Madeira could represent an interesting alternative for Brazilian companies wishing to avoid the consequences of recent Brazilian legislation on Corporate Income Tax (Imposto de Renda de Pessoas Jurídicas), Law No. 9249 of December 26 1995, which came into force on January 1 1996.
Under Article 25 of the new law, profits, income and capital gains generated abroad will be considered in determining the effective business profit of Brazilian corporate entities. Paragraph 2 of Article 25 says profits generated abroad by subsidiaries, branches or controlled companies of corporate entities domiciled in Brazil will be taken into account in determining the profit generated in the financial year. The following rules must be observed:
- Subsidiaries, branches and controlled companies must demonstrate the profit generated in each financial year in accordance with the provisions of the Brazilian law.
- This profit will be added to the net profit of the mother/parent company in proportion to its shareholding, to determine the effective profit of the latter.
Finally, paragraph 6 of Article 25 lays down that the results of the investment valuations made, in accordance with the 'equity method', will continue to be treated as foreseen in the legislation in force, notwithstanding the provisions of paragraphs 1, 2 and 3.
The most peculiar aspect of the new legislation is that in changing the territorial system of taxation in force in Brazil until now, the new law goes beyond the worldwide system which was its main goal. The worldwide income system aims to tax in Brazil the income generated by branches of Brazilian companies abroad as well as dividends distributed by foreign companies to the parent companies in Brazil. Nevertheless, the new law not only contemplates the taxation of this income, but also considers as taxable profit of the Brazilian company that part of the profit of the subsidiary company disregarding its legal personality and therefore adopting a tax transparency regime.
This situation often occurs in other countries in relation to the investments made in low or nil taxation jurisdictions in order to attack tax-planning strategies aiming to provide for the accumulation of income in places with more advantageous taxation than that of the investment's country of origin.
However, companies located abroad and controlled by Brazilian companies will be excluded from the scope of the new law if a double tax treaty has been signed between Brazil and the country where the subsidiary is located.
This is because all of Brazil's double tax treaties, in accordance with the OECD model, establish that the business profits of an enterprise of a contracting state can only be taxed in the other state if the enterprise carries on or has carried on business in the other state through a permanent establishment there. If the enterprise falls into this category, the business profits or the enterprise may be taxed in the other state but only the part that is attributable to the permanent establishment.
Therefore, the business profit of a subsidiary of a Brazilian enterprise domiciled in a country which has a double tax treaty in Brazil can only be taxed in the former country because the subsidiary is considered an enterprise organized and existing in accordance with the law of that country. Only business profits earned by a Brazilian enterprise though a permanent establishment located in that country (for instance a branch) can be taxed in Brazil.
Madeira is in an advantageous position as regards not only other low taxation jurisdictions but also all other countries with which Brazil has a double tax treaty. Companies licensed to operate in Madeira's International Business Centre are included in the double tax treaty signed between Brazil and Portugal. Companies also enjoy a temporary exemption on corporation tax until 2011 and a temporary exemption until 2011 on withholding tax on dividends distributed to their shareholders, provided the companies' income does not derive from activities carried on in Portuguese territory.