MEMORANDUM TO CLIENTS
09/06/2010 Tax
Newsletter - Tax Law
TAX FAVORABLE JURISDICTIONS AND PRIVILEGED TAX REGIMES BLACK LIST – NORMATIVE INSTRUCTION N.º 1,037, OF JUNE 4TH, 2010
What is the news?
Normative Ruling (“IN”) n.º 1,037 issued by the Brazilian Federal Revenue Office was published on the Federal Official Gazette last June 7th. Accordingly, IN n.º 1,037/10 has revoked IN n.º 188, of August 6th, 2002 and, as such, sets forth the updated list of countries or jurisdictions deemed by Brazilian tax authorities to provide favorable taxation and privileged tax regimes.
In comparison with IN n.º 188/02, the current IN brought some innovations by dividing the black list into two articles: (i) the first article presents the ordinary blacklist list of countries generically deemed to be tax favorable jurisdictions (“TFJ”); and (ii) article 2, wherein tax authorities have listed tax regimes provided by countries and jurisdictions that are not usually considered TFJ but deemed to be tax privileged (Privileged Tax Regimes – “PTR”).
For purposes of article 1, are deemed to be TFJ the countries or jurisdictions that do not tax income or that tax it at a tax rate lower than 20%, or that impose restrictions on the disclosure of shareholding composition. In this sense, to the list of countries generically deemed to be TFJ provided by IN n.º 188/02, 14 new jurisdictions have been added: (i) Ascension Island; (ii) Brunei; (iii) Kiribati; (iii) Norfolk Island; (iv) Pitcairn Island; (v) Queshm Island; (vi) Saint Helena Island; (vii) Federation of Saint Christopher and Nevis; (viii) Saint Pierre and Miquelon Island; (ix) Solomon Island; (x) Saint Kitts and Nevis; (xi) Kingdom of Swaziland; (xii) Switzerland; and (xiii) Tristan da Cunha. On the other hand, we should note that Malta and Luxembourg are no longer blacklisted as jurisdictions generically deemed to be TFJ, but only some types of companies that may be incorporated under their laws are considered PTR, as we will examine further.
With regard to PTR, article 2 of IN n.º 1,037/10 lists the regimes deemed by Brazilian tax authorities to be privileged. In general lines, have been deemed as benefiting from PTR the legal entities incorporated under the form of: (i) holding companies in Luxembourg, Denmark and Netherlands; (ii) Sociedades Financieras de Inversión - SAFI´s in Uruguay which have been incorporated until December 31st, 2010;(iii) International Trading Company in Island; (iv) offshore KFT in Hungary; (v) Entidad de Tenencia de Valores Extranjeros - ETVEs in Spain; (vi) International Trading Company and International Holding Company in Malta; and (vii) State Limited Liability Companies – LLC held by non-residents and not subject to federal income tax in the United States of America.
How should IN n.º 1,037/10 be interpreted?
In our view, IN n.º 1,037/10 should be interpreted in light of the applicable legislation that provides for the legal notions of TFJ and PTR for each situation. Any conclusion regarding the applicability of the IN cannot be achieved without prior and proper evaluation of the relevant legislation.
In this sense, we should stress that, for purposes of Brazilian Income Tax legislation, there is no general concept of what has been commonly named “tax havens”. Rather, within the Brazilian legal framework, we can find different notions of TFJ specific for different circumstances.
Therefore, the concept of TFJ is not uniform, as it varies according to the specific transaction under analysis in which the concept is relevant – since the notion of TFJ is defined under the relevant legal provision that sets forth the tax treatment for that particular transaction. In view of that, we can affirm that Brazilian tax legislation provides different notions of TFJ and PTR, according to the type of transaction subject to its application, although some common features to the concepts can be identified.
How is IN n.º 1,037 going to impact foreign investments in the Brazilian financial and capital markets?
For purposes of denying the applicability of the beneficial income tax treatment granted by Brazilian tax legislation to income and gains realized by foreign investors that invest in the Brazilian financial and capital markets through National Monetary Council Resolution N.º 2,689, of January 26th, 2000 (“Qualified Investors”), the relevant TFJ notion is the one that makes reference to “countries that tax income at a rate lower than 20%”, as provided under Law n.º 9,959, dated January 27th, 2000.
