AES SUL Distribuidora Gaúcha de Energia S/A is active in footwear industry. It had paid for services to related foreign companies in South Africa, Argentina, Canada, China, South Korea, Spain, France, Holland, Italy, Japan, Norway, Portugal and Turkey.
The tax authorities were of the opinion that withholding tax applied to these payments, which they considered royalty, and on that basis an assessment was issued.
Not satisfied with this assessment AES filed an appeal, which was allowed by the court of first instance.
An appeal was then filed by the tax authorities with the Superior Tribunal.
Judgement of the Superior Tribunal de Justiça
The court upheld the decision of the court of first instance and dismissed the appeal of the tax authorities.
“Therefore, the income from the rendering of services paid to residents or domiciled abroad, in the cases dealt with in the records, is not subject to the levy of withholding income tax.
The refund of amounts proved to have been unduly paid, therefore, may be requested by the plaintiff, as she would have borne such burden, according to article 166 of the CTN.”
“This Superior Court has a firm position according to which IRRF is not levied on remittances abroad arising from contracts for the provision of assistance and technical services, without transfer of technology, when there is a treaty to avoid double taxation, and the term “profit of the foreign company” must be interpreted as operating profit provided for in arts. 6, 11 and 12 of Decree-law 1.598/1977, understood as “the result of the activities, main or accessory, that constitute the object of the legal entity”, including income paid in exchange for services rendered, as demonstrated in the decisions summarized below”
“1. The case laws of this Superior Court guide that the provisions of the International Tax Treaties prevail over the legal rules of Domestic Law, due to their specificity, subject to the supremacy of the Magna Carta. Intelligence of art. 98 of the CTN. Precedents: RESP 1.161.467/RS, Reporting Justice CASTRO MEIRA, DJe 1.6.2012; RESP 1.325.709/RJ, Reporting Justice NAPOLEÃO NUNES MAIA FILHO, DJe 20.5.2014.
2. The Brazil-Spain Treaty, object of Decree 76.975/76, provides that the profits of a company of a Contracting State are only taxable in this same State, unless the company performs its activity in the other State by means of a permanent establishment located therein.
3. The term profit of the foreign company must be interpreted not as actual profit, but as operating profit, as the result of the activities, main or accessory, that constitute the object of the legal entity, including, the income paid as consideration for services rendered.”
“Article VII of the OECD Model Tax Agreement on Income and Capital used by most Western countries, including Brazil, pursuant to International Tax Treaties entered into with Belgium (Decree 72.542/73), Denmark (Decree 75.106/74) and the Principality of Luxembourg (Decree 85. 051/80), provides that the profits of a company of a contracting state are only taxable in that same state, unless the company carries on its activities in the other contracting state through a permanent establishment situated therein (branch, agency or subsidiary); moreover, the Vienna Convention provides that a party may not invoke the provisions of its domestic law to justify breach of a treaty (art. 27), in reverence for the basic principle of good faith.
7. In the case of a controlled company, endowed with its own legal personality, distinct from that of the parent company, under the terms of the International Treaties, the profits earned by it are its own profits, and thus taxed only in the Country of its domicile; the system adopted by the national tax legislation of adding them to the profits of the Brazilian parent company ends up violating the International Tax Pacts and infringing the principle of good faith in foreign relations, to which International Law does not grant relief.
8. Bearing in mind that the STF considered the caput of article 74 of MP 2158-35/2001 to be constitutional, the STF adheres to this stand and considers that the profits earned by a subsidiary headquartered in Bermuda, a country with which Brazil has no international agreement along the lines of the OECD, must be considered to have been made available to the parent company on the date of the balance sheet on which they were ascertained.
9. Art. 7, § 1 of IN/SRF 213/02 exceeded the limits imposed by the Federal Law itself (art. 25 of Law 9249/95 and 74 of MP 2158-35/01) which it was intended to regulate; in fact, upon analysis of the legislation supplementing art. 74 of MP 2158-35/01, it may be verified that the prevailing tax regime is that of art. 23 of DL 1. 598/77, which did not change at all with respect to the non-inclusion, in the computation of the taxable income, of the methods resulting from the evaluation of investments abroad by the equity accounting method, that is, of the counterparts of the adjustment of the value of the investment in controlled foreign companies.
10. Therefore, I hereby examine the appeal and partially grant it, partially granting the security order claimed, in order to affirm that the profits earned in the Countries where the controlled companies headquartered in Belgium, Denmark, and Luxembourg are established, are taxed only in their territories, in compliance with article 98 of the CTN and with the Tax Treaties (CTN). The profits ascertained by Brasamerican Limited, domiciled in Bermuda, are subject to article 74, main section of MP 2158-35/2001, and the result of the contra entry to the adjustment of the investment value by the equity accounting method is not part of them.”
