Brazil Tax Alert - 23 May 2012
Court rules payments for outbound technical services not subject to withholding tax
By Marcelo Natale and Cristina Arantes Berry
The second chamber of the Brazilian Superior Court of Justice (STJ) issued a decision on 17 May 2012 concluding that payments made by a Brazilian resident for technical services provided by companies in Canada and Germany are not subject to withholding tax because the payments constitute business profits under Brazil’s treaties with the two countries. In affirming the 2009 decision of a Brazilian federal court, the STJ ruled that payments for technical services that do not involve a transfer of technology should not be subject to the 15% withholding tax in Brazil’s tax treaties with Canada and Germany (the latter of which was terminated as from 1 January 2006, but applied at the time the payments were made).
The decision is significant because the STJ (the highest instance court that rules on non-constitutional issues) has ruled in favor of the taxpayer and for the first time has held that tax treaty provisions prevail over domestic tax legislation.
The decision follows the OECD’s interpretation of the business profits article in the OECD model treaty (article 7), according to which services income should be a component of the profits of a resident in a treaty country and, therefore, taxed only in its country of residence. Although Brazil is not a member of the OECD, most of its treaties are based on the OECD model and Brazil relies on the Commentary to the model treaty (although with certain reservations).
According to Normative Ruling COSIT 1/2000 issued by the tax authorities in 2001, for tax treaty purposes, income related to technical services that do not involve a transfer of technology should be deemed “other income” rather than “business profits” and, therefore, taxed in Brazil under domestic law, i.e. a 15% withholding tax. The tax authorities’ position is based on the fact that the term “profit” is not defined in Brazil’s treaties, so article 7 should not apply. It is also important to note that some lower courts previously issued similar decisions in favor of the taxpayer.
The STJ’s decision is another indication that the Brazilian courts may follow the OECD Commentary on the interpretation of tax treaties, but also confirms the understanding that domestic legislation should not override the provisions in a tax treaty. The case may be relevant for future decisions since lower instance administrative federal courts have been issuing conflicting decisions on the same issue. However, judicial precedent does not automatically apply to all taxpayers and, therefore, other assessments may be issued until tax authorities formally review their position.