This is the seventh 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
Decree 78,107, published on July 23, 1976, contains the text of the Bilateral Income Tax Treaty signed by Brazil and Austria ("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"). In particular, though, the Treaty with Austria establishes in Article 24 that the principle of non-discrimination between the tax treatment of Brazilian and Austrian nationals/residents applies to all taxes labeled as "impostos", not only the ones applicable to income. We discuss the application of this Article in further detail below.
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 (prior to 1977), 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 to an exemption in Austria and vice-versa. Specifically:
- For dividends received by a beneficial owner resident in a Contracting State, the maximum WHT is set at 15%.
Under current Brazilian Law, however, dividends paid to Brazilian or foreign recipients are exempt from WHT.1
If the dividends are paid by a legal entity in Austria to a legal entity in Brazil that owns at least 25% of its stock, these dividends shall be exempt from IRPJ and CSLL in Brazil.
- 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 financial institution exclusively owned by this Government, or 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 any financial institution exclusively owned by this Government, shall only be taxed in this Contracting State.
Under current Brazilian Law, interest paid to foreign recipients is subject to a WHT of 15%.2
- For royalties, the maximum WHT rate is set at (a) 10% if they remunerate the use or right to use copyright associated to literary, artistic and scientific works, but not to movies or TV and radio shows; (b) 25% if they remunerate the use of trademarks; and (c) 15% in all other cases.
Under current Brazilian Law, royalties paid to foreign recipients are subject to a WHT of 15%.3
- 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 and aircrafts (and from assets associated to the transportation by ships and 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%.4 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
Unlike more recent Brazilian tax treaties, our Treaty with Austria does not contain the expression "beneficial owner". The treaty uses the term "beneficiary", which may or may not refer to the more specific concept of "beneficial ownership" (it is important to highlight, however, that only in recent treaties has Brazil acquiesced to a specific Limitation on Benefits clause, and only in broad terms).
Brazilian tax authorities view the absence of a treaty definition of "beneficiary", as is the case with the Treaty between Brazil and Austria, as a permission for tax authorities of the State applying the treaty to interpret the expression as they see fit – which opens the gates for an interpretation of "beneficiary" as "beneficial owner". 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
Though there are situations in which Austria is required by the Treaty to grant Brazilian sourced income an exemption (e.g., when dividends are paid by a Brazilian legal entity to an Austrian legal entity that owns at least 25% of its stock), in other payments of dividends, interest and royalties, Austria is required to grant a tax sparing credit to its resident beneficiaries.
The tax sparing credit is usually greater than the WHT rate applicable under the treaty or under domestic law. In the Treaty with Austria, the credit is established as follows:
- For dividends, a tax sparing credit of 25%.
- For interest, a tax sparing credit of 25%.
- For royalties, a tax sparing credit of 25%.
This tax sparing is only applicable on payments from Brazil to Austria, and not on vice-versa.
- Income derived from technical assistance and technical services
In the Protocols of the majority of Brazilian Bilateral Income Tax Treaties, income derived from technical assistance and technical services is characterized as royalties, and therefore subject to the WHT imposed on royalties (generally in accordance with Article 12).
This issue is relevant 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, because the Protocol to the Treaty with Austria does not presently contain any association between the remuneration of technical assistance and technical services and royalties, this remuneration shall be treated as business profits (in accordance with Article 7th, solely taxable in the State of residence, unless the entity has a permanent establishment in Brazil).
- Application of Article 24 to all taxes labeled as "impostos"
Unlike its counterpart in the majority of Brazilian tax treaties, Article 24, paragraph 5 of the Treaty with Austria states that the principle of non-discrimination shall apply to all taxes labeled as "impostos" (and therefore not only to income taxes per se). In other words, Brazil may not discriminate Austrian nationals/residents – nor Brazilian entities controlled by them or Brazilian permanent establishments of Austrian entities – strictly on the basis of nationality/residence for purposes of the following taxes (in addition to IRPJ, IRPF, WHT and CSLL):
- Federal Excise Tax on Manufactured Products ("IPI");
- Federal Import and Export Taxes ("II" and "IE");
- Federal Taxes on Credit, Foreign Exchange, Insurance, Bonds/Titles, and Gold as a Financial Asset or Foreign Exchange Instrument ("IOF/Credit", "IOF/FX", "IOF/Insurance", "IOF/Bonds/Titles", and "IOF/Gold");
- Federal Tax on Rural Properties ("ITR");
- Federal Wealth Tax ("IGF"), if ever enacted;
- State Value-Added Tax ("ICMS");
- State Tax on Succession and Donation ("ITCMD");
- State Tax on Automotive Vehicle Property ("IPVA");
- Municipal Tax on Urban Properties ("IPTU");
- Municipal Tax on Services ("ISS"); and
- Municipal Tax on Transfer of Real Estate Property ("ITBI").
