While the removal is only temporary pending a review requested by Spain, it is welcome news for taxpayers in light of the resulting tax relief for ETVE activities. Nevertheless, it comes as something of a surprise, considering the FRD's long-lasting opposition to those entities.
The ETVE Regime and the Brazilian Tax Authorities
The ETVE regime was introduced in 1995 and benefits any Spanish legal entity with limited liability that is taxable in Spain on its overall income. Regardless of the specific compliance requirements, this is a widely used regime not only because of the tax benefits granted by Spanish law, but also because of the potential tax shelter provided by Spain's tax treaties with other countries.
In brief, and from an inbound perspective, Spanish law exempts an ETVE-qualified holding company from tax on dividends and capital gains in Spain if the source of those payments is a foreign subsidiary that is subject to a domestic tax that is comparable to the Spanish corporate income tax (CIT) and that carries out active business activities outside of Spain, and if the corporate relationship between the ETVE company and the foreign subsidiary meets the minimum participation requirement.
From an outbound perspective, dividends distributed by an ETVE company to a foreign shareholder are not subject to withholding tax in Spain if the investor is not a resident of a tax haven jurisdiction and if the dividends are distributed out of exempt dividends or capital gains obtained by the ETVE company from subsidiaries that meet the requirements listed in the previous paragraph. Dividends are also subject to a zero rate if the beneficiary is domiciled in the European Union and is subject to the EU parent-subsidiary directive. Other than that, a 19 percent rate applies unless otherwise determined in an applicable tax treaty.
Because Brazil is not a tax haven jurisdiction under the Spanish concept, investments to and from Brazil to Spanish ETVE companies usually qualify for the benefits mentioned above. That fact, coupled with Brazil's beneficial tax treaty with Spain, often results in the use of ETVE companies as investment channels in international tax planning strategies involving Brazilian companies.
Needless to say, the FRD does not welcome this strategy. From an inbound investment perspective, the FRD dislikes the idea that business profits are not taxed at source in Brazil (under article 7 of the treaty) but also are not taxed in Spain. And it's even worse from an outbound perspective: The FRD objects to Brazilian companies interposing ETVE companies between themselves and their foreign subsidiaries, thereby benefiting from a dividend exemption in Spain and from a tax exemption for undistributed profits in Brazil under the Brazil-Spain income tax treaty.
In an attempt to fence in tax planning based on the use of Spanish ETVE companies, the FRD in 2002 issued an administrative ruling (Ato Declaratório Interpretativo 6) unilaterally excluding ETVE companies from the Brazil-Spain tax treaty. According to the ruling, profits and dividends received by Brazilian resident or domiciled parties are subject to Brazilian income tax if they are generated or paid by an ETVE. The treaty thus did not prevent the taxation of ETVEs' undistributed profits.
The ruling caused some controversy within the FRD and even more so among Brazilian taxpayers that already had Spanish-based investment structures, as it took an even stronger stance against those with profits accumulated before 2002. It stated that the income tax would apply retroactively to profits generated and/or dividends distributed from January 1, 1996, onward.
While the ruling was flagrantly illegal, it caused many Brazilian outbound investments from 2002 onward to bypass the Spanish ETVE regime so as to avoid conflicts with the FRD.
The Gray List
Against that backdrop, Brazilian taxpayers were not surprised when ETVE companies were included in the gray list of privileged tax regimes issued by the FRD in June 2010.
Over the past few years, Brazil has been listing countries and dependencies that are considered to be low-tax jurisdictions. This blacklist includes jurisdictions that:
- do not impose tax on income;
- tax it at a maximum rate of less than 20 percent; or
- allow for corporate or ownership secrecy.
In 2008 Brazil adopted tax legislation that created the privileged tax regime designation, which refers to tax regimes or corporate forms in specific countries and dependencies. A tax regime is considered privileged if:
- it does not tax income or taxes domestic or foreign income at a maximum rate that is lower than 20 percent;
- it allows corporate secrecy or secrecy with respect to the ownership of assets or rights or to economic operations; or
- it grants tax benefits to domestic individuals or companies with no requirement of substantial business activity therein.
Given the uncertainty around this new concept and the continued publication of blacklists over the years, observers expected the FRD to issue a new, more comprehensive list of privileged tax regimes.
The latest list came out in June 2010, and as expected, the list indicated not only countries and dependencies that are considered to be low-tax jurisdictions, but also regimes that are considered to be tax-privileged, including:
- Luxembourg holding companies;
- Uruguayan offshore holding companies (SAFIs);
- Danish and Dutch holding companies;
- Icelandic international trading companies (ITCs);
- Hungarian offshore companies (KFTs);
- U.S. limited liability companies;
- Maltese international trading and holding companies (IHCs); and
- Spanish ETVEs.
Along with the blacklist and gray list, the FRD created administrative procedures for listed countries or dependencies to request reviews of their classification as low-tax or privileged tax regime jurisdictions.
