Stephanie Makin and Ana Lúcia Marra of Machado Associados discuss changes to the withholding tax on service remittances abroad and the impact on multinational corporations.
The high tax burden imposed by Brazil on remittances abroad related to the import of services, as well as multiple taxes, various tax rules and taxing authorities’ interpretation of double tax treaties (DTTs),
are famously known to cause difficulties to multinational groups with presence in Brazil.
Brazil imposes up to six taxes on these remittances regulated by different federal and municipal laws, which contribute to the contentious scenario involving the import of services into Brazil, including discussions on the withholding income tax (WHT).
The effects of the DTTs signed by Brazil to reduce or eliminate the WHT levied on the remittances for the payment of services and the moment in which the WHT should be paid have been surrounded by controversy. In 2020, these important aspects regarding the levy of the WHT on service remittances were analysed by the Superior Court of Justice (STJ), the second highest judicial level in Brazil, bringing new perspectives to be considered by multinational groups.
Effects of double tax treaties on WHT on service remittances
In December 2020, the second panel of the STJ issued a decision, when analysing Special Appeal (REsp) 1.759.081-SP, concerning the qualification of remittances abroad for the payment of technical services under the DTTs signed by Brazil, which has the potential of altering the current scenario regarding the levy of WHT on these remittances vis-à-vis DTTs and adding yet another chapter to this long-standing discussion.
Background for the decision
Historically, Brazilian tax authorities have defended that WHT should be levied on technical service remittances abroad, under the interpretation that these remittances would fall under Article 21 (other income) of the
DTTs. Traditionally, Article 21 of DTTs signed by Brazil allow both Contracting States to tax the remittances. This position was surprisingly upheld by Brazilian tax authorities even in cases in which the specific DTT did not include any article concerning “other income”.
In May 2012, a decision issued by the STJ on the subject (Resp 1.161.467 – RS) brought about a complete turn- around in the position of the Brazilian tax authorities. The judges in this case concluded that Brazil was not allowed to tax the remittances based on Article 7 (business profits) of the DTTs. The main argument considered by the STJ in its decision was that service income would be included in the concept of business profits under national law.
Shortly after, the Brazilian Federal Revenue Service (RFB) issued Interpretative Declaratory Act 5/14 (ADI 5/14), according to which the remittances for the provision of technical services to countries with which Brazil has signed a DTT shall fall under:
- Article 12 (‘royalties’), if the protocol of the DTT expressly states that technical services and technical assistance are included in the concept of royalties. Article 12 of the DTTs signed by Brazil follows the United Nations Model Double Taxation Convention, allowing Brazil to impose WHT on the royalty payments to contracting states.
- Article 14 (personal independent services), if (a) the rendering of the services relies on the technical qualification of a person or group of people; (b) the DTT allows for the taxation in Brazil; and (c) Article 12 does not apply. Article 14 of the DTTs signed by Brazil would generally grant Brazil the right to tax the remittances under certain situations. Despite the deletion of Article 14 from the OECD’s Model Convention, Brazil’s policy is to include this article in DTTs signed by the country; and
- Article 7, providing Articles 12 and 14 do 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 royalties for the purpose of the DTTs, without defining technical services. Under the Brazilian tax authorities’ interpretation, technical services are defined as services that require some type of specific knowledge. From a practical perspective, this definition encompass- es almost all services, regardless of any transfer of technology. It is only recently that Brazil has begun to include its unique and extremely broad definition of technical services into the DTTs (e.g. protocol to the DTT with Argentina signed in 2017, DTT signed with Singapore in 2018).
Since the enactment of ADI 5/14, Brazilian tax authorities have consistently recognised that WHT should not be levied on remittances abroad when the corresponding DTT does not expressly include technical service and technical assistance in the scope of Article 12 (which is the case of France, for example), understanding that the remittances fall under Article 7.
Only in very specific circumstances did the RFB classify remittances under Article 14.
A new chapter in the discussion
In REsp 1.759.081-SP, judged by the STJ on December 18, 2020, the court was requested to determine whether remittances made by a Brazilian company to a Spanish entity for the payment of engineering and administrative assistance services should fall under Article 7 (business profits), Article 12 (royalties) or Article 14 (independent personal services) of the Brazil–Spain DTT.
The Brazil–Spain DTT is one of the DTTs signed by Brazil that expressly includes technical service and technical assistance serviced in the scope of Article 12. Under this article, Brazil may levy a 10% WHT on the remittances made to Spain (in comparison to the 15% general rate).
The definition of ‘independent personal services’ under Article 14 expressly includes engineering services. Based on this article, Brazil would be allowed to tax the remittances to Spain with no rate reduction.
Under Article 7 of the DTT, on the other hand, Brazil would not be entitled to levy WHT on the remittances made to Spain.
Upon its own analysis of the case, the lower judicial court (Federal Regional Court of the 3rd Region – TRF3) studied the agreements entered into by the parties and concluded that they did not provide for any transfer of technology and, thus, the payments for the engineering and administrative assistance services should not be classified as royalties for the purposes of the DTT.
Rather, in the TRF3’s view, the agreements provided for the mere rendering of services by the Spanish entity and so the related remittances 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 issued by the same court, always based on STJ’s position on the case judged in 2012 (Resp 1.161.467 – RS) and cases judged by the STJ after that.
The application of Article 14 was not examined by TRF3 in this case, following TRF3’s usual practice of not contemplating it in its decisions.
The TRF3’s decision in this case was challenged by the Brazilian tax authorities. Upon analysing the specific circumstances, the STJ decided that the matter should be analysed once again by the lower judicial level, taking into consideration the Interpretative Declaratory Act 5/14.
The STJ stated that, differently from the lower court’s understanding, the Brazilian law and STJ case law’s definition of royalties for tax purposes does not require any trans- fer of technology.
Partner Machado Associados T: +55 11 3093 4834
Stephanie Makin is a partner at Machado Associados. Her practice focuses on direct taxes, international taxation and TP.
Ana Lúcia Marra
Partner Machado Associados T: +55 11 3093 4833
Ana Lucia Marra is a partner of Machado Associados with 24 years’ experience in tax consulting in audit companies and law firms