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back to index backLATINtalk March,  2006

Outline of Brazilian Concept of Permanent Establishment

Although Brazilian tax laws are complex on many issues, the permanent establishment (PE) test is relatively straightforward, particularly when compared to other jurisdictions, such as the U.S. Whether a PE exists in Brazil under domestic law or tax treaties depends, in most cases, on whether an agent is used and, in particular, the extent to which an agent is authorized to bind a foreign business.

In general, Brazil imposes two tests to determine whether income effectively connected to Brazil is derived by a PE. The first test deals with whether an effective trade or business is carried out directly by a foreign person in Brazil, and the second relates to the use of a local agent to conduct such activities on behalf of a foreign person or entity.

The purpose of this note is to briefly highlight the major features of the Brazilian PE definition.

Trade or Business Test

Brazil does not have a specific definition of the term "trade or business." Instead, under the "Lucro Arbitrado" rules in the tax regulations, the tax authorities can assess a minimum taxable income to taxpayers that fail to comply with general tax requirements, such as registration and corporate form requirements.
In general, any regular and continuous activity carried on directly for profit by a foreign or domestic person will be deemed to be a taxable trade or business activity, regardless of the corporate form adopted. Thus, even unincorporated foreign businesses that have a local trading presence may be viewed as PEs by the Brazilian tax authorities.

Although there must be an office or a place of business (even if not registered) to treat a foreign entity as conducting business in Brazil through a PE, it is not necessary that the address be fixed, provided the tax authorities can demonstrate that the trade or business is regularly carried out in Brazil.

The tax authorities may take the view that any physical facility (e.g. a hotel room), or in the absence of such a facility, the place where goods or services are regularly supplied, constitutes a PE. Article 127 (§1º) of the Tax Code seems to provide authority for such an interpretation, as follows:
- [in the absence of a proper establishment] … the tax domicile should be deemed to be the place where the goods are located or where the tax triggering event takes place.
However, the mere holding of property or an office is not likely to be sufficient to give rise to a PE because the presence of a regular trade or business and a person with decision-making authority also are crucial to the creation of a PE.

The Brazilian Tax Court has held that a PE or a de facto business exists regardless of whether it is registered with the Board of Trade, as long as the partners effectively carry on a trade or business for profit. In such a case, the tax authorities can assess income tax on gross revenue or on other reasonable amounts:

A de facto business exists, regardless of the existence of formal articles of incorporation, provided there are persons jointly engaged in carrying on a trade or business. If the existence of a de facto business is proved, the business should be treated as a regular taxpayer and the partners are jointly liable for the taxes on activities of the business. If the business does not submit the proper accounting and financial documents to the tax authorities, the income and related taxes of the business may be presumed.

Certain transactions will not be deemed to give rise to a Brazilian trade or business:
• The trading of securities, commodities and derivatives through a local broker: however, income or gains may be subject to withholding tax as they are effectively connected to Brazil.
• The local supply of services by a foreign entity: income derived from such transactions would be subject to withholding tax as it is effectively connected to Brazil, but the foreign person would not be subject to local income tax as a resident. A nonresident individual carrying out business activities in Brazil for more than 183 days in a year, however, may be deemed to be a Brazilian resident, and his/her worldwide income must be reported to the Brazilian tax authorities for income tax purposes.
• The mere acquisition of assets in Brazil (even through an agent) and the mere holding of an interest in a local business.

Agency Test

Brazilian tax law applies a similar test to foreign entities doing business in the country through a local agent rather than directly as discussed above. The Brazilian agent rules deal with local agents hired and authorized by a foreign person to effectively conduct a local trade or business. This situation differs from the situation above because it requires the presence of a local agent (i.e. a representative) rather than the foreign person itself (or an employee of the foreign person).

Under article 539 of the Brazilian Income Tax Code, an agent will create a PE of a foreign entity if both of the following conditions are satisfied:
• The local agent has authority to conclude sales on behalf of the foreign entity; and
• The local agent has authority to commercially bind the foreign entity.

Where an agent's authority is limited to the purchase of goods or merchandise for a foreign business in Brazil, or where the agent's authority is limited to activities such as marketing, researching potential customers and the provision of price lists, no PE should arise. Further, a controlling interest of a foreign entity in the business where the local agent is employed does not imply binding powers, according to the Superior Tax Court:
There must be proof, for the purposes of an assignment of income, that the agent in Brazil has authority to commercially bind the foreign entity with a local buyer. The fact that a foreign entity holds an interest equivalent to 99.99% of the capital of the agent does not imply the granting of such authority.

In general, if a foreign person carries on a trade or business in Brazil, by means of a person with decision-making authority and the carrying out of regular activities in Brazil, the income must be reported to the local tax authorities. Also, if the agency test is met through the presence of a local representative who has authority to commercially bind the foreign person, the representative will be deemed to create a PE of the foreign business in Brazil.

Income from a PE must be reported and will be taxed in Brazil. Such income likely will be treated as ordinary income and subject to local taxation in the same was as a resident entity would be subject to tax. The current marginal net income tax rate in Brazil is 34% for businesses and 27.5% for individuals.

Source: Deloitte Touche Tohmatsu Consultoria Contábil e Tributária S/C Ltda - GAI

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