The Brazilian Court held that beneficial treaty provisions prevail over Domestic Controlled Foreign Corporation Rules.
The taxpayer, a state-private oil firm, was incorporated in Brazil and has Petrobras Netherlands BV as a fully-owned subsidiary there. The WOS made BRL 3 billion in income in the years 2013 and 2014, but the Brazilian taxpayer did not offer it for tax.
Due to alleged failure to pay corporate income tax on such money obtained by the WOS, the Brazilian tax authorities slapped the taxpayer with additional income of BRL 3 billion. According to Brazilian controlled foreign corporation (CFC) rules, the profits made by subsidiaries, branches, or other controlled companies abroad should be taken into account when calculating the true profits of the Brazilian parent entity in accordance with the balance sheet calculated as of December 31 of each year. The Brazilian tax authorities took into account the taxpayer’s earnings, including the WOS income, and issued the assessment order in accordance with this.
If the taxpayer was required to pay tax in Brazil on the earnings made through its foreign WOS was the question before the CARF.
The CARF noted that the rule of exclusive tax jurisdiction imposed by the tax treaties is flagrantly violated when the legal personality of the subsidiary is disregarded through the tax transparency system and it receives the same tax treatment as a PE.
The CARF ruled that WOS’s profits would only be subject to taxation in Brazil if WOS had a permanent establishment (or “PE”) there. However, absent a PE in Brazil, WOS’s profits were not subject to taxation in Brazil under Article 7 of the double taxation avoidance agreement between Brazil and the Netherlands (or “Brazil-Netherlands DTAA”). Given the foregoing, it was determined that the taxpayer is exempt from taxation in Brazil on profits made by its WOS.