Reciprocity principle & tax exemption for airlines

Federal justice in Brazil is comprised of several Trial Courts and five Regional Federal Appellate Courts. The circuits are: TRF1 (Brasília); TRF2 (Rio de Janeiro); TRF3 (São Paulo); TRF4 (Porto Alegre); and TRF5 (Recife). Jurisdiction is determined mostly by Article 109 of the Constitution, and cases heard generally involve the federal government and its agencies. Thus, a major part of tax disputes in Brazil are settled in these courts. The reason for this is either due to a long-lasting tradition of taking administrative courts as just a first round of a broader litigation strategy; or due to the fact that State and Municipal governments, although important litigators in State courts, pale in comparison with the monumental size of the federal apparatus. The sheer scope of the federal government in taxing Brazilian individuals and companies also accounts for that. The case I’d like to comment today – Aerovias Nacionales de Colombia (Avianca) v. The Federal Government – was recently heard by the Federal Trial Court in Rio de Janeiro and then by the Regional Federal Appellate Court (TRF2).

The Federal Government filed an action against Avianca for the collection of overdue tax charges related to a social contribution (FINSOCIAL). At the core of the case, rather interestingly, no debate arose as to the FINSOCIAL itself, which is target at funding social programs in food, public housing, health, education, and justice policies; and at supporting small producers (as provided by Decree-Law No. 1.940, of May 25th, 1982). Instead, the discussion revolved around a more general topic of tax law and an underlying matter of international law.

As debtors are allowed to collateralize and challenge the merits of the charges, Avianca basically argued that: a) it was exempt from the payment due to the Agreement in the form of an exchange of letters (No. 136/1970) between Brazil and Colombia; and b) it qualified for a remission of the debt, in both cases by means of Federal Law No. 10.560, of November 13th, 2002. To Avianca, this Law set forth a number of rules admittedly designed at rescuing airline companies going through a crisis in the beginning of the 2000’s. Some tax breaks in the purchase of fuels were given; but, more relevantly to the case, a whole scheme was put into play to boost both Brazilian and foreign companies in their operations both in Brazil and abroad.

Article 4 of that law, following the guidelines of art. 172 do National Tax Code, provided for the remission of FINSOCIAL liabilities held by national aviation companies. Paragraph 1 of article 4 stated that the extension of this tax break to foreign companies would depend upon an agreement between Brazil and the country of domicile of the airline – an agreement whereby Brazilian companies would enjoy a similar treatment in relation to all taxes due in the same period of time, that is, as of February 1st, 1999. Later on, in 2004, art. 20 of Federal Law No. 11.051, of December, 29th, 2004, added paragraph 3 to art. 4 of Federal Law No. 10.560, thus providing that, for the purposes of that Law, any form of an adjustment between the relevant countries shall be deemed an agreement.

Avianca claimed it was exempt from the payment of the contribution due to the principle of reciprocity and due to the provision of an Agreement by exchange of letters between Brazil and Colombia. In deciding the matter, the Trial Court established that said Agreement did not qualify as a proper treaty under international law. Such an agreement constituted a mere means for entering into a treaty. However, for tax purposes, in Brazil, the exchange of letters could not be tantamount to entering into a treaty, let alone passing a Law by Congress, as provided by Article 96 of the National Tax Code and by Article 150, paragraph 6, of the Constitution. Additionally, Article 111 of the Tax Code brought some guidance to the interpretation of tax relief rules: such clauses are to be interpreted restrictively. Therefore, Avianca’s claim was refuted.

Furthermore, the Trial Court delved into the question whether Avianca was entitled to the remission of that liability. As previously established, it was found that the exchange of letters was insufficient to demonstrate the reciprocity required by Article 4 of the Federal Law No. 10.560. The company also introduced evidence of Colombian Law No. 71, of 1993, which approved the exchange of letters. Even if such means of proof were to be accepted, (it wasn’t due to a lack of proper translation), the Court found that it was not to be considered pertinent, since it was published after the taxable events discussed in the case.

The Court of Appeals, though, has taken a different approach to the matter. Two precedents were invoked to support the conclusion that no further specific statute was necessary to render Avianca exempt from FINSOCIAL. Both of these precedents, under similar circumstances, found that the reciprocity principle under international law would suffice to create a specific tax regime for South African airlines: firstly, an exemption of a contribution known as COFINS; secondly, an exemption of the contribution on net income. More generally, and not so much taking into account any international implications, the Appellate Court ruled that Federal Law No. 10.560 was itself sufficient to meet the requirements of Article 150, paragraph 6, of the Constitution.