Brazil–UK double tax treaty: a new solution to an old riddle?

At the end of 2022, Brazil and the UK signed their first comprehensive double tax treaty. On July 19 2023, the UK Parliament approved the agreement and it is only pending final approval by Brazilian legislative organs for the treaty to become effective.

This double tax convention is Brazil’s fifth signed with a G7 country and is a sign of a renewed energy in Brazil’s treaty policy.

The treaty is a clear nod to the OECD and its tax policy standards. It incorporates post-BEPS minimum standards and key items of the OECD and United Nations model treaties. The incorporation of the arm’s-length standard and a principal purpose test with a comprehensive limitation on benefits article can be highlighted.

One of the items included that could have a great practical impact is the provision regarding Brazilian taxation on the importation of services.

The payments relating to this kind of transaction used to be qualified as payments of royalties by the Brazilian tax authorities to ensure source taxation, since most of the Brazilian treaties provide for the taxation of royalties at source. However, the criteria for considering a payment as royalties were imprecise and therefore led to uncertainty for taxpayers.

This article will explain how this treaty addresses the issue, and provides a recap of the legislative and case-law developments on the topic in Brazil.

The treaty was designed to split into two articles the provision concerning the taxation of royalties (Article 12) and the taxation of technical services (Article 13) – a framework that resembles OECD standards.

Article 12 provides for a withholding tax (WHT) on royalties capped at 10%. This could be significant, depending on the rates in the UK, as the main Brazilian domestic WHT rate is 15% and other treaties Brazil has entered into with other European jurisdictions (e.g., the Netherlands) have a 15% rate.

Article 13 provides for a taxation of fees for technical services by tapering a WHT rate of 8% for the first two years, reducing to 4% for years three and four, and 0% thereafter. The scope of this article is very broad and it encompasses any payment for any service of a managerial, technical, or consultancy nature. This is a significant positive development given that there is a common understanding in the international community that no WHT should be applied to fees for technical services.

This is a substantial change in the historical stance of Brazilian tax policy, since, according to the Brazilian tax authorities, Article 7 (business profits) should not prevent taxation at source for services (even in the absence of a permanent establishment), as such fees should be qualified under the article concerning royalties (usually, Article 12). Thus, this clear and specific provision for technical services should resolve a significant number of discussions concerning this topic.

In the 1990s, the Brazilian Federal Revenue Service (RFB) took the stance that remittances arising from contracts for the provision of technical assistance and technical services, even without any technology transfer, were subject to WHT, since they should be qualified under Article 21 of most treaties as "income not expressly mentioned". This understanding was provided for by administrative acts and rulings (for instance, COSIT Declaratory Act 01/00). However, in 2012 this interpretation was rejected by the Brazilian Superior Court of Justice (STJ) in Recurso Especial 1,161,467 (the Copesul case).

The Copesul case concerned the taxation of remittances related to services rendered with no technology transfer in the context of the Brazil–Germany and Brazil–Canada treaties. The court highlighted the difference between income obtained from the provision of information resulting from experience acquired in the industrial, commercial, or scientific sector (‘know-how’) and that from the provision of services with no technology transfer. The first kind should be qualified under Article 12 of the treaties as royalties and subject to WHT, according to both treaties, and the provision of services in general in Article 7, implying that they should not be taxable in Brazil. The classification as "income not expressly mentioned" argued by the RFB was rejected then.

As a consequence of the decision in the Copesul case, the tax authorities started to defend the stance that WHT would be legitimate when a treaty signed by Brazil had any provision assimilating fees for the provision of technical services and technical assistance to royalties (Opinion PGFN/CAT 2,363/13).

The following year, the RFB ratified this understanding by means of Interpretative Declaratory Act 5/14. The act states that the tax treatment of income paid from a Brazilian source to an individual or legal entity residing abroad for the provision of technical services and technical assistance, with or without technology transfer, based on a treaty signed by Brazil must be in accordance with the article that deals with royalties, when the respective treaty (even by means of a protocol) contains a provision that stipulates fees for technical services and technical assistance should be taxed as royalties.

Of the 32 treaties signed by Brazil at that time, only five did not have a provision in a protocol making fees for technical and technical assistance equivalent to royalties: France, Finland, Austria, Japan, and Sweden.

In 2015, the Iberdrola case (Recurso Especial 1,272,897) concerned WHT related to payments for services rendered by a Spanish company, and the crux of the matter was to determine whether the expression "business profits" referred to in Article 7 of the Brazil–Spain treaty encompassed the gross income that was the object of the withholding taxation. The tax authorities argued that profit is a net result, a synthesis of revenues and expenses. Since legislation prescribed a tax on the gross amount of the payment, this could not be qualified as profit. It was therefore decided that the foreign company's profit should not be interpreted restrictively as the taxable (net) profit of the company Lucro Real but as any income or gross revenue that is part of the resulting profit, which, in turn, can only be assessed by the residence state.

In May 2020, the same court issued a decision in the Alcatel case (Recurso Especial 1,618,897) reaffirming the prevalence of the provisions of treaties over domestic law. In the Alcatel case, the taxpayer pleaded to not bear WHT on payments for technical services provided by a French company. Taking the rationale from the Iberdrola case, the court confirmed that, in accordance with Article 7 of the Brazil–France treaty, the profits of the French company include an item of income (gross income) paid in consideration of services provided and therefore cannot be taxed in Brazil.

Neither the legal and infra-legal determinations nor the STJ case law were able to provide a clear answer to taxpayers about the classification of payments made outwards as remuneration for services rendered. Indeed, the fact that has become clear is that Brazilian tax authorities have been constantly changing the legal criteria for taxing service-related remittances, for treaty countries and non-treaty countries.

For this reason, the new treaty between Brazil and the UK was correct in segregating the matter into two articles (articles 12 and 13), to put a practical end to an old discussion that seemed to have no possible end.