Riggs National Corporation & Subsidiaries (f.k.a. Riggs National Bank and Subsidiaries) v. Commissioner

107 T.C. No. 18
UNITED STATES TAX COURT
RIGGS NATIONAL CORPORATION & SUBSIDIARIES,
(f.k.a. RIGGS NATIONAL BANK AND SUBSIDIARIES), Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 24368-89. December 10, 1996.
P regularly made and participated in loans to
borrowers located in foreign countries, including Brazil.
It was one of hundreds of banks that were involved in the
restructuring of Brazil's foreign debt.
As required by Brazilian law, various non-tax-immune
Brazilian borrowers paid Brazilian withholding tax on
their net loan interest remittances to P during 1980
through 1986. Although the Brazilian Supreme Court had
held that, under Article 19 of the Brazilian
Constitution, tax-immune Brazilian governmental entities,
like the Central Bank, were not liable to pay withholding
tax on their net loan interest remittances to foreign
lenders, beginning in 1984, the Central Bank purportedly
paid withholding tax on its Brazilian restructuring debt
interest remittances to P.
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On its income tax returns for 1980 through 1986, P
claimed a foreign tax credit under sec. 901, I.R.C., for
the purported withholding tax payments made by the
Central Bank and other Brazilian borrowers on their net
loan interest remittances to P.
1. Held: The withholding tax paid by non-tax-
immune Brazilian borrowers is potentially creditable to
P but must be reduced, under sec. 4.901-2(f)(3)(ii),
Temporary Income Tax Regs., 45 Fed. Reg. 75653 (Nov. 17,
1980), and sec. 1.901-2(e)(3)(ii), Income Tax Regs., by
the pecuniary benefit the borrowers received from the
Brazilian Government. Nissho Iwai Am. Corp. v.
Commissioner, 89 T.C. 765 (1987); Norwest Corp. v.
Commissioner, T.C. Memo. 1992-282, affd. 69 F.3d 1404
(8th Cir. 1995); Continental Ill. Corp. v. Commissioner,
T.C. Memo. 1988-318, affd. without published opinion sub
nom. Citizens & S. Corp. & Subs. v. Commissioner, 919
F.2d 1492 (11th Cir. 1990), affd. in part and revd. in
part 998 F.2d 513 (7th Cir. 1993), followed.
2. Held, further: P is not legally liable for
Brazilian tax on the Brazilian restructuring debt
interest remittances it received from the Central Bank.
Under Brazilian law, P was not required to pay Brazilian
tax, and neither it nor the Central Bank had a legal
liability to pay the withholding tax. The purported
Central Bank withholding tax payments are not creditable
to P because these purported payments were noncompulsory
amounts and not a tax to Brazil. Sec. 1.901-2(e)(1),
(5), Income Tax Regs.
Joel V. Williamson, Thomas C. Durham, Scott M. Stewart,
Richard M. Timmel, Patricia Anne Flaming, and Kim Marie Boylan, for
petitioner.
Theodore J. Kletnick, William G. Merkle, Diane P. Thaler, Paul
S. Manning, Rajiv Madan, Mary Ann Amodeo, and Janice E. Lamartine,
for respondent.
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JACOBS, Judge: Respondent determined deficiencies in the
Federal income tax of petitioner Riggs National Corporation &
Subsidiaries, formerly known as Riggs National Bank and
Subsidiaries.
The dispute involves petitioner's entitlement to foreign tax
credit under section 9011 for Brazilian taxes withheld on interest
income petitioner received, during the years 1980 through 1986, as
a result of its loans to Brazilian borrowers. The primary issues
for decision are as follows: (1) Whether petitioner is legally
liable for the Brazilian withholding tax purportedly paid by its
Brazilian borrowers on their net loan interest remittances to
petitioner (the legal liability issue); (2) whether the alleged
withholding tax paid by the Banco do Central Brazil (Central Bank)
on its Brazilian restructuring debt interest remittances to
petitioner is a noncompulsory amount and thus not a tax to Brazil
(the Central Bank issue); and (3) whether a subsidy, equal to a
percentage of the tax withheld, that borrowers received from the
Brazilian Government during the period from January 1, 1980,
through June 28, 1985, reduces the amount of foreign tax credit
allowable to petitioner (the subsidy/pecuniary benefit issue).
To a major extent, the legal liability and subsidy/pecuniary
benefit issues have been previously dealt with in Norwest Corp. v.
1
Unless otherwise indicated, all statutory references
are to the Internal Revenue Code in effect for the years in
issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
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Commissioner, T.C. Memo. 1992-282, affd. 69 F.3d 1404 (8th Cir.
1995); First Chicago Corp. v. Commissioner, T.C. Memo. 1991-44;
Continental Ill. Corp. v. Commissioner, T.C. Memo. 1988-318, affd.
without published opinion sub nom. Citizens & S. Corp. & Subs. v.
Commissioner, 919 F.2d 1492 (11th Cir. 1990), affd. in part and
revd. in part 998 F.2d 513 (7th Cir. 1993) and Nissho Iwai Am.
Corp. v. Commissioner, 89 T.C. 765 (1987). However, none of those
cases involved withholding tax paid by a tax-immune Brazilian
governmental entity/borrower, like the Central Bank here, on its
Brazilian restructuring debt interest remittances.
FINDINGS OF FACT
Some of the facts have been stipulated and are found
accordingly. The parties have further stipulated in evidence
portions of the trial transcripts in the Continental Illinois and
Nissho Iwai cases and various exhibits related to the testimony of
certain witnesses in those cases.
A. Background
Petitioner's principal place of business was in Washington,
D.C., at the time the petition was filed.
Riggs National Corporation is the parent company of a group of
corporations which filed consolidated income tax returns for the
years in issue. Its wholly owned subsidiary Riggs National Bank
regularly made and participated in loans to borrowers located in
foreign countries, including Brazil.
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B. Foreign Loans and the Brazilian Economy in General
In 1974, Brazil incurred a trade deficit of $4.7 billion as a
result of higher prices charged for oil due to the energy crisis.
At that time, a trade deficit of this size was large for Brazil.
After 1974, Brazil greatly increased its reliance on foreign debt.
Its foreign debt increased dramatically from 1974 to 1983, and the
ratio of Brazil's total foreign debt to its foreign currency
reserves grew larger. The Brazilian Government sought to reduce
Brazil's trade deficit by decreasing imports, increasing exports,
and encouraging foreign borrowing for internal domestic
development. It hoped to increase the country's productive
capacity by stimulating greater investment in steel, oil, pulp and
paper, aluminum, petrochemical products, fertilizers, capital
goods, and other capital items.
Brazil's currency, the cruzeiro, was not convertible to
foreign currency in international markets. Although the cruzeiro
was freely tradeable, as a practical matter, foreign parties
outside of Brazil would not accept payment in cruzeiros.
Brazil needed to maintain adequate foreign currency reserves
to engage in international trade to finance its trade deficit.
During 1974 through 1975, the Brazilian Government sought to
maintain a foreign currency reserve of about $6 billion for this
purpose.
During 1974, Brazilian borrowers generally were reluctant to
take out foreign loans because the Central Bank required a minimum
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term for foreign loans which varied from 5 to 12 years. Although
the Brazilian Government sought to decrease the effects of
inflation through an indexing system, in taking out a long-term
foreign loan, a Brazilian borrower incurred a substantial risk that
a decline in the exchange rate for the cruzeiro as a result of
domestic inflation could increase the cost of the loan.
To increase foreign borrowing, the Brazilian Government
provided incentives to Brazilian borrowers in order to overcome
their reluctance to take out foreign loans. These incentives
included the pecuniary benefit, the Resolution 63 loan program, and
the Resolution 432 loan program, all of which are more fully
discussed infra.
Until about 1982, lending to Brazilian borrowers was quite
profitable for many foreign lenders, including some major U.S.
banks. The interest rate spreads (i.e., the interest rate charged
on a loan, less the cost of the loan funds to the lender) on
Brazilian loans were higher than the interest rate spreads on loans
made in many other countries. In addition, the ability to claim
foreign tax credits significantly enhanced the after-tax income
some foreign lenders derived with respect to their Brazilian loans.
C. Brazilian Regulation of Foreign Lending
Brazil imposes restrictions on the receipt and exchange of
foreign currency. By law, all loans from foreign lenders to
Brazilian borrowers must be registered with and approved by the
Central Bank. Through the registration process, the Central Bank
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sets the range of acceptable interest rates and periodically
establishes the minimum repayment terms of loans. Once the Central
Bank approved a loan, the lender remitted the proceeds in foreign
currency to the borrower via a commercial bank in Brazil. The
Brazilian bank converted the foreign currency into Brazilian
currency by means of an exchange contract, whereby the borrower
sold the foreign currency to the bank for Brazilian currency at the
official exchange rate periodically set by the Central Bank.
The Brazilian borrower received a Certificate of Registration
that enabled the borrower to effect payment of interest and
principal in the foreign currency in which the loan was made. On
each payment date, the borrower purchased foreign currency from a
Brazilian bank at the official exchange rate. The Brazilian bank
then tendered the foreign currency to the foreign lender.
D. Payment of the Withholding Tax Generally
Where withholding tax is required, Brazilian law prohibited
remittance of an interest payment to a foreign lender without proof
of payment of the withholding tax on interest remitted abroad.
