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Brazil's new treaty reflects an effort to harmonise tax legislation with OECD standards, say local lawyers Allan Fallet and Ariene Reis, who detail some of the agreement's important clauses.
Brazil and the United Kingdom have a long-standing trading relationship. Brazil-UK commerce was worth £6.5 billion (R$40.5 billion) in 2022, according to data published by the UK Department for International Trade in January 20 2023.
Brazil and the United Kingdom signed a double tax treaty (DTT) on November 29, 2022, with the goal of enhancing the flow of economic interactions and providing legal clarity for all parties involved.
TP and PE
The DTT states in Article 5(3)b that workers of an entity may qualify 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 an important partner of the OECD (and aspires to become a member), which involves significant changes in various Brazilian legislation, particularly in taxation. The DTT is Brazil's first tax treaty to implement the arm's-length principle, which means transactions subject to transfer pricing (TP) laws in the framework of Article 9 (related firms).
Article 9 of the DTT allows a contracting state entity to advocate unilateral adjustment to assess taxable profits, as long as the standards outlined in letters "a" and "b" of the article are met. The rule's phrasing also allows the other contracting state to make the appropriate adjustment to the amount of tax levied on such profits.
As a result, this provision empowers the tax treaty to resolve TP rule issues. As a result, economic double taxation of such gains is avoided - but legal double taxation is not - and it is consistent with the new Provisory Measure n. 1.152, which was announced on December 29, 2022, and incorporates revisions to the Brazilian TP regime.
Withholding taxes
Article 10 of the DTT authorises both nations to apply a withholding tax on dividends in accordance with the OECD Model Convention. 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. Article 10 of the DTT might be a tremendous ally in reducing the tax burden at a time when Brazilian tax reform is back on the agenda, particularly taxation at source due to dividend payments by Brazilian corporations (which are now tax-exempt).
Another pertinent problem is interest taxation. Article 11 of the DTT provides for a withholding tax exemption for interest paid to a beneficiary who is a pension plan or the other contracting state's government (and its subsidiaries, agencies, and authorities). There is also a lower tax rate of 7% (compared to the regular tax rate of 15%) on interest paid to financial institutions or insurance firms for at least five years on loans used to finance infrastructure projects and public utilities. Interest originating from I loans granted by financial institutions or insurance companies in general, as the parties are not related enterprises; (ii) stock exchange-listed bonds and securities; and (iii) sale on credit due to the procurement of machinery and equipment is taxed at 10%.
Royalties, remittances, and other payments
Unlike the majority of tax treaties Brazil has signed, Article 12 of the DTT establishes a 10% tax rate on all forms of royalties received, which may represent a significant reduction in the tax burden in this sector.
The taxation of remittances as compensation for technical services imported by a resident in Brazil is a frequent matter of controversy in administrative and judicial courts, even when a tax treaty is involved. This is because, when signing various treaties, Brazil expanded the scope of Article 12 of the DTT. The term "royalty" refers to the payment of royalties in exchange for the use of one's property.
To add fuel to the fire, certain Brazilian courts have used the presence of technology transfer as a condition for charging technical services as royalties, both in domestic legislation and in treaties.
To address these concerns, Article 13 of the DTT 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 notes that payments for technical services can be taxed by both jurisdictions. However, if the recipient is a resident of the other contracting state, the applicable tax rates cannot exceed I 8% during the first two years; (ii) 4% during the third and fourth years; and (iii) 0% beginning with the fourth year. Regarding those terms, the DTT is not clear if they refer to the beginning of the commercial agreement which foresees the supply of technical services or the date when the tax treaty enters force.
In terms of dividends, interests, and royalties, the protocol says that if Brazil changes its internal legislation to assign lower rates than those specified in the treaty, the contracting parties would meet to discuss revising the agreement. If Brazil adopts lower rates in any other tax treaty (excluding those with Latin American nations), these rates will immediately apply for the purposes of the DTT.
Making profits
Article 14, which deals with capital gains from movable properties and rights, states that earnings from the other contracting state may be taxed in this contracting state. However, if such gains are achieved in a third country despite being negotiated by parties from Brazil and the United Kingdom, they will be taxed exclusively in the seller's home state. These rules do not apply to gains obtained from the sale of ships and aircrafts (or other properties associated with this type of business), because the taxation rights are assigned to the entity that operates the ship/aircraft.
It is important to remember that, in accordance with Article 29 of the DTT, all of the unique benefits brought about by the provisions above apply to taxpayers from both contracting parties only where there is no allegation of abusive tax planning.
Optimistic outlook
When compared to previous treaties signed by Brazil, the new provisions reflect the Federal Revenue of Brazil and the government's determination to reform tax policy and match it with OECD norms.
Finally, while both states have signed the DTT, it is not yet in effect since legislative procedures have not been completed (there may or may not be wording changes). In Brazil, the treaty is now being considered by the Ministry of Foreign Affairs, and it still need National Congress approval and presidential ratification. Following ratification, it will be incorporated into domestic law through the issuance of a decree.
By fLEXI tEAM