On 28 August 2020, the Dutch State Secretary of Finance issued a policy decision (the "Decision") on the treatment of the juros sobre o capital próprio (also called interest on net equity, or "IoNE"). According to the Decision, IoNE should qualify as interest for the purposes of the tax treaty between the Netherlands and Brazil (the "Treaty"). You can find the policy decision (Besluit kwalificatie Braziliaanse interest on net equity) here.
As a result, a Dutch taxpayer receiving IoNE from a Brazilian subsidiary would be entitled only to a credit of 20% (the percentage applicable to interest). However, there is solid support that IoNE should qualify as a dividend, and accordingly, a credit of 25% should be granted. IoNE is subject to withholding tax in Brazil at a rate of 15%, so in essence the question is whether Dutch taxpayers are entitled to an additional tax sparing credit of 5% or 10%.
Characteristics of IoNE
IoNE is a specific type of income under Brazilian law that was introduced in 1996 as part of a larger set of rules to support the local economy. A Brazilian company may elect to make a payment of IoNE to its shareholders, in proportion to their equity participation in the company. Like a regular dividend, IoNE is a remuneration for the capital that has been contributed by a shareholder. Under certain conditions and subject to certain limitations, a Brazilian company is allowed to deduct from its corporate income tax base the IoNE amount that is paid to the shareholder.
View of the state secretary
In the Decision, first the state secretary contends that pursuant to the Treaty, the tax treatment of IoNE in the source state is decisive for the qualification of IoNE as either dividend or interest. Thereafter, the state secretary concludes that IoNE should qualify as interest for purposes of the Treaty, because IoNE is treated as interest for Brazilian tax purposes.
In our view, this reasoning is based on shallow grounds and, therefore, taxpayers who challenge the position of the state secretary before a Dutch tax court have a good chance of prevailing for a number of reasons.
1. Priority rule
First of all, based on the priority rule, IoNE cannot be qualified as interest because it already qualifies as dividend within the meaning of the treaty. The priority rule is laid down in paragraph 19 of the OECD Commentary of 1992, and provides that the term interest as used in article 11 (interest article) does not include items of income which are dealt with under article 10 (dividend article).
Although Brazil is not a member state of the OECD, the OECD Commentary should still be considered an important source for the interpretation of the Treaty by the Netherlands. This is because the relevant Treaty definitions of dividend and interest closely follow the text of the OECD Model Tax Convention 1963. In addition, Brazil has determined its position on the OECD Model Tax Convention and its Commentaries. Accordingly, for purposes of treaty interpretation, the position of Brazil should be equal to OECD member states.
Since the Treaty was concluded in 1990, the question arises whether a subsequent change in the OECD Commentary can be of relevance for the interpretation of the Treaty by the Netherlands. Both the Dutch State Secretary of Finance and the Dutch Supreme Court are of the opinion that amendments in the OECD Commentary that are aimed to clarify earlier treaties or OECD Commentary, are applicable to treaties that were concluded at an earlier date. As the priority rule clarifies the earlier OECD Commentary, this later commentary should be considered applicable to the Treaty.
2. Income from shares
The Treaty defines the term dividend as 'income from shares …'. The term 'shares' is not defined in the Treaty. Pursuant to article 3, paragraph 2 of the Treaty, terms not defined in the treaty shall have the meaning which it has under the law of the state applying the Treaty, i.e., the Netherlands. It is clear that under Dutch law IoNE qualifies as income from shares. In fact, the state secretary confirms this in the Decision. This is also in line with the interpretation of tax treaties sanctioned by the Dutch Supreme Court.
3. Interest definition
The Treaty definition of the term 'interest' is derived from the 1963 OECD Draft Double Taxation Convention on Income and Capital and includes 'other income assimilated to income from money lent by the taxation law of the Contracting State in which the income arises' as a residual category. According to the Decision, IoNE falls within this residual category because for Brazilian tax purposes, an IoNE payment is deductible by the payer and taxable in the hands of the receiver. However, it can be argued that although IoNE is subjected to the same taxation treatment as interest in Brazil, this does not necessarily mean that it is also assimilated to income from money lent. In addition, by referring to 'income', article 11 only considers the position of the shareholder receiving IoNE. The position of the subsidiary making the IoNE payment, and whether or not the IoNE payment is deductible for Brazilian tax purposes, is therefore not relevant at all.
The Decision contains the state secretary's view with regard to how the law should be applied in certain situations. As such, policy decisions are binding upon the Dutch Revenue Service, but not binding upon taxpayers. Taxpayers are not precluded from taking a different position in their tax return.
Dutch taxpayers qualifying IoNE as dividend and applying a credit of 25% in their corporate income tax return, may expect to be contested by tax inspectors. However, if contested, a Dutch tax court may very well hold that the Treaty should be interpreted differently from the state secretary's position taken in the Decision, in which case the judgment of the tax court will prevail. As set out above, the position of the state secretary lacks a solid reasoning.
Dutch taxpayers can perhaps draw hope from a decision by the German Federal Tax Court of 22 June 2010, in which the court ruled that IoNE has to be treated as a dividend for purposes of the 1975 German-Brazil tax treaty, which contained the same definitions of dividend and interest as the definition of such terms in the Treaty.