foreign legal entity without any formal relationship with the Brazilian company, but is made with the same purpose (avoid the payment of the corresponding Brazilian tax).
In addition, Brazilian thin capitalization rules established by Provisional Measure No. 472, of December 15, 2009, transformed into Law No. 12,249, of June 11, 2010, must be duly observed. This means that in the case of intercompany loans between a foreign legal entity which is domiciled in a favored taxation country or dependency or is deemed to be subject to a privileged fiscal regime, as lender, and a Brazilian company, as borrower, the interest paid by the Brazilian borrower to the foreign lender will only be deductible for income tax purposes if the debt/equity ratio of the Brazilian borrower does not exceed 30% of its net worth value.
Therefore, under the current legislation, the foreign companies subject to a privileged fiscal regime are only adversely affected by the transfer pricing and thin capitalization rules outlined above, which also apply to the companies with head offices in favored taxation countries or dependencies.
V. Foreign Entities subject to Privileged Fiscal Regime in Brazil
According to the classification set forth by RFB Normative Instruction 1037/2010 the following entities are subject to privileged fiscal regime in Brazil4:
- in the case of Uruguay, the regime applied to the entities incorporated in the form of Sociedad Financiera de Inversion (SAFI), which is the Uruguayan Financial Service Corporation which existed until December 31, 2010;
- in the case of Denmark, the regime applied to the entities incorporated in the form of holding company (Danish Holding Company) which do not exercise any substantive economic activity;
- in the case of Netherlands (Holland), the regime applied to the entities incorporated in the form of holding company (Dutch Holding Company) which do not exercise any substantive economic activity5;
- in the case of Iceland, the regime applied to the entities incorporated in the form of International Trading Company (ITC);
- in the case of Hungary, the regime applied to the entities incorporated in the form of the offshore KFT, which is the acronym for Korlátolt Felelõsségû Társaság (the Hungarian Limited Liability Corporation);
- in the case of the United States of America, the regime applied to the entities incorporated in the form of Limited Liability Company (LLC) whose equity participation is formed by non-residents, which are not subject to the US federal income tax, such as Delaware, Nevada, Florida and other US states which adopt a similar regime;
- in the case of Spain, the regime applied to the entities incorporated in the form of Entidad de Tenencia de Valores Extranjeros (ETVE), which is the International Spanish Holding Company; and
- in the case of Malta, the regime applied to the entities incorporated in the form of International Trading Company (ITC) and International Holding Company (IHC).
Therefore, the Danish or Dutch Holding Companies which have a substantive economic activity do not fall into this category.
The latest list of favored taxation and privileged fiscal regimes countries and dependencies announced through RFB Normative Instruction 1037/2010, which included Switzerland as a favored taxation jurisdiction and the Dutch Holding Companies as privileged fiscal regime entities, disliked many people who did not agree with such classification!
For this reason, by means of RFB Normative Instruction No. 1045, of June 23, 2010, the Brazilian tax authorities decided to permit the affected offshore jurisdictions to apply for the request of the review of their classification as favored taxation or privileged fiscal regime country or dependency. This measure came into force on the following day (June 24, 2010), after its publication in the DOU.
The review request mentioned herein must be sent by the representative of the foreign government of the interested country or dependency and addressed to the RFB´s Secretary, together with proof of the content and effectiveness of the applicable tax legislation that justifies the review of the corresponding classification. It can be received with suspensive effect at the discretion of the RFB´s Secretary. Both the granting of the suspensive effect and the result of the analysis of the review request shall be formalized by means of an Executive Declaratory Act (Ato Declaratório Executivo – ADE) issued by the RFB´s Secretary and published in the DOU.
Based on RFB Normative Instruction 1045/2010, Switzerland and Netherlands already decided to use this prerogative. The Danish Government requested the review of the status of the Dutch Holding Companies, for the purpose of being excluded of the privileged fiscal regime status, and the effect was suspended by means of ADE No. 10, of June 24, 2010. The Swiss Government also requested the review two exclude Switzerland of the status of favored taxation country and the effect was suspended by means of ADE No. 11, of June 24, 2010. Both acts have been published in the DOU of June 25, 2010 and remain in full force and effect.
