July 10, 2010 | By Keith Martin in Washington, DC

Brazil completed approval in May of a decree that limits the ability of Brazilian companies to transfer profits abroad to shareholders in tax havens as interest payments on inter-company loans.

The strategy is called “earnings stripping.” Many companies use the strategy when setting up subsidiaries in other countries. Instead of capitalizing a subsidiary entirely with equity, the parent company puts part of the capital into the subsidiary in the form of a loan. This allows it to pull out profits as interest payments on the loan. Interest is deductible and reduces the tax base in the country where the subsidiary is located.

Brazil restricts the amount of interest that can be deducted to two times the net equity of the subsidiary. However, it reduced the limit last December in Decree No. 472 to 30% of the net equity in the case of inter-company loans paid to shareholders in tax havens.

The decree would have expired unless ratified by Congress. The Brazilian Senate completed Congressional approval on May 4.