Ricardo Maitto of TozziniFreire Advogados summarizes the Brazilian tax administration’s current position on the application of double tax treaties to outbound payments of service fees by Brazilian companies, and considers the practical impact for multinational groups that have entered into cross-border services agreements with their Brazilian subsidiaries.
Brazil has double tax treaties (DTTs) in place with over 35 countries, including France, Austria, Sweden, Japan, Spain, Italy, Netherlands, China, Portugal, and Mexico. While most of these countries have a common interpretation regarding the application of a DTT to service fees, which attributes taxing rights to the service provider’s home country and prevents the imposition of withholding tax (WHT) in the source country, the Brazilian tax administration has historically adopted a conflicting position on this matter.
According to Declaratory Act 1/2000, amounts paid by a Brazilian party to a foreign beneficiary in consideration for the rendering of technical services, without transfer of technology, do not fall within the concept of “business profits,” as provided by Article 7 of DTTs. The Brazilian Internal Revenue Service (IRS) used to claim that these payments fall within the scope of Article 21 (other income), which in the case of Brazilian DTTs generally allocates taxing powers to both source and residence countries.
The practical consequence of the above position is that Brazil was free to impose its WHT (usually at a 15% rate) over outbound service fees, whereas the other country—where the beneficiary resides—would have to grant a tax credit or exemption.
The issues deriving from such a unilateral position are twofold:
In addition to this one-sided position, Brazil has consistently increased the tax burden imposed over outbound service fees, through the introduction of taxes that are not covered by DTTs. In fact, under Brazilian domestic law, taxes applied to the importation of services can be as high as 50%, considering nominal rates—for example, 15% to 25% WHT; 5% municipal services tax; 10% Federal contribution CIDE; 9.25% social security charge on importation; and 0.38% financial tax on foreign exchange transactions.
Following a request for information submitted by the Finnish government, at the end of 2013 the Brazilian General Office of the National Treasury Attorney issued an opinion on the application of a DTT to service fees (PGFN Opinion 2,363/2013). According to such opinion, the definition of “business profit” of foreign enterprises should comprise payments made by Brazilian sources in consideration for technical services without transfer of technology.
In practice, the opinion acknowledges the application of the DTT Article 7 (business profits) to service fees, in which case the taxing powers are allocated exclusively to the residence country, thereby preventing Brazil from collecting any (income) taxes on such payments (unless the fees are attributable to a permanent establishment of the beneficiary situated in Brazil).
Some months after the opinion had been made public, the Brazilian tax administration reviewed the previous position. Pursuant to Declaratory Act 5/2014, the tax treatment applicable to fees paid by Brazilian sources to individuals or legal entities abroad in consideration for the rendering of technical services, with or without transfer of technology, should be determined based on Article 7 (business profits) of the DTT.
According to Declaratory Act 5/2014, Article 7 does not apply for cases in which the DTT protocol equates technical services with royalties—in which case Article 12 (royalties) applies instead—as well as where the provision of technical services is related to the technical qualification of a person or group of persons, in which case Article 14 (independent personal services) may apply.
The main practical effect of Declaratory Act 5/2014 is that service fees paid by a Brazilian company or individual to a foreign beneficiary may no longer be subject to Brazilian WHT in the event there is a DTT in place between Brazil and the country where the beneficiary is located.
However, such position may have a limited scope because most Brazilian DTTs include additional provisions in their protocols stating that the concept of royalties encompasses, for treaty purposes, income from technical services. The qualification of service fees as “royalties” under Article 12 of a Brazilian DTT would have a negative impact, as such article usually entitles both countries to tax royalties, thereby allowing Brazil to impose a WHT on cross-border payments. (Article 12 of Brazilian DTTs deviates from the OECD Model Convention. While the OECD Model attributes exclusive taxing rights to the residence country, Brazilian DTTs allow both countries to tax royalties, usually with a 15% or 10% rate limitation in the source country.)
Some authors dispute the Brazilian IRS position that intends to qualify service fees as “royalties” based on DTT protocols. Those authors claim that not all technical services should be treated as royalties, but only those services that are instrumental to a transfer of technology or know-how. In fact, when Declaratory Act 5/2014 tries to extend the application of Article 12 (royalties) to service fees, regardless of whether those services are linked to know-how or transfer of technology agreement, it seems to go far beyond the definition of “royalties” provided in the DTTs.
The flip side of the above controversy is that certain Brazilian DTTs do not contain similar provisions in their protocols (this is the case for the DTTs with France, Austria, Sweden, Japan and Finland). For those cases, the (uncontroversial) application of Article 7 will ensure that Brazil is restrained from exercising its taxing powers.
Although the scope of Declaratory Act 5/2014 is somewhat limited, it clearly represented a positive development in the application of DTTs in Brazil. Under this ruling, fees payable to service providers (legal entities) with fiscal domicile in France, Austria, Sweden, Japan and Finland fall under Article 7 of the DTT and, therefore, are not subject to the Brazilian WHT (which would otherwise apply at the rate of 15%).
As for transactions with other countries covered by a DTT, controversy still exists around whether such fees should be qualified as “business profits” under Article 7 or as “royalties” under Article 12. Such controversy has already led many Brazilian companies to file lawsuits to claim the application of Article 7 and not to be subject to WHT under DTTs, and most of the court decisions issued so far have been favorable to such taxpayers. It is expected that Brazilian Superior Court of Justice will issue a final position on this matter soon.
Therefore, multinational groups that have entered into cross-border services agreements with their Brazilian subsidiaries may consider the possibility of reviewing their tax positions in view of the application of DTTs and, as the case may be, filing individual lawsuits to claim their right not to pay the WHT as well as to obtain tax refunds for WHT that has been unduly paid in the past.
This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Ricardo Maitto is a tax partner with TozziniFreire Advogados, Brazil.