In this sense, please note that the notion of TFJ to be considered in this context does not include a reference to the disclosure of shareholding composition or any other reference to the concept of PTR.
As a consequence, in our view, article 2 of IN n.º 1,037/10 shall not impact the assessment of whether or not a certain foreign investor qualifies for the beneficial income tax treatment under Brazilian law. Rather, only the list provided under article 1 of the IN could be argued as the one containing the countries or jurisdictions which residents are not entitled to the beneficial income tax treatment.
What about the impacts on transfer pricing and thin capitalization rules?
It is in the context of applying Brazilian transfer pricing and thin capitalization rules that we may find the greatest impact brought by IN n.º 1,037/10. For purposes of applying those rules, the relevant concept of TFJ is the one defined under article 24, of Law n.º 9,430, dated December 27th, 1996, as subsequently amended by Law n.º 11,727, dated June 23rd, 2008, especially with regard to the inclusion of the notion of PTR under article 24-A of the above mentioned law. Therefore, in these two situations the notion of PTR must be borne in mind.
Considering that before IN n.º 1,037/10 there was no guidance by the tax authorities regarding what should be deemed to be PTR, taxpayers could only evaluate the applicability of such concept in the context of transfer pricing and thin capitalization rules on a case by case basis, in light of the legal concepts explained above, which left room for uncertainty.
How does the IN impact the taxation of remittances to and capital gains realized by foreign investors?
For purposes of applying the increased 25% Withholding Income Tax (“WHT”) rate upon remittances to TFJ residents and capital gains realized by non-residents domiciled in TFJ, the relevant notion of TFJ is embedded in other legal provisions, which, in principle, do not refer to the notion of PTR. In these situations, although the relevant legislation refer to article 24 of Law n.º 9,430/96, they do not refer to article 24-A (the one that brings the notion of PTR).
It can also be argued that in both these contexts, no reference is made to the disclosure of shareholding composition for purposes of qualifying a TFJ. Hence, it follows that, for applying the 25% WHT rate only the countries and jurisdictions blacklisted under article 1 should be considered.
Are the lists exhaustive?
Despite all the particularities above mentioned, in our view, the new lists should be interpreted in light of the applicable legislation, considering the notions of TFJ and PTR applicable in each situation. Thus, it follows that, from a legal perspective, the lists should be illustrative, i.e., non-exhaustive.
Therefore, for instance, even if a certain country or jurisdiction has been blacklisted under article 1 of IN n.º 1,037/10, the possibility of challenging the applicability of the more burdensome treatment shall remain, in case the factual and legal circumstances of the relevant jurisdiction leaves room for arguing that it does not qualify under the applicable legal concept of TFJ. The reason for that is that the legal provisions do not refer to the list issued by the tax authorities, nor they list countries or jurisdictions; rather they define notions. Following the same line of reasoning, in our view, transactions with countries and jurisdictions not listed under IN n.º 1,037/10 could also be challenged in view of the specific legal notions of TFJ.
Nonetheless, it is worth mentioning that Brazilian tax authorities tend to cling to the list when determining whether a certain country is deemed to be a TFJ, disregarding the specific legal notion of TFJ provided for each particular situation. In this sense, even though we are not able to predict what shall the Brazilian tax authorities approach towards the new lists be, in our view, the tax authorities are likely to take the stand that the list of article 1 is exhaustive, which would lead to the practical result of applying the more burdensome treatment to all transactions that involve the countries listed therein, irrespective of the specific TFJ notion provided for each particular circumstance.
Despite the pragmatic approach of the tax authorities, the greatest level of legal protection countries and jurisdictions can assure is indeed not being blacklisted under IN n.º 1,037/10 and not qualifying as a TFJ or PTR under the specific legal concepts provided for each situation. Moreover, in case Brazilian tax authorities challenge a transaction with a non-listed country or jurisdiction, the taxpayer could make use of the existing lists as a defense argument.
Conclusion
In our view, the most important feature of IN n.º 1,037/10 is the acknowledgement by tax authorities that tax legislation does not provide for a singular concept of “tax haven”. Rather, there are cases of TFJ and there are cases of PTR and these situations must be analyzed separately. On the other hand, its greatest flaw might have been the mistaken inclusion of certain country, jurisdiction or regime under the lists because of an erroneous interpretation of the foreign law.
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