In addition to updating the low-tax jurisdiction and privileged tax regime lists, Brazil's tax authorities have established criteria that should be considered in determining whether a company is a holding company with substantial economic activity. Taxpayers should be aware that the criteria are still somewhat abstract and, as a result, companies that are not pure holding companies may be considered holding companies.

On September 13, 2016, the Brazilian Revenue Authority published Normative Instruction (NI) 1,658, which amends the lists of countries considered to be low-tax jurisdictions (LTJ) and companies considered to be subject to privileged tax regimes (PTR) for Brazilian tax purposes.

Background

For tax purposes, Brazil has had lists of LTJ and PTR for many years. Placement on the LTJ or PTR list triggers a series of potentially adverse tax consequences in Brazil, both from an inbound and an outbound perspective.

From a transfer pricing standpoint, the transactions performed with LTJs or PTRs will be considered as controlled transactions, even though the parties are not related.

For inbound investments, different thin capitalization rules apply when a debt is taken up by a Brazilian company from an LTJ or PTR entity (the maximum allowed debt-to- equity ratio is 0.3:1, rather than the general ratio of 2:1). Also, additional requirements must be satisfied for the deductibility of expenses (such as, identification of the "real beneficiary" of the entity, additional documentation to prove the cost of assets bought or services rendered by the LTJ or PTR entity and proof of the operational capacity of the entity).

Payments of income to an LTJ entity are generally subject to a higher withholding rate of 25% (which, so far, does not usually apply to payments to a PTR entity).

From an outbound perspective, the presence of a LTJ or PTR entity may affect the outcome of Brazil's tax on foreign profits. When an LTJ or PTR entity acts as an intermediary holding company of a Brazil-based group, it and its direct and indirect subsidiaries will be unable to participate in a consolidation when the Brazilian parent calculates its foreign profits (so-called contamination effect). The lists of LTJ and PTR, often called black and gray lists respectively, were originally issued by Brazil through NI 1,037 in 2010, and have been amended a few times since then, with countries and tax regimes being included, excluded and suspended from the lists.

Declaratory Act No. 3/2015, published on December 21, 2015, made the last modification to the PTR list. The Declaratory Act placed Dutch holding companies without "substantial economic activity" back on Brazil's list of PTR (gray list) (see Tax Alert 2015-2430).

Normative Instruction

NI 1,658 makes the following changes to the lists:

— Includes Curacao, Sain Martin and Ireland on the LTJ list

— Excludes the Dutch Antilles and St. Kitts and Nevis from the LTJ list

— Includes the holding company regime in Austria on the PTR list

In addition, NI 1,658 includes a definition of holding company with "substantial economic activity" for the purposes of the PTR list. This definition, however, will only assist companies located in Denmark and the Netherlands because the PTR list explicitly mentions that holding companies in those countries will only be considered to be subject to a PTR if they do not have substantial economic activity.

Under NI 1,658, the tax authorities have provided some guidance for determining whether a holding company has substantial economic activity based on the ability to demonstrate proper operational capacity in the country of residence. NI 1,658 establishes the following criteria to assess such capacity:

— Reasonable and qualified staff to perform the activities

— Adequate physical installations for the effective management and decision making related to the holding company's activities, assets and equity interests

Although the tax authorities have tried to determine what is substantial economic activity by providing elements that should be taken into consideration when analyzing the activities and substance of Danish and Dutch holding companies, the definition is still somewhat abstract as it lacks clear and objective criteria to make this assessment.

As a result, considering the lack of definition of holding company, tax authorities may include companies, other than pure holdings, in the "concept" of holding company.

NI 1,658 is effective August 1, 2016. The retroactive effective date is quite controversial because the Brazilian tax system only allows rules to be retroactive if they are merely interpretative and procedural, which may not be the case because the retroactive effective date might result in a higher tax burden for some taxpayer. Whether the adverse tax effects that result in a higher income tax burden will apply in 2016 is also debatable because the Brazilian Federal Constitution forbids requiring any increased tax in the same year in which the rule establishing the increase was published.

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