Under Brazilian law, the borrower initiated payment of the
withholding tax by submitting a Documento de Arrecadacao de
Receitas Federais (DARF) and the accompanying tax payment to a
commercial Brazilian bank. Any bank making an interest payment in
foreign currency which was subject to Brazilian tax would require
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a completed DARF and payment of the tax as evidence that the proper
amount of the tax had been paid.2
E. Net Loans and Gross Loans
In making loans to borrowers in Brazil and other countries, it
was an accepted and common practice among foreign lenders to
require that interest payments be made to them on a "net quoted"
basis. A net loan is a loan in which the lender and the borrower
have agreed that all specified payments of principal and interest
to the lender, under the loan contract, will be made net of any
applicable Brazilian taxes.
Under Brazilian law, when the Brazilian borrower under a net
loan assumes the burden of the withholding tax, the amount of
interest remitted is considered net of tax and an adjustment known
as a "gross-up" is required to be made for purposes of computing
the withholding tax. This gross-up adjustment would be computed as
follows:
Grossed-up interest = Net interest
1 - Withholding tax rate
2
The borrower prepared the DARF and delivered a copy of
it and the registration certificate to the Brazilian bank
handling the payment of interest through a foreign exchange
contract. The bank recorded the amount of interest and tax on
the Certificate of Registration and submitted the certificate,
exchange contract, and DARF to the Central Bank for approval.
Upon approval by the Central Bank, the bank remitted the interest
to the foreign lender and returned to the borrower a stamped copy
of the DARF, the Certificate of Registration (stamped), and a
copy of the exchange contract. The borrower sent a copy of the
DARF to the foreign lender which then had proof (the DARF) that
the withholding tax was paid. The lender performed no act in
Brazil for the collection of tax.
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In contrast to a net loan, a gross loan is a loan in which
there is no contractual agreement between the borrower and foreign
lender to pay taxes imposed by the borrower's country. With a
gross loan, the Brazilian borrower will deduct withholding taxes
that are due from the interest specified under the loan contract
and will pay the lender the gross interest net of taxes.
From 1970 through 1986, net loans generally were the
predominant type of loan extended by foreign lenders to borrowers
in Brazil. With a net loan, the foreign lender shifts the risk of
any increase in taxes imposed by the borrower's country to the
borrower. Correspondingly, in a net loan, the borrower, not the
foreign lender, will benefit from any reduction in or waiver of
taxes imposed by the borrower's country.
F. Institution of the Subsidy/Pecuniary Benefit
Under Decree-law 1,215, enacted May 4, 1972, the Brazilian
Minister of Finance was given discretion to grant a reimbursement
or reduction of, or exemption from, the withholding tax on interest
provided: (1) The borrower's costs were reduced; (2) the loan was
of national interest, (3) the loan met the minimum repayment term
set by the National Monetary Council;3 and (4) the loan complied
with other conditions set forth by the Ministry of Finance.
3
The National Monetary Council is a Government agency
responsible for economic programs. Its members include the
Finance Minister, the Central Bank's President, and
representatives of the largest Brazilian commercial banks. The
Finance Minister presides over the council's meetings. The
council acts through the Central Bank.
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Decree-law 1,351, which was enacted on October 24, 1974,
authorized the National Monetary Council to temporarily reduce the
income tax on interest, commissions, and expenses remitted to
persons residing or domiciled abroad. On the same date that
Decree-law 1,351 was enacted (October 24, 1974), the Central Bank
issued Resolution 305, which temporarily reduced the tax on
interest, commissions, and expenses received on currency loans
registered with the Central Bank from 25 percent to 5 percent.
Decree-law 1,411, enacted July 31, 1975, amended Decree-law
1,351 and allowed the National Monetary Council to: (1) Reduce the
income tax on interest, commissions, and expenses remitted to
persons resident or domiciled abroad, or (2) grant pecuniary
benefits to Brazilian borrowers receiving loans in foreign
currency.
On August 5, 1975, the Central Bank issued Resolution 334,
which revoked Resolution 305, thereby reinstating the 25-percent
withholding tax on interest, commissions, and expenses paid on
currency loans registered with the Central Bank.
G. Mechanics and Amount of the Subsidy/Pecuniary Benefit
On the same day that the 25-percent tax on interest was
reinstated (i.e., August 5, 1975), the Central Bank issued
Resolution 335, which provided that borrowers taking out foreign
loans duly registered with the Central Bank would receive a
pecuniary benefit equal to 85 percent of the tax paid on interest,
commissions, and expenses due on such loans.
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Also on August 5, 1975, the Central Bank issued Circular 266,
which provided in part:
a. a DARF would be used for the payment of the 25-
percent income tax on interest resulting from foreign
currency loans;
b. on the date of payment, the banking establishment
receiving the payment would, by means of a credit to the
borrower's account, pay the borrower the equivalent of 85
percent of the income tax; and
c. the banking establishment receiving the tax payment
would debit its own account entitled "Pecuniary Benefit-
D.L. 1,411," and would charge the total value of the
pecuniary benefit against the Central Bank.
On July 26, 1979, the pecuniary benefit was reduced to 50
percent of the tax. On December 7, 1979, the pecuniary benefit was
increased to 95 percent of the tax; on May 8, 1980, the pecuniary
benefit was reduced to 40 percent of the tax; and on June 28,
1985,4 the pecuniary benefit was reduced to zero.
H. Resolution 63 Loans
Many Brazilian companies that needed working capital were not
able to provide foreign lenders with adequate financial information
or proper guaranties to obtain a loan. To provide Brazilian
companies with the funds needed for their development, and in
keeping with the Brazilian Government's efforts to develop the
country's economy and generate foreign exchange, the Central Bank
issued Resolution 63 on August 21, 1967. Resolution 63 permitted
certain Brazilian banks to borrow funds from abroad for the
4
The parties have stipulated and agreed to use June 28,
1985, as the date for all purposes relating to the reduction of
the subsidy to zero in this case.
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specific purpose of relending (repassing) the corresponding
borrowed funds in Brazilian currency to Brazilian companies (repass
borrowers). The charges paid by a repass borrower to a Brazilian
bank were in the same proportion as the charges paid by the
Brazilian bank to the foreign lender. The loan between the foreign
lender and the Brazilian bank was independent of the loan between
the Brazilian bank and the repass borrower. The foreign lender had
no legal relationship with the repass borrower and in general did
not know the repass borrower's identity.
Foreign loans which were repassed under Resolution 63 were
subject to the same restrictions on the receipt and exchange of
foreign currency as other foreign loans. Circular 266 provided
that in the case of a Resolution 63 loan, the bank receiving the
foreign loan was required to transfer the total value of the
pecuniary benefit to the borrower receiving the repass funds, and
in cases in which the foreign loan was transferred to several
repass borrowers, the pecuniary benefit was transferred
proportionately to each of such borrowers.
I. Details of Repass Borrowing Under Resolution 63
Generally, a foreign lender was concerned only with the credit
risk of the Brazilian bank. The initiative to borrow foreign funds
for lending to local companies under Resolution 63 was that of the
Brazilian bank, which would repass loans if and when local
borrowers were available. In making Resolution 63 loans to
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Brazilian banks, foreign lenders generally assumed that the
Brazilian bank would repass its cost of funds (the cost of the
foreign lender's loan) and charge a spread or commission to the
repass borrower.
The Brazilian bank was allowed to charge its borrower only a
repass commission. The repass commission was usually calculated as
a set percentage per year of the principal balance of the repass
loan. The amount of the repass commission was the same as the
commission charged for other types of loans. During the years in
issue, there was no limit on repass commissions, and the commission
was as high as 10 percent, depending upon the individual repass
borrower's credit.
Except for the term of the loan, all other financial
conditions of the loan between the Brazilian bank and the repass
borrower had to be the same as those between the foreign lender and
the Brazilian bank. If the interest rate charged by the foreign
lender to the Brazilian bank was net of the Brazilian withholding
tax, then the interest rate payable by the repass borrower was
likewise net of the Brazilian withholding tax. If the Brazilian
bank was entitled to a pecuniary benefit, then it passed on the
benefit to the repass borrower. The transfer of the pecuniary
benefit from the Brazilian bank to the repass borrower reduced the
repass borrower's cost of the repass loan and thus encouraged
foreign borrowing.
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Beginning in 1974, Resolution 63 funds not utilized in repass
operations could be deposited with the Central Bank. When such
funds were deposited, the Central Bank paid the interest on the
foreign loan; and if there was a net loan involved, no withholding
tax was paid with respect to the Central Bank's interest payment.
J. Resolution 432
As a result of the historically high inflation in Brazil and
the periodic currency exchange devaluations, the National Monetary
Council issued, on June 23, 1977, Resolution 432, which authorized
borrowers of registered foreign currency loans to hedge cruzeiros
(intended to be used for payments on the loans) against currency
exchange devaluations by depositing foreign funds at the borrower's
Brazilian bank. Pursuant to Resolution 432, the borrower would
purchase the funds to be deposited at its Brazilian bank at the
official exchange rate. The foreign funds remained on deposit
until such time as the borrower was required to make payment to the
lender. The foreign currency deposited at the borrower's bank was
then transferred to the Central Bank which paid (2 days prior to
the date the borrower was required to make payment to the lender)
interest on the deposited funds at a rate equal to that payable by
the Brazilian borrower to the foreign lender (as set forth in the
certificate of registration). To the extent that interest was paid
to the foreign lender with funds deposited in the Central Bank, the
Brazilian borrower had no obligation to withhold income taxes
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thereon; correspondingly, the Brazilian borrower received no
subsidy.
