Recently, the Brazilian Federal Court of the Third Region (the appellate court with jurisdiction over the states of São Paulo and Mato Grosso do Sul) rendered an important precedent regarding the applicability of treaties executed by Brazil and several other countries in order to avoid double taxation (proceeding no. 2005.61.00.024461-1/SP, published on February 6, 2012).
According to the decision, the amounts remitted to residents of treaty countries in consideration for services are not subject to withholding income tax in Brazil. This is the same conclusion reached by the Federal Court of the Fourth Region (appellate court with jurisdiction over the States of Santa Catarina, Paraná and Rio Grande do Sul) in proceeding no. 2002.71.00.0006530-5/RS (published on June 19, 2009).
Even though other rulings (such as those from the federal appellate court with jurisdiction over the States of Rio de Janeiro and Espírito Santo) have determined the applicability of the tax to the same type of remittance, the decisions mentioned above indicate that such disputes may have a favorable outcome for taxpayers, and that the matter will only be settled once submitted to the Brazilian Superior Courts.
Understanding the controversy
In January 2000, the Brazilian Internal Revenue Service (IRS) issued Normative Declaratory Act COSIT no. 01, establishing that the income earned by non-residents that is derived from the provision of services without the transfer of technology is taxable in Brazil pursuant to the domestic legislation (25%).
Taxpayers claim, on the other hand, that these payment fall under Section 7 of the double taxation treaties executed between Brazil and several countries, which provides that a company’s profits shall only be taxed in the country of residence, unless the profits generated in Brazil are connected to a permanent establishment in Brazil.
According to this recent precedent, double taxation treaties and the domestic legislation hold the same authority, but the treaties should prevail in these particular situations because they are specific, while the domestic legislation is general (lex specialis derogate generalis).
Once this issue was decided, the judges inquired about the exact scope of Section 7 of the treaties and concluded that service payments (not including transfers of technology) are qualified as business profits under double taxation treaties, which, per se, eliminates Brazil's jurisdiction to tax service payments to treaty countries.
Even though the treaties refer to the taxation of “profits,” the court concluded that this word is the same as what the domestic legislation technically refers to as “income/revenue.” This conclusion was reached based on the rationale that costs and expenses are deducted from the income for the assessment of the profit. Considering that the amount of profit could never be determined by the source of payment, the judges determined that the correct interpretation is that the treaties exclude from taxation in the country of source not only the profits, but also the income/revenue that originated in such country.
Challenging the tax levy
The above-mentioned decisions only affect the parties to the proceedings. In practice, each interested party should file a writ of injunction or another judicial lawsuit in order to enable remittance of the amounts without the tax levy.
Since the applicable tax rate is 25 percent, challenging the tax levy before the Brazilian courts may be attractive. This is especially so for companies that have a continuous service relationship with Brazilian clients and are domiciled in treaty countries, and even more so when they are not able to credit the tax withheld. In addition, it is worth noting that it would also be possible to claim restitution for the amounts of tax paid in the previous five years, the applicable statute-of-limitation period.
One aspect that is important to highlight is that the favorable precedents do not apply to services involving a transfer of technology, which receive the same treatment as royalties under the treaties.
Currently, Brazil is a party to double taxation treaties with the following counties: Argentina, Austria, Belgium, Canada, Chile, China, Czech Republic, Denmark, Ecuador, Finland, France, Hungary, India, Israel, Italy, Japan, Korea, Luxembourg, Mexico, Netherlands, Norway, Peru, Philippines, Portugal, Slovakia, South Africa, Spain, Sweden, Trinidad and Tobago and Ukraine.
*Leonardo Homsy is a partner and Fernanda Junqueira Bastos is an associate with Campos Mello Advogados. DLA Piper works in cooperation with Campos Mello Advogados to grant our clients access to the firm and its lawyers in Brazil. Learn more here.