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In light of this Private Letter Ruling, investors may want to reevaluate their foreign investment structures into Brazil, taking into consideration their global footprint and the potential availability of tax treaty benefits.

In Private Letter Ruling (Solução de Consulta) No. 150 (dated September 22), the Brazilian tax authority (RFB) confirmed that the capital gain generated by a Portuguese resident company on the sale of its equity interest in a Brazilian company is subject to nonresident capital gains tax at the 15% rate by applying the "most-favored-nation clause" of the Brazil-Portugal double tax treaty.

Background

Under Brazilian domestic law, capital gains realized by nonresidents on the sale of assets located in Brazil (including Brazilian shares/quotas) are generally subject to nonresident capital gains tax at progressive rates ranging from 15% to 22.5%, depending on how much gain is realized.

Private Letter Ruling No. 150

In the present case, a Portuguese resident company sold its equity interest in a Brazilian company, triggering capital gains tax. As Brazil has a tax treaty with Portugal, the RFB considered whether relief was available to reduce the capital gains tax.

Initially, the RFB determined that, by applying the domestic law and Art. 13(4) of the Brazil-Portugal tax treaty (which allows gains to be taxed in both States), the transaction should be subject to nonresident capital gains withholding tax at the progressive rates under the domestic law. However, the RFB went on to consider Item 6 of the Protocol to the Brazil-Portugal tax treaty. Under Item 6, if Brazil concludes a treaty with another jurisdiction (not in Latin America) after concluding the treaty with Portugal and that treaty limits the power to tax, that limitation generally should apply to the Brazil-Portugal treaty (this clause is commonly known as the "most-favored nation clause").

Article 13(3) of the Brazil-Israel tax treaty — a treaty concluded after the Brazil-Portugal treaty - establishes that capital gains derived by a resident of a Contracting State from the transfer of shares in a company of the other Contracting State may be taxed in that other State. The other Contracting State, however, may only tax the capital gains if the resident of the first Contracting State directly or indirectly owned shares giving at least 10% of the voting rights in that company to the resident at any time during the 12 months preceding the transfer. In those cases, the tax imposed may not exceed 15% of the gross capital gains.

As the conditions of Item 6 of the Brazil-Portugal treaty were met, the RFB concluded that the limitation in the Brazil-Israel treaty automatically applied to the transaction with the Portuguese investor. As such, the 15% capital gains tax rate applied in the present case, rather than the progressive rates established under domestic law.

Although not applicable to the present case, the RFB noted that Item 9 of the protocol to the Brazil-Portugal tax treaty restricts the application of the benefits under the treaty. Item 9 states that the potential benefits of the tax treaty should not apply to persons benefiting from certain tax regimes (e.g., Free Trade Zone of Madeira Island and the Santa Maria Island Free Trade Zone in Portugal).

While a Private Letter Ruling does not represent law or legal precedent, it does provide further support and guidance for Brazilian entities about how the RFB is treating arrangements under consideration.

Implications

In light of the proposed Brazilian tax reform, which would reintroduce dividend withholding taxes, the importance of properly structuring foreign investment into Brazil will likely increase. This decision demonstrates yet another reason for foreign investors to reevaluate their current holding structures, especially taking into consideration their global structures. Foreign investors may also wish to consider the availability of tax treaty relief for transactions involving Brazil.

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