If the 432 program loan was a gross loan, the Central Bank
would pay the withholding tax due on the interest payable to the
foreign lender during the period the funds were deposited in the
Central Bank. If the 432 program loan was a net loan, the Central
Bank would pay no withholding tax with respect to the interest
payable to the foreign lender.
K. Brazilian Tax Law in General
The Brazilian tax system is divided into three types of
authority: The Federal Constitution of Brazil (Federal
Constitution), the National Tax Code, and ordinary Federal, State,
and municipal legislation.5
The Federal Constitution divides the authority to tax among
the Federal Government, the States, and the municipalities of
Brazil. Pursuant to Article 21 of the Federal Constitution, the
Federal Government has authority to impose all types of taxes,
including a tax on income, except as otherwise granted by the
Federal Constitution to the States or municipalities.
5
The National Tax Code is a complementary law and has an
authoritative status below that of the Federal Constitution but
above that of ordinary laws. Where the National Tax Code
conflicts with an ordinary law, the National Tax Code will
prevail.
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Article 19 of the Federal Constitution provides that the
Federal Government, States, and municipalities are to enjoy
immunity from taxation of their income, assets, and operations.
Article 19 further extends this immunity from taxation to
"autarquias" (i.e., autonomous governmental entities) like the
Central Bank.
The National Tax Code establishes the parameters within which
the taxing authority of the Federal Government, States, and
municipalities may be exercised. It does not, in and of itself,
create or impose any taxes.
Article 4 of the National Tax Code specifies that the legal
nature of a tax is determined by its generating factor (that is,
the taxable event); the name and other formal characteristics of
the tax are irrelevant to the legal nature of the tax.
Article 9 of the National Tax Code generally provides that an
entity's immunity or exemption from tax will not relieve it of its
obligation to collect withholding taxes that are due with respect
to its income remittances to third parties.
Article 113 of the National Tax Code divides tax obligations
into principal and accessory obligations. The principal obligation
is created by the taxable event and has as an objective the payment
of tax. The accessory obligation is derived from the tax
legislation and has as its objective the performance of specific
acts (e.g., maintaining books and records, filing tax returns) in
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the interest of collection of tax. The taxable event which gives
rise to the tax on income is the economic or legal availability of
such income.
Under Article 45 of the National Tax Code, the person entitled
to "the economic or legal availability of income" is called the
contribuente, or taxpayer. However, the status of contribuente can
be attributed to the holder of assets producing the income or
earnings. In addition, the source making payment of the income can
be liable for the tax if the source is required by law to withhold
and pay such tax to the Brazilian Treasury.
Under Article 121 of the National Tax Code, the person
obligated to make the payment of tax is called the "passive
subject" of the principal obligation. The passive subject of the
principal obligation is either: (1) The contribuente, when he has
a direct and personal relationship with the taxable event or (2)
the responsavel (responsible person or person liable) when, without
having the status of contribuente, he has an obligation to pay the
tax by an express provision of law.
Article 122 of the National Tax Code defines the passive
subject of an accessory obligation as the person obligated to
perform the duties which make up the accessory obligation.
Article 123 of the National Tax Code specifies that, except as
otherwise provided by law, private agreements concerning the
liability to pay taxes are not binding on the public treasury.
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Article 128 of the National Tax Code provides that the
liability for a tax claim may be assigned to a third party who is
related to the taxable event which gives rise to the tax
obligation.
Since 1943, Brazilian Federal legislation generally has
provided for withholding tax imposed on interest paid by Brazilian
borrowers to foreign entities, at the following rates:
Rate Years
10% 1944-47
15 1948-54
20 1955-58
25 1959-74
5 1974-75
25 1975-Present
Article 11 of Decree-law 401,6 which was enacted on December
30, 1968, provides as follows:
Subject to the deduction of the Income Tax at source
is the value of interest remitted to a foreign country,
payable by virtue of purchase of goods on installment,
even when the beneficiary of the revenue is the actual
seller.
6
Prior to Decree-law 401, the Brazilian Supreme Court,
in several decisions, held that remitted interest with respect to
goods purchased abroad on an installment basis could not be
taxed, because the interest was part of the purchase price and
had been earned abroad. Decree-law 401 was passed to clarify
that generally such interest was taxable under Brazilian law.
Its provision in Article 11 that the taxable event was the
remittance of the interest and the borrower was the contribuente,
generated considerable controversy, because that provision seemed
contrary to the normal rules of Brazilian tax law. In a June 14,
1972, decision, however, the Brazilian Supreme Court upheld the
validity of Decree-law 401.
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For purpose of this article, the remittance to a
foreign country is considered the generative fact of tax,
and the remitter is considered the contribuente.
L. SRF 368 and FIRCE 80
On June 10, 1980, Secretary Francisco Dornelles (Dornelles),
the head of the Brazilian equivalent of the Internal Revenue
Service (Brazilian IRS), issued SRF 368 to the head of the Central
Bank's Department of Foreign Capital Fiscalization and Registration
(FIRCE). SRF 368 was an "officio", a formal written communication
between two governmental agencies that is binding upon the
governmental agencies. SRF 368 stated, in pertinent part:
Subject: Notification of waiver of payment of income
tax on remittances abroad
Ref. Off. Let. FIRCE-1-0-80/059, dated 6/3/80
Dear Sir:
In reply to the above mentioned official letter, of
interest to your Department, I hereby inform you, for
such measures as you may deem necessary, that, in the
exercise of the powers delegated to me by MF
Administrative Ruling 648/79, I AUTHORIZE the waiver of
payment of withholding income tax incident on the
remittance of interest and other legal charges on behalf
of Banco do Brasil S/A-Grand Cayman Branch with respect
to the foreign loan transaction in the amount of $60
million contracted by the Federative Republic of Brazil,
Ministry of Foreign Relations at that bank.
* * * * * * *
2. I would also like to take this opportunity to inform
you of the directive contained in SRF Official Letter no.
1016 dated 12/26/79 addressed to DECAM (Departmento de
Cambio) [Department of Foreign Exchange], according to
which the Central Bank of Brazil, independently of any
prior statements made by this Secratariat, is authorized
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to waive the withholding of said tax on remittances
abroad made by public-sector entities that prove they
have assumed the tax burden [(i.e., have net loans)].
The Brazilian IRS's above position in paragraph 2 of SRF 368
was supported by certain decisions of the Brazilian Supreme Court
which held that public-sector entities were not required to pay
withholding tax with respect to their net loan interest remittances
abroad, because of their immunity from taxation under Article 19 of
the Federal Constitution.7
As a result of receiving SRF 368, the head of FIRCE issued
FIRCE Service Instruction No. 80 (FIRCE 80) on May 19, 1981. FIRCE
80 stated, in pertinent part:
We hereby inform the Central and Regional Divisions
that as per Official Letters SRF no. 368 and DRF
(Departmento da Receita Federal) * * * [Brazilian
IRS] no. 040/81, dated 6/10/80 and 2/4/81 respectively,
the * * * [Brazilian IRS] authorized this bank to
waive the payment/collection of withholding income tax in
the case of remittances abroad of interest and other
charges originating from currency loans and financing for
the importing of goods, when the domestic contracting
party fulfills the following requirements:
(a) it is a public-sector legal entity;
(b) it has proven that it has assumed the tax burden
[(i.e., has a net loan)];
7
Brazil is a civil law, as opposed to a common law,
country. Court decisions are technically binding only upon the
litigants of the case. Prior similar cases are not considered to
be strictly binding as precedents, although both the courts and
litigants will frequently cite such prior cases as representing
the correct legal reasoning to be applied and the proper holding
to be made.
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For purposes of clarification, the following are
public-sector entities:
-the Union, States, Federal District, and
Municipalities * * * ;
-federal territories * * * ;
-federal, state, and municipal autonomous government
agencies * * * .
Consequently, we recommend that, in the case of
transactions with the characteristics outlined above, the
corresponding Certificates be issued with the additional
observation:
"Payment/collection of withholding tax on income
is waived on remittance(s) (indicate the nature of
the remittance) covered by this Certificate
(Official Letter SRF no. 368, dated 6/10/80)."
M. Latin Debt Crisis
A number of Latin American countries, including Brazil and
Mexico, incurred large foreign debts. Beginning in about the early
1980's, some of these countries experienced problems in paying
their foreign debts. This Latin debt crisis persisted for a number
of years.
In about 1982, a large number of Mexico's foreign lenders
(including some major international banks in the G-7 countries) and
the Mexican Government agreed to a restructuring of Mexico's
foreign debt.
Brazil began experiencing similar problems in paying its
foreign debt in 1982. In late 1982, the Brazilian Government
declared a moratorium with respect to the repayment of Brazil's
foreign debt.
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As a practical matter, the major international banks, like
Citibank, that held large amounts of outstanding loans in Latin
American countries were compelled to help Brazil, Mexico, and other
Latin American countries work out their financial problems. These
major international banks and the governmental banking regulators
in the G-7 countries feared that a default by a Latin American
country, especially a major debtor country like Brazil, on its
foreign debt could trigger a collapse of the international banking
system. The banks and the regulators believed that a default by
one Latin American country on its foreign debt could lead to
worsening economic conditions which would cause other Latin
American countries to default on their foreign debts. For instance,
in 1982, Citibank held about $4.6 billion in total outstanding
Brazilian loans, an amount equal to an extremely high percentage of
Citibank's then net equity. Citibank thus could not afford to
write down its Brazilian loans, as such a writedown might lead to
its becoming insolvent for bank regulatory accounting purposes.
For its part, Brazil had to obtain considerable financial help
from the major international banks in attempting to work out its
financial problems. Brazil was desperately short of the foreign
currency needed for imports to keep its economy functioning.
