UK signs double tax treaty with Brazil
The UK’s double taxation agreement with Brazil is the most significant development in the trade relationship between the countries in many years.
Key development in UK-Brazil trade relationship
The United Kingdom and Brazil signed a Double Taxation Agreement (DTA) on 29 November 2022. This is the most significant step forward in the trade relationship between the countries in many years, and an important development for UK multinational groups with existing operations, or considering new investments, in Brazil. This article provides a comprehensive summary of some of the key provisions of the new DTA.
Whilst Brazil’s football team may be capturing all the headlines at present with their attacking brand of football setting the World Cup alight, this year has also been a year of progress in Brazil’s alignment with international tax standards.
Back in May we wrote an article reporting on the announcement that Brazil intends to adopt a new transfer pricing framework fully aligned with the OECD Transfer Pricing Guidelines. We suggested this might pave the way for negotiations on a DTA between the UK and Brazil. We explained why a DTA, which comprehensively addresses the double taxation risks in relation to cross-border payments for services, was key to UK headquartered groups seeing the full benefits of Brazil’s harmonisation of transfer pricing rules.
Exploratory talks to find common ground on the principles for a possible DTA started in 2017. In September 2022, HMRC published a joint declaration confirming it would visit Brasilia between 12 and 16 September 2022 to launch a first round of negotiations. It is remarkable that less than three months later the countries have been able to agree a comprehensive DTA.
Entry into force
The effective dates for specific tax purposes in Brazil and the UK are set out in Article 31 of the DTA and are dependent on the dates the DTA enters into force. The DTA will only enter into force once both countries have notified each other in writing through diplomatic channels of the completion of the procedures required by domestic law for the bringing into force of the DTA. The UK Parliamentary procedures to ratify a new DTA can usually be completed within a matter of months. In Brazil the DTA is ratified only after approval by the National Congress and this can take several years, for example the treaties with Switzerland and Singapore were approved by Congress within three and four years respectively.
So there is some uncertainty over how long it will take for the DTA to be effective.
Key provisions of the DTA
We have summarised below some of the key provisions (non-exhaustive) relevant to UK corporates investing overseas. For commentary on the impact that the DTA will have on globally-mobile employees and their employers see our GMS Flash Alert.
- Taxes covered: In the case of the UK, the DTA applies to income tax, corporation tax and capital gains tax. In the case of Brazil, the DTA applies to federal income tax (IRPJ), currently levied at 25 percent, and the social contribution on net profit (CSLL), currently levied at 9 percent. It is positive that the DTA refers explicitly to the CSLL as an in scope tax. Not every treaty concluded by Brazil makes this express reference, and this can lead to uncertainty. The DTA will also apply to any identical or substantially similar taxes to those set out above enacted by the UK or Brazil after the date of signing the DTA.
- Territorial scope: The territory of the UK is defined consistent with other UK tax treaties and includes the UK continental shelf. Brazil is defined in Article 2 as the territory of the Federative Republic of Brazil, as well as the zone adjacent to Brazil’s territorial sea where Brazil “exercises sovereign rights or jurisdiction in conformity with both international law and its national legislation for the purpose of exploring, exploiting, conserving and managing the living and non-living natural resources or for the production of energy from renewable sources”.
- Residence: The term ‘resident of a Contracting State’ is defined broadly in line with the OECD Model but with the addition of place of incorporation as one of the criterion. Specific provision is also made to include a pension scheme established in a State, as well as certain organisations who are treated as a resident of a State according to its laws (notwithstanding that all or part of its income or gains may be exempt from tax under the domestic law of that State). Dual residence for companies is addressed with the OECD Model clause, providing for the competent authorities of the UK and Brazil to determine by mutual agreement where the company is tax resident.
- Business profits: Unless a company resident in one state is carrying on a business in the other jurisdiction through a Permanent Establishment (PE), the profits of the company may only be taxed in its home state. The separate enterprise principle applies when attributing profits to a PE. Article 7(3) helpfully states that in determining the profits of a PE there shall be allowed as deductions expenses which are incurred for the purposes of the PE, including executive and general administrative expenses so incurred. However, such deductions must be in accordance with the provisions, and subject to the limitations of the tax laws, of the Contracting State concerned.
- Permanent Establishment: As expected, the PE article provides for an expanded definition of a PE by comparison to the OECD Model – most notably that a PE will be created if a UK resident is furnishing services in Brazil for a period or periods aggregating more than 183 days in any 12-month period commencing or ending in the fiscal year concerned. The same 183 days threshold also applies to a building site, a construction, assembly or installation project or connected supervisory activities. The PE article also includes an anti-fragmentation rule aligned with the OECD Model and a specific clause relating to insurance business.
