INSIGHT: Brazilian Tax Reform—Key Considerations for U.S. Multinationals

The Brazilian government has made tax reform a top priority and is considering several tax reform measures. Although various proposals are being discussed, two main proposals—Constitutional Amendments PEC No. 45/19 and PEC No. 110/19—which are currently being reviewed by both the House of Representatives and Senate could gain more traction in the coming months.

These two amendments could significantly impact the taxation of goods, services, social security and corporate profits in Brazil. In relation to profit taxation, the amendments include three key features with far-reaching implications:

• the combination of the two existing income taxes (IRPJ and CSLL) into a single, unified corporate income tax;
• a reduction of the standard Brazilian overall tax burden from 34% to approximately 20%–25% (please note that financial institutions would have a total tax burden of 40%); and
• an introduction of a withholding tax regime on dividends with possible tax rates varying from 15%, 18% and 25%.

U.S. multinational companies with operations in Brazil may be significantly impacted by these potential tax law changes. For example, with the introduction of a Brazilian withholding income tax on dividend distributions, double tax treaties (DTT) could play an important role in mitigating overall double taxation. However, Brazil and the U.S. do not currently have a DTT in force, thereby excluding the possibility of withholding tax rate reductions on dividends from a Brazilian subsidiary to its U.S. parent company.

U.S. multinational companies with direct or indirect ownership in Brazilian companies should consider a careful analysis of the changes under the proposed Brazilian tax reform. A closer look at the impact of profit repatriation could reveal a previously unanticipated tax burden.

Below are several issues to consider as a result of a potential Brazilian tax reform.

Overview of U.S. Corporate Taxation on Foreign Dividends

U.S. multinational companies have had to contend with an overhaul of the U.S. international tax system in recent years, as the U.S. Congress attempted to shift its system of taxation from a global system with an offshore deferral regime to a worldwide inclusion system subject to a small percentage of active earnings potentially being eligible for a participation exemption. One significant legislative change came from the treatment of the foreign source portion of dividend distributions from active non-U.S. subsidiaries.

Prior to U.S. tax reform, U.S. shareholders were generally required to include dividend distributions from foreign corporate subsidiaries in income. The Tax Cuts and Jobs Act introduced Section 245A, which generally provides certain U.S. corporate shareholders with a 100% dividends-received deduction for the foreign source portion of any taxable dividends received from certain 10%-owned foreign corporations, subject to exceptions such as hybrid dividends.

Potential Alternatives to Mitigate Tax Downsides, in a Post-tax Reform Scenario

In the event that the proposed changes to Brazilian tax law impact U.S. taxpayers, particularly through the taxation of dividends, it is never too early to start considering tax-efficient structuring alternatives.

For example, a direct change in control of a Brazilian company may allow for more tax-efficient repatriation options, such as the Interest on Net Equity (INE). Further, a DTT in force and signed by Brazil may avoid “tax leakage” or even provide for new repatriation/planning opportunities.

However, it is important to note that there are other, ancillary considerations to take into account. For example, changing the direct shareholder of a Brazilian company may trigger a Brazilian nonresident capital gains under a broad concept of disposal (see Article 18, Law 9,249/95 and Article 26, Law 10,833/03). The gain, which should correspond to the positive difference arising from the sales proceeds against the cost basis, is subject to progressive tax rates as follows:

It is also important to consider other U.S. tax consequences upon the transfer of stock of a controlled foreign corporation (CFC) to a related party. Although such a transaction may be structured to be tax-free, the transaction may also trigger adverse U.S. tax consequences if not properly structured. Therefore, these transactions should be specifically analyzed to ensure they are undertaken in the most tax-efficient manner.

Assuming it would be possible to execute a “tax-free” reorganization from both a Brazil and U.S. perspective, it may be possible to optimize the distribution of taxable dividends in a post-tax reform scenario.

Tax resident shareholders in countries that have a DTT with Brazil may potentially reduce Brazilian withholding tax rates on dividends. For instance, if a qualifying Mexican shareholder held more than a 20% interest of a Brazilian entity, the dividend withholding tax would be limited to 10% as stated in the DTT between Brazil and Mexico (see Article 10, Decree 6.000/2006).

Currently, some level of uncertainty exists regarding the Brazilian withholding tax rate that may be introduced. However, existing proposals and reports indicate the rate will likely fall within the 15–18% range. Ultimately, DTTs allow for an alternative that could potentially reduce the overall tax burden on dividends.

Additionally, it is important to note that some treaties may offer additional tax benefits.

Cross-border payments, like the INE, paid by a Brazilian company to a company resident in the Netherlands could result in tax savings. Assuming the INE would provide a tax deduction for interest expense in Brazil, it would be included in Dutch taxable income and subject to Dutch corporate income tax at the current prevailing rate of 25% (20% for the first 200,000 euros ($217,000) of profits)).

Based on the characteristics of the INE, the INE payments would qualify for Dutch tax purposes as a dividend (despite the Brazil characterization as interest). As such, a tax sparing (deemed) credit of 25% may be claimed under the Brazil–Netherlands DTT (Decree 355/1991). This tax sparing credit may offset the Dutch corporate income tax charge, reducing overall taxation. However, U.S. shareholders should be aware of U.S. hybrid dividend rules, which may cause INE payments to be subject to U.S. tax on a current basis.

Planning Points

A closer review of the final wording of any new Brazilian legislation is highly recommended. Significant changes may impact Brazilian operations, requiring a review and analysis of existing structures in light of the new rules.

Neil Sheth is a Managing Director, International Tax at KPMG LLP and Murilo Rodrigues de Mello is a Partner, International Tax at KPMG Brazil.

The information in this article is not intended to be “written advice concerning one or more federal tax matters” subject to the requirements of Section 10.37(a)(2) of Treasury Department Circular 230 because the content is issued for general information purposes only.

The information contained in this article is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. This article represents the views of the authors only, and does not necessarily represent the views or professional advice of KPMG LLP.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.