There may be changes in income tax legislation
Brazilian tax law is under review. At the moment, the Brazilian National Congress is discussing some important constitutional amendments and legislative proposals on two fronts:
- Standardization of the existing consumption-based taxes, possibly in the form of a comprehensive and simplified value added tax; and
- Income tax reform, a series of nuclear law changes that may result in some structural changes in the Brazilian tax system.
Local political scientists dare to say that this is a test of more general and restructuring tax reform.
All of these changes lead to multiple discussions from different perspectives. This article focuses on the need to rethink international tax structures in light of possible changes in income tax legislation in Brazil.
These legislative proposals are the subject of an intense legislative debate and for this reason the scope of our analysis is limited to the currently prevailing qualitative trends as findings for future tax strategy reformulations. Particular attention is paid to the taxation policy for profits and dividend distributions.
Current Brazilian dividend distribution policy
Since 1996, Brazil has taken the position not to tax dividends paid by resident companies to their shareholders, whether or not they are Brazilian residents. It is important to note that dividends from non-resident companies are taxable in Brazil. This policy had a double impact. On the one hand, this was cited as a reason for a higher tax rate on corporate profits, as dividends would not be taxed.
On the other hand, this diminished the importance of double taxation agreements (DTAs), at least with regard to dividend distributions from companies based in Brazil. As there can be no double taxation on such dividends if they are not taxed in Brazil.
An important exception was those agreements that provided for matching credit or tax saving clauses – which granted a tax credit to non-resident shareholders, even if dividends were not taxed in Brazil. This represented a tax advantage that resulted in a lower income tax burden. But these clauses have become rarer in newer contracts and only exist in older ones.
This policy of predominantly taxing profits at the expense of dividends makes Brazil less vulnerable to the taxation of rights attributions in DTAs, as profits are generally only taxed at source, but there are restrictions on dividend taxation. From the taxpayer’s point of view, the DTAs have been less effective or attractive in this regard.
New proposed policy and its implications for tax planning strategies
One of the most important pillars of the current proposal for income tax reform is the return of dividend taxation. The current version of the draft law provides for a tax withholding of 20% if the dividends are paid to a non-resident and 30% if they are paid to a resident of a state that is considered a tax haven or has a privileged tax system.
The resulting impact would be the opposite of current policy. First, double tax treaties on dividend payouts would gain in importance for tax efficiency in receiving dividends from Brazil, which will likely require re-planning of ownership structures for Brazilian company shares and interests.
Second, the reduction in corporate tax on profits, coupled with the possible limitation on dividend taxation provided by DTAs, may result in total income tax paid in Brazil, also depending on the domestic tax rate approved for profit taxation. However, this outcome will depend on some strategic tax planning.
It should be emphasized that this planning needs a solid foundation in light of the new pattern of anti-tax avoidance rules adopted domestically or in DTAs. The tax authorities in Brazil are increasingly inclined, following international trends, to disregard legal structures or transactions for which there is no economic justification other than tax relief.
This guideline even appears in newer DTTs, such as the main purpose test (PPT). PPT is represented in the DBA Brazil-Argentina after a protocol ratification in 2017 and in more recent DBAs that Brazil has signed with Switzerland, Singapore and the United Arab Emirates. However, the concept of the main purpose or the main goal is not yet found in older ones. (Schoueri and Moreira; Abuso dos Acordos de Bitributação e Teste do Objetivo Principal; 2019)
A solid tax plan can therefore not be created in the short term; it must be integrated into the overall business strategy of every company and should be taken into account when designing the business model and making subsequent adjustments.
Additionally, such business strategy readjustment and reassessment should be dynamic, continuous, and flexible as legislative reforms and policy changes will be much more frequent given the pace of one’s own social change in a digital world.
Paulo Victor Vieira da Rocha
Partner, VRBF Attorneys at Law
Custodio Moreira Brasileiro Silva
Associate, VRBF Lawyers
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