This is the ninth of our series of posts on Brazilian tax treaties. In each post we provide an overview of a specific tax treaty between Brazil and a particular foreign country, as well as comments on any Brazilian administrative or judicial precedents applying the treaty, and highlights on the impact of the OECD Base Erosion and Profit Shifting ("BEPS") project in its application.
Overview of the treaty
According to the Indian Government1, Brazil is one of the most important trading partners of India in the entire LAC (Latin America and Caribbean) region. India-Brazil bilateral trade has increased substantially in the last two decades.
Decree 510, published on April 28, 1992, contains the text of the Bilateral Income Tax Treaty signed by Brazil and India ("Treaty"). This Treaty is aimed at preventing double imposition and double non-imposition of income taxes in cross-border operations between the two countries.
For Brazilian purposes, as of December 09, 2015, the treaty generally applies not only to the Individual and Corporate Income Taxes ("IRPF" and "IRPJ") and to the Withholding Income Tax ("WHT"), but also to the Social Contribution on Net Profits ("CSLL").
With regard to CSLL, this tax is not expressly mentioned in the Treaty. However, recent Law 13,202/2015 clarifies that Bilateral Income Tax Treaties signed by Brazil include CSLL:
Art. 11. For purposes of interpretation, the international agreements and conventions signed by the Government of the Federative Republic of Brazil to avoid double taxation include CSLL.
(...)
Please note that our reference to the Withholding Income Tax ("WHT") in the next paragraphs does not describe the entire tax burden imposed on certain income streams, such as royalties, for example. Other taxes may be imposed on cross-border royalty payments (such as the Special Tax on Royalties ("CIDE"), the Municipal Tax on Services ("ISS") and the Tax on Foreign Exchange Transactions ("IOF-FX")), but because these taxes do not qualify as "income taxes", they are outside of the scope of the Treaty.
The Treaty was generally based on the OECD Draft Convention available at the time (1977, with amendments), as well as on Brazilian tax treaty practice prior to 2000. Key aspects of this Treaty from a Brazilian perspective are:
- Source taxation
Dividends, interest and royalties earned are generally subject to WHT in Brazil and to a WHT credit (or an exemption) in India and vice-versa. Specifically:
- For dividends (or profits from a permanent establishment) received by a beneficial owner resident in a Contracting State, the maximum WHT is set at a 15% rate. Under current Brazilian Law, dividends paid to Brazilian or foreign recipients are exempt from WHT.2
- For interest received by a beneficial owner resident in a
Contracting State, the maximum WHT is generally set at 15%.
However:
(1) Interest arising in a Contracting State and paid to the Government of the other Contracting State, including any of its political subdivisions, or to any agency (including a financial institution) exclusively owned by this Government, or exclusively owned by a political subdivision thereof, is exempt from WHT in the first Contracting State – except if the interest is classified under item (2) below.
(2) Interest from obligations, bonds or debentures issued by the Government of a Contracting State, or by a political subdivision thereof, or by any agency (including a financial institution) exclusively owned by this Government, or exclusively owned by a political subdivision thereof, shall only be taxed in this Contracting State.
Under current Brazilian Law, interest paid to foreign recipients is generally subject to a WHT of 15%,3 which is coincident with the treaty limit. In case of Brazilian governmental bonds issued locally, based on our internal law, exemption applies to non-resident investors that comply with a number of requirements (i.e., residing in a jurisdiction other than a tax haven, registering with the Brazilian Central Bank ("BACEN") and the Brazilian Securities and Exchange Commission ("SEC") as a qualified foreign investor – "4,373 Regime", and appointing a Brazilian Bank as its representative in Brazil). - For royalties, the maximum WHT rate is set at (a) 25% for
trademark use, and (b) 15% for all other cases (including payments
for technical services and technical assistance).
