approach with the Article 7 of the OECD model double taxation convention

Rafael Fiuza Casses*

This article intends to expose the particular approach issued by Brazilian Revenue Service with the Article 7 of the OECD double taxation convention model, which carries important consequences to foreign companies that keep services contracts and earns payments for these services from brazilian enterprises, in order to advise in general about those consequences.

The mentioned article 7 uses the concept of ‘profits’ and establishes that the profits of an enterprise of a contracting State shall be taxable only in that State, unless the enterprise carries on business in the other contracting State through a permanent establishment situated therein.

The question is the brazilians authorities interpret the article 7 according the internal legislation which considers ‘profit’ a different concept from individual incomes, like the payment that arises from a service contract.

In Brazil the internal legislation consider ‘profits’ just the mathematic result from all kind of income minus the costs or financial losses in certain period, usually an year. So they apply that concept to justify the taxation over the service contracts by the rate of 25% while if the same income was considered inside the concept of ‘profit’ present in the OECD model there would be not taxation in Brazil.

The fact is: the concept of ‘profit’ used by the OECD model is larger than the meaning accepted by the Brazilian Revenue Service. To the OECD model the concept of ‘profit’ is income in general and not the same concept that exists for one or other country, in case for Brazil.

The idea built above is confirmed by the excerpt extracted from the Revised Commentary on article 7 of The OECD model tax convention, as follows:

“This paragraph is concerned with two questions. First, it restates the generally accepted principle of double taxation conventions that an enterprise of one State shall not be taxed in the other State unless it carries on business in that other State through a permanent establishment situated therein.” (Revised Commentary on Article 7 of The OECD Model Tax Convention. 10 april 2007, page 5)

Therefore, the article 7 does not intend to attend the various ‘profit’ concepts existents around the world in the member countries internal legislation but to realize a general principle of the double taxation wich is no enterprise can be taxed in other country, and the meaning behind the principle deals with the idea that the enterprise can not be taxed by any tax. Important to note that the rule create just one exception what is when the enterprise has a permanent establishment situated on the other country.

The conclusion is that despite the article 7 to grant the non taxation for the enterprises that do not have a permanent establishment on the other country, the Brazilian Revenue Service do not apply this rule for incomes generated by services contracts under the argument of the internal legislation and the principal consequence is the taxation by the income tax which can achieve the rate of 25% with no deductions depending on the case.

Considering the high income tax rate that the service contract will be involved in some situations, the best tax planning is create a permanent establishment in Brazil when the income will be taxed by lower rates and deductions will be allowed.

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*Rafael Fiuza Casses is lawyer, tax specialist associated to Junqueira de Carvalho, Murgel & Brito Law Firm.