N. Brazilian Foreign Debt Restructuring in General
As relevant to this case, the Brazilian foreign debt
restructuring that took place was divided into three phases: Phase
I, phase II, and phase III. Initially, the major international
- 23 -
banks involved in negotiating phase I of the Brazilian foreign debt
restructuring believed that Brazil's financial problems could be
resolved if Brazil were given some relatively short-term financial
assistance in overcoming its present shortage of foreign currency,
as Brazilian borrowers generally were continuing to make payments
in cruzeiros on their foreign loans. In imposing the foreign debt
repayment moratorium, the Brazilian Government and the Central Bank
were blocking remission of these loan payments because Brazil
lacked sufficient foreign currency reserves with which to
effectuate the foreign loan payments. This belief of the major
international banks proved to be erroneous, and Brazil continued to
require yet additional financial assistance from its foreign
lenders, including the later phase II and phase III of the
Brazilian foreign debt restructuring.
Officials at the highest levels of the Brazilian Government
were concerned with and kept informed of the status of the phase I,
phase II, and phase III restructuring negotiations. Of the
individuals representing the Brazilian Government and the Central
Bank during these negotiations (the Brazilians), the principal
negotiators were Finance Ministry officials and Central Bank
officials.
O. Mechanics and Negotiations of the Brazilian Foreign Debt
Restructuring
The Central Bank served as the borrower under certain
agreements entered into in connection with phase I, phase II, and
- 24 -
phase III of the Brazilian foreign debt restructuring, with the
Brazilian Government being the guarantor of the Central Bank's
obligations under these agreements. The major international banks
involved in negotiating the Brazilian debt restructuring wanted the
Central Bank to be the borrower, as the Central Bank, unlike the
Brazilian Government, could be sued in foreign courts.
Additionally, the Central Bank held all of Brazil's foreign
currency reserves.
There were perhaps as many as 600 foreign lenders holding
outstanding Brazilian loans. Collectively, these lenders had
issued thousands of outstanding loans to numerous Brazilian
borrowers.
As it was not feasible to have the foreign lenders and their
Brazilian borrowers renegotiate all these loans, the deposit
facility agreement (DFA) mechanism was devised. The prior
outstanding loans would be left in place. When a prior loan
borrower made a loan payment, the payment would be deposited with
and held by the Central Bank pursuant to a new loan entered into by
the Central Bank and the foreign lender.
As a further part of the restructuring, Brazil also needed to
obtain additional foreign capital to enable its economy to
function. Much of this additional foreign capital or new money was
furnished under the credit guaranty agreement (CGA) entered into by
the Central Bank and some of the foreign lenders. Only the 170
foreign lenders holding the largest amounts of outstanding
- 25 -
Brazilian loans participated in the phase I CGA. In contrast,
almost all of the foreign lenders participated in the phase II
CGA.8
The loans made to the Central Bank under the phase I and phase
II DFA's and CGA's were net loans that had repayment terms of 7 to
9 years. In the phase I and phase II DFA's and CGA's, provision
was made for funds that would otherwise be lent to the Central
Bank, as borrower, to be alternatively lent or relent to other
Brazilian persons and companies. Many of the foreign lenders
wanted to maintain their business relationships with their longtime
Brazilian customers. They thus wanted their customers to have some
ability to borrow and take out loans from the large amount of
foreign exchange and capital to be provided by the foreign lenders
to the Central Bank pursuant to the DFA's and CGA's. The phase I
DFA, phase II DFA, phase I CGA, and phase II CGA each provided that
there would be an initial period of about 16 or 18 months during
which DFA and CGA funds could be alternatively lent or relent to
other Brazilian persons and companies (the relending period).9
Phase I
After the Brazilian Government imposed its foreign debt
repayment moratorium in December of 1982, Citibank and Morgan Bank,
8
No phase III CGA was entered.
9
As part of the later phase III restructuring discussed
more fully infra, the relending period for the phase II DFA was
extended from June 30, 1985, to April 1986, and the relending
period for the phase II CGA was extended from June 30, 1985, to
March 1986.
- 26 -
two major international banks holding the largest amounts of
outstanding Brazilian loans, took the lead in negotiating the phase
I restructuring of Brazil's foreign debt. The phase I
restructuring agreements were entered into by Brazil and its
foreign lenders on February 25, 1983.
The phase I restructuring included: (1) A phase I DFA that
covered the scheduled debt payments due in 1983 on prior
outstanding Brazilian loans, (2) a phase I CGA under which the
Central Bank would be lent up to an additional $4.4 billion in new
money, (3) a phase I trade receivable commitment agreement, and (4)
a phase I interbank commitment agreement.10
As indicated previously, only the 170 foreign lenders holding
the largest amounts of outstanding Brazilian loans participated in
the phase I CGA. Their shares of this $4.4 billion of new money to
be provided to Brazil were based on their relative holdings of
outstanding Brazilian loans.
In negotiating the phase I restructuring, Citibank, Morgan
Bank, and the Brazilians were under extreme time pressure to
conclude an agreement quickly because of the Brazilian Government's
debt repayment moratorium. If a restructuring agreement were not
concluded, then many of the foreign lenders' Brazilian loans would
10
Under the phase I and later phase II trade receivable
commitment agreements and interbank commitment agreements the
major international banks pledged to provide short-term credit to
Brazil in connection with certain trade receivables and interbank
lines of credit at the same levels which existed prior to the
Brazilian foreign debt crisis.
- 27 -
have to be placed into nonperforming status. (Generally, for bank
regulatory accounting purposes, once a bank loan is placed into
nonperforming status and a specified period of time elapses, among
other things, previously accrued but uncollected interest income
with respect to the loan must be written down by the bank. Such
writedowns could cause the international financial community to
lose confidence in Brazil's ability to repay its foreign debt.)
Moreover, if any foreign lender were to declare its outstanding
Brazilian loans to be in default, Brazil's foreign debt crisis then
could well escalate out of control, with disastrous consequences
for a number of major international banks and the international
banking system.
Phase II
During the first half of 1983, Brazil and its foreign lenders
realized that the phase I restructuring would not be sufficient to
solve Brazil's financial problems. They thus began negotiation of
what became known as the phase II restructuring. At about this
time, the head of the International Monetary Fund (IMF) announced
that he was conditioning Brazil's receipt of any further financial
assistance from the IMF upon at least 90 percent of Brazil's
outstanding foreign debt that was owed to private foreign lenders
being restructured.
On January 27, 1984, Brazil and its foreign lenders entered
into four agreements to effectuate the phase II restructuring of
Brazil's foreign debt: (1) A phase II DFA that covered the
- 28 -
scheduled debt payments due in 1984 on prior outstanding Brazilian
loans, (2) a phase II CGA under which the Central Bank would be
lent up to an additional $6.5 billion in new money, (3) a phase II
trade receivable commitment agreement, and (4) a phase II interbank
commitment agreement.
During the phase II restructuring negotiations, Brazil did not
declare another moratorium with respect to the repayment of its
foreign debt. As a result, although there was pressure for Brazil
and its foreign lenders to conclude a phase II restructuring deal,
the time pressure they were under was not as severe as that which
they had experienced during the phase I restructuring negotiations.
Many of the foreign lenders were unhappy with Citibank's and
Morgan Bank's negotiation of the phase I restructuring. They felt
that they had no input into the phase I negotiations and that the
phase I restructuring agreements had been forced upon them by
Citibank and Morgan Bank.
As a result, the major international banks and Brazil decided
that a Bank Advisory Committee for Brazil (BAC) should be formed to
negotiate the phase II restructuring on behalf of the foreign
lenders. The BAC was formed on June 16, 1983. It had 14 members,
Citibank, Morgan Bank, Lloyd's Bank, Arab Banking Corporation, Bank
of America, Bank of Montreal, the Bank of Tokyo, Bankers Trust,
Chase Manhattan Bank, Chemical Bank, Credit Lyonnais, Deutsche
Bank, Manufacturers Hanover Trust, and Union Bank of Switzerland.
Citibank served as the BAC's chairman; Morgan Bank and Lloyd's Bank
- 29 -
served as its deputy chairmen. A senior executive at Citibank,
William Rhodes (Rhodes), represented Citibank in its role as the
BAC's chairman.
The BAC also appointed certain coordinating banks in various
sectors of the international financial community. The BAC members
and coordinating banks would advise foreign lenders of the status
of the negotiations. Also, any foreign lender could raise any
issue in connection with the proposed phase II restructuring that
it wished with the BAC.
The BAC adopted a set of operating rules concerning its
deliberations and its negotiation of the phase II restructuring.
The BAC would formulate its position only by reaching a unanimous
consensus among the BAC members. It would further negotiate with
the Brazilians only those issues pertaining to the phase II
restructuring that it considered to be of importance to all of the
foreign lenders, as a group, in effectuating the restructuring; it
would not negotiate with the Brazilians those issues that it felt
concerned only some of the foreign lenders. However, on those
issues which it would not negotiate, but which it believed were
important issues to certain foreign lenders, the BAC would advise
the Brazilians of the issue's existence and its importance to some
of the foreign lenders.