Under current Brazilian Law, royalties paid to foreign recipients (including payments for technical services and technical assistance) are subject to a WHT of 15%.4 - Capital gains, differently from the OECD Model Convention, are
taxable in both Contracting States, and there is no WHT limitation
in the Treaty. The only exception is Article 13, paragraph 2, which
determines that gains obtained from alienation of ships or
aircrafts operated in international traffic (and from movable
assets used to operate these ships or aircrafts) are taxable only
in the country where the headquarters of the company are
located.
Under current Brazilian Law, capital gains obtained by foreign residents (not located in a tax haven) are subject to a WHT of 15%.5 Source taxation is applicable even in case of non-resident seller and buyer – in this case, the buyer is required to withhold the corresponding amount, nominate an attorney-in-fact in Brazil and cause this attorney-in-fact to collect the WHT due.
As of January 1st, 2017, recently enacted Law 13,259/2016 shall modify existing legislation to convert the WHT on capital gains into a progressive tax. In accordance with its Article 1st, WHT on capital gains earned by non-residents shall be:
(i) 15% on the part of the capital gains up to a maximum limit of BRL 5,000,000.00 (five million reais);
(ii) 17.5% on the part of the capital gains between BRL 5,000,000.00 (five million reais) and BRL 10,000,000.00 (ten million reais);
(iii) 20% on the part of the capital gains between BRL 10,000,000.00 (ten million reais) and BRL 30,000,000.00 (thirty million reais); and
(iv) 22.5% on the part of the capital gains above 30,000,000.00 (thirty million reais).
- Beneficial ownership
Though the expression "beneficial owner" is mentioned in Articles 10, 11 and 12 of the Treaty, the treaty does not define what "beneficial ownership" means (only in recent treaties Brazil has acquiesced to a specific Limitation on Benefits clause, and only in broad terms).
Brazilian tax authorities view the absence of a treaty definition of "beneficial ownership", as is the case with the Treaty between Brazil and India, as a permission for tax authorities of the State applying the treaty to interpret the expression as they see fit. This position is supported by Article 3rd, paragraph 2, of the Treaty, which states:
Article 3rd, Paragraph 2: For the application of this Treaty by a Contracting State, any term not defined herein shall, unless the context otherwise requires, have the meaning that it has at that time under the law of that State for the purposes of the taxes to which the Convention applies.
- Tax sparing
The Treaty contains a reciprocal tax sparing clause, which is a treaty provision that requires India to grant tax credits at a deemed WHT rate for specific payments made by Brazilian residents and vice-versa (many of the Brazilian tax treaties that contain tax sparing clauses benefit residents of the other Contracting State, but the Treaty with India has a clause applicable to payment streams coming from either Contracting State).
The tax sparing credit is usually greater to the WHT rate applicable under the treaty or domestic law. In the Treaty with India, they are:
- For interest, a tax sparing credit of 25%.
- For royalties not derived from trademark use, a tax sparing credit of 25%.
- Income derived from technical assistance and technical services
In accordance with Item 3 of the Protocol of the Treaty, income derived from technical assistance and technical services is regarded as royalties (Article 12) for Treaty purposes. Also, it is important to highlight that, unlike other treaties, the Treaty with India contains a textual reference to the services of "management" and "consultancy", the remuneration of which is similarly regarded as royalties.
This classification is important because Brazilian taxpayers have challenged the imposition of WHT on payments for services to recipients resident in Treaty countries (at the time, Germany and Canada), claiming that the business profits provision of the corresponding agreements (Article 7th) would prohibit taxation at source. The landmark case on this subject, REsp 1161467/RS, was decided in 2012 by the Second Chamber of the Superior Court of Justice ("STJ"), and it was favorable to taxpayers.
Nonetheless, Interpretative Declaratory Act 05, issued on June 16, 2014, by the Federal Revenue Secretariat of Brazil ("RFB"), states that if "income derived from technical assistance and technical services" is regarded as royalties in any particular Treaty, its treatment shall be the one attributed to royalties (Article 12), and not to business profits (Article 7th). Besides, RFB has adopted a very broad concept of "technical services", considering as such any services in which the provider needs "skills, technique and training".
