According to Brazilian Law, JSCP result from applying an interest rate over the equity of the company and are distributed to the shareholders out of the profits of the company and pro rata to their holdings in the capital.
Despite the corporate and accounting treatment of JSCP as income obtained from the holding of shares (which is undisputed), the TEAC takes the view that they must be characterisd for tax purposes in accordance with the tax laws of Brazil, as stipulated under Articles 10 (dividends) and 11 (interest) of the Spain-Brazil tax treaty. Therefore, because -according to the TEAC- JSCP are characterised as interest for Brazilian tax purposes, their qualification for the exemption granted to dividends and shares in income under Spanish domestic legislation and in the Spain-Brazil tax treaty itself has to be denied.
Additionally, because JSCP are treated as a deductible expense for Brazilian corporate income tax purposes, the TEAC deems there to have been no economic double taxation of the income, which also disqualifies JSCP for the exemption.
In our view, the TEAC's interpretation of the connection between the Spain-Brazil tax treaty and Spanish domestic legislation is, at least, disputable. In the context of tax treaties, characterisation pursuant to the country of source (Brazil, in this case) is significant for the sole purpose of determining the right to tax the income and to avoid double taxation. After the country with the right to tax has been determined (Brazil, at source, Spain, at residence), only the country in which the income is received has the task of characterising the income (in this case JSCP) and determining the form of taxing it, within the scope of its own domestic legislation. The position taken by the TEAC makes the characterisation and taxing of income in Spain dependent on the characterisation and interpretation of such income in another country (Brazil), which is tantamount to a transfer of tax sovereignty which is difficult to justify.
JSCP should be characterised in the context of the tax legislation being applied (Spanish domestic legislation). But even if this were not the case and it were necessary to refer to the tax treaty, the fact is that JSCP, as income from shares, would have to fall under the independent definition of dividends set forth under Article 10.4 of the Spain-Brazil tax treaty and not under Article 11.5 of the same tax treaty, on interest (please see, in this connection, the judgment handed down on December 14 2010 by the Economic Administrative Tribunal –FG- of Nürnberg regarding the treatment given to JSCP under German law). As a result, the receipt of JSCP should be tax exempt in Spain pursuant to the domestic participation exemption regime and the provisions of article 23.3 of the Spain-Brazil tax treaty.
Lastly, the TEAC forgets (especially in the ruling dated April 13 2011) that under the Spanish exemption scheme, the requirement that there be taxation for a foreign tax which is identical or analogous to the Spanish tax (this being the ground for the economic double taxation which is to be avoided) refers to the investees and not to the income they obtain. Therefore, and given that there is a iures et de iure presumption of submission to an analogous foreign tax where there is a tax treaty which applies to the investees (as in the case of Brazil), the presumed taxation of the Brazilian investees and, in particular, the deductibility of a part of the income distributed should be irrelevant.
These two rulings are not isolated cases and it is possible that we will soon be faced with other cases in which the Spanish tax authorities use the general provisions of the tax treaties and the legislation of other countries as support for re-characterising income. But income should only be re-characterised in accordance with instruments (provided for under domestic law or under tax treaties) specifically designed for such purpose and, above all, suitably integrated in the principles and methods of characterisation of Spanish law. We trust that the Spanish courts will soon clarify the uncertainties generated among Spanish taxpayers by this administrative tendency.
Rafael Calvo (firstname.lastname@example.org)
Garrigues is the Spanish member firm of Taxand
Tel: +34 91 514 52 00