The Brazilian tax authorities interpret non-defined terms within a tax treaty
On June 30 2020, the Federal Brazilian Tax Authorities (RFB) published Solução de Consulta - Cosit 49/2020 (dated June 22 2020) providing that the DTT concluded between Brazil and France is not applicable to the territory of French Polynesia, given that ‘overseas collectivities’ are not included within the tax treaty definition of a resident of a contracting state (being France).
The interested party is an airline company responsible for transporting passengers and cargo, headquartered in the city of Papeete in French Polynesia and based on the Faa'a International Airport (Tahiti International Airport) seeking to clarify the tax treatment of the remittance of profits / income resulting from the sale of international airline tickets in the national territory through a branch, functioning as an offline point of sale (POS). More specifically, the possibility of applying Article 8 of the DTT concluded between Brazil and France, which allows taxation of profits relating to shipping and air transport only in the country where effective management of the enterprise is situated.
By the background, Brazil is not a member of the OECD, although the tax treaties generally do follow the OECD Model Convention framework (as amended from time-to-time), with some differences. Broadly speaking, Article 1 of the DTT between Brazil-France states that the convention shall apply to persons who are residents of one or both of the contracting states. Pursuant to the general definitions section in Article 3, the contracting states are defined to be France and Brazil. Brazil being defined as the Federal Republic of Brazil and France being defined as the European and overseas departments (Guadeloupe, French Guiana, Martinique and Réunion) of the French Republic and the areas adjacent to the territorial waters of France over which, in accordance with international law, France may exercise its rights relating to the seabed, the seabed and its natural resources.
In the present case, the RFB considered that having regard to the definition of the term ‘Overseas Department’, the commentary to the OECD Model Convention provides, as a general interpretive rule, that where there is no express definition in the convention, it is necessary to consider the domestic legislation in effect when the tax is required. The RFB considered that the context is, therefore, determined by the intention of the contracting states when signing the convention, as well as by the meaning attributed to the term in the legislation of the contracting state to which it refers.
The RFB went on to conclude that based on the French legislation, there is a significant difference between the definition of ‘oversea territory’ (which includes French Polynesia)* and ‘overseas department’ with respect to competence to tax, with the former enjoying autonomy to define the taxation of its residents. In this regard, the French Republic has concluded a DTT with French Polynesia. As such, French Polynesia should not fall within the definition of a resident of France for the purposes of applying the DTT.
* It was highlighted that in 2003, following reforms to the French Constitution, overseas territories became referred to as overseas collectives.
Tax authorities confirm treatment of foreign reimbursements related to partner-administrators or expatriate costs
The Federal Brazilian Tax Authorities (RFB) on August 25 2020 published Solução de Consulta DISIT/SRRF02 2006 (dated July 20 2020) (SC 2006/2020). It confirms that the reimbursement by a Brazilian entity of certain costs originally supported by an entity in the same group located abroad should not be subject to withholding tax (WHT), or other contributions that are applicable on cross-border payments. Furthermore, it confirms that such amounts should be treated as deductible for corporate income tax purposes where such expenses are necessary to the business activities of the Brazilian entity.
By way of background, the reimbursement of costs to foreign related parties has been a controversial issue over the years. In addition to common cost-sharing issues faced by taxpayers in foreign jurisdictions relating to adequate allocation and documentation criteria, the RFB has recently released decisions providing that international cost-sharing arrangements should generally be treated similarly to the importation of technical services. While a Solução de Consulta does not represent law or legal precedent, it does provide further support and guidance for Brazilian entities in relation to how the RFB is treating arrangements under consideration.
It is important to highlight that the decisions referred to above contemplate costs passed to the Brazilian entity relating to partner-administrators or expatriates. However, the rationale adopted by the tax authority in coming to its decision appears aligned with previous guidance issued by the RFB supporting the non-application of transaction taxes in the context of international cost-sharing agreements (i.e. that the reimbursement does not constitute income in the hands of the foreign entity).
