Foreign tax credit under American new legislation and Brazil’s convergence towards OECD guidelines

Foreign tax credit under American new legislation and Brazil’s convergence towards OECD guidelines

On December 28, 2021, the American Treasury Department released final regulations (TD 9959, Final Regulations) regarding foreign tax credit (FTC) to be offset in the USA. In a nutshell, the legislation under which the tax was paid abroad must be reasonably similar to US rules.

Brazilian tax legislation does not hold the principles that would allow FTC in the US under TD 9959. Brazil levies withholding taxes (WHT) on the payment source, differently from the production source required by US new legislation. Additionally, Brazilian transfer pricing (TP) rules currently are not under OECD guidelines, i.e., the arm’s length principle (ALP) is not strictly observed.

In this sense, if there is a WHT burden on a remittance from Brazil to the US, there would be no offset by the American taxpayer. Also, considering the scenario of a Brazilian company as a subsidiary of an American company, there would be no FTC regarding Global Intangible Low-Taxed Income (GILTI) legislation – American Controlled Foreign Companies (CFC) rules.

Nevertheless, Brazil has initiated its accession process for OECD membership. A Roadmap was published by the Organization on June 10, 2022, which says that OECD Committees will evaluate Brazilian legislation and propose alterations for Brazil’s accession. A Federal Decree was published in Brazil on June 27, 2022, determining the domestic groups that will develop the analysis along with OECD Committees.

Brazilian Federal Revenue (RFB) already initiated the changes that are needed regarding TP: a new approach under OECD guidelines was presented by the RFB, which affirmed that the respective bill will be available soon in order to start the legislative process. A seminar hosted by RFB and IDB (Inter-American Development Bank) occurred on June 29, 2022, demonstrating the updates on the convergence towards OECD standards. The private sector was invited to present its inputs and multiple countries’ representatives shared their experience with OECD guidelines so that Brazilian tax authorities could be prepared regarding its system.

In addition, organizations have been discussing the TD 9959 with the Brazilian Economy Ministry, pointing out that there will be a double taxation between Brazil and the US. At a recent meeting, it was proposed that Brazil should request US Treasury an extension of two (2) years for starting the application of the new rules, so that Brazil would have time to accommodate US requirements on its legislation. The new approach for TP and the negotiation of a Double Tax Treaty (DTT) were also discussed, focusing on having the TP bill as soon as possible and then initiating the DTT discussions.

At the seminar occurred on June 29, however, the USA representative said that the Final Regulations will necessarily be applied by the end of 2022 and that the observance of the ALP in Brazil is a condition to start the discussions for the DTT. We emphasize, though, that there is no need to have a DTT in order to have FTC in the USA: if the TD 9959 requirements are met, the credit is allowed. Additionally, before the Final Regulations, it was possible to offset Brazilian FTC in the US. 

Hence, the taxpayers should observe the next steps on the Brazilian convergence towards OECD guidelines, especially regarding the possibility of American entities offsetting Brazilian FTC.