Some current trends in taxation in emerging markets: Brazil, China and India

Professional articles

The gradual transition of the BRIC economies towards a focus on domestic growth is matched by a corresponding shift in tax policy. The following article considers the development of taxation in Brazil, China and India, particularly with regard to how they will affect inward investment.


Daniel Armesto Macías
Tax Planning International Review. Volume 39, Number 11.

It is no news that Brazil, India and China are among the fastest growing economies. Most multinational companies opened shop in those countries looking for low cost manufacturing centres in order to remain competitive in a globalized economy. But now these economies are becoming more mature, their middle class is expanding very rapidly, and they are increasingly looked at as attractive markets. This trend has been reinforced with the current weak situation of traditional western markets.

Their governments are also aware of this change of paradigm and, in the tax field, are moving from a tax system designed to attract foreign investment to a more revenue-oriented model. They want to share in the profits that foreign companies expect to make in these rapidly expanding consumer markets. Their tax systems are becoming more sophisticated, with tax incentives losing relevance and subjects such as anti-abuse legislation and transfer pricing high on the agenda. In this new context, multinationals are expecting also more legal certainty.

We will briefly look at the recent trends in these three jurisdictions mainly from the point of view of the foreign investor. This article is based on the session on the same subject presented by the authors in the 2012 Taxand Global Conference and touches on some of the topics discussed there. It does not intend to give a detailed explanation of specific legal changes in each of these jurisdictions, which would undoubtedly be better served by monographic surveys, but to identify the main common guidelines, if any, of the tax environment that a foreign investor may expect to find in these countries.

I. Tax incentives narrowed

Traditionally incentives have not been generally available to foreign investors in Brazil. The currently available ones in the direct tax field focus on specific regions (Northeast and Amazon regions), software development and IT services and infrastructure projects. There currently also exist incentives related to the organization of the 2014 FIFA World Cup.

By comparison, incentives available to foreign investors were traditionally widespread in India and China, but both countries have been reducing their scope in the last years and are focusing them now more narrowly.

India started reducing the scope of its tax incentives following the task force's report on tax reforms issued in 2002 phasing out such incentives as the exemption for export oriented enterprises. Remaining incentives are focused in special economic zones, in the Northeastern regions and in the infrastructure sector.

In China the change of trend was marked by the approval of the new Enterprise Income Tax Law in 2007. Most generally available incentives have been phased out in the period 2008-2012. There has been a shift from preferential policies in favour of foreign investment enterprises in general to incentives aimed at encouraging investment in specific sectors and regions. High technology (including IT services, software development and manufacture of integrated circuits) and environmental protection industries are highly encouraged. “Go West” is the slogan as far as the geographical location is concerned. Even in these areas the incentives tend to be less generous than they used to be.

The governments of these three countries clearly understand that their rapidly growing markets are sufficiently appealing to foreign investment to no longer need to provide tax holidays to attract foreign investment. Their priorities are infrastructure development and the acquisition of technology. Incentives specific to these sectors may still be attractive to companies engaged in these industries. However the regional incentives have proved less attractive to foreign investors, as they by definition apply in less developed areas, where infrastructure may be inadequate and are usually far away from the target markets.

II. Anti-abuse

In Brazil, general anti-avoidance rules were introduced in 2001. These provisions lack the necessary further detailed regulation concerning both substantive (conditions and criteria for its application) and procedural matters. However, even in the absence of this regulation, the Brazilian tax authorities have been applying the general provisions of the tax and civil codes in order to single out for tax purposes acts or transactions that, according to their point of view, were carried out without a business purpose and were aimed only at obtaining tax savings. Brazilian administrative and judicial courts have no consolidated case law regarding the conditions for the application of these general anti-avoidance rules. This situation has generated uncertainty among taxpayers, which do not have specific guidelines or a consolidated jurisprudence to rely on when structuring their transactions.