In the context of international cost-sharing arrangements, the recent trend of decisions by the RFB has been to characterise such remittances as income, consideration or remuneration for technical services (depending on the particular tax or contribution). As such, while the decision is favourable for certain operations, the treatment of broader international cost-sharing arrangements remains controversial.
Brazilian Superior Tribunal of Justice (STJ) confirms the triggering event for withholding tax
The Superior Tribunal of Justice (STJ) unanimously confirmed that the mere accounting recognition of a debt (as an ‘accounts payable’) was not sufficient to constitute the triggering event for income withholding tax (WHT). Rather, it is necessary that the debt is enforceable by the foreign creditor, so that WHT should only be triggered when the debt matures or at the moment of payment, whichever comes first.
By way of background, over the years, there has been substantial debate in relation to the timing of the triggering event for WHT purposes. More specifically, whether the reference to ‘credit’ within the contemplated potential triggering events could be taken to mean the mere accounting ‘credit’ in the Brazilian entity's accounting books. At the other end of the spectrum, there exists the view that WHT should only be due upon actual payment/remittance. Finally, there exists a ‘middle ground’ being the view that the triggering event should be the earlier of the payment being made, or the obligation to make payment arising, whichever comes first. It is this latter view that was adopted by the STJ.
The judgment concluded that Article 685 of Decree 3,000/1999 (the previous version of the Brazilian income tax regulations) determines that the incidence of WHT arises on income, capital gains and other earnings paid, credited, delivered, employed or remitted abroad. The accounting recognition of the debit does not correspond to any of the concepts referring to the economic availability (payment, delivery, employment, remittance) or legal availability (credit). Therefore, the accounting recognition cannot be considered as the triggering event for the WHT, which in this case only happens with the maturity or the anticipated payment of the debt.
It is important to note that while the STJ`s decision only contemplated WHT, the relevant Solução de Consulta 153/2017 from the RFB has previously not only addressed WHT but also CIDE, PIS/COFINS-importation. In this regard, instead of ‘income’, CIDE refers to ‘remuneration’, whereas PIS/COFINS refers to ‘consideration’, however the relevant triggering events also refer to ‘paid, credited, delivered, employed or remitted’. As such, while the decision does not create binding precedent, it does appear that the reference to Solução de Consulta 153/2017 could be viewed as providing further guidance for taxpayers in relation to how the STJ may interpret such situations going forward.
However, in a cross-border context, circumstances will continue to exist where despite the maturity date arising (and passing), there is no legitimate expectation of the income actually arriving in the hands of the non-resident (in cash or kind) or the value of the debt being employed in favour of the non-resident beneficiary. In such cases, where the debt is never to be paid and the value of the debt never employed in favour of the beneficiary or at its direction, there appears to remain a question as to the appropriateness of the liability to tax. Considering this and contemplating the form of taxation (i.e. via withholding), further judicial discussion is expected
The Brazilian Supreme Federal Court (STF) resumes discussion on taxation of software transactions
Software transactions have been under increasing scrutiny and interest of the Brazilian tax authorities (RFB) over the last few years. Historically, transactions with ready to use software (i.e. off-the-shelf software) were deemed to be akin to sales with goods, therefore subject to the same tax implications of a buy/sell transaction with a regular, tangible good. However, the STF is now debating whether such understanding still prevails.
One of the new lines of argumentation is that the software is now currently updated, including maintenance services and user assistance - which can no longer be considered as a "good", but rather a service, regardless of whether such software is customizable or an off-the-shelf one.
This distinction is relevant for the Brazilian entities which need to engage in such transactions because the taxation applied to goods and services in Brazil (in terms of indirect taxes) should not overlap. Therefore, to the extent that this STF understanding prevails, then the application of a local state VAT tax (known as ICMS) would no longer be possible, and a municipal service tax (ISS) would be due instead. However, given the lack of certainty at this point, certain companies were conservatively collecting both taxes - and the ICMS burden can be quite high (traditionally 18%), whereas ISS cannot go above 5%. While not final, Brazilian entities dealing with software were optimistic about the STF decision thus far.