- Offshore Activities : It is unsurprising, given the importance of energy and natural resources to the Brazilian economy, that the DTA includes a separate Offshore Activities article (Article 24) which extends the circumstances where a resident of the other Contracting State will be treated as having a PE in the source state as a result of activities in connection with the exploration, exploitation or extraction of the seabed and subsoil and their natural resources. The 30 day threshold for the deemed PE rule under Article 24 is very restrictive.
- Associated Enterprises: The provisions apply the arm’s length principle and are based on, and largely consistent with, Article 9 of the OECD Model meaning that provision is made for compensating adjustments under the Mutual Agreement Procedure article. This is a major plus point of the DTA, especially if one considers the historical treaty negotiation position of Brazil was not to adopt paragraph 2 of Article 9. In fact, the DTA is the first Brazilian treaty to include a paragraph like Article 9(2) of the OECD Model convention, allowing for a corresponding transfer pricing adjustment and potentially avoiding economic double taxation. This novelty can be interpreted as a sign of the expected convergence of Brazilian transfer pricing rules to the ‘OECD Transfer Pricing Guidelines’, since Brazil's historic refusal to apply corresponding adjustments was based on the peculiarities of its traditional Brazilian transfer pricing rules.
There are a couple of departures from the OECD Model which are worthy of mention though. Article 9(3) provides that a Contracting State is not required to make a corresponding adjustment after the expiry of the time limits provided in its domestic law. Article 9(4) provides that there is no compensating adjustment available in the case of fraudulent or negligent conduct. The protocol to the DTA also states that a compensating adjustment will only be made in one Contracting State if the other Contracting State agrees, both in principle and in respect of the amount of the adjustment.
- Dividends: Withholding tax (WHT) on dividends is capped at 15 percent but this is reduced to 0 percent if the beneficial owner of the dividends is a pension scheme established in the other Contracting State, and 10 percent if the beneficial owner is a company which holds directly at least 10 percent of the capital of the payer throughout the year up to and including the day of payment of the dividends (subject to a carve out for dividends paid by certain investment companies out of profits derived from immovable property). It is important to note that under Brazilian domestic law dividends paid out of retained earnings and certain reserves are not subject to income WHT if related to profits generated after January 1996.
It should also be noted that in September 2021 the Brazilian Lower House approved the Brazilian Federal Government’s proposed tax reform including the reintroduction of a WHT on dividends at a 20 percent rate. Since then, the Bill of Law has been pending approval of the Senate. Although it is unclear whether this change will move forward, the DTA provides for an effective reduction of 10 percent should Brazil implement a 20 percent dividend WHT.
Brazil also recognises another category of payment known as ‘interest on net equity’ or ‘JCP’, which is tax deductible (subject to restrictions) and is subject to WHT under domestic law at 15 percent (or 25 percent when paid to certain beneficiaries located in low-tax jurisdictions). The protocol confirms that JCP is considered to be interest within the meaning in Article 11(3).
- Interest: WHT on interest is capped at 15 percent, consistent with the main Brazilian domestic WHT rate which would otherwise have applied on payments of interest to the UK. However, there are several reductions available. A reduced rate of 10 percent may apply to: (i) interest on loans granted by banks and insurance companies to independent persons; (ii) interest on bonds or securities that are regularly and substantially traded on a recognised stock exchange; and (iii) interest on certain equipment and machinery finance leases. A 7 percent WHT is available for interest paid to a bank or insurance company on a loan of at least five years for the financing of infrastructure projects and public utilities. Finally, there is a full exemption in the case of interest paid to a pension scheme or governmental body / sub-division resident in the other state.
- Royalties: WHT on royalties is capped at 10 percent - this is a positive development as the main Brazilian domestic WHT rate is 15 percent and other treaties Brazil has previously entered into with other European jurisdictions (e.g. Netherlands) have a 15 percent rate.
- Fees for technical services (FTS): the DTA contains a separate article for FTS and this provides for a tapering WHT rate on FTS of 8 percent for the first two years, reducing to 4 percent for years three and four and 0 percent thereafter. The scope of FTS is very broad and means any payment for any service of a managerial, technical or consultancy nature. This is a significant positive development as the long term position should be that no WHT applies to FTS. Indeed, the UK has been able to negotiate a more beneficial position than that found in a number of Brazil’s existing DTA’s.