During the phase II negotiations, perhaps the most contentious
issue the BAC dealt with was the issue of new money to be provided
to Brazil. Under the proposed phase II CGA, all foreign lenders
- 30 -
holding outstanding Brazilian loans were being asked to contribute
their pro rata share of the new money. However, a number of
foreign lenders were reluctant to contribute any new money
whatsoever. The BAC then informed the foreign lenders that, in its
negotiation of a phase II restructuring deal on the foreign
lenders' behalf, there would be "no free riders". Although each
foreign lender would still have to consent to the terms of any
restructuring deal the BAC negotiated on its behalf with the
Brazilians, the BAC's official position was that a phase II
restructuring would be "all or none". The BAC feared that if a
large number of foreign lenders refused to contribute any new
money, its (the BAC's) efforts to conclude a phase II restructuring
deal between Brazil and Brazil's foreign lenders might unravel and
fail. While the BAC could not be certain that all of the foreign
lenders would ultimately agree to participate, it hoped to obtain
as close to 100 percent participation as possible, as any shortfall
of new money resulting from some foreign lenders' nonparticipation
and refusal to contribute would have to be made up by the other
participating foreign lenders.
On October 6, 1983, 60 major international banks agreed on a
framework for the phase II restructuring. Under this framework,
Brazil would be provided $6.5 billion in new money.
On October 12, 1983, the BAC issued to the foreign lenders its
term sheet with respect to the proposed phase II restructuring.
- 31 -
The term sheet outlined the major terms of the proposed
restructuring that the BAC had negotiated with the Brazilians.
From about November 1983 through January 27, 1984, virtually
all of the foreign lenders submitted their individual written
commitments to the term sheet that the BAC had negotiated on their
behalf with the Brazilians. Prior to and during this period, some
foreign lenders, including Commercial Credit Corporation, a
subsidiary of Control Data Corporation, initially indicated that
their approval of the term sheet would be conditional upon the
Brazilians' resolving the withholding issue favorably to them,
which issue is discussed more fully infra.
Phase III
The phase III negotiations began in about the fall of 1984 and
continued through July 1986. Originally, the BAC and the
Brazilians contemplated restructuring the scheduled Brazilian
foreign debt payments due in the 7-year period from January 1,
1985, through December 31, 1991. However, no such 7-year
restructuring agreement was ultimately concluded.
On July 25, 1986, Brazil and its foreign lenders signed the
phase III DFA. The phase III DFA covered the scheduled Brazilian
foreign debt payments due in 1985 and 1986. Under the phase III
DFA, any 1985 debt payments would be available for relending to
other Brazilian persons and companies during a specified relending
period; 1986 debt payments, on the other hand, would not be
available for relending.
- 32 -
The phase I DFA and the phase II DFA did not cover foreign
debt payments that were due after January 1, 1985. During the
phase III negotiations, Brazil and its foreign lenders agreed to
about six interim loan arrangements under which debt payments due
after January 1, 1985, being made by Brazilian borrowers would be
held by the Central Bank as "interim deposits". These interim
arrangements required the Central Bank to pay the foreign lenders
interest on such interim deposits, on a "net quoted" basis. The
interim arrangements themselves did not provide for any relending
period, as the Brazilians and the BAC envisioned that these interim
deposits would ultimately be rolled over into and covered under the
phase III DFA they anticipated would be concluded.
P. Various Foreign Lenders' Efforts During the Phase I and Phase
II Restructuring Negotiations To Have the Central Bank Issue Them
DARF's With Respect to Its Net Loan Interest Remittances
For certain U.S. and other foreign lenders who were in a
position to claim and utilize them, foreign tax credits potentially
represented a significant further source of tax benefits, with
respect to their Brazilian loans. Although, in the case of a net
loan, the U.S. lender would have to pay U.S. income tax with
respect to the additional interest income resulting from the gross-
up, a foreign tax credit equal in amount to the additional interest
income could be utilized to reduce the lender's U.S. income tax
liability on a dollar-for-dollar basis.11
11
See Nissho Iwai Am. Corp. v. Commissioner, 89 T.C. 765,
772-773 (1987).
- 33 -
As indicated previously, the Central Bank paid withholding tax
on its gross loan interest remittances abroad, but not on its net
loan interest remittances, including its Resolution 432 loan
program net loan interest remittances. Prior to 1982, some foreign
lenders, including certain major international banks, like
Citibank, sought to have the Central Bank pay withholding tax and
issue them DARF's with respect to the Central Bank's 432 loan
program net loan interest remittances, as this would enable these
foreign lenders to claim potential foreign tax credits. However,
their efforts were unsuccessful, as officials at the Central Bank
rejected the foreign lenders' requests to have the Central Bank
issue such DARF's to them. Central Bank officials advised the
foreign lenders that the Central Bank was not required to pay
withholding tax with respect to its net loan interest remittances
abroad because it was a tax-immune governmental entity under the
Brazilian Constitution.
At about the time of the negotiation of the phase I Brazilian
debt restructuring, a number of foreign lenders (including some
major international banks, like Citibank) intensified their efforts
to have the Central Bank issue DARF's on its net loan interest
remittances to them, including DARF's with respect to (1) the
Central Bank's 432 loan program net loan interest remittances and
(2) the Central Bank's proposed phase I DFA and phase I CGA
interest remittances (the withholding issue). These intensified
efforts by the foreign lenders to have the Central Bank issue them
- 34 -
such DARF's continued until about the time the phase II
restructuring agreements between Brazil and its foreign lenders
were entered into in late January 1984.12
During the phase I negotiations, the Brazilians indicated that
they would have the Central Bank issue DARF's to the foreign
lenders on the Central Bank's restructuring debt interest
remittances on some limited basis, but they also indicated that
they needed additional time in which to study and arrange for the
implementation of the Central Bank's payment of such withholding
tax.13 On or about December 28, 1982, the Central Bank requested
a ruling from the Brazilian IRS with respect to its payment of
withholding tax during the relending periods of the proposed phase
I DFA and phase I CGA. The ruling request and the March 1984
12
Alexandre Leite (Leite), the head of Citibank-Brazil's
tax division, testified that he and Citibank had been seeking
DARF's from the Central Bank on 432 program net loan interest
remittances since at least 1979. Leite related that the Central
Bank officials he met with rejected Citibank's request to have
the Central Bank issue such DARF's to it. Following the Central
Bank's issuance of FIRCE 80 in May 1981, Leite had concluded that
Citibank would not be able to persuade the Central Bank to issue
such DARF's, as FIRCE 80 was authorized and sanctioned by SRF
368.
13
The parties disagree over whether the Central Bank was
legally liable for and actually paid withholding tax with respect
to its restructuring debt interest remittances during the
relending periods of the DFA's and CGA's. The terms "payment"
and "withholding tax" are used herein for convenience and are not
intended as ultimate findings or conclusions concerning the
Central Bank's liability for and payment of such withholding tax.
Similarly, the use herein of terms indicating that DARF's or
withholding receipts were issued by the Central Bank to the
foreign lenders should not be construed as our conveying any
legal conclusion concerning the Central Bank's liability for and
payment of such withholding tax.
- 35 -
private ruling that ultimately was issued by the Brazilian IRS to
the Central Bank are discussed more fully infra.
During the phase II negotiations, some foreign lenders,
including Citibank, wanted the BAC to negotiate the withholding
issue with the Brazilians. The BAC decided that it could not
negotiate the withholding issue with the Brazilians, as the
withholding issue, although important to a number of foreign
lenders, did not concern all of the foreign lenders.14 Even those
BAC members, like Citibank and Lloyd's Bank, that would
substantially benefit from being able to claim potential foreign
tax credits realized that they could not afford to be accused of
using their positions on the BAC to further their own individual
interests at the expense of other foreign lenders.15 The BAC,
instead, advised the Brazilians that the withholding issue was a
very important issue to a number of foreign banks, and that the
Brazilians would have to resolve the withholding issue as a matter
of the applicable Brazilian law. The BAC further created a
subcommittee to study the withholding issue.
14
Some foreign lenders operated in countries which did
not allow foreign tax credits with respect to Brazilian
withholding tax payments. Still other lenders were not in a tax
position to benefit from claiming potential foreign tax credits.
15
To a significant extent, Citibank sought to segregate
the activities and functions of Rhodes (the Citibank senior
executive who acted as the BAC's chairman) from the individual
concerns and matters which Citibank pursued during the phase II
restructuring negotiations. At various BAC meetings, other
Citibank employees (principally the top employees of Citibank-
Brazil), and not Rhodes, would represent and present Citibank's
position.
- 36 -
Until about the signing of the phase II restructuring
agreements in January 1984, Citibank continued to press the
Brazilians to reach a favorable resolution of the withholding
issue. Top employees of Citibank-Brazil utilized virtually every
opportunity available to them, outside of the BAC's meetings, to
lobby Brazilian Government officials and Central Bank officials on
the withholding issue.16 Other foreign lenders, including
Commercial Credit Corporation, also pressed the Brazilians to
resolve the withholding issue favorably to these foreign lenders.
On December 8, 1983, Citibank's in-house tax counsel met with
the general counsel of the Central Bank and presented Citibank's
position on the withholding issue. During the meeting, the Central
Bank's general counsel indicated that DARF's would be issued by the
Central Bank on its restructuring debt interest remittances but
refused to address whether the Central Bank would issue DARF's on
its 432 loan program net loan interest remittances.17
On January 22, 1984, the Brazilian Planning Minister, the
Central Bank's general counsel, and other Brazilian officials met
16
Job Maats, who functioned as Citibank-Brazil's
financial controller, served on the BAC's withholding issue
subcommittee and played a central role in Citibank's efforts to
obtain DARF's from the Central Bank, testified that Brazilian
officials were told that a favorable resolution of the
withholding issue would also benefit Brazil and be in Brazil's
interest, because it would improve the climate to conclude a
restructuring deal.
