Tax Treaty Series: The Bilateral Income Tax Treaty Between Brazil And Spain

This is the fourth of our series of posts on Brazilian tax treaties. In each post we provide an overview of a specific tax treaty between Brazil and a particular foreign country, as well as comments on any Brazilian administrative or judicial precedents applying the treaty, and highlights on the impact of the OECD Base Erosion and Profit Shifting ("BEPS") project in its application.

Overview of the treaty

Decree 76,975, published on January 05, 1976, contains the text of the Bilateral Income Tax Treaty signed by Brazil and Spain ("Treaty"). This Treaty is aimed at preventing double imposition and double non-imposition of income taxes in cross-border operations between the two countries.

For Brazilian purposes, as of December 09, 2015, the treaty generally applies not only to the Individual and Corporate Income Taxes ("IRPF" and "IRPJ") and to the Withholding Income Tax ("WHT"), but also to the Social Contribution on Net Profits ("CSLL"). In particular, though, the Treaty with Spain establishes in Article 24 that the principle of non-discrimination between the tax treatment of Brazilian and Spanish nationals/residents applies to all taxes labeled as "impostos", not only the ones applicable to income. We discuss the application of this Article in further detail below.

With regard to CSLL, this tax is not expressly mentioned in the Treaty, because it was created after its signature, and as a partial replacement of IRPJ. However, recent Law 13,202/2015 clarifies that Bilateral Income Tax Treaties signed by Brazil include CSLL:

Art. 11. For purposes of interpretation, the international agreements and conventions signed by the Government of the Federative Republic of Brazil to avoid double taxation include CSLL. (...)

Please note that our reference to the Withholding Income Tax ("WHT") in the next paragraphs does not describe the entire tax burden imposed on certain income streams, such as royalties, for example. Other taxes may be imposed on cross-border royalty payments (such as the Special Tax on Royalties ("CIDE"), the Municipal Tax on Services ("ISS") and the Tax on Foreign Exchange Transactions ("IOF-FX")), but because these taxes do not qualify as "income taxes", they are outside of the scope of the Treaty.

It is also important to highlight that although Spain is one of our Treaty partners, the country is mentioned in our list of favorable fiscal regimes ("graylist"). Specifically, Brazilian authorities consider that the Spanish regime applicable to legal entities incorporated as Entidades de Tenencia de Valores Extranjeros ("ETVE") is a graylisted regime.1

Since the publication of Executive Declaratory Act RFB 22, on December 02, 2010, the Federal Revenue Secretariat of Brazil ("RFB") has suspended Spain from the graylist, but the suspension may be terminated at any moment, either to reinstate the regime (which is what happened to the Netherlands on December 2015) or to remove it definitively (which is what happened to Luxembourg in 2011 and Hungary in 2014). In this post, we will address the interplay between the terms of the Treaty and the potential future qualification of the Spanish beneficiary as a graylisted company.

The Treaty was generally based on the OECD Draft Convention available at the time (1963), as well as on Brazilian tax treaty practice prior to 2000. Key aspects of this Treaty from a Brazilian perspective are:

Source taxation Dividends, interest and royalties earned are generally subject to WHT in Brazil and to a WHT credit in Spain and vice-versa. Specifically:

For dividends received by a beneficial owner resident in Brazil, the maximum WHT is 15%. For the recipient, the dividends will be subject to a regular tax credit (i.e., a tax credit for the WHT actually imposed) if the payor is an ETVE.2 Otherwise, the dividends will be subject to an exemption from IRPJ and CSLL.3 For dividends received by a beneficial owner resident in Spain, the maximum WHT is generally set at 15%. If, however, the person receiving the dividends is a Spanish legal entity that owns at least 25% of the voting stock of the Brazilian payor, the WHT is reduced to 10%.4

Under current Brazilian Law, dividends paid to Brazilian or foreign recipients are exempt from WHT.5

For interest received by a beneficial owner resident in a Contracting State, the maximum WHT is generally set at 15%. If, however, the recipient is a bank and if the loan is granted for a minimum term of 10 (ten) years, related with the purchase of assets and equipment, the maximum WHT drops to 10%. A tax sparing credit may be available for the Spanish recipient as well as for the Brazilian recipient of interest (see below). In Brazil, the tax sparing credit may be used to offset applicable IRPJ and CSLL.

For interest received in the following situations, an exemption or non-imposition of WHT may be available:

(1) Interest arising in a Contracting State and paid to the Government of the other Contracting State, including its political subdivision or local authority, or to any of its branches (even a financial institution), or to a political subdivision thereof, is exempt from WHT in the first Contracting State.

(2) Interest from obligations, bonds or debentures issued by the Government of a Contracting State or by any of its branches (even a financial institution), shall only be taxed in this Contracting State.

Under current Brazilian Law, interest paid to foreign recipients is subject to a WHT of 15%.6

For royalties derived from trademark use, the maximum WHT rate is 15%. In all other cases (including payments for technical services and technical assistance), the maximum WHT rate is 10%.7 A tax sparing credit may be available for the Spanish recipient as well as for the Brazilian recipient of royalties (see below). In Brazil, the tax sparing credit may be used to offset applicable IRPJ and CSLL.

Under current Brazilian Law, royalties paid to foreign recipients (including payments for technical services and technical assistance) are subject to a WHT of 15%.8

Capital gains, differently from the OECD Model Convention, are taxable in both Contracting States, and there is no WHT limitation in the Treaty. The only exception is Article 13, paragraph 2, which determines that gains obtained from alienation of ships and aircrafts are taxable only in the country where the headquarters of the company are located. Under current Brazilian Law, capital gains obtained by foreign residents (not located in a tax haven) are subject to a WHT of 15%.9 Source taxation is applicable even in case of non-resident seller and buyer - in this case, the buyer is required to withhold the corresponding amount, nominate an attorney-in-fact in Brazil and cause this attorney-in-fact to collect the WHT...