It should be noted, however, that this suspension is only temporary and its effectiveness will cease at any time, if and when the RFB concludes that the challenged classification should be maintained and denies the review request. For this reason, to avoid any undesired surprises, it is advisable to wait to structure any transaction originated from Switzerland or having as a vehicle a Dutch Holding Company with no substantive economic activity, until this matter is finally defined by the Brazilian tax authorities.
VI. Conclusion
It is important to bear in mind that the list and classification contained in RFB Normative Instruction 1037/2010 can be reviewed by RFB at any time for the purpose of including other jurisdictions either as a favored taxation country or dependency and/or in the category of privileged fiscal regime, at the discretion of the Brazilian Government.
The current rules aim to reduce and close almost all the tax planning structures and alternatives envisaged by creative business lawyers based on offshore vehicles.
Therefore, when structuring an investment in Brazil through an offshore jurisdiction deemed to be “tax haven”, the investor should take into account all the adverse consequences that may arise as a result of this decision because many times the apparent “tax haven” may become a true “tax hell”!
Footnotes
1. This is an extremely relevant aspect that needs to be considered. As part of this requirement, client due diligence processes (CDD process) conducted by custodial services providers and brokerage houses will have to disclose the identity of the ultimate beneficial owner. This means that when securities are involved, this identification must be made at the BM&FBOVESPA S.A. – Securities, Commodities and Futures Exchange (BM&FBOVESPA S.A. – Bolsa de Valores, Mercadorias e Futuros – BVMF)´s trading system, and the assets will be held under an individual account in the BVMF Central Depositary. Brazil is an Ultimate Beneficial Owner market. Furthermore, this requirement is emphasized by the Brazilian Securities and Exchange Commission (Comissão de Valores Mobiliários – CVM). CVM Instruction No. 387, of April 28, 2003, that establishes standards and procedures to be followed in the securities and exchange transactions on the floor and in electronic trading and registration systems in the stock exchange and in the future and commodities exchange and other provisions, also sets forth that the brokerage houses must keep records of their clients and provide the exchanges and the clearinghouses with accurate client data to allow the clients´ perfect identification and qualification. In addition, CVM Instruction No. 325, of January 27, 2000, as amended by CVM Instruction No. 419, of Mary 2, 2005, that contains the registration procedures of non-resident investors regulated by Resolution No. 2,689, of January 26, 2000 issued by the Brazilian Monetary Council (Conselho Monetário Nacional –CMN), determine that the same rules about identification be applied for foreign investors.
2. As further explained in this article, the inclusion of Switzerland in the list was temporarily suspended by the RFB´s Secretary by means of Executive Declaratory Act No.11, of June 24, 2010.
3. The same rates are valid in the case of payment of interest on net equity (juros sobre capital próprio) for both situations. The tax exemption applied to income earned in Brazilian Private Equity Funds (Fundos de Investimento em Participação – FIPs) is not applicable. Furthermore, the current applicable taxation rules for investments in the Brazilian financial and capital markets must also be observed. In the case of foreign investors, these rules may be summarized as indicated herein. There is an income tax withheld at source at the following: (i) for stocks, futures and listed options, public securities: zero rate; (ii) for funds and over-the-counter (OTC) derivatives: 10%; and (iii) for interest and capital earnings: 15%. Only for investors with head offices in favored taxation countries or dependencies, the applicable tax rate is established by the same rules applied to Brazilian residents, as follows: (a) period of up to 180 days: 22.5%; (b) period from 181 days up to 360 days: 20.0%; (c) period from 361 days up to 720 days: 17.5%; and (d) period above 721 days: 15%.
4. In the case of Luxembourg, the privileged fiscal regime applied to the entities incorporated in the form of holding company (Luxembourg Holding Company) was revoked by RFB Executive Declaratory Act No. 3, of March 25, 2011, as a result of the termination of this vehicle.
5. As further explained in this article, the inclusion of the Dutch Holding Companies with no substantive economic activity has been suspended by the RFB´s Secretary by means of Executive Declaratory Act No. 10, of June 24, 2010.