17
Citibank estimated that, for 1979 through 1983, a
potential foreign tax credit of $30 million could be claimed by
Citibank with respect to the Central Bank's 432 program net loan
interest remittances.
- 37 -
with Rhodes (the Citibank senior executive who functioned as the
BAC's chairman) and certain other BAC members to advise the BAC
with respect to how the Brazilians had decided to resolve the
withholding issue. During the meeting, the Planning Minister
initially asked the Central Bank's general counsel to review and
discuss the generally applicable Brazilian law with respect to the
payment of withholding tax on interest remittances made abroad.
The Planning Minister then telephoned the Brazilian Finance
Minister to find out whether the applicable Brazilian law had been
clarified with respect to the Central Bank's payment of withholding
tax on its restructuring debt interest remittances. He learned
that the Brazilian IRS would issue a ruling to the Central Bank,
which would hold that the Central Bank was required to withhold on
interest remittances during the relending periods of the phase I
DFA, phase II DFA, phase I CGA, and phase II CGA, beginning January
1, 1984.18 The Planning Minister advised Rhodes and the other BAC
members of this anticipated ruling. He indicated that the Finance
Ministry would shortly send a telex to the BAC confirming this,
which telex was received by Rhodes on or about January 24, 1984.
This anticipated ruling discussed at the January 22, 1984, meeting
18
The foreign lenders who were seeking DARF's from the
Central Bank wanted to receive DARF's with respect to the 1983
restructuring debt interest payments made to them. In addition
to enabling them to claim potential foreign tax credits for 1983,
they believed that the Internal Revenue Service was more likely
to challenge the foreign tax credits claimed by them with respect
to the 1984 restructuring debt interest payments if no similar
foreign tax credits had been claimed by them for 1983.
- 38 -
was the March 1984 private ruling that the Brazilian IRS ultimately
issued to the Central Bank, which ruling is more fully discussed
below.
Notes of the January 22, 1984, meeting taken by the lead
attorney of the law firm that served as the BAC's counsel,
stated:
Rhodes
(1) Banks think 83 will be solved.
(2) IRS won't accept 84 if don't get 83.
(3) negative feeling for banks in the future.
Sobreira [Central Bank's general counsel]
(1) Tax owed by anyone paying interest or fees
abroad.
(2) Authority that remits charged with deduction
& paying.
(3) Cent Bk agrees to pay on acct of Banks.
(4) Only way CB can pay is if law is interpreted
to require payment. Interpretation is from
Treasury which has issued the interpretation.
(5) Treasury legal opinion applies to 1984 but
not to 1983.
Waiting for XXXXXX
(1) Delfim [the Brazilian Planning
Minister] says decree will be solved by
inserting limit.
(2) Wh tax. Phase I and phase II from 1/1/84 on
during reborrowing period.
º Agreement of Delfim.
Rhodes + Coleman [the Morgan Bank senior
executive who functioned as the BAC's deputy
chairman] accept #1.
Rhodes says he can't guarantee Bank acceptance of
#2.
- 39 -
Q. The Brazilian IRS's March 1984 Private Ruling to the Central
Bank
On or about December 28, 1982, the head of FIRCE submitted a
"consulta" or ruling request by the Central Bank to the Brazilian
IRS. The December 28, 1982, consulta stated, in pertinent part:
Subject: Withholding tax levied on interest on
* * * [proposed phase I DFA and phase I CGA].
Mr. Secretary,
In the next few days, the Central Bank of Brazil will
enter into, with the international financial community,
* * * [the proposed phase I DFA and phase I CGA].
* * * * * * *
2. In contracting these * * * [agreements], the
Central Bank * * * will act in the capacity of Agent
of the Federal Government in implementing the foreign
exchange policy determined by the National Monetary
Council.
3. Therefore, all the financing charges resulting from
the above agreements will be for the account of the
National Treasury, which will be responsible for the
respective services related to payments and remittances.
4. During the negotiations for such Agreements, the
Brazilian Authorities assumed the commitment to provide
the creditors with withholding receipts (DARF's) for the
withholding tax paid on the interest payable by the
Central Bank on the funds of * * * [the phase I DFA
and phase I CGA], during the period in which such funds
remain deposited at the Central Bank and available for
relending to borrowers in Brazil.
5. In view of the special characteristics of these
transactions, we hereby request your opinion on the
matter, pointing out that the following has already been
negotiated with the creditor bankers:
(a) issuance of the DARF's in the names of
the agent bank of * * * [the proposed
phase I DFA and phase I CGA], considering that
- 40 -
the large number of lender bankers makes it
impractical to issue one DARF in the name of
each of them;
(b) the payments are to be made individually
per agent/taxable event/tax rate in view of
the different tax rates available under
double-taxation treaties.
6. In view of the foregoing, we hereby ask also for
your opinion regarding the following aspects:
(a) if the Central Bank, in this case, is
entitled to the pecuniary benefit * * * ;
(b) the possibility of establishing a period
of 15 (fifteen) days for the payment of the
tax, such period to start as of the date of
remittance of the interest to the foreign
creditors, on account of the complex
calculation of the interest and consequently
of the tax itself;
(c) the possibility of indicating "Brazilian
Financing Plan" as the reference in space 31
of the DARF as there is no Certificate of
Registration for these transactions;
(d) in the event that the withholding tax is
paid late:
(i) whether the Central Bank would
nevertheless be entitled to such
pecuniary benefit;
(ii) whether it would be possible to
waive the ancillary charges (default
interest and monetary correction),
particularly as regards the penalty.
(e) whether the position to be adopted by
your Office can be extended to agreements of
identical characteristics that may be executed
in the future in a possible development of the
present negotiation phase.
(7) Finally, we point out that the matter is of special
importance for the completion of the mentioned
Agreements.
- 41 -
Following the Central Bank's submission of the above ruling
request, by around June or July 1983, certain employees of the
Brazilian IRS prepared a proposed draft ruling which held that the
Central Bank was required to pay withholding tax on its
restructuring debt interest remittances to the foreign lenders
during the relending periods of the DFA's and CGA's, because it was
subject to the same withholding tax collection and payment rules
that were applicable to non-public-sector entities (the Doniak-
Kahan draft ruling). The Doniak-Kahan draft ruling was hotly
debated within the Brazilian IRS and the Brazilian Government
because of its conflict with SRF 368 and existing Brazilian Supreme
Court decisions. As a result, Dornelles (the head of the Brazilian
IRS) decided he could not approve the issuance of the Doniak-Kahan
draft ruling to the Central Bank.
In about early January of 1984, Dornelles directed two top-
level Brazilian IRS officials to redraft and revise the Doniak-
Kahan draft ruling. He instructed them to reach the same holding
as in the Doniak-Kahan draft ruling (i.e., that the Central Bank
was required to pay withholding tax on its restructuring debt
interest remittances to the foreign lenders during the relending
periods of the DFA's and CGA's) but to keep their revised ruling
within the provisions of SRF 368. In revising the Doniak-Kahan
draft ruling, these two Brazilian IRS officials devised and
formulated a new theory that the Central Bank was required to pay
withholding tax on its restructuring debt interest remittances
- 42 -
during the relending periods of the DFA's and CGA's because until
the expiration of the applicable relending period the loan funds
were not yet irrevocably committed to the Central Bank, and it,
therefore, had to pay withholding tax on behalf of future,
unidentified "borrowers-to-be" (the borrowers-to-be theory). They
incorporated this borrowers-to-be theory into the revised draft
ruling they prepared, which revised draft ultimately became the
final version of the ruling the Brazilian IRS issued to the Central
Bank in March 1984.
By letter dated March 14, 1984, the Brazilian Finance Minister
forwarded to the Central Bank's President the Finance Minister's
decision on the ruling request and the ruling the Brazilian IRS had
issued. The March 14, 1984, letter stated, in pertinent part:
I refer to the inquiry made by your Bank regarding the
tax treatment for the Agreements called * * * [CGA
and DFA].
2. In this respect, I enclose a copy of the opinion of
* * * [the Brazilian IRS] on the matter, as well as of
the decision I issued on this date on account of the
discussions I had jointly with you for the negotiation of
such agreement.
The ruling issued to the Central Bank was a private ruling that was
given limited circulation. The ruling was not made available to
the public and was not published in the Brazilian Government's
Official Gazette.
The Finance Minister's decision stated:
Case No.:
Interested Party: CENTRAL BANK OF BRAZIL
- 43 -
DECISION: I agree fully with the conclusions of the
attached opinion of the * * * [Brazilian IRS]. In
view of item 13 of said opinion, I direct the Central
Bank of Brazil to implement the payment of income tax on
or before the last business day of the month following
the month in which the withholding is made.
Brasilia, March 14, 1984
/Ernane Galveas/
ERNANE GALVEAS
Minister of Finance
The Brazilian IRS ruling, which he enclosed to the Central
Bank, stated:
Federal Government Service
Ministry of Finance
* * * [Brazilian IRS]
OPINION
Income tax withheld on interest due
to parties resident or domiciled
abroad
* * * [FIRCE] of the Central Bank of Brazil requests
an opinion about the tax treatment of Agreements called
* * * [CGA and DFA] under which such government agency
[autarquia] is liable for the payments and remittances
pertaining to them, in the period of availability of such
funds for relending.
