It is well known that Brazil’s heavy tax burden on remittances abroad related to the import of services, as well as multiple taxes, various tax regulations and the interpretation of double taxation treaties (DTTs) by the tax authorities create difficulties for multinational groups with a presence in Brazil.
Brazil levies up to six taxes on these remittances, which are governed by various federal and local laws. This adds to the controversial scenario where services are imported into Brazil, including discussions about withholding tax (WHT).
The impact of the DTTs signed by Brazil to reduce or eliminate the WHT imposed on remittances for payment for services and when the WHT should be paid has been surrounded by controversy. In 2020, these important aspects related to the WHT's survey on remittances were analyzed by the Supreme Court (STJ), the second highest tier of justice in Brazil, to offer new perspectives to multinational groups.
Impact of double taxation treaties on WHT on remittance of services
In December 2020, when analyzing the Special Appeal (REsp) 1.759.081-SP, the second panel of the STJ issued a decision on qualifying remittances abroad for payment of technical services under the DTTs signed by Brazil that have the potential to do so to change the current scenario regarding the collection of WHT on these referrals to DTTs and to add a further chapter to this long-standing discussion.
Background for the decision
In the past, the Brazilian tax authorities have defended that WHT should be levied on transfers of technical services abroad, on the interpretation that these transfers would fall under Article 21 (Other Income) of the DTTs. Traditionally, Article 21 of the DTTs signed by Brazil allow both contracting states to tax the transfers. This position was surprisingly confirmed by the Brazilian tax authorities even in cases where the specific DTT did not contain an article on “other income”.
In May 2012, a decision by the STJ on this issue (Resp 1.161.467 – RS) resulted in a complete reversal of the position of the Brazilian tax authorities. The judges in this case concluded that Brazil could not tax the transfers under Article 7 (Corporate Profits) of the DTTs. The main argument that the STJ took into account in its decision was that service income is included in the concept of corporate profits under national law.
Shortly thereafter, the Brazilian Federal Revenue Service (RFB) enacted the Interpretative Declaratory Act 5/14 (ADI 5/14), according to which remittances for the provision of technical services to countries with which Brazil has signed a DTT are subject to the following:
- Article 12 (license fees) if the DTT protocol expressly states that technical services and technical support are included in the concept of license fees. Article 12 of the DTTs signed by Brazil follows the United Nations Model Double Taxation Convention, which allows Brazil to impose license fees on WHT contracting states.
- Article 14 (personal independent services) if (a) the provision of the services depends on the technical qualifications of a person or group of people; (b) the DTT allows taxation in Brazil; and (c) Article 12 does not apply. Article 14 of the DTTs signed by Brazil would generally give Brazil the right to tax the transfers under certain circumstances. Despite the deletion of Article 14 from the OECD Model Convention, Brazilian policy is to include this article in the DTTs signed by the country. and
- Article 7, if Articles 12 and 14 apply, does not apply. In this case, Brazil would not be allowed to impose WHT unless there is a permanent establishment of the service provider in Brazil.
Most of the DTTs signed by Brazil classify technical services and technical assistance as license fees for the purposes of the DTTs without defining technical services. According to the interpretation of the Brazilian tax authorities, technical services are defined as services that require certain knowledge. From a practical point of view, this definition includes almost all services, regardless of technology transfer.
It is only recently that Brazil started to incorporate its unique and extremely broad definition of technical services into the DTTs (e.g. DTT protocol with Argentina in 2017, DTT in 2018 with Singapore).
Since the entry into force of ADI 5/14, the Brazilian tax authorities have always recognized that WHT should not be charged on transfers abroad unless the relevant DTT specifically includes technical service and technical assistance within the scope of Article 12 (which is the case in France ) for example) to understand that the transfers fall under Article 7.
The RFB only classified transfers according to Article 14 under very specific circumstances.
A new chapter in the discussion
In REsp 1,759,081-SP, judged by the STJ on December 18, 2020, the court was asked to determine whether remittances from a Brazilian company to a Spanish entity for the payment of engineering and administrative assistance services should fall under Article 7 (corporate profits ), Article 12 (License Fees) or Article 14 (Independent Personal Services) of the DTT Brazil – Spain.
The Brazil-Spain DTT is one of the DTT signed by Brazil that specifically includes the technical service and support provided under Article 12. According to this article, Brazil can charge 10% WHT on transfers made to Spain (compared to the general rate of 15%).
The definition of “independent personal services” in Article 14 explicitly includes engineering services. Based on this article, Brazil could tax the transfers to Spain without lowering the interest rate.
On the other hand, under Article 7 DTT, Brazil would not be entitled to levy WHT on transfers made to Spain.
After analyzing the case itself, the lower court (Federal Regional Court of the 3rd Region – TRF3) examined the agreements made by the parties and came to the conclusion that they should not provide for technology transfer and thus payments for the engineering and administrative support services in the sense of the DTT cannot be classified as royalties.
According to the TRF3, the agreements which provide for the mere provision of services by the Spanish company and the related transfers should fall under Article 7 of the DTT and could only be taxed in Spain. The TRF3's position in this case is consistent with several other decisions previously made by the same court and is always based on STJ's position on the 2012 case (Resp 1,161,467 – RS) and those judged thereafter by STJ Cases.
