Nélio Weiss		Philippe Jeffrey

A Brazilian court of second instance from the State of Rio Grande do Sul has recently issued an important decision in connection with the non-application of withholding income tax on remittance for services to beneficiaries located in a tax treaty country.

The court ruled out that remittance for technical service (not involving a transfer of technology or know-how) to residents of Canada and Germany could not be subject to the Brazilian withholding income tax due to the application of the article 7 (business profits) included in the Brazil-Canada tax treaty and the Brazil-Germany tax treaty (the latter was in force until the end of 2005).

The decision is an important precedent as it is well known that the Brazilian tax authorities do not apply the business profits principle to exempt income not subject to withholding under a specific article of a treaty (in other words, income other than dividends, interest, or royalties).

The latter interpretation was officialised on January 5 2000, when the authorities issued a normative act unifying the official position of the Federal Revenue Department on the proper treatment of withholding taxes for technical service payments remitted outside Brazil.

According to the normative act, payments made abroad for technical services without transfer of technology should be governed by the article in a tax treaty dealing with other income and consequently, subject to Brazilian taxation.

In the decision, the court disregarded the official position of the Federal Revenue Department and ruled out that the income earned from the services rendered by the foreign entities to the Brazilian entity qualify as business profits under domestic legislation and should then be subject to the provisions of article 7 of the tax treaties.

Article 7 and in the scenario under analysis mean Brazil would only have taxing rights if the foreign entity would have a permanent establishment in the country.

Domestic tax and central bank regulations do not contain any provisions that would allow income exempted from Brazilian tax by a treaty to be first remitted abroad without the imposition of withholding tax.

This, as well as the involvement of the banks in the remittance process, means it is generally not possible for a Brazilian company to transfer payments abroad without having paid withholding tax on the basis that the income is exempt business profits under one of Brazil's double taxation treaties.

This is unless a ruling is obtained from the Brazilian tax authorities or as in the current case, the taxpayer seeks protection of a court order by filing a suit against the federal government.

It is important to note that the above decision is not final and may still be subject to further appeal by the Brazilian authorities.

Nélio Weiss (nelio.weiss@br.pwc.com) & Philippe Jeffrey (philippe.jeffrey@br.pwc.com), São Paulo