In general, Brazilian tax treaties only require the application of the non-discrimination principle to income taxes. This modified clause is a feature of the Treaty with Austria and only ten other treaties (Belgium, Denmark, Finland, France, Japan, Luxembourg, Mexico, Portugal, Spain and Sweden).
- 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. The Treaty with Austria specifically exempts dividends received by a Brazilian company (if the recipient owns at least 25% of the stock of the payor) in Article 23, paragraph 2. Though some precedents of CARF attempt to draw a line between "dividends" and "undistributed profits", this distinction has not found its way into the case law of STJ and/or STF. As a consequence, the terms of this Treaty may be used by Brazilian companies to support the non-application of CFC rules for the profits of Austrian controlled entities.
Administrative and judicial case law
Three CARF precedents have applied the Treaty to date (STJ and STF have not issued any decisions on the terms of the Treaty with Austria). Please find a detailed description of these three decisions below:
In Ruling 1302-001.620, the Brazilian entity claimed that the interest on Austrian and Spanish Government bonds should not be taxable by CSLL in Brazil, because both treaties establish that this type of interest is only subject to tax in the Contracting State of source. The Third Chamber of the First Section of CARF denied the application of both treaties to CSLL, stating that this particular tax has not been included in their text.5 However, in Ruling 1401-001.037, after the analysis of a similar case, the Fourth Chamber of the First Section stated that the two treaties apply to CSLL, since this tax has the same taxable basis of IRPJ, and should therefore receive the same treatment.6 The same decision was also issued in favor of the taxpayer by the First Chamber of the First Section, in Ruling 1101-000.902.7
Although this debate has prompted heated sessions in CARF until 2015, as we mentioned above, since December 09, 2015, CSLL is applicable to all Brazilian tax treaties currently in effect.
Both Austria and Brazil (respectively a member and an associate country 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 Austria, 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,8 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 resident 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 Austria, the clause that would have to be modified (or overridden) for this proposal to become effective is Article 4th, paragraph 3, which currently establishes that dual-residency issues will be resolved in favor of the State in which the legal entity has its place of effective management.
Also, according to the OECD,9 "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 Austria (possibly through a Multilateral Instrument) would affect not only WHT reductions (which could be partially denied if the person ultimately receiving the income is not a resident from Austria), but also the entitlement to tax sparing credits, established in Article 23, paragraph 5, as explained earlier.10
- 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.11
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.12
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,13 (ii) the publication of decisions on treaty issues for the benefit of taxpayers,14 and (iii) a commitment to mandatory arbitration (which, admittedly, is not a consensus among G20 countries).15
Article 25 of the Treaty with Austria 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.
For further comments on the application of the Treaty between Brazil and Austria, please do not hesitate to contact our firm.
(*) With the collaboration of our associate Lucas de Lima Carvalho (firstname.lastname@example.org)
1 See Article 10 of Law 9,249/1995.
2 See Article 28 of Law 9,249/1995.
3 See Article 3rd of Provisional Measure 2,159-70/2001.
4 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.
5 See CARF. Ruling 1302-001.620. First Section, Third Chamber, Second Ordinary Group. Session of February 03, 2015. Published on February 13, 2015.
6 See CARF. Ruling 1401-001.037. First Section, Fourth Chamber, First Ordinary Group. Session of September 10, 2013. Published on January 07, 2014.
7 See CARF. Ruling 1101-000.902. First Section, First Chamber, First Ordinary Group. Session of June 12, 2013. Published on March 18, 2014.
8 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.
9 See note 8 above. OECD: 2015, pp. 139-143.
10 The final report provides an example that illustrates the interplay between hybrid mismatch rules and a tax sparing clause, such as the one in the Treaty between Brazil and Austria, in the proposed item 26.7 to the OECD Commentary: "[Brazil] and [Austria] have concluded a treaty identical to the Model Tax Convention. [Brazil] considers that an entity established in [Austria] is a company and taxes that entity on interest that it receives from a debtor resident in [Brazil]. Under the domestic law of [Austria], however, the entity is treated as a partnership and the two members in that entity, who share equally all its income, are each taxed on half of the interest. One of the members is a resident of [Austria] and the other one is a resident of a country with which [Brazil] and [Austria] do not have a treaty. The paragraph provides that in such case, half of the interest shall be considered, for the purposes of Article 11, to be income of a resident of [Austria]." In this example, only half of the interest received would be associated with a tax sparing credit of 25%, in line with Article 23, paragraph 5, of the Treaty.
11 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.
12 See note 11 above. OECD: 2015, pp. 21-69.
13 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.
14 See note 13 above. OECD: 2015, p. 17.
15 See note 13 above. OECD: 2015, p. 41.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.