BRAZIL'S CONTINUED RESISTANCE TO OECD GUIDELINES STALLS BTT

UNCLAS SECTION 01 OF 03 BRASILIA 000890

SENSITIVE
SIPDIS

STATE FOR WHA/BSC, WHA/EPSC, EEB/OMA MERRIN, EEB/ODF SIEMER
TREASURY FOR LUYEN TRAN MICHAEL MUNDACA
COMMERCE FOR ANNE DRISCOLL

E.O. 12958: N/A
TAGS: EFIN ECON EINV BR
SUBJECT: BRAZIL'S CONTINUED RESISTANCE TO OECD GUIDELINES STALLS BTT
NEGOTIATIONS

REFS: A) BRASILIA 809 B) BRASILIA 828


1. (SBU) Summary: Tax treaty negotiators from the U.S. Treasury and
Brazil's revenue collection agency, Receita Federal (Receita),met
via DVC on July 10 to assess the potential for renewed progress on a
bilateral tax treaty (BTT),and to develop a consensus message to
present to the CEO Forum in anticipation of the Forum's July 20-21
meeting. Brazilian negotiators concluded that tax treaty
negotiations would be difficult until the Brazilian Congress has
taken action on the Tax Information Exchange Agreement (TIEA),a
necessary internal political step for Brazil to advance in the
treaty process, but as was reminded by Ambassador Sobel, not a
requirement from the U.S. side. Furthermore, Brazil's resistance to
acceptable positions on taxation of services, transfer pricing,
dispute resolution and arbitration, and tax sparing continue to pose
significant challenges in the near-term. Coincidentally, the head
of Receita, Lina Vieira, was fired on July 10. Her dismissal, which
according to the press was due to internal struggles within an
environment of falling tax revenues, will likely not impact BTT
negotiations in the near-term. End Summary.

BACKGROUND
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2. (SBU) The DVC occurred as a result of Casa Civil Minister Dilma
Rousseff and Finance Deputy Minister Nelson Machado's agreement -
during Deputy National Security Advisor Froman's June visit to
Brasilia - that tax treaty negotiators would meet before the CEO
Forum, to assess what progress is possible and the viability of
continued negotiations in the near term (reftel A). Acting
Assistant Secretary for Tax Policy Michael Mundaca led the U.S.
Treasury negotiation team and Coordinator General for International
Coordination Marcos Valadao led the team from Receita.

RECEITA FEARS REDUCED TAX COLLECTIONS
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3. (SBU) Valadao emphasized that Brazil's primary concern with a
BTT is the potential drop in tax collections that could result upon
treaty implementation, a point he has vocalized in the past (reftel
B). In order to help project the potential impact on Receita's
collections, Valadao requested U.S. Treasury data on flows of income
between the United States and Brazil. (Note:On July 13, U.S.
Treasury provided Receita with this data.)

BRAZIL POSSIBLY WILLING TO DISCUSS SOME TREATY REDUCTIONS IN
WITHHOLDING RATES
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4. (SBU) Mundaca summarized United States preferred treaty policy
regarding withholding taxes on cross-border payments of interest,
royalties, and dividends. Receita did not directly voice objection
to the preferred rates but did point out that rate reductions would
be difficult given Brazil's current fiscal environment. Receita
also pointed out that the United States and Brazil differ
substantially on the treatment of income from services. Valadao
noted that Brazil, unlike the United States, does not require the
existence of a permanent establishment when levying taxes on income
from services performed. Moreover, the tax imposed by Brazil on
service providers is a gross basis tax that is withheld by the
payor. Ambassador Sobel noted that Brazil's taxation of income from
services is out of step with the OECD approach. Valadao said that
it would be difficult for Brazil to move away from a payor rule but
that there might be flexibility on reducing the income tax rate
itself.

SIGNIFICANT HURDLES REMAIN
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5. (SBU) Negotiators determined that the following issues would
continue to prevent BTT progress in the near-term:

Information Exchange: Unlike the United States where TIEAs are
executive agreements, Brazil's compliance to information exchange is
dependent on congressional approval. Valadao commented on the
current TIEA legislation before the Brazilian Congress, saying its
passage was a critical requirement for the resumption of active BTT
negotiations. Ambassador Sobel clarified that a signed TIEA is not
needed for the United States to move forward with BTT negotiations.

