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Brazil Declares Delaware to be a Tax Haven
by Robert Eugene DiPaolo September 11, 2008
On
June 23, 2008, Brazil's Congress published Law 11,727/2008, which,
effective as of January 1, 2009, will amend Brazil's transfer pricing
regulations and expand the legal definition of tax havens. The
surprising news in all of this is that it is widely believed that these
Brazilian changes were made specifically so that the exotic U.S.A. state
of Delaware could be designated as a tax haven, or at least a
jurisdiction with the characteristics of one.
Yes, you read that right - Delaware - the second-smallest state in the
United States. The state which elected Joe Biden, Barack Obama's vice
presidential running mate, as a United States senator, may be designated
by Brazil as a fiscal paradise, just like the Cayman Islands, Panama,
the British Virgin Islands and Bermuda.
At
this point, Brazil's tax authorities still need to adopt an expanded
definition of tax havens, review its existing list of blacklisted
jurisdictions and decide if it wants to add or remove any countries or
locations. So, until Brazil's IRS issues a new list of tax havens to
implement this legislation, something which it is expected to do by the
end of this year, Delaware will remain something of a tax haven in
waiting, or at least in the minds of many Brazilian lawyers and tax
advisors.
Now that you've wrapped your head around the seeming absurdity of
Delaware being designated a tax haven, particularly if you happen to
live there, you're no doubt wondering why in the world would Brazil want
to designate Delaware as a tax haven. Before we address that issue,
let's first take a look at what I'm calling the so what aspect of this
legislation or why do I care if Brazil designates Delaware as a tax
haven.
Well, Delaware being designated a tax haven or a jurisdiction with the
characteristics of one, would have a dramatic impact on the tax rates
Brazil levies on certain payments made to persons or companies located
in Delaware. Interest and royalty payments, as well as payments for
service fees to companies or persons located in Delaware would be
subject to 25% withholding tax rather than the general 15% rate.
Capital gains taxes applicable to the sale of the shares of Brazilian
companies by residents of Delaware would also be increased. And payments
made to non-related parties located in Delaware would be treated as if
they were payments made to related parties, and be subject to higher tax
rates as well.
Those are some of the consequences of Delaware being blacklisted. Now
let's take a look at how Brazil expanded the definition of tax havens.
Prior to the enactment of this legislation, tax havens were defined as
countries or locations that didn't tax income or taxed it at a maximum
rate of up to 20%. Law 11,727/2008 broadens this definition to include
jurisdictions which don't permit access to information about a legal
entity's shareholders, members or partners, how much equity they own, or
the identity of its nonresident beneficial owners.
Basically, if a jurisdiction doesn't require and permit access to a
registry of the shareholder, members and partners of legal entities
located there, then such jurisdiction may be designated as a
jurisdiction with favored taxation or a tax haven.
Well, as it turns out Delaware is such a jurisdiction. For instance,
when you create a limited liability company or LLC in Delaware you are
not required to list the equity participants, called members, in the
document you file with the state to form the LLC. Nor are you required
to file, register or disclose the LLC Agreement in which the members and
their equity participation in the LLC are designated.
So, unless the members of the LLC decide to disclose this information,
or a governmental agency such as the IRS or the Securities Exchange
Commission decides to cause or require the LLC or its members to
disclose it, you can't access it.
Alright, Delaware amazing fits Brazil's broadened definition of a tax
haven. Let's now turn to what I refer to as the what's the deal with
Delaware question or what does Delaware have to do with Brazil. Well,
plenty it would seem. It just so happens that Delaware LLCs are popping
up all over the place in Brazil as the partners and equity holders of
Brazilian companies.
And it seems that the Brazilian investors and Brazilian investment funds
are in many cases the members of these Delaware LLCs. So, presumably
Brazilian authorities have concluded that Brazilian investors and
investment funds are using Delaware LLCs as part of some sort of tax
planning scheme designed to conceal their identity and avoid paying
taxes.
You see, in Brazil you can access information about the shareholders of
a Brazilian company. In fact, if you create a sociedade limitada, the
most common form of legal entity used in Brazil, you are required to
list the shareholders, called quotaholders, in the document you file at
the commercial registry to create the limitada. You must amend this
document whenever new shares, called quotas, are issued or a quotaholder
transfers his quotas to another quotaholder or a third party.
Each amendment must also be filed at the commercial registry. And once
filed, this document and each amendment becomes a public document. So
any one, including the Brazilian IRS, can obtain information about a
limitada's quotaholder and how many quotas they own. But if you invest
in a limitada through a Delaware LLC, it's the LLC that shows up as the
quotaholder, not the members of the LLC, whose identity, as we have
seen, is difficult if not impossible to access.
Now while there are many reasons why someone, including a Brazilian
investor, may want to use a Delaware LLC as an investment vehicle,
including the predictability of Delaware law, the availability of
pass-through taxation and limited liability protection for members, its
not entirely clear that the primary reason for doing so is because
Delaware does not permit access to information about the members of the
LLC or the identity of their nonresident members.
Yet, this is the focus Brazil's legislation broadening the definition of
tax havens. Ironically, it may also turn out it be its pitfall. This is
because while using Delaware LLCs may at the moment be in vogue in
Brazil, as are driving bullet proof SUVs and using unlocked iPhones
purchased in the U.S., Brazilian investors and investment funds could
just as easy use LLCs from the state of Nevada or Wyoming, two states
that are well known for not having any state or corporate tax, and which
also do not permit access to information about shareholders, members or
partners of legal entities.
While I admit that I have not done a 50 state survey, I think its safe
to say that no other state in the U.S. requires the members of an LLC to
be listed in the certificate of formation used to create it, nor
requires the registration, filing or disclosure of the LLC Agreement,
sometime referred to as an Operating Agreement, in which the members of
the LLC and their participation therein are designated.
So, while Delaware, undoubtedly much to the surprise of its residents,
would appear to be a tax haven in waiting, it's quite possible that once
Brazil has blacklisted this state, and Brazilian investors and
investment funds start using LLCs formed in other equally exotic U.S.
states, the Brazilian IRS will be quite busy updating its list of
blacklisted jurisdictions for years to come, always seemingly one or two
steps behind the times in terms of what's in vogue as far as LLCs go.
For all we know, Wyoming, a state most Brazilians have probably never
even heard of, may be next on its list. Now, that would be something
that Vice President Dick Cheney, who grew up there, could really feel
proud about.
Robert Eugene DiPaolo is the founder and managing director of The
Fidelis Law Group, a legal consultancy offering U.S. and Brazil legal
capacity. Robert can be reach by email at
dipaolo@fidelisgroupco.com
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