By Allan Fallet, Ariene Reis February 28, 2023
Brazil’s new treaty shows an effort to align tax law with OECD standards, say local lawyers Allan Fallet and Ariene Reis, who list some of the agreement’s key provisions.
Brazil and the UK have a solid long-standing trade partnership. According to data published by the UK Department for International Trade on January 20 2023, Brazil and the UK’s trade was worth £6.5 billion (R$40.5 billion) in 2022.
Aimed at increasing the flow of commercial relations and guaranteeing legal certainty for parties involved, Brazil and the UK signed a double tax treaty (DTT) on November 29 2022.
PE and TP
In Article 5(3)b, the DTT says that the provision of services, including consultancy services, by employees of an entity may be qualified as a permanent establishment if such activities are carried out in the other contracting state for a period (or periods) of 183 days within any 12-month window beginning or ending in the tax year concerned.
Brazil is a key partner of the OECD (and aims to become a member), which implies a substantial change in several Brazilian rules, especially in tax. The DTT is the first tax treaty signed by Brazil that adopts the arm’s-length principle – in the context of Article 9 (associated enterprises), it means transactions subject to transfer pricing (TP) rules.
Article 9 of the DTT allows an entity of a contracting state to promote unilateral adjustment to determine the profits subject to tax, as long as the requirements foreseen in the letters “a” and “b” of the article are met. the wording of the rule also allows the other contracting state to make the correspondent adjustment to the amount of tax charged on such profits.
Thus, this provision allows the tax treaty to solve controversies regarding TP rules. Consequently, the economic double taxation of such profits is also avoided – though legal double taxation is not – and it goes hand in hand with the new Provisory Measure n. 1.152, published on December 29 2022, which includes changes to the Brazilian TP regime.
Withholding taxation
Following the OECD Model Convention, Article 10 of the DTT authorises both states to charge a withholding tax on dividends. However, in case the beneficiary resides in the other contracting state, the tax rates applicable cannot exceed (i) 10% of the gross amount paid as dividend (if the beneficiary is an entity which directly holds at least 10% of the equity that pays the dividend throughout a 365- day period); or 15% of the gross amount paid as dividend in all other cases. At a time when Brazilian tax reform is back on the agenda, including taxation at source owing to dividend payments by Brazilian entities (which are currently tax-exempt), Article 10 of the DTT could be a great ally to reduce the tax burden.
Another relevant topic is the taxation of interests. Article 11 of the DTT establishes a withholding tax exemption for interests paid to a beneficiary that is a pension plan or government (and its subdivisions, agencies, and bodies) of the other contracting state. There is also a reduced tax rate (considering that the general tax rate is 15%) of 7% on interest paid for at least five years to financial institutions or insurance companies on loans used to finance infrastructure projects and public utilities. The tax rate of 10% is applied to interest arising from (i) loans made by financial institutions or insurance companies in general, as the parties are not associated enterprises; (ii) stock exchange- listed bonds and securities; and (iii) sale on credit due to the acquisition of machinery and equipment.
Royalties, remittances and more
Unlike the majority of tax treaties signed by Brazil, Article 12 of the DTT establishes a tax rate of 10% for all types of royalties paid, which may represent a significant reduction of the tax burden in this area.
The taxation of remittances as compensation for technical services imported by a resident in Brazil is a constant topic of discussion in administrative and judicial courts, even when a tax treaty is involved. That is because Brazil, when signing several of its treaties, has extended the scope of Article 12 of the DTT. In those cases, such services are taxed as royalties, resulting in the taxation of these remittances at source.
To add more heat to the discussions, some Brazilian courts have adopted the existence of technology transfer as a criterion for taxing technical services as royalties, both in domestic legislation and in the context of treaties.
To minimise those controversies, the DTT contains Article 13, which defines technical services as any payment for any managerial, technical or consulting service, unless the payment is made (a) to an employee (individual) of the payer; (b) as a result of teaching at an educational institution or for teaching provided by an educational institution; or (c) by an individual for services for her/his own use.
The same article says that payments for technical services can be taxed by both states. Nonetheless, in case the beneficiary is resident of the other contracting state, the tax rates applicable cannot exceed (i) 8% during the first two years; (ii) 4% during the third and fourth years; and (iii) 0% from the fourth year on. Regarding those terms, the DTT is not clear if they refer to the beginning of the commercial agreement which foresees the rendering of technical services or the date when the tax treaty enters force.
With reference to dividends, interests and royalties, the protocol establishes that if Brazil changes its internal legislation to attribute lower rates than those foreseen in the treaty, the contracting states will discuss updating the agreement. As for technical services, if Brazil adopts lower rates in any other tax treaty (except for treaties with Latin American countries), these rates will automatically apply for the purposes of the DTT.
Making gains
Article 14, dealing with capital gains from movable properties and rights, determines that the gains originating from the other contracting state may be taxed in this contracting state. However, if such gains are made in a third state despite being negotiated by parties from Brazil and the UK, they will be taxed only in the state of the seller’s residence. Those rules do not apply to gains derived from the disposal of ships and aircrafts (or other properties related to this type of operation), as the taxing rights are attributed to the state of residence of the entity that operates the ship/aircraft.
It is important to have in mind that all those innovative benefits brought on by the rules above are applied to taxpayers of both contracting states only in situations in which there is no allegation of abusive tax planning, in line with Article 29 of the DTT.
Positive outlook
When compared to treaties already signed by Brazil, the new provisions demonstrate the commitment of the Federal Revenue of Brazil and the government to improve tax legislation and align it with the OECD standards.
Finally, while the DTT has been signed by both states, it is not yet in force because the legislative procedures have not been completed (there may or may not be wording changes). In Brazil, the treaty is currently in progress before the Ministry of Foreign Affairs and still needs approval from the National Congress and ratification by the president. After ratification, it will be incorporated in domestic legislation through the promulgation of a decree.
Allan Fallet is a partner at Mauger Muniz Advogados in São Paulo, while Ariene Reis is a tax specialist at Embraer, also in São Paulo.
https://www.internationaltaxreview.com/article/2bcae5qtck6bf8w1jr9j4/in-detail-the-uk-and-brazils-double-tax-treaty