The application of Article 14 was not checked by TRF3 in this case, as TRF3 follows the usual practice of not taking it into account in its decisions.
The TRF3's decision in this case has been challenged by the Brazilian tax authorities. In analyzing the particular circumstances, the STJ decided that the matter should be re-examined by the lower judiciary, taking into account the Interpretative Declaratory Act 5/14.
The STJ found that Brazilian law and the STJ case law definition of royalties for tax purposes, unlike what the lower court found, does not require technology transfer.
According to STJ, the referring court should pay particular attention to the fact that engineering services would come under the definition of independent personal services provided in Article 14 of the Brazilian-Spanish DTT. Given that the protocol to the DTT Brazil – Spain explicitly states that Article 14 would also apply to services provided by legal persons, the STJ tended to apply Article 14 (instead of Article 7) and thus levy WHT in Brazil.
Further developments are expected not only once the TRF3 reanalyzes the matter, but also as other courts begin to apply the understanding of STJ to other cases based on their own interpretation of this decision.
In addition to highlighting Article 14 of the DTTs, STJ drew the attention of the TRF3 to the fact that the analysis should take into account the treatment attributed by Spain to these transfers, so as not to create a hybrid non-compliance agreement in relation to Action 2 of the BEPS project of the OECD / G20, which raised concerns that taxpayers could benefit from lower taxation.
While consideration of mismatches is indeed important from a practical point of view, the broad definition of the technical services ascribed by the Brazilian tax authorities and their views on the application of DTT can actually result in double taxation.
Time of payment by WHT
In August 2020, when analyzing REsp 1.864.227, the First Panel of the STJ unanimously decided that the WHT should be paid on the due date of the liability rather than on the date of its booking credit.
The case arose out of a federal tax assessment against the taxpayer demanding payment of the WHT for remittances to a US-based company in connection with the license to market software, as the liability from the Brazilian company for accounting purposes was recorded.
Under Brazilian law, the WHT must be paid for upon payment, crediting, delivery, use or transfer of funds to a beneficiary abroad. In the past, federal tax authorities have interpreted the phrase credit to match the payer's accounting credit in Brazil, which was inconclusive.
However, in March 2014, the Supreme Court of Appeal (CSRF), the highest federal administrative level, had already made it clear that the WHT should not be considered due on the basis of the accounting credit, but only at the moment the funds are economically or economically by law available (income tax trigger event). In the view of the administrative court on a civil law basis, the liability would be legally available on the due date.
From a practical point of view, this justification would prevent the Brazilian company's decision not to pay or settle the liability to the service provider abroad from postponing or even avoiding the payment of WHT.
Until this confirmation by the STJ, there was still some discussion about whether the WHT should only be paid when the funds are actually transferred abroad or when the payment is due.
It should be noted that, in theory, this justification should not apply to the other federal taxes levied on the import of services – such as the social contributions on imports (PIS / COFINS import) and the contribution for economic intervention (CIDE ) – The tax authorities could try to extend this reasoning to these taxes and only question the collection of these taxes when the funds are actually paid abroad.
The Administrative Court for Tax Complaints (CARF) has come to the conclusion in at least one case that WHT and CIDE have the same triggering event and that CIDE should also be charged if WHT is considered due.
This way of thinking is controversial. While income tax in Brazil is generally levied on the economic or legal availability of income, the same concept does not apply to CIDE. CIDE is not collected from income under any circumstances.
Importance of keeping up to date
Although the legislative background related to the taxation of imports of services has not changed significantly in recent years, new interpretations and approaches are widespread in Brazil. This requires that the parties doing business in Brazil and providing services in Brazil be vigilant and keep pace. The previous confirmations of their procedures correspond to the current practices in order to rule out possible contingencies and to visualize possible opportunities.
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Stephanie Makin |
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partner Stephanie Makin is a partner at Machado Associados. Her practice focuses on direct taxes, international taxes, and transfer pricing (TP). During her 11+ years with the company, she has worked on major corporate reorganization and M&A transactions with multiple countries. Stephanie also supports clients doing business in Brazil as well as Brazilian clients investing overseas, with an emphasis on the impact of Brazilian Controlled Foreign Corporation (CFC) regulations and the impact of double taxation treaties signed by Brazil. Her practice also focuses on preparing / reviewing TP calculations and solving TP problems for clients doing international business. Stephanie graduated from Insper, São Paulo with a degree in tax law. |
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Ana Lucia Marra |
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partner Ana Lucia Marra is a partner at Machado Associados with 24 years of experience providing tax advice to accounting firms and law firms. She manages projects and teams to advise local and multinational companies in Brazil and overseas companies in various sectors. Ana's practice includes extensive experience in assessing the tax implications of complex operations / structures, identifying alternatives to optimize the tax burden and mitigating tax risk, and providing advice on the application of the Brazilian CFC rules, the Brazilian TP rules and the Taxation of international transactions. She also assists clients with tax audits and litigation in their areas of expertise. Ana holds degrees in business administration from Fundação Getúlio Vargas, in tax law from the Pontifical Catholic University of São Paulo and in international tax law from Instituto Brasileiro de Direito Tributário in São Paulo. |
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