Articles 76 and 77 of the new law establish that CFCs held directly or indirectly by a Brazilian corporation are subject to Brazil's universal basic income tax regime. Under that regime, profits accrued by CFCs are included in the corporate income tax (IRPJ) and social contribution on net profits (CSLL) bases of the investing corporation in Brazil in a proportion equal to its participation in the year that the profits accrued.
Special Oil and Gas Incentive
Article 77, paragraphs 3-5 of the new law establish that the portion of profits earned abroad by a directly or indirectly held subsidiary or associated foreign corporation in connection with a time charter, bareboat charter, financing or operational lease, rental, loan of goods, or rendering of services directly related to the exploration and extraction of oil and gas in Brazil will not be included in the IRPJ and CSLL bases of the investing corporation in Brazil.
For the benefit to apply, the Brazilian shareholder must be:
- a concessionary;
- a corporation that retains authorization to develop activities related to oil and gas;
- a corporation under Brazil's production sharing regime or onerous lending regime; or
- a corporation hired by one of the above-mentioned corporations.
It is worth noting that the National Congress amended the bill that was converted into Law 12,973/14 to exempt from taxation not only the profits accrued by directly held CFCs that develop activities directly related to oil and gas exploration and extraction, but also to indirect CFCs and associated foreign corporations.
Article 77, paragraph 3 of the new law states that the provisions of article 91, paragraph 1 of Law 12,708 of August 17, 2012, will be observed for purposes of the application of the tax incentive. Those provisions establish that provisional measures or bills of law that result in a loss of state revenue because of a tax incentive or benefit must contain a clause of duration of five years.
Notably, several amendments to remove the five-year limit were proposed and rejected. However, it is possible that Law 12,973/14 will be amended in the future to extend the duration of the benefit.
Article 77, paragraph 3 of the new law states that only activities1 carried out to identify and evaluate oil or natural gas fields qualify for the benefit. Activities related to the extraction and transport of oil and gas do not qualify. Several amendments to extend the tax benefit to oil and gas production activities were proposed and rejected.
The special oil and gas regime represents a full tax exemption in Brazil for profits accrued by CFCs that undertake activities directly related to oil and gas exploration, even when the profits are distributed in Brazil as dividends. There are four main arguments supporting this position:
- Article 77, paragraph 3 of the new law mentions that the benefit applies only if article 91, paragraph 1 of Law 12,708/12 -- which establishes some of the conditions for the waiver of state income due to the granting of tax incentives or benefits -- is observed. Under this scenario, a loss of state income would occur only upon an exemption from taxes.
- All previously enacted rules regarding the taxation of foreign corporations were revoked by Law 12,973/14, and there is no provision in the law for determining the taxation of dividends distributed to a Brazilian shareholder by a controlled or associated foreign corporation that carries on activities directly related to the exploration and extraction of oil and gas.
- The rule is an incentive created to increase investment in oil and gas projects.
- According to Brazilian tax authorities, profits accrued abroad that are accounted in Brazil through the net equity equivalence method, as for CFCs, are considered to be profits of the Brazilian shareholder, regardless of whether they are distributed as dividends. This is because a CFC's profits are included in the balance sheet of the investing corporation as net profits, even if they are not distributed as dividends. In this context, the distribution of profits as dividends is irrelevant because the profits should already be subject to taxation upon accounting in the balance sheet of the investing company. Therefore, the benefit is considered a tax exemption for the profits of the Brazilian company, which are considered to be made available to the Brazilian source regardless of distribution.
On the other hand, dividends distributed to the Brazilian company will be subject to taxation once the foreign profits are deemed available to the Brazilian shareholder. The main arguments supporting this position are:
- In Explanatory Memorandum (MP) 627/13, the Ministry of Finance projected a loss of public revenues of BRL 14.35 million in 2015, BRL 15.79 million in 2016, and BRL 17.36 million in 2017, in relation to the dividend tax rule. If an exemption is granted, the impact would be much higher.