Tax Sparing: Brazil maintained its position of requiring tax sparing
as part of a BTT. Valadao volunteered that Brazil could be flexible
if the United States showed flexibility on the issue. When Mundaca

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explained the U.S. Senate's firm opposition to tax sparing and
investment credit clauses, Valadao asked for the consideration of a
creative solution on the issue. When prompted, Valadao did not
propose a specific suggestion, but said he would give it more
thought. Ambassador Sobel added that he knew a number of Brazilian
senators who - in the case that all other BTT items reached
consensus - would not allow the tax sparing issue to become a deal
breaker.

Dispute Resolution and Arbitration: Mundaca summarized that previous
negotiations had revealed that Brazil does not have sufficient
flexibility within its legal system to carryout dispute resolutions,
adding that a robust dispute resolution framework would be required
in a BTT for anticipated cases of double taxation and transfer
pricing issues. Valadao suggested that Brazil could possibly create
a work-around mechanism to allow for treaty-related dispute
resolution to trump local tax law, but that this would require a
change in Brazil's tax laws. Prospects for such a change, however,
are unlikely. Valadao added that due to domestic law constraints,
there would be no way to include arbitration provisions in a BTT,
and that disputes over transfer pricing would be especially
difficult to resolve.

Transfer Pricing: Receita indicated it would not consider a
departure from statutory profit margin requirements with respect to
transfer pricing because Receita has no authority under domestic law
to deviate from these statutory requirements. The United States
continues to seek a strong arm's-length standard for transfer
pricing along the lines of the policies developed by the OECD.

BRAZIL'S BLACKLIST TAX HAVEN LEGISLATION
--------------


6. (SBU) In response to a U.S. Treasury question on Brazilian
legislation, passed January 1, 2009, broadening Brazil's definition
of tax havens to possibly include certain U.S. states, Valadao
explained that the legislation remains ineffective due to the
absence of a normative instruction attached to the law. He did not
offer any additional guidance as to when or if such normative
instruction would be introduced to make the legislation enforceable.


CONSENSUS MESSAGE TO THE CEO FORUM
--------------


7. (SBU) U.S. Treasury and Receita discussed a consensus message to
deliver to the July 20-21 CEO Forum regarding future BTT negotiation
progress. Negotiators are currently trading draft statements that
will address the importance to Brazil of the Brazilian Congress's
passage of the TIEA. The message will also indicate that progress
on issues such as taxation of income from services, transfer
pricing, dispute resolution and arbitration, and tax sparing would
not be possible in the short term.

RECEITA'S TOP OFFICIAL FIRED
--------------


8. (SBU) Coincidentally, the head of Receita, Lina Vieira, was
fired on July 10. According to the press, her dismissal was due to
internal struggles within an environment of falling tax revenues.
Press reports have also named Finance Deputy Minister Nelson Machado
as a possible replacement. A contact from within the Ministry of
External Relation's (MRE) financial and tax cooperation group told
econoff that domestic tax collection issues would most likely be the
focus of the new leadership, and external issues like the BTT would
probably not receive different attention under a new management.
That said, Valadao was named the lead tax treaty negotiator when
Vieira assumed her duties approximately one year ago, and the MRE
contact admitted that a larger leadership shuffle was possible.

COMMENT
--------------


9. (SBU) Comment: The Brazilian negotiators suggested tying the
future of BTT discussions to the Brazilian Congress passage of the
TIEA. However, an issue by issue analysis of the core BTT points
indicates that Brazil's continued inability to accept fair and OECD
compliant positions leaves the negotiation process essentially
unchanged from when talks resumed three years ago. If Receita
requires passage of the TIEA before negotiations resume, the CEO
Forum, the broader U.S.-Brazilian business community and other BTT
proponents will have to lobby the Brazilian Congress for passage of
the TIEA, a process that could take an indefinite amount of time.

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It should be kept in mind that the linking of the TIEA to the BTT is
being made by Receita Federal, not by the United States. Were
progress on the substantive BTT issues possible, the U.S. Treasury
would be willing to resume discussions before approval of the TIEA.
Unfortunately, however, the July 10 DVC revealed that until Brazil
adopts positions more in conformity with OECD guidelines on core BTT
issues such as taxation of services, transfer pricing, dispute
resolution and arbitration, and tax sparing, progress remains
difficult if not impossible. End Comment.


10. (U) This cable was cleared by U.S. Treasury Acting Assistant
Secretary for Tax Policy Michael Mundaca's office.

SOBEL