In China, the 2008 Enterprise Income Tax Law included a general anti-abuse provision for the first time. Generally, anti-abuse provisions prevent any tax benefit from any structure that is not supported by real commercial activities. They can apply in different situations, such as treaty abuse, abuse of form or corporate organization or use of tax havens. Whether a particular form or transaction might be considered abusive must be determined case by case. Tax authorities evaluate whether an enterprise is involved in a tax avoidance arrangement based on the principle of substance over form, after a comprehensive review of the arrangement, taking into consideration factors such as the time when the arrangement was established, the connection between its implementation steps, financial effects and tax implications for the parties. In 2011, anti-tax avoidance efforts were reported to have increased tax revenue by 23.9 billion renminbi.

However the introduction of such a rule in India was only proposed in the 2012 Finance Bill. The general anti-avoidance rule was initially part of the new direct tax code under development and debate for the last three years and due to be implemented next year. Similarly, the application of the new anti-abuse rule was deferred to April 1, 2013, while an expert committee examined the draft regulations. This committee has recently proposed a further three-year deferral.

Under the proposed provisions, the Revenue authorities could declare an arrangement as an impermissible avoidance arrangement if the main purpose or one of the main purposes of such an arrangement is to obtain a tax benefit and the arrangement creates rights or obligations not normally created between persons dealing at arm’s length, if the arrangement results in abuse of provisions of tax laws, lacks or is deemed to lack commercial substance or is carried out in a manner which is normally not employed for bona fide purposes.

The onus of proof will lie with the taxpayer and the Revenue would gain powers to disregard, combine or look through the arrangement, relocate place of residence of a party, or location of a transaction or situs of an asset to a place other than provided in the arrangement. The rule would allow the Revenue to override treaty provisions. The tax administration will issue guidelines prescribing the conditions and manner of applying the general anti-avoidance provisions. It is hoped that certain “safe harbor” rules will be prescribed within these guidelines. The expert committee has recommended far-reaching changes, such as respecting the primacy of tax treaties, and, in particular, the India-Mauritius tax treaty, or refinements in key terms to define tax avoidance, as opposed to legitimate tax mitigation.

While the three countries have introduced – or are in the process of introducing – general anti-abuse provisions, their practical application depends largely in each country’s circumstances and the attitude of the tax authorities. Their practical application in China and Brazil so far has shown that the tax authorities make generous use of such rules, often creating uncertainty among taxpayers. Some practitioners in Brazil feel that the tax authorities have challenged, under these provisions, transactions with economic substance.carried out for sound business reasons. In China, the key focus in recent years has been placed on the control of the taxable profits of multinational enterprises, with a current trend to extend it to other anti-abuse areas, including controlled foreign companies and use of tax havens. The impact of the new anti-abuse rule in India remains to be seen. The draft regulations raised a significant debate in the country, taxpayers being concerned with the effects that too open a clause could have, a context in which the recommendations of the expert committee have been warmly received. If these recommendations are followed, the refined rules will be materially different from the draft.

III. Indirect transfers

An intense debate was stirred in India – and elsewhere – by the aftermath of the Vodafone case. In fact this case arises from a perceived form of taxpayer abuse, the so-called indirect transfers. An indirect transfer occurs when assets in a country are owned through a company in a different jurisdiction. If the shares in this company are sold to a third party, most national tax systems would in principle treat that transaction as a taxable event in the country of residence of the company being sold. However some tax systems can perceive a form of abuse here, as a transaction aimed at avoiding the taxes that would be due in the country where the underlying assets are located if those assets, rather than foreign company owning them, had been sold. This perception will be more tenacious if the company being sold has little or no substance and most of its assets are located in one single country. The underlying asset is often a company or group of companies in the first country, whose control is indirectly transferred by means of the sale of its parent located in a different country.

