In this article we discuss the very interesting position paper KG:040:2023:4. In the position paper the Knowledge Group international taxation, corporate income tax & profits of the Dutch tax authorities answers the question whether a notional Brazilian withholding tax can be deducted as cost for Dutch (corporate) income tax purposes?

 

Facts of the underlying case

Dutch company (BV X) provides technical services to customers in Brazil. Brazil did not levy tax over the remuneration for those services. However based on the Dutch-Brazilian Convention for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income (hereafter: the Convention) Brazil was allowed to levy (withholding) tax over said remuneration. Pursuant to Article 23, Paragraph 4 under c of the Convention (“Elimination of double taxation”), the tax paid in Brazil is deemed to amount to 20% (tax sparing credit). BV X does not want to credit this notional Brazilian withholding tax with the Dutch corporate income tax due but wants to deduct it as costs from its Dutch taxable profit.

Question

Is BV X allowed to deduct the notional Brazilian withholding tax as a cost for Dutch corporate income tax purposes?

 

Answer

No, BV X is not allowed to deduct the notional Brazilian withholding tax as a cost for Dutch corporate income tax purposes.

 

Legal context

 

Article 12 of the Convention (“Royalties”)

1   Royalties arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State.

2   However, such royalties may also be taxed in the Contracting State in which they arise and according to the laws of that State, but if the recipient is the beneficial owner of the royalties the tax so charged shall not exceed:

a) 25 per cent of the gross amount of the royalties arising from the use or the right to use trade marks;

b) 15 per cent of the gross amount of the royalties in all other cases.

3   The term “royalties” as used in this Article means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work (including cinematograph films, films or tapes for television or radio broadcasting), any patent, trade mark, design or model, plan, secret formula or process, or for the use of, or the right to use, industrial, commercial, or scientific equipment, or for information concerning industrial, commercial or scientific experience.

(…)

 

Article 23 of the Convention (“Elimination of double taxation”)

1   The Netherlands, when imposing tax on its residents, may include in the basis upon which such taxes are imposed the items of income which, according to the provisions of this Convention, may be taxed in Brazil.

2   However, where a resident of the Netherlands derives items of income which according to Article 6, Article 7, paragraph 4 of Article 10, paragraph 5 of Article 11, paragraph 4 of Article 12, paragraphs 1 and 2 of Article 13, Article 14, Article 15, Article 16 and Article 19 of this Convention may be taxed in Brazil and are included in the basis referred to in paragraph 1, the Netherlands shall, subject to the provisions concerning the mode of application, including the provisions concerning the compensation of losses, in its national regulations for the avoidance of double taxation, exempt such items from tax consistently with the above-mentioned provisions of this Convention.

3   Further, the Netherlands shall allow a deduction from the Netherlands tax so computed for the items of income which according to paragraph 2 of Article 10, paragraph 2 of Article 11, paragraph 2 of Article 12, paragraph 3 of Article 13, Article 17, paragraph 1 of Article 18 and Article 22 of this Convention may be taxed in Brazil to the extent that these items are included in the basis referred to in paragraph 1. The amount of this deduction shall be equal to the tax paid in Brazil on these items of income, but shall not exceed the amount of the reduction which would be allowed if the items of income so included were the sole items of income which are exempt from Netherlands tax under the provisions of Netherlands law for the avoidance of double taxation.

4   For the purpose of paragraph 3, the tax paid in Brazil shall be deemed to be:

a) with respect to dividends as meant in paragraph 2 of Article 10, 25 per cent of such dividends if they are paid to a company of the Netherlands holding at least 10 per cent of the voting capital of the Brazilian company, and 20 per cent in all other cases,

b) with respect to interest as meant in paragraph 2 of Article 11, 20 per cent of such interest,

c) with respect to royalties as meant in sub-paragraph b of paragraph 2 of Article 12, 25 per cent of such royalties if they are paid to a company of the Netherlands holding directly or indirectly at least 50 per cent of the voting capital of a Brazilian company provided that they are not deductible in the determination of the taxable income of the company paying the royalties, and 20 per cent in all other cases.

 

Article 5 of the Protocol to the Convention

With reference to Article 12, paragraph 3

It is understood that the provisions of paragraph 3 of Article 12 shall apply to payments of any kind received as a consideration for the rendering of technical assistance and technical services.

 

Article 38 of the Bvdb 2001 (“Cost deduction”)

At the written request of the taxpayer, Article 36 shall not apply to dividends, interest and royalties received in a year as referred to in that Article and to the tax levied thereon by developing countries.

 

From the considerations of the Dutch tax authorities

The Brazilian revenues from the services provided by BV X qualify as royalties within the meaning of Article 12, paragraph 3 of the convention in conjunction with Article 5 of the Protocol.

Pursuant to Article 12, Paragraph 2 under b of the Convention as a source state Brazil is entitled to withhold 15% withholding tax over the fees. Pursuant to Article 23, Paragraph 3 of the Convention, as the state of residence, the Netherlands must grant a credit for the tax paid in Brazil over these components of the income. Pursuant to Article 23, Paragraph 4 under c of the Convention, the tax paid in Brazil in the underlying case is deemed to amount to 20%.

Although Brazil does not actually levy any withholding tax over the income in question, under the Convention the Netherlands must grant a credit for a notional withholding tax of 20%.

BV X does not want to credit this notional Brazilian withholding tax against its corporate income  tax, but wants to take the notional Brazilian withholding tax into account as deductible costs for Dutch corporate income tax purposes. The Convention does not include this method of avoidance of double taxation. Article 38 of the Decree on the Prevention of Double Taxation 2001 (Besluit voorkoming dubbele belasting 2001) (hereafter: Bvdb 2001) does mention the possibility of a cost deduction. The Convention however does not contain any reference to the Bvdb 2001.

Article 10, Paragraph 1 under e of the Dutch corporate income tax (DCIT) Act does explicitly prohibits the deduction of tax levied abroad on the profit or components of the profit as a cost for Dutch corporate income tax purposes if an arrangement to prevent double taxation applies to such profit or such components of the profit. The latter is the case here.

However, in paragraph 3.6.2 of the Decree of the Secretary of State for Finances of April 28, 2023, State Gazette 2023/12301 (hereafter: the Decree) it has been approved that a taxpayer can also apply for a cost deduction under Article 38 of the Bvdb 2001 in cases in which a tax treaty applies. This provision disables the operation of Article 10, Paragraph 1, under e of the DCIT Act. As a result, the tax levied by a treaty country can also be deducted as costs for Dutch corporate income tax purposes.

However, According to the Dutch tax authorities the application of Article 38 Bvdb 2001 offers no solution in the underlying case. After all, for being allowed to take into account a cost deduction this provision requires that the tax was levied. However, as already noted, the tax sparing credit of 20% is not actually levied, but a notional/fictitious Brazilian withholding tax.

Therefor nor the Convention nor Article 38 of the Bvdb 2001 offers BV X the possibility to deduct the notional Brazilian withholding tax as a cost for Dutch corporate income tax purposes.

 

The full Dutch text of the position paper (in the Dutch language) with considerations can be found here.

 

Other position papers on international taxation that we already discussed earlier can be found here.

 

 

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