TaxAnalysts
Worldwide Tax Daily
by Stephanie Soong Johnston
Practitioners from Brazil, Russia, India, and China came together to highlight and analyze the significance of recent tax developments in their respective jurisdictions at a May 21 conference in Boston.
Practitioners from Brazil, Russia, India, and China came together to highlight and analyze the significance of recent tax developments in their respective jurisdictions at a May 21 conference in Boston.
They spoke May 21 at the sixth annual Worldwide International Tax Update, hosted by Sullivan & Worcester LLP, marking the first time that the conference focused primarily on BRIC.
Brazil
Brazil saw a few significant tax-related court decisions in the past year, but none so hotly anticipated as the Supreme Court’s (STF’s) final decision in a decade-old corporate tax case (ADIN 2588-2001), which questioned the constitutionality of Brazil’s controlled foreign corporation rules on April 10, according to Fernanda Junqueira Calazans of Velloza & Girotto in São Paolo.
Under the Brazilian CFC rule (article 74 of Provisional Measure 2.158-35/2001), which was issued in 2001, a Brazilian company with a controlled or affiliated entity abroad must include the profits of those entities in its tax base when it reports its taxable earnings on December 31 of each calendar year in which the profits are made abroad, regardless of the profits being distributed.
“It was a very generic rule that applies to all cases of controlled and affiliated entities abroad,” Calazans said.
The case involved an industry association that filed a lawsuit in 2001 to challenge the constitutionality of the CFC rule, and for more than a decade, the case was in limbo in the STF. Each member of the Court cast its votes, resulting in a tie. The tiebreaking vote came from one minister who expressed support for the CFC rule’s constitutionality in the context of a controlled company but expressed doubt about the rule’s viability in cases involving affiliates.
In April, however, the last minister finally gave his opinion, and the STF held that Brazilian companies with affiliates or controlled entities in jurisdictions on the Brazilian government’s tax haven blacklist must pay tax in Brazil on those entities’ profits. (Prior coverage .)
“The purpose of the CFC rule is to be an antiavoidance mechanism, as a way to avoid tax planning abroad, so presumably when a company has a controlled or affiliate entity in a tax haven, the intention is to avoid taxes,” Calazans said.
In addition to the landmark STF ruling, she noted that Brazil had recently published a presidential decree that promulgated Brazil’s tax information exchange agreement with the U.S., which was signed on March 20, 2007. Brazil’s Federal Senate had ratified the TIEA with the United States on March 7. (Prior coverage .)
The agreement covers such Brazilian taxes as the federal excise tax (IPI), Program for Social Integration contribution (PIS), Contribution for the Financing of Social Security (COFINS); individual and corporate income taxes, and the financial transactions tax (IOF).
“It is basically a normal TIEA, there was nothing peculiar about it,” Calazans said. “However, the Brazilian government expedited the process to get this agreement in force.”
She pointed to one element of the TIEA that allowed information exchange requests to be realized after the TIEA comes into force regardless of the tax period that the request relates to.
“Governments can request information from previous years, so this is something to keep in mind,” Calazans said.
Russia
Some media outlets have reported that Russia’s GDP is very low and that inbound investments are drying up, but the recent press reports don’t paint an accurate picture of the business climate in the country, according to Stepan Guzey of the Moscow office of Lidings.
“In general, the view on the Russian business climate is optimistic,” Guzey said, adding that international investors are treating Russia as a growing market with great potential for robust investment.
In recent years, the government has generally tried to align most legislation with OECD and Financial Action Task Force standards — and transfer pricing rules were no exception, Guzey said.
Russia’s transfer pricing rules were adopted on July 18, 2011, and entered into force on January 1, 2012; the new rules largely follow OECD transfer pricing principles, with exceptions for some global commodity transactions. (Prior coverage .)
The burden is on the taxpayer to prepare and file stringent transfer pricing documentation, which is a task that will be crucial starting from 2014, when Russian taxpayers may be slapped with transfer pricing penalties amounting to an extra 20 percent of tax on adjusted income if they do not file the required documentation; the penalty will increase to 40 percent starting in 2017.
Documentation must address such items as functional analysis, transfer pricing method and reasoning behind choosing the method, data sources, and list of related parties involved.
“This is why Russian taxpayers are now in tax hell, because they must prepare a lot of documentation,” Guzey said.
Large companies might do well to apply for an advance pricing agreement with Russian tax authorities, he said, noting that Russia currently has APAs in place with only four companies — Aeroflot, Rosneft, Gazprom, and Gazprom Neft — all of which are partly owned by the government. The APAs can be applied retroactively to the
application date and will remain in force for up to three years with a possible two-year extension.