The issue of whether RFB exceeded the limits of its interpretive authority by issuing an Interpretive Declaratory Act that effectively restricted the scope of a court decision by STJ (albeit a non-binding one) is yet to be resolved.
In the meantime, strict compliance with treaty provisions and domestic law would indicate that "income derived from technical assistance and technical services" should be subject to a WHT of 15%, the domestic WHT rate applicable to payments of royalties and technical services.
- Interaction with Brazilian CFC rules
In 2013, a binding decision issued by the Federal Supreme Court ("STF") in ADI 2588/DF defined that Brazilian CFC rules could apply to controlled foreign companies in blacklisted jurisdictions ("tax havens") and could not apply to affiliated foreign companies out of blacklisted jurisdictions.
Among the questions not answered by STF in the 2013 decision is whether controlled foreign companies in Treaty countries would be exempt from CFC rules. Decisions issued by STJ and by the Administrative Court of Tax Appeals ("CARF") have already dealt with this subject, mostly in favor of the taxpayers, but STF is yet to confirm that position from a constitutional perspective. While STF does not issue a final ruling on this subject, Brazilian tax authorities rely on references in the text of treaties (or the absence thereof) to impose CFC rules.
While STF does not issue a final ruling on this subject, Brazilian tax authorities rely on references in the text of treaties (or on the absence thereof) to impose CFC rules. The Treaty with India does not contain any specific provision disallowing the imposition of CFC rules. Though it establishes a specific bilateral exemption for dividends taxed at the State of source (Article 23, Paragraph 3rd), the exemption for profits earned is unilateral: only India is required to exempt profits earned by a permanent establishment in Brazil.
Administrative and judicial case law
To date, CARF, STF and STJ have not issued any decisions on the terms of the Treaty with India.
BEPS highlights
Both India and Brazil (key partners of the OECD) have actively participated in the drafting of the final reports for the 15 Actions of the Base Erosion and Profit Shifting ("BEPS") project. The two countries have distinct tax systems and tax treaty networks, but the OECD expects that both of them, as well as the entire G20 community, are able to implement BEPS proposals in a consistent and seamless manner.
Among the BEPS aspects associated with the application of the Treaty between Brazil and India, we would like to highlight the following:
- Hybrid Mismatches (Action 2)
The OECD proposals on treaty issues associated with hybrid mismatches are mainly focused on two separate areas: (i) treaty residence of dual-resident entities; and (ii) a clarification of the entitlement to benefits of transparent entities.
According to the OECD,6 tax authorities should be able to decide, on a case-by-case basis, the State of residence of so-called dual-resident entities (entities that either by virtue of treaty provisions, domestic law, or a combination of both, are regarded as residents in two separate jurisdictions). If tax authorities are not able to reach an agreement, the taxpayer would not be entitled to any treaty benefit (except for the ones agreed upon by competent authorities of both States).
In the Treaty between Brazil and India, the clause that would have to be modified (or overridden) for this proposal to become effective is Article 4th, paragraph 3, which currently (i) favors the default jurisdiction of the place of effective management, and (ii) does not specifically allow case-by-case decisions.
Also, according to the OECD,7 "income derived by or through an entity or arrangement that is treated as wholly or partly fiscally transparent under the tax law of either Contracting State" should be regarded as "income of a resident of a Contracting State", but only to the extent that the income is treated, for purposes of taxation by that State, as the income of a resident of that State.
The inclusion of this proposal in Article 1st of the Treaty between Brazil and India (possibly through a Multilateral Instrument) may affect WHT reductions, which may be partially denied if the person ultimately receiving the income is not a resident from India, or vice-versa.