It has been usual to resort to indirect ownership structures when making investments in India, particularly those based in Mauritius. It is interesting to note that out of the total of USD 243,055 million that was invested into India between April 2000 and January 2012, 40 percent was invested through Mauritius. Indian businesses have often exchanged hands offshore through transfers of intermediate holding companies. Although the Indian Revenue intended to tax the gain on such sales, the Supreme Court of India declared that such transactions could not be taxed in the absence of specific legal provisions allowing to do so. It is due to this judicial resort that the Indian Government intends to include in the statute a provision allowing it to tax indirect transfers. For these purposes interest in offshore assets shall be deemed to be situated in India if such assets derive their value substantially from assets situated in India. Not to miss anything, a withholding tax obligation is imposed upon a non-resident acquirer irrespective of whether it has a prior relationship or business presence in India. Furthermore, unwilling to accept judicial defeat in Vodafone, the Indian Revenue authorities proposed such new provisions to have retrospective effect so as to bring past indirect transfers within the tax net.

By virtue of this retrospective legislation, and taking into consideration the limitation period, the Revenue would have the powers to re-open transactions concluded in the last seven years, where it has reason to believe that income has escaped assessment. In some cases involving concealment of income relating to offshore assets, the period of limitation is also proposed to be extended to 16 years to dissuade tax evaders and at the same time mobilize revenues for sustaining growth. Anti-abuse provisions mandating fair market valuations have also been incorporated to deal with specified situations.

While it is acknowledged that the Indian legislature does have the power to legislate with retrospective effect and similar instances of retrospective amendments in previous budgets have not been a surprise, the proposed overhauling of source based rules for taxation of non-residents has attracted adverse reaction, both from the domestic and international communities. The government’s intentions in reversing one of the most celebrated rulings of the Supreme Court are being questioned on the principles of justness and fairness. A recent statement by India’s new finance minister, Palaniappan Chidambaram, suggests that, while it is still his intention to introduce provisions allowing the Indian revenue services to tax indirect transfers, those provisions would not have the highly criticized retroactive effect previously intended. The expert committee on general anti-abuse rules is examining the implications of the retrospective rules and is expected to issue its report in October.

In the case of China, legislation clearly establishing the taxation in China of indirect transfers of Chinese companies by means of the offshore sale of their foreign parent companies has been in place since 2009. The Chinese tax authorities issued Notice 698 in December 2009, which set out the basis on which they may tax a foreign company that indirectly transfers an equity interest in a subsidiary in China. According to the regulations, such transactions must be reported by the transferor. If the tax authority concludes that the indirect transfer lacks a reasonable commercial purpose, it will assess the tax due on the capital gain. Failure to report may attract penalties up to three times the amount of the unpaid tax. A key issue is therefore to determine when the transfer can be commercially justifiable.

The Chinese tax authorities have been active in pursuing this type of transactions since the regulations were enacted in 2009. The Chinese tax may take the form of a withholding tax, for which the acquirer is liable. Therefore the acquirer of an offshore holding company owning assets in China should be aware of these implications and make sure that the offshore holding has the necessary business substance and that the transaction makes commercial sense.

It is worth noting that even before the regulations were enacted, the Chinese tax authorities had already assessed similar transactions on the basis of the general anti-avoidance rules included in the 2008 Enterprise Income Tax Law, similarly to what the Indian Revenue did (but the courts reversed) in the Vodafone case. In Brazil there is not an explicit rule to tax indirect transfers of Brazilian companies. However, foreign investors may be concerned that the Brazilian revenue could intend to tax them on the basis of general anti-abuse provisions, as it already happened in China and India.

A foreign investor should be aware that in case of indirectly acquiring an existing company, it may be exposed to a tax liability as withholding agent. That was precisely the basis of the assessment made to Vodafone by the Indian Revenue. There are also other reasons that can make a direct investment more attractive. A direct acquisition will usually step-up the tax basis of the target shares, while an indirect transfer will not. Therefore, in an indirect acquisition the acquirer inherits the latent tax liability associated with the low tax basis of the shares in the underlying subsidiary, which may represent a tax cost in the future. In particular its investment may turn into a tax trap if the relevant jurisdiction subsequently adopts legislation – or administrative practice – to tax indirect transfers. Furthermore, in the Brazilian case, a high tax basis in the shares can – subject to the general anti-abuse provisions discussed above – be converted into goodwill (agio) in the target in some types of corporate reorganization and this agio may be deductible in some circumstances. Thus the tax paid on the capital gain on the acquisition may be fully or partially recovered.