Guzey also noted there are strong signs that Russia is starting to take a tougher stance against corporate tax avoidance by being more aggressive in identifying beneficial owners of structures.
He pointed to a recent case (Case A60-2650/2011) involving Russian limited liability company Element-Trade LLC, which used the Monetka trademark and paid royalties to a company in Cyprus that served as an intermediary licensing vehicle. In turn, the Cypriot company paid the royalties to the true owner of the trademark, which was a company in the British Virgin Islands. (Prior coverage .)
The Russian tax authorities argued that the structure was created purely to avoid withholding taxes on the royalties paid from Russia, and they went to great lengths to identify the true beneficial owner of the Cyprus company.
“The Russian tax authorities tried to pierce the corporate veil by using data and evidence from Interpol without official request, and used this data in tax litigation against the taxpayer,” Guzey said. Although the court ruled in favor of the taxpayer, the case showed just how aggressive the tax authority can be in finding a beneficial owner through the collection of data, Guzey noted.
“In the future, we could be faced with a situation when special rules regarding beneficial ownership will be enacted in the Russian Tax Code in the form of amendments,” he added.
India
India has enjoyed strong economic growth since it opened up its economy in the early 1990s, fueling a growing confidence in the country’s abilities to reach even higher levels of growth. However, that confidence may have led to misconceptions about the true impact of the Revenue Department’s actions on the economy and colored the attitudes of the revenue authorities and finance ministry officials alike, according to Shreya Rao of Nishith Desai Associates in Mumbai.
The government had made more than 200 retrospective amendments to the tax code over the past five years, including the most controversial amendment, unveiled in 2012, that introduced indirect transfer provisions with retrospective effect from 1962. (Prior coverage .)
Under the amendments, the source rule in section 9 of the Income Tax Act, 1961, was clarified to include the transfer of offshore assets if those assets derive substantial value from assets situated in India. Also, the definitions of “capital asset” and “transfer” were clarified to include interests in capital assets and indirect and direct transfers, respectively.
Rao said the move was a knee-jerk reaction to the Vodafone case, which involved a more than $2 billion capital gains tax assessment related to the telecom company’s majority-stake 2007 purchase of an Indian mobile phone company from Hutchison Whampoa Ltd. in Hong Kong. The transaction occurred between a Cayman Islands entity holding Hutchison Whampoa’s assets and Vodafone’s Dutch subsidiary.
The case was litigated up to the Supreme Court, and in January 2012, the Court ruled that Vodafone should not be held liable for the bill because the transaction took place offshore. However, weeks after the decision, the government included the indirect transfer provisions in the 2012-2013 budget, much to the surprise and dismay of investors. (Prior coverage .)
The budget also introduced a broad general antiavoidance rule aimed at curbing tax avoidance, giving tax authorities powers to examine the factors for a transaction and refuse tax benefits if they find the transaction’s sole purpose was to avoid tax. Its implementation date was deferred until 2016. (Prior analysis .)
In the quarter immediately following the introduction of the retrospective indirect transfer provisions, foreign direct investment into India dropped by about 60 percent, according to Rao.
“I think [then-Finance Minister Pranab Mukherjee] did not realize that when the tax regime becomes more uncertain, and the provisions become more aggressive, or the revenue authorities start behaving in unreasonable ways, that it can have an impact even on a very strong economy,” she said.
Shortly after the 2012-2013 budget, newly appointed Finance Minister Palaniappan Chidambaram appointed a committee led by Parthasarathi Shome to review the indirect transfer provisions and the GAAR, and to evaluate taxpayer and investor complaints about the legislation contained in Finance Act 2012. (Prior coverage .)
In the aftermath of the indirect transfer provisions, which currently do not contain a substantiality threshold, Rao noted that U.S.-based companies have expressed concern about how the provisions might affect the course of their day-to-day affairs, even if they derive 25 to 30 percent of their value from India, either in terms of revenue or assets.
The current provisions are so expansively worded that they could trigger Indian tax consequences on the sale of a single share of a U.S. listed company, the repurchase of shares by a U.S. company from U.S. investors, or something as simple as a U.S. company taking out a loan from a bank in the U.S. and pledging U.S. company shares. Even the creation of a pledge on shares of a U.S. company can be considered the creation of an interest, or a transfer of interest from the perspective of the Indian transfer provisions, according to Rao, although such a situation may not be enforceable under India’s constitution and tax laws.
“The potential risk is wider than what one would imagine based upon an understanding of the Vodafone case,” she said. “As long as the provisions continue to hang over our heads like a sword of Damocles, it will have an impact on the activities of India-focused businesses. While there have been recommendations proposed by the Shome Committee to fine-tune these provisions, these are yet to form part of the law.”