(2) By virtue of the special characteristics of these
transactions, the question arises as to whether there is
an incidence of income tax, in view of the government
agency's [autarquia's] assumption of the burden, and if
so whether,
(a) the DARF's may be issued in the name of the agent
bank centralizing each project, considering that the
large number of lenders makes it impractical to complete
one DARF for each of them;
(b) the tax rates established in the treaties signed by
Brazil to avoid double taxation may be applied;
(c) the pecuniary benefit * * * applies;
- 44 -
(d) it is possible to establish another period for the
payment of the tax, as from the date of remittance of the
interest to the foreign lenders, because of the complex
calculation of the interest and consequently of the tax
itself;
(e) it is possible, in space 31 of the DARF, to indicate
"Brazilian Financing Plan" as a reference, given the
absence of a Certificate of Registration for these
transactions;
(f) in the event that the income tax is paid late:
(f)(1) whether the Bank will nevertheless be entitled
to the above-mentioned pecuniary benefit;
(f)(2) whether it would be possible to waive the
monetary correction, delinquent interest and penalty.
(3) Interest received by individuals or legal entities,
resident or domiciled abroad, from individuals or
entities resident or domiciled in Brazil, or received
from a permanent establishment located in Brazil, owned
by individuals or legal entities resident or domiciled
abroad, is subject to withholding tax at the rate of 25%
* * * . The * * * [contribuente] of this tax is an
individual or legal entity, resident or domiciled abroad,
which has the legal availability of the interest. Said
tax must be withheld at the time of payment or credit by
the interest paying source bearing in mind that the * *
* [contribuente] individual or legal entity, resident or
domiciled abroad - does not file an income tax return in
Brazil. Said tax must be withheld even if the paying
source is a legal entity of public law with tax immunity,
because this is not a tax on the entity of public law
that has immunity but rather on parties resident or
domiciled abroad.
(4) It is obvious that, if the party resident or
domiciled abroad, the interest creditor, is immune or
exempt from this tax, on account of international treaty
or domestic legislation, the tax should not be withheld.
In the case of the interest paid by the Central Bank of
Brazil * * * , there is an atypical situation. * *
* [The Central Bank] is a federal government agency
[autarquia] responsible, among other duties, for issuing
currency, acting as depositary of the official gold and
foreign currency reserves, providing for the placement of
domestic and foreign loans, furthering the normal
function of the exchange market, acting as a monetary
- 45 -
policy instrument of the Government and exercising
control over credit in all its forms.
(5) The financial transactions conducted by * * *
[the Central Bank] are, in general, conducted on behalf
of the Federal Union or in its interest. In loan
transactions, agreed upon with a net interest rate, the
financial burden of the tax is transferred to the
borrower. When the borrower assumes the tax burden, what
actually happens is a gross-up of the income of the
beneficiary lender. For this reason and in order to
calculate the gross income obtained, the law determines
that the basis of calculation of the tax - the amount of
interest - be grossed up. In this way, the borrower pays
the income tax to the Union on behalf of the lender,
ensuring the net rate promised to the lender by means of
the payment of a greater amount.
(6) Following the same reasoning, * * * it is
possible to deduct, as an expense of a legal entity, the
amount of tax incident on income tax paid to third
parties, when the legal entity contractually assumes the
burden as it is a supplemental expense and not a
withholding tax.
(7) Now, when * * * [the Central Bank] acts on
behalf of the interest of the Federal Union, in cases of
transactions agreed upon with net interest rates, it
could claim a reimbursement for the amount paid in the
form of income tax. In reality, * * * [the Central
Bank] would pay the tax to the Federal Union and the
Federal Union could return it to * * * [the Central
Bank]. Under this scenario, the payment of tax, as it
would be a simple accounting transaction, could be
waived.
(8) It should be noted that, as regards the possibility
mentioned - loans of funds which must be relent to
borrowers in Brazil - said Bank must, in substitution of
the future not yet identified debtors of the tax, pay the
income tax on the interest paid during the period in
which the funds remained available for relending. The
fact is that, since the loan benefits persons which have
not yet been identified from whom the payment of
withholding tax is stipulated law, * * * [the Central
Bank] must in practice perform these acts on behalf of
such persons.
(9) Considering, therefore, the peculiarity of the
relationship * * * the Central Bank/Federal Union and
- 46 -
the Central Bank/Final borrowers of the relent funds, I
believe that, as regards the funds that must be released
to those as yet unidentified borrowers in Brazil, * *
* [the Central Bank] must as a substitute for such
borrowers pay the income tax incident on the interest
from January 1, 1984 to the end of the period of
availability for such funds to be relent.
(10) On account of the foregoing, there are the following
consequences to the transactions in question:
(a) payment of withholding tax is due and the
calculation base should be adjusted * * * [i.e.,
grossed-up];
(b) as there are innumerable lenders and income is
received through an agent bank which will then distribute
it, the DARF may be issued in the name of the agent to
simplify the payment;
(c) if there is a Convention to avoid double income
taxation signed with countries in which beneficiaries are
domiciled, the rates established in the conventions shall
be applied to that portion of the income corresponding to
each;
(d) once the tax has been made, the pecuniary benefit
* * * is applicable * * * ;
(e) in completing the DARF, the code to be used is code
0393 and, as no certificate of registration is issued in
these transactions, "Brazilian Financing Plan" may be
indicated in the appropriate space, as the reference to
the certificate is merely a control requirement.
(11) As regards the delay in paying the tax not withheld,
if the taxable event occurs while the inquiry is pending,
the tax must be paid with monetary correction and without
penalties * * * .
(12) As the term for payment of the tax is suspended, as
far as the taxable events occurring while the inquiry is
pending are concerned, as a consequence, the pecuniary
benefit will be applicable in relation to the tax paid by
the thirtieth day from the date of knowledge of the
decision.
(13) As far as the extension of the tax payment period is
concerned, this matter falls under the authority of the
Minister of Finance * * * .
- 47 -
For higher consideration.
Brasilia,
/Eivany Antonio da Silva/
Assistant Secretary of * * * [the Brazilian IRS]
I agree with the above Opinion, which I approve.
For the consideration of the Minister of Finance.
Brasilia,
/Luiz Romero Patury Accioly/
Acting Secretary of * * * [the Brazilian IRS]
R. Foreign Lenders' Efforts During the Phase III Negotiations To
Have the Central Bank Issue Them DARF's in Other Situations Not
Covered in the March 1984 Brazilian IRS Ruling
During the phase III negotiations, a number of foreign lenders
sought to have the Central Bank issue them DARF's with respect to
all of its net loan interest remittances to them, and not just on
its restructuring debt interest remittances during the relending
periods of the DFA's and the CGA's. The Brazilians rejected these
efforts to have the Central Bank issue DARF's to the foreign
lenders in additional situations outside the scope of the
borrowers-to-be theory employed in the March 1984 Brazilian IRS
ruling to the Central Bank. However, the Brazilians did indicate
some willingness to negotiate a longer relending period with
respect to the proposed phase III DFA.
On January 5, 1985, the Brazilians submitted their written
comments to a proposed draft of certain phase III basic business
terms that had been prepared by the BAC. Their comments with
respect to the Central Bank's provision of DARF's were as follows:
WITHHOLDING TAX RECEIPTS
In the first place, Pricing and Withholding Tax Receipts
are intimately linked and shall be dealt with altogether.
- 48 -
There is no room for any change as regards * * * [the
Central Bank's] tax immunity. As on Phases I and II,
withholding tax receipts shall only be provided to the
creditors for the initial period during which the amounts
remain deposited with the Central Bank for relending to
borrowers in Brazil (Relending Period), based on the
concept of "borrowers to be". No withholding tax shall be
collected on amounts redeposited with the Central Bank as
a result of the relending flexibility referred to above,
as occurs with other similar deposits held by the Central
Bank. Politically speaking, there is no ground for any
material change in the Brazilian withholding tax system,
when Mexico negotiated their debt rescheduling without
having to make any change on their fiscal policies. In
fact, around 75% (US $36 billion) of the total amount of
debt to be rescheduled (US $48 billion) is exempt from
withholding tax on the grounds of being considered
governmental debt.
Furthermore, were the Central Bank to provide the
creditors with tax receipts during the Relending Period,
this would disencourage [sic] the relendings themselves,
with negative consequences over the necessary regular
flow of funds for the financing of the Public and Private
Sectors. As to the subject of withholding tax on loans
with Phase III funds, the possibility of determination of
a higher limit (over 10 years) for withholding is under
consideration and tax exemption shall be dealt with
altogether with the level of spread. It must always be
kept in mind that it is essential to keep in relation
both the domestic interest rates and the financial costs
of external borrowing. The increase in the latter will
lead to an increase in domestic interest rates, in real
terms, which is detrimental to the economic development
and to the degree of freedom of monetary policies.
S. Central Bank's Payment of Withholding Tax on Its Restructuring
Debt Interest Remittances and the Caixa Unico System
In Brazil, Banco do Brazil, which among other things operated
as a commercial bank, was the Brazilian National Treasury's agent
for payment of taxes. During the years in issue, the Central Bank
collected and paid over to Banco do Brazil, for the account of the
National Treasury, withholding taxes, export taxes, taxes on
financial operations, and social security taxes. The withholding
- 49 -
taxes the Central Bank collected and paid over included withholding
tax on the salaries of its employees and withholding tax on its
interest remittances to foreign lenders.
Prior to 1980, the Central Bank made tax payments to Banco do
Brazil by issuing an administrative check. The check would be
physically delivered to Banco do Brazil and then cashed through the
normal check liquidation and payment procedure. Beginning in 1980,
there was a change in the manner by which the Central Bank made tax
payments to Banco do Brazil. Rather than issuing an administrative
check, the Central Bank credited Banco do Brazil's Banking Reserves
Account at the Central Bank with the amount of the tax payment.