Similarly, in India goodwill can not be depreciated. However, some courts have ruled that it is eligible for amortization. In a recent case the Indian judiciary has held that the sum titled as "goodwill" in a slump sale agreement was in essence an aggregate of the acquisition of rights such as business claims, business information, business records, contracts, skilled employees and knowhow, and therefore entitled to depreciation. This type of consideration, as well as others connected with financial reporting issues or a company’s reputation, can indeed make some acquirers prefer a direct acquisition even if this involves paying some taxes upfront.

In all three countries, if the acquirer still opts for an indirect acquisition it will have to make sure that the ownership structure may withstand a business purpose scrutiny. There is little or no room left for empty inactive holding companies. Those who choose to set up an intermediate holding company in a suitable third jurisdiction should make sure that it has the adequate substance and business rationale.

IV. Legal certainty

While it is hardly questionable that abusive transactions should be tackled, open anti-abuse clauses raise legal certainty concerns among taxpayers. They are often written in such broad terms that they leave a lot of room for interpretation. It is often difficult to predict what will be perceived as legitimate tax planning and what might be seen as abusive. Moreover, in an international context this problem can be accentuated by cultural differences. An enhanced relationship with the tax authorities is then necessary so that taxpayers can convey to the tax authorities the business rationale of certain transactions. An open and frank relationship can resolve many misunderstandings. Explaining to the tax authorities the company’s plans in advance may help them sense from the very beginning the business motives behind a transaction, which several years afterwards, and seen from the isolation of the tax office, might appear as purely tax driven.

China is, undoubtedly, a big country. It is no wonder that there are regional differences in the interpretation and implementation of tax regulations and local tax practices may vary from one place to another. This leads to uncertainties when coming across legal grey areas. Where prevailing tax regulations do not provide clear guidance, the tax authorities may refer to internal circulars or precedents from other tax authorities. If these are not available, at the request of the enterprise, the in-charge tax authorities could apply for tax rulings. However, the application process is usually very time-consuming and the outcome cannot be guaranteed. As a result, the tax authorities will often assess the tax status of the enterprise and its activities on a case-by-case basis, subject to their discretion. It is therefore very helpful to maintain a frank relationship with the tax authorities, and get their views in advance on tax-related matters. Communication with the tax authorities plays an important part in doing business in China.

India has a well established advance ruling authority which can be approached to gain certainty on the tax treatment in relation to a proposed transaction involving non-residents. Such rulings are binding on the applicant and the concerned revenue authorities. However, the tax authorities are not always fully receptive to well-reasoned arguments presented by the applicant. This has led to a sort of temporary deadlock for foreign companies in assessing their tax risks in India. However, Indian tax practitioners expect that the Indian tax policy will evolve and stabilize in the near future. Thankfully the Indian judiciary has generally maintained a rational and unbiased approach. The approach to the reforms shown by the new finance minister also seems to point in the same direction.

Foreign investors in Brazil will often complain that the country’s tax system is complex and confusing. The Federation, each one of the 27 states and each one of more than 5,000 municipalities are constitutionally entitled to legislate in tax matters. There seem to be too many taxes, too many laws and too many interpretations. Even the arithmetic of the calculations of indirect taxes is intricate. Clearly a simplification of the tax system would be greatly appreciated.


Notwithstanding different paces and calendars and specific characteristics in each jurisdiction, common trends appear in the development in recent years of the tax systems in the three jurisdictions under analysis. They are moving from a tax system intended to attract foreign investment to one in which that is not the priority except in particular industrial sectors or regions. They now expect foreign enterprises investing in the country to make their fair contribution and are implementing anti-abuse provisions to counter perceived or potential tax avoidance. In this new context foreign investors must clearly align their tax structures and tax with the rationale of their underlying business, but they also expect increased legal certainty in those tax systems and a more cooperative relation with the tax administration.


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