One positive sign in Finance Act 2013 was that the triggers for GAAR have been narrowed.
“Previously the trigger was that if even one of the purposes is tax avoidance, the GAAR was capable of being invoked, but now the main purpose is to obtain a tax benefit,” Rao said. “So we’re still seeing some degree of finetuning, but there is still a lack of clarity on how the provisions will be implemented because a lot of terms you see out there are perhaps necessarily open-ended.”
Despite the uncertain business climate in India, Rao expressed hope that the situation will improve soon.
“While there is growing concern about issues of legislative process and tax administration, we are also hopeful that these could translate into positive changes in the next few years,” she said, pointing to the Shome Committee’s strong opposition to the retrospective tax amendments and the fact that this year’s Finance Act contains only one such amendment.
“Whether investors and the economy manage to wait that long is something we have to wait and see,” she added.
China
One major tax development out of China is the nationwide expansion of the country’s VAT pilot program to replace the business tax regime. The pilot program, which was launched in January 2012, operates in five cities (Beijing, Shanghai, Shenzhen, Tianjin, and Xiamen) and six provinces (Anhui, Fujian, Guangdong, Hubei, Jiangsu, and Zhejiang).
On April 10, the Chinese government announced that the program would expand nationwide on August 1 for transportation services and certain “modern services,” including information technology services, research and development, and consulting. (Prior coverage .)
Under the pilot program, the transportation service industry will be subject to an 11 percent VAT rate, tangible moveable property leasing services will be taxed at 17 percent, and all other selected modern services will be taxed at 6 percent. A credit mechanism is also available to remedy the business tax regime’s double taxation problem.
“It’s really an earthshaking event,” said Peter Guang Chen of Zhong Lun Law Firm in Hong Kong, adding that he anticipates the program will be rolled out nationwide and will affect all sectors by 2015. “It’s a massive change and it affects companies, people’s bottom lines, and cash flow significantly.”
For the most part, businesses have expressed mixed reactions about the pilot program so far, Chen observed. “Some think it’s great because when they calculate it and project it, they see that the company is saving money, if you can get the VAT refund,” he said.
Chen noted that the Chinese VAT system works similarly to those in other countries, in that companies that purchase goods or services from another supplier pay input VAT, and collect output VAT when selling goods or services domestically. Companies that specialize in exports still have to pay input VAT, but upon exportation of goods or services, may only receive a partial VAT refund from the government.
“When you export, you do not in most cases receive a complete refund because China does not have jurisdiction on the foreign customer to charge VAT,” he said. “So for some companies that are very heavy into exports, they would be losing out, whereas previously they wouldn’t when they paid business tax.”
Chen also discussed developments in tax treaty benefits, noting that before 2008, the conventional tax advice was to form a company in jurisdictions that have favorable tax treaties with China, such as Hong Kong, Mauritius, or Barbados, in order to receive treaty benefits. However, times have changed, he said.
“China is now very serious about beneficial ownership, meaning you qualify for treaty benefits,” Chen said. “They have to do that more so at the ground level than the U.S. because up to now only two of China’s tax treaties have a limitation of benefits clause.”
To address the lack of limitation on benefits clauses in its treaties, China’s State Administration of Taxation has passed a series of circulars providing guidance, the most recent being Circular 165, which was issued on April 12 but not made public until early May. (Prior coverage .)
Circular 165 concerns the application of the country’s beneficial owner rules to Hong Kong corporations seeking tax treaty benefits under the China-Hong Kong tax arrangement , specifically the low dividend tax rate provided under the arrangement. (2008 protocol ; 2010 protocol .)
Under the circular, if a Hong Kong company does not make profit distributions to entities that are not resident in Hong Kong, its beneficial owner status will not be negatively affected and investments in holding companies will be considered as “substantive business activities.”
“It’s quite encouraging in the sense that under this circular a Hong Kong company is able to claim treaty benefits despite the fact that its business was really a holding company with investments in another country [as long as] it doesn’t have any other business,” Chen said. “Everyone is very excited about this circular, thinking that China is taking a softer approach on treaty benefits.”
Tax Analysts Information
Jurisdictions: Brazil; Russia; India; China, People’s Republic of
Subject Areas: Capital gains taxation
Corporate taxation
Legislative tax issues
Litigation and appeals
Tax avoidance and evasion
Tax havens
Tax system administration issues
Treaties
Value added taxation
Transfer pricing
Author: Johnston, Stephanie Soong
Institutional Author: Tax Analysts