Controversies Involving the Gray List
Blacklists and gray lists like the ones mentioned above have always generated controversy in Brazil -- the most important and recurring question being whether they can be expanded. Because Brazil's tax legislation does not require these lists -- and considering the fact that other, unlisted jurisdictions and regimes may also meet the blacklist or gray-list criteria -- some taxpayers fear that the tax authorities see the lists as nonexclusive. (This has not been the case over the years, however, because of the basic principle of juridical safety granted to every taxpayer.)
The gray list issued this year was controversial because it included the regimes of some countries while excluding similar regimes in other countries. For example, what were the criteria for listing Danish holding companies but not listing those in Austria?
The inclusion of the Netherlands on the gray list was another point of contention, considering the amount of foreign investment channeled through that country. In this case, however, the pressure was intense, and a week after the gray list was published, the FRD restricted the listing of Dutch holding companies to those that do not exercise substantive activity in the Netherlands.
That was not enough, however, and the Dutch authorities acted quickly against the list. A day after that response was published, the FRD tentatively removed Dutch holding companies from the gray list of privileged tax regimes. The same can be said about the inclusion and tentative removal of Switzerland from the blacklist of tax haven countries and dependencies.
The removal of the Spanish ETVE regime comes almost six months after the issuance of the gray list, and like the Dutch case, this case is not definitive because the tax authorities are still reviewing Spain's request.
Effects of the Tentative Removal
The inconsistency of Brazil's tax legislation as it applies to the tax haven issue may lead to interpretation problems. Because the low-tax jurisdiction and privileged tax regime concepts were created at different times and refer to different situations, Brazilian taxpayers must be careful when analyzing the tax statutes.
The low-tax jurisdiction concept increases withholding tax rates in cases of foreign investment in Brazilian financial and capital markets and in cases of remittances of payments for services, loan interest, interest on equity, and capital gains. It also limits the corporate tax deduction for costs and expenses in the application of the transfer pricing and thin capitalization rules, and the corporate tax deduction for costs and expenses derived from general remittances.
The privileged tax regime, on the other hand, limits only the costs and expenses regarding transfer pricing and thin capitalization and from general remittances.
Given these differences, the inclusion of the ETVE regime on the gray list never increased withholding tax rates on remittances by Brazilian companies to their investors or holding companies in Spain. If it had, the Brazil-Spain tax treaty would likely have reduced the applicable rate, thus nullifying the effect of the listing of the ETVE regime. However, Brazilian taxpayers certainly faced the possibility of long discussions with the tax authorities, given their unilateral exclusion of ETVE companies from the tax treaty.
The suspension of ETVE companies from the gray list certainly affects transfer pricing and thin capitalization rules as well as expenses from general remittances. The relief is limited in some cases, however.
Under Brazil's transfer pricing legislation, a nonresident party is considered to be related to a Brazilian party if they have a corporate or commercial relationship or if the nonresident party benefits from a privileged tax regime (or is domiciled in a low-tax jurisdiction). Because ETVE companies generally are used as investment channels, they usually are related to the Brazilian party from a corporate perspective, so their suspension from the gray list will not affect the necessity of transfer pricing calculations in many cases.
While the transfer pricing relationship standards also determine the necessity of thin capitalization calculations, the suspension of ETVE companies from the gray list is more relevant for thin capitalization purposes because:
- the deduction of expenses with interest payable by a Brazilian company to a nonresident company with which it has a commercial or (direct or indirect) corporate relationship follows a rough debt-to-equity proportion of 2-to-1; and
- the deduction of expenses with interest payable by a Brazilian company to a nonresident company that benefits from a privileged tax regime (or is domiciled in a low-tax jurisdiction) follows a debt-to-equity limitation of 30 percent of the net equity of the Brazilian company, even if it has a commercial or corporate relationship with the nonresident company.
Considering that the thin capitalization rules impose a more restricted limitation for expenses with interest payable to a jurisdiction with a privileged tax regime, the suspension of the ETVE regime from the gray list theoretically allows for a more flexible limitation if the ETVE is a related party. If it is not related, the suspension will remove all limitations in the case of these interest expenses.
The ETVE suspension is also beneficial for the deduction of general remittances. According to article 26 of Law 12,249/10, expenses with any amounts payable by a Brazilian party to a nonresident party under a privileged tax regime (or to a low-tax jurisdiction) are only deductible:
- if the effective beneficiary of the nonresident party that receives the payment is identified;
- if the operating capability of the nonresident party to perform the transaction is proved; and
- if payment of the price is demonstrated and the receipt or use of the corresponding goods, rights, or services is attested.
With the temporary elimination of ETVE companies from the gray list, expenses (including interest expenses) with remittances thereto follow the general deduction rule for operating expenses.
Because the FRD ruling was published December 2, the effects are valid for expenses accrued as of that date, so for transactions involving ETVE companies between June and November, the ETVE companies should be considered part of a privileged tax regime.
Taxpayers should view the exclusion of ETVE companies from the gray list as a welcome relief from current tax plannings involving expenses such as those described above. Because the exclusion is temporary, however, new tax planning strategies should take into consideration the fact that the FRD is entitled to deny Spain's request and put the ETVE regime back on the gray list. If Spain's request is denied, the effects should not be retroactive to December 2.
Fuente: Tax Analysts