- Article 77, paragraph 3 of the new law refers only to profits, without any mention of dividends, so dividends should be subject to taxation upon distribution, when the profits are made available to the Brazilian source.
Though it seems that the benefit foreseen in article 77, paragraphs 3-5 of Law 12,973/14 represents a full tax exemption for the profits accrued by foreign corporations that perform activities directly related to oil and gas exploration, it is unclear whether the Brazilian tax authorities will hold that position and not challenge the taxation of the dividends distributed by such corporations in future audits. A normative ruling expressing the opinion of Brazil's Federal Revenue would be helpful in bringing legal certainty to taxpayers.
Special Incentive for Oil and Gas Companies and Income Tax Treaties
Notably, the provisions of article 77, paragraphs 3-5 of Law 12,973/14 do not fully protect foreign oil and gas companies' profits from being taxed in Brazil. The five-year incentive applies only to activities directly related to exploration and not production, reducing the number of foreign CFCs and affiliate companies that could benefit from the nontaxation of their profits in Brazil.
Foreign oil and gas companies that do not qualify for the special oil and gas regime will, in principle, be subject to Brazil's worldwide tax regime and their profits will be taxed in Brazil in the same year in which they accrue. Such CFCs may also opt for the taxation of their profits in proportion to their distribution for a period of up to eight years, even though an amount equivalent to 12.5 percent of the profits accrued the first year will be taxed.
Oil and gas affiliates that do not qualify for the special regime are subject to taxation in Brazil when profits are considered to be "made available" to the Brazilian shareholder, in accordance with article 81 of Law 12,973/14.
It so happens that several oil and gas companies are located in jurisdictions that have entered into income tax treaties with Brazil. Article 7 of Brazil's tax treaties states:
The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein.
On that basis, the profits accrued by a company may be taxed in Brazil only after they are distributed as dividends to the Brazilian shareholder, regardless of whether they qualify for the special oil and gas regime. Further, there is no rule requiring the taxation of the profits at a 12.5 percent rate on the first year and at the full rate thereafter until the eighth year of their accrual.
Some income tax treaties, including the Brazil-Spain treaty, establish that dividends distributed by a Spanish corporation to its Brazilian shareholder cannot be taxed in both Brazil and Spain. The Austria-Brazil treaty provides an exemption for dividends distributed by an Austrian corporation that is at least 25 percent owned by a Brazilian corporation. Therefore, under the Spanish and Austrian treaty provisions, oil and gas companies established in those jurisdictions should not be taxed on the profits accrued, and the dividends distributed, in Brazil.
Those treaty provisions appear to directly conflict with the rules for CFCs and associated foreign corporations established in Law 12,973/14.
Moreover, the law does not contain any provisions establishing whether the CFC and associated foreign corporation rules apply if a subsidiary or associated foreign corporation engages in activities related to the exploration and extraction of oil and gas in a jurisdiction that has an income tax treaty with Brazil, suggesting that all CFCs and associated foreign corporations engaged in such activities, regardless of being located in a jurisdiction that has an income tax treaty with Brazil, are subject to the tax rules established in Law 12,973/14.
Nonetheless, article 98 of the Brazilian Tax Code establishes that income tax treaties prevail over Brazil's domestic laws. In view of that provision, Brazil's Superior Court of Justice on April 24 ruled in Special Appeal 1,325,709, that profits accrued by foreign corporations located in countries that have an income tax treaty with Brazil -- specifically, Belgium, Denmark, and Luxemburg -- cannot be taxed at the level of the Brazilian shareholder.
The ruling is being challenged before the Federal Supreme Court, which has the final word on the taxation of CFCs located in jurisdictions that have tax treaties with Brazil.
Clemens Philipp Schindler, partner, Wolf Theiss, Austria, and Murillo Estevam Allevato Neto, Brazilian tax lawyer and associate, Wolf Theiss, Austria. The authors lead the firm's Brazil practice.
1 As defined in article 6, section XV, of Law 9,478 of August 6, 1997.
END OF FOOTNOTE
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