- Entitlement to Treaty Benefits (Action 6)
The final report of Action 6 recommends the adoption of an "Entitlement to Benefits" clause, inspired by the Limitation on Benefits clause present in the United States Model Income Tax Convention.8
The purpose of the new "Entitlement to Benefits" clause would be to prevent granting treaty benefits to persons that should not be entitled to them, either because doing so is not in the interest of either Contracting State, or because the relevant taxpayer has employed a structure completely devoid of economic substance for the sole or main purpose of enjoying protection under the treaty. The proposed clause is divided into a set of objective and subjective criteria (the "principal purpose test", or PPT section), and if its text is included in the Multilateral Instrument of Action 15, taxpayers wishing to enjoy treaty benefits must comply with both criteria.9
At this stage, it is difficult to forecast whether Brazil will sign up or not for a Multilateral Instrument containing this proposed clause. Remember that the majority of Brazilian treaties either (i) do not have a Limitation on Benefits clause, but do mention the expression "beneficial owner" or "beneficiary", or (ii) have a Limitation on Benefits clause that is significantly broader than the already quite broad proposal issued by the OECD. Would Brazil be willing to relinquish its all-encompassing interpretive power of "beneficial ownership" in favor of a streamlined clause that would supersede provisions in all of its existing treaties? As implementation of BEPS proposals goes on, Brazilian policymakers will be compelled to provide a clear answer to this question.
- Effectiveness of Dispute Resolution Mechanisms (Action 14)
The OECD has proposed a number of adjustments not only to the text of Article 25 of tax treaties in existence, but to the application of its terms by Contracting States around the world. According to the OECD, a minimum standard for Dispute Resolutions would include (i) a commitment to the timely resolution of treaty disputes,10 (ii) the publication of decisions on treaty issues for the benefit of taxpayers,11 and (iii) a commitment to mandatory arbitration (which, admittedly, is not a consensus among G20 countries).12
Article 25 of the Treaty with India is, in general terms, a feature of the totality of tax treaties signed by Brazil. It does not compel Brazilian tax authorities to reach a decision on the claim presented by the taxpayer, nor does it require that this resolution, if reached, is communicated in a timely fashion. Brazilian tax practice with Dispute Resolution Mechanisms is virtually non-existent: anecdotal evidence points to either a blatant disregard for requests for the application of Article 25 or to formal communications stating that the position of Brazilian Law is not subject to debate before treaty partners. Implementation of BEPS, therefore, will possibly show whether Brazil is willing to modify its historical position of indifference or deficient application of Article 25.
Footnotes
1 http://www.mea.gov.in/Portal/ForeignRelation/Brazil__May_2014.pdf
2 See Article 10 of Law 9,249/1995.
3 See Article 28 of Law 9,249/1995.
4 See Article 3rd of Provisional Measure 2,159-70/2001.
5 See Article 685, item I, of Decree 3,000/1999 (Income Tax Regulations, or "RIR/99"). See also Article 21 of Normative Instruction RFB 1,455/2014.
6 OECD. Neutralising the Effects of Hybrid Mismatch Arrangements, Action 2 – 2015 Final Report. OECD/G20 Base Erosion and Profit Shifting project. OECD: 2015, pp. 137-138. Available at: http://dx.doi.org/10.1787/9789264241138-en.
7 See note 6 above. OECD: 2015, pp. 139-143.
8 OECD. Preventing the Granting of Treaty Benefits in Inappropriate Circumstances, Action 6 – 2015 Final Report. OECD/G20 Base Erosion and Profit Shifting project. OECD: 2015, p. 11. Available at: http://dx.doi.org/10.1787/9789264241695-en>.
9 See note 8 above. OECD: 2015, pp. 21-69.
10 OECD. Making Dispute Resolution Mechanisms More Effective, Action 14 – 2015 Final Report. OECD/G20 Base Erosion and Profit Shifting project. OECD: 2015, pp. 15-16. Available at: http://dx.doi.org/10.1787/9789264241633-en.
11 See note 10 above. OECD: 2015, p. 17.
12 See note 10 above. OECD: 2015, p. 41.
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