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 -------------- ¶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 -------------- ¶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 -------------- ¶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 -------------- ¶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 BRASILIA 00000890 002 OF 003 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. BRASILIA 00000890 003 OF 003 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