Payments to foreign companies and withholding income tax

This lengthy 2012 ruling of the Superior Court of Justice exemplifies a bit of the Brazilian case law in regards to withholding issues related to payments made to foreign companies. Like several countries, Brazil too has ratified international treaties for the avoidance of double taxation with respect to taxes on income – this, of course, makes the whole thing a matter of international law interacting with domestic law.

In accordance to Article 105, III, a, of the Federal Constitution, the SCJ hears special appeals arising from disputes over the interpretation both of the federal legislation and of treaties entered into by Brazil. A Brazilian company, Companhia Petroquímica do Sul – COPESUL, had contracts with a Canadian and a German company for the rendering of services which undisputedly implicated no transfer of technology. Moreover, there were no permanent establishments in Brazil of the Canadian and German contracting parties. Payments were made to such companies without any sort of withholding, but tax authorities levied charges which COPESUL then took to courts by seeking a declaratory judgment action.

Two major issues were discussed in the ruling. On the one hand, the Court found that Article VII of both treaties, setting out standards for business profits, would support COPESUL not withholding income tax. Under the correct construct of Article VII, payments made by COPESUL would constitute profits of the Canadian and German enterprises and therefore would be taxable only in those countries. Secondarily, the Court discussed the rather more normative matter of the effects of the treaties in Brazil in the face of domestic legislation. After the ratification of theese treaties, Brazilian federal legislation (Article 7 of Federal Law No. 9.779, of January 19th, 1999) had come to expressly command federal authorities to levy the tax. However, the Court found that the lex specialis derogat legi generali principle - meaning the specific rule of the treaty as opposed to Brazilian general domestic legislation - would be applicable.

The Court addressed the matter also from what seems to be an excellently pragmatic standpoint. The federal government tried to disqualify the payments as being part of the profits of the foreign companies. The payments, so says the government, were to be considered only a sort of revenue for the foreign companies. Thus, until the books of those companies were closed, there would be no way to assess if any profits were made, which would cause the application of Article XXI of the tax treaties (“Items of income of a resident of a Contracting State, arising in the other Contracting State and not dealt with in the foregoing Articles of this Convention, may be taxed in that other State”). It was found, nonetheless, that such a broad construct of Article XXI would erode the very foundations of the treaties. Indeed, it seems that no company is in the position to assess whether payments it makes to other companies will actually turn out to form part of its final fiscal profits; or whether it will be only items of income out of the scope of the treaty.

REsp 1161467/RS, Rel. Ministro CASTRO MEIRA, SEGUNDA TURMA, julgado em 17/05/2012, DJe 01/06/2012. In Portuguese here.