“Therefore, I hereby examine the appeal and partially grant it, partially granting the security order claimed, in order to affirm that the profits earned in the Countries where the controlled companies headquartered in Belgium, Denmark, and Luxembourg are established, are taxed only in their territories, in compliance with article 98 of the CTN and with the Tax Treaties (CTN). The profits ascertained by Brasamerican Limited, domiciled in Bermuda, are subject to article 74, main section of MP 2158-35/2001, and the result of the contra entry to the adjustment of the investment value by the equity accounting method is not part of them.”
“1. The plaintiff, the defendant, hired foreign companies to render services to be performed abroad without technology transfer. In view of the provisions of article VII of the Brazil-Germany and Brazil-Canada Conventions, according to which “the profits of a company of a Contracting State are only taxable in that State, unless the company exercises its activity in another Contracting State by means of a permanent establishment situated therein”, it stopped collecting the withholding income tax.
2. Due to the non-collection, the Federal Revenue Service assessed the company under the consideration that the income sent abroad as consideration for services rendered does not fit into the concept of “profit of the foreign company”, provided for in article VII of the two Conventions, since the profit is only perfected at the end of the financial year, after the additions and deductions determined by the governing legislation.
Thus, it concluded that the income should be taxed in Brazil – which imposed on the service taker its withholding -, since it would be a matter of income not expressly mentioned in the two Conventions, under the terms of article XXI, verbis: “The income of a resident of a Contracting State from the other Contracting State and not treated in the preceding articles of this Convention shall be taxable in that other State”.
3. According to articles VII and XXI of the Brazil-Germany and Brazil-Canada Double Taxation Conventions, the income not expressly mentioned in the Convention will be taxable in the State from which it originates. However, those expressly mentioned, among them the “profits of the foreign company”, will be taxable in the State of destination, where the person receiving the income is domiciled.
4. The term “foreign company profit”, contained in article VII of the two Conventions, is not limited to “real profit”, otherwise, there would be no possible materiality on which the provision would apply, because any payment or remuneration remitted abroad is – and always will be – subject to additions and subtractions throughout the financial year.
5. Taxation of income only in the State of destination allows the necessary adjustments to be made there in order to ascertain the effectively taxable profit. If advance – and, therefore, final – withholding of tax at the paying source is accepted, as the National Treasury claims, the aforementioned adjustments will be unfeasible, ruling out the possibility of offsetting if negative taxable income is ascertained at the end of the financial year.
6. Therefore, “foreign company profits” should be interpreted not as “actual profits” but as “operating profits”, as provided for in arts. 6, 11 and 12 of Decree-law 1.598/77 as “the result of the main or secondary activities that constitute the legal entity’s object”, obviously including income paid in exchange for services rendered.
7. The supposed antinomy between the convention rule and the domestic tax law is resolved by the rule of specialty, even if the domestic rule is posterior to the international one.
8. Article 98 of the CTN must be interpreted in light of the lex specialis derrogat generalis principle, whereby there is no revocation or derogation of the domestic rule by the international rule, but only suspension of effectiveness, which only affects situations involving the subjects and the foreign elements described in the convention rule.
9. The internal rule loses its applicability in that specific case, but does not lose its existence or validity in relation to the internal normative system. A “functional revocation” occurs, in the expression coined by HELENO TORRES, which makes the internal rules relatively inapplicable to those situations provided for in the international treaty, involving certain persons, situations and specific legal relations, but does not entail the revocation, strictly speaking, of the rule for the remaining legal situations involving elements unrelated to the contracting states.
10. In this case, article VII of the Brazil-Germany and Brazil-Canada Conventions must prevail over the rule inserted in article 7 of Law 9779/99, since the international rule is special and applies exclusively to avoid double taxation between Brazil and the two other signatory countries. To the other legal relations not covered by the Conventions, the internal rule is fully and unreservedly applied, which determines the taxation by the paying source to be performed in Brazil.
11. Special Appeal not provided.
(REsp 1161467/RS, Reporting Justice CASTRO MEIRA, SECOND PANE, judged on 05/17/2012, DJe 01/06/2012)
Therefore, to accept the Appellant’s allegations that the amounts remitted by the Defendant have the legal nature of royalties would require an analysis of contractual clauses and the reexamination of factual matter, which is unfeasible in a special appeal, in light of the obstacles contained in Precedents n. 5 and n. 7 of this Court, stated as follows, respectively: “The mere interpretation of a contractual clause does not give rise to a special appeal” and “The claim of simple reexamination of evidence does not give rise to a special appeal”.”