Brazilian taxation on profits earned through foreign controlled or affiliate entities (CFCs) is terrible tax policy and must be modified, in light of the current scenario where Brazilian companies are expanding and becoming multinationals.

The worldwide trend reveals that the taxation on profits earned through CFCs has two basic purposes: (i) prevent abuses and (ii) ensure the competitiveness of the local companies investing abroad.

Therefore, CFC rules usually follow a pattern: foreign passive income is taxable at the moment it is earned, regardless of dividend distributions (especially if deriving from tax havens), while foreign active business income is either exempt or granted deferral until its actual distribution to the shareholder. 

Indeed, the potential for abuse is in passive-type income, which is easily movable. The active business income implies the existence of plants, offices and employees in the other country, and the potential for abuse is reduced.

For example, the American system does not tax active business income earned through CFCs until such income is distributed to the shareholders (even passive income can be granted deferral if the taxes in the country where such income was accrued exceeds 90% of the US income tax). The German system exempts income earned through CFCs, except in case of passive income taxed in the other country at a rate lower than 25%.

In Brazil, the income earned through CFCs is taxed regardless of its nature (passive or active income) or actual distribution (dividend distribution by the CFC to the Brazilian investor).

Therefore, foreign active business income deriving from an industrial activity carried out in a high-tax country receives the same tax treatment applicable to passive income accrued by an offshore entity incorporated in a tax haven.

The Brazilian system does not even apply to the situation where the potential for abuse is unlimited: passive income earned by individuals through CFCs. In this case, Brazilian taxation can be easily and indefinitely deferred.

Brazilian CFC rules are irrational and undermine the competitiveness of Brazilian enterprises abroad, as they do not adopt the international pattern. The result is a disaster for the Brazilian companies now facing the huge challenge of becoming global enterprises.

(Marco Antonio Moreira Monteiro – LL.B. USP; LL.M. Georgetown University; member of Veirano Advogados)