Originally published in the December 10 edition of World Tax Daily (Copyrights Tax Analysts – www.taxanalysts.com)
Even with the CFC regime’s constitutionality currently under review by the Supreme Court, Brazil’s Superior Court of Justice (Superior Tribunal de Justiça, or STJ) — the second-highest court in the country — decided not to wait for the Supreme Court and ruled that Brazil’s controlled foreign corporation regime is legal. The decision did not accept the taxation for foreign affiliate companies.
The decision was delivered by the STJ’s Second Panel in Special Appeal 907,404, filed by Viragro Participações S/C Ltda. and published in Brazil’s official gazette of November 13. This was the last of a series of unfavorable decisions delivered to the taxpayer, which had an injunction denied at the court level and unfavorable decisions at both the court and appellate levels.
The STJ took the position that corporate taxpayers should be taxed on profits of their CFCs, as determined by provisional measure 2,158/2001. The measure taxes parent companies on the earnings of their CFC at year-end, regardless of whether the profits have been distributed. Article 74 of the measure provides:
For purposes of determining the tax basis of corporate income tax and CSL, pursuant to Article 25 of Law No. 9,249, of December 26, 1995, and Article 21 of that Provisional Measure, profits generated by foreign controlled or affiliate companies will be considered available to the Brazilian controlling company on the date of the balance sheet in which such profits have been accrued in the form established in the regulations.
Profits accrued by foreign controlled or affiliate companies until December 31, 2001 will be considered available on December 31, 2002, except if before such a date, any of the situations of availability [of profits] provided in the existing rules has occurred.
A similar case has been under review by Brazil’s Supreme Court since 2001, when the National Confederation of Industry (CNI) filed Declaratory Action of Unconstitutionality 2,588, challenging the application of article 74 of Provisional Measure 2,158/2001. CNI argues that Brazilian income taxes, and the accompanying 9 percent social contribution on net income (CSL), should not apply to undistributed profits.
The STJ judgment was based solely on legal arguments. The court ruled that the CFC regime did not violate the National Tax Code.
Although the STJ did not base its rationale on constitutional arguments (that is the Supreme Court’s jurisdiction), the STJ did make express reference to the opinion delivered by Supreme Court Justice and President Ellen Grace in the judgment of Declaratory Action of Unconstitutionality 2,588. Justice Grace partially sided with the government ruling that Brazil’s CFC rules were constitutional regarding CFCs, but admitted they should not apply in the same way to foreign affiliates, because Brazilian parent companies might not have control over those affiliates to cause them to distribute profits by year-end. The same arguments were adopted by the STJ’s decision.
Many tax experts believe the STJ should not have delivered this decision before the Supreme Court’s decision, because constitutional issues (decided by the Supreme Court) prevail over merely legal issues. For taxpayers, this decision may represent a threat as lower courts may now rely on the STJ decision to deny or reverse prior favorable decisions that prevent taxation on foreign-source profits before actual distribution.
David Roberto R. Soares da Silva