This is an important change in the historic position of the Brazilian tax authorities, who have always considered that Article 7 (Business Profits) should not prevent taxation at source for services (even in the absence of a PE). This position has meant Brazil has generally kept its taxing rights over technical services. More recently, they have accepted the application of Article 7 but only in relation to those treaties where the protocol does not equate payments for technical services and technical assistance to royalties. There are, however, only a handful of Brazilian treaties where this is the case. The wording of the DTA is therefore a significant development for UK service companies with Brazilian customers, as the Brazilian tax authorities have finally agreed not to levy WHT after the period outlined above.
Another positive is that in the interim (once the DTA becomes effective in the UK) it should be possible to claim a credit for the WHT on FTS in the UK, subject to the usual restrictions in credit relief. Currently this is not possible where a Brazilian company is subject to WHT on services fees it pays for work performed in the UK, as the income is treated as UK source and is therefore not eligible for unilateral relief. However, Article 25 (Elimination of Double Taxation) paragraph 2 of the new DTA provides a mechanism for credit relief which includes the usual wording confirming that for the purposes of that paragraph, profits, income and gains owned by a resident of the UK, which may be taxed in Brazil in accordance with this Convention, shall be deemed to arise from sources in Brazil.
- Importance of arm’s length transfer pricing: Reduced rates of WHT on interest, royalties and FTS under the DTA are all broadly limited to the arm’s length amount of any payment. It will therefore be important for taxpayers to ensure that charges are supported by robust supporting transfer pricing analysis.
- Most favoured nation: If, after the date of signing the DTA, Brazil enters into a DTA with another state pursuant to which the applicable WHT rates on dividends, interest and royalties are lower (including any exemption) than those set out in the DTA, Brazil is required to notify the UK of this, and the UK and Brazil shall consult as to whether to amend the DTA. Whilst this does not create an automatic entitlement to better terms, it is still a helpful clause to have. However, the protocol provides for an automatic reduction in the WHT rate on FTS if, after the date of signature of the DTA, Brazil agrees, in a DTA with any other OECD Member State (excluding any State in Latin America), to rates that are lower (including any exemption) than the ones provided in Article 13 (2).
- Capital gains: When negotiating treaties, the Brazilian tax authorities have always deviated from the OECD Model Convention that generally provides for exclusive residence taxation for capital gains. With the sole exception of the treaty with Japan, all other treaties concluded by Brazil provided taxing rights for the source country in connection with capital gains. The DTA generally provides for residence taxation only on Article 14 (3), but Article 14 (2) allows source taxation in connection with gains from the alienation of any property or right. It remains to be seen whether shares in a Brazilian company could be considered as property or a right under Article 14 (2), in which case Brazil would have a right to tax gains on shares as well.
- Entitlement to Benefits: Entitlement to benefits under the DTA is not automatic and Article 29 (Entitlement to Benefits) ensures that only those residents of a Contracting State who satisfy one (or more) of the stated conditions are able to benefit from the DTA. Article 29 contains both Limitation on Benefits provisions and a Principal Purpose Test. UK corporates should ensure they confirm their entitlement to benefits under this Article before moving on to consider the impact of specific relieving provisions in the DTA.
- Mutual Agreement Procedure (MAP): Whilst there is a MAP Article this only requires that the competent authority ‘endeavour’ to resolve the case by mutual agreement with the competent authority of the other Contracting State. There is no provision for binding arbitration in the DTA and it remains to be seen how effectively the competent authority process will be able to resolve cases as we understand that there is very limited experience of MAP in Brazil. The case must be presented within three years from the first notification of the action resulting in taxation not in accordance with the provisions of the DTA.
- Non-discrimination: The DTA contains a ‘non-discrimination’ clause which is important with respect to the application of certain provisions of UK domestic law, for example the UK qualifying private placement exemption and the exemption from the transfer pricing rules for Small and Medium-Sized Enterprises.
- Exchange of information: Article 28 of the DTA contains the standard provisions allowing the exchange of information between tax authorities in the UK and Brazil, and the protocol states that the “Contracting States affirm their commitment to spontaneously exchange information which they consider to be of interest to the other State.”
A comprehensive DTA between the UK and Brazil has been a recurrent request from UK multinational businesses for many years so the swift agreement of a DTA is welcome news. When the DTA becomes effective, UK corporates can expect to benefit from the reduction in Brazilian WHT on royalties and fees for technical services and improved possibilities to claim credit relief in the UK for the WHT.
The DTA should help reduce tax costs and administrative barriers to trade and investment between the UK and Brazil. The date of entry into force of the DTA is uncertain due to the potential for ratification in Brazil to take several years. In the meantime, UK corporates should continue to monitor progress in the harmonisation of Brazil’s transfer pricing rules with OECD standards as this is another important aspect of improved certainty when investing in Brazil.