By law, all commercial banks were required to maintain a
Banking Reserves Account at the Central Bank with a minimum balance
equal to 20 percent of their demand deposits. Banco do Brazil,
however, was not subject to this requirement because the Central
Bank would, on a frequent basis, credit and advance substantial
funds to Banco de Brazil's Banking Reserves Account, due to the
governmental functions and operations Banco do Brazil carried out.
Until 1965 when the Central Bank was formed, Banco do Brazil
served as the country's sole monetary authority. During the times
relevant to this case, Banco do Brazil was owned 51 percent by the
Brazilian Government and 49 percent by private shareholders. From
1965 through 1986, Banco do Brazil had four primary functions: (1)
A commercial bank, (2) a monetary authority, (3) management control
and distribution of currency, and (4) responsibility for bank
- 50 -
clearing. Like the Central Bank, Banco do Brazil also functioned
as: (1) A lender of last resort to public-sector entities, (2) a
development bank responsible for various subsidized credit programs
of the Brazilian Government, and (3) a fiscal authority that
managed the Brazilian Government's budget. Together, Banco do
Brazil and the Central Bank performed a number of governmental
functions, including their unified management and operation of
Brazil's monetary and financial system under what was known as the
caixa unico system.19
To perform its various governmental functions, Banco do Brazil
needed access to funds. Such funding was provided by the Central
Bank. When Banco do Brazil, in carrying out its governmental
functions, would draw down its Banking Reserves Account at the
Central Bank below the legally required minimum level, the Central
Bank would advance Banco do Brazil sufficient funds to replenish
and maintain its reserves account at the required level. The
Central Bank would level Banco do Brazil's reserves account on a
daily basis. Banco do Brazil and the Central Bank each maintained
a movement account in which they kept track of the funds the
Central Bank advanced to Banco do Brazil.
The Central Bank financed the Brazilian Government's
operations and the governmental functions that Banco do Brazil
carried out, through its issuance of (1) Brazil's currency and (2)
19
The Brazilian term "caixa unico" means a unified system
of cash or financial management.
- 51 -
governmental securities in the name of the National Treasury.
Essentially, the automatic transfer mechanism described above,
whereby the Central Bank provided funds to Banco do Brazil through
crediting its Banking Reserves Account, recognized and reflected
that, under the caixa unico system, the Brazilian Government
ultimately financed the governmental functions and operations Banco
do Brazil and the Central Bank carried out.20
On its books, Banco do Brazil made entries reflecting the
following: (1) Transfers of Central Bank tax payments to Banco do
Brazil's Banking Reserves Account at the Central Bank, (2)
collections of Federal Government tax receipts, and (3) deposits of
Federal Government revenues payable upon demand to the National
Treasury.
On the record presented in this case it is impossible to
determine what entries were made on the respective books of the
Central Bank and the National Treasury to reflect the Central
Bank's payment of withholding tax on the restructuring debt
20
The record is not entirely clear whether daily
surpluses or excess funds in the Banking Reserves Account were
turned back over to Banco do Brazil or whether the Central Bank
kept such surpluses in repayment of the funds it had advanced.
When the caixa unico system was ended in 1987, the Central Bank
was owed several billions of dollars by Banco do Brazil as a
result of its advancement of funds to Banco do Brazil over the
years. This liability of Banco do Brazil to the Central Bank,
however, was offset by an equivalent liability that the National
Treasury owed to Banco do Brazil. In ending the caixa unico
system, a novation was effected whereby Banco do Brazil's
liability to the Central Bank was canceled and the National
Treasury directly assumed the previous liability that Banco do
Brazil had owed to the Central Bank.
- 52 -
interest remittances. We are unable to ascertain what, if any,
entries were made to determine: (1) Whether the Central Bank was
reimbursed by the National Treasury for its withholding tax
payments; or (2) whether the Central Bank received the pecuniary
benefit based on those withholding tax payments. The Central
Bank's ruling request raised these two matters, and the March 1984
Brazilian IRS ruling discussed the two possibilities.21
Beginning in 1984, the Central Bank issued DARF's to the agent
banks of the foreign lenders to whom it transmitted loan payments
under the DFA's and CGA's, reflecting its withholding tax payments
on restructuring debt interest remittances during the relending
periods of the DFA's and CGA's. From 1984 through 1988 the Central
Bank issued a total of 324 DARF's to these agent banks.
T. Foreign Tax Credit Claimed by Petitioner in Dispute Between The
Parties
On its 1980 through 1986 income tax returns, petitioner
generally reported its interest income and withholding tax payments
with respect to its Brazilian loans on a cash basis. Petitioner
claimed a foreign tax credit and reported interest income gross-up
when it received a DARF. On its returns covering the period from
1980 through June 28, 1985, petitioner reduced the amount of
21
An expert witness for petitioner acknowledged that the
Central Bank might be entitled to reimbursement from the National
Treasury for its restructuring debt withholding tax payments, as
the Central Bank was acting on the Brazilian Government's behalf
and in the national interest. However, he claimed that the
Central Bank would have to ask the Brazilian Government for
reimbursement and that any such expenditure would require the
Brazilian Congress' approval.
- 53 -
foreign tax credit it claimed in connection with its Brazilian
loans by an amount equal to the pecuniary benefit provided by the
Brazilian Government to Brazilian borrowers.
In its amended petition, petitioner asserted, among other
things, that the foreign tax credit otherwise allowable to it for
1980 through 1986 should not be reduced by the pecuniary benefit
provided to Brazilian borrowers.
The total foreign tax credit claimed by petitioner for 1980
through 1986 that is still in dispute between the parties, and the
amounts of the disputed credit attributable to the legal liability,
Central Bank, and subsidy/pecuniary benefit issues, are as follows:
Issues
Total Subsidy/Pecuniary
Year Credit Legal Liability Central Bk Benefit
1980 $53,358 $53,358 -- $21,343
1981 545,462 545,462 -- 218,185
1982 814,969 814,969 -- 325,988
1983 489,341 489,341 -- 195,736
1984 312,353 312,353 $166,415 124,941
1985 242,781 242,781 181,272 93,506
1986 355,679 355,679 317,019 --
OPINION
Section 901 allows a domestic corporation to claim as a credit
against its Federal income tax (subject to certain limitations not
applicable herein) the amount of any income taxes paid on behalf of
the taxpayer to a foreign country. Sec. 4.901-2(a), Temporary
Income Tax Regs., 45 Fed. Reg. 75648 (Nov. 17, 1980); sec. 1.901-
- 54 -
2(a), Income Tax Regs.22 The purpose of the credit is to reduce
international double taxation. American Chicle Co. v. United
States, 316 U.S. 450, 452 (1942). U.S. tax principles are applied
in deciding whether a foreign levy is a creditable income tax.
Goodyear Tire & Rubber Co., 493 U.S. 132 (1989); Biddle v.
Commissioner, 302 U.S. 573 (1938); United States v. Phillips
Petroleum Co. v. Commissioner, 104 T.C. 256, 295 (1995). However,
the law of the foreign state is first looked at to determine the
nature of the obligations and rights which form the basis of the
claim of a foreign tax credit. Cf. Phillips Petroleum Co. v.
Commissioner, supra; H.H. Robertson Co. v. Commissioner, 8 T.C.
1333 (1947), affd. 176 F.2d 704 (3d Cir. 1949). Although prior
cases involving other U.S. taxpayers' entitlement to foreign tax
credits for Brazilian withholding tax paid on interest remittances
to them have generally held the Brazilian withholding tax to be a
creditable foreign income tax for purposes of section 901, e.g.,
Continental Ill. Corp. v. Commissioner, 998 F.2d at 518-519; Nissho
Iwai Am. Corp. v. Commissioner, 89 T.C. 773-774, none of those
cases squarely dealt with the legal liability and Central Bank
issues to be resolved by us infra.
22
In November 1980, the Internal Revenue Service issued
temporary regulations which set forth requirements for, and
limitations on, the amount of foreign tax credit. Secs. 4.901-2
to 4.903-1, Temporary Income Tax Regs., 45 Fed. Reg. 75647-75658
(Nov. 17, 1980). These temporary regulations generally were made
applicable to taxable years ending after June 15, 1979. Final
regulations under sec. 901 were made effective for taxable years
beginning after Nov. 14, 1983.
- 55 -
I. The Legal Liability Issue
A foreign tax is generally creditable for purposes of section
901 only if the domestic corporation is legally liable under
foreign law for the tax. Nissho Iwai Am. Corp. v. Commissioner,
supra at 773-774; sec. 4.901-2(g), Temporary Income Tax Regs., 45
Fed. Reg. 75655 (Nov. 17, 1980); sec. 1.901-2(f), Income Tax Regs.
However, it is recognized that legal liability for the tax and the
obligation to pay are not necessarily the same. For example, under
a withholding system, legal liability for the tax and the
obligation to pay the tax are different. The Federal wage
withholding system illustrates this difference--the employer is the
person obligated to withhold the tax and to pay the withheld tax to
the Government; the employee is the person legally liable for the
tax. Nissho Iwai Am. Corp. v. Commissioner, supra at 773.
To resolve the legal liability issue, we must examine
Brazilian law. In this regard, Rule 146 provides, in pertinent
part:
RULE 146. DETERMINATION OF FOREIGN LAW
* * * The Court, in determining foreign law, may
consider any relevant material or source, including
testimony, whether or not submitted by a party or
otherwise admissible. The Court's determination shall be
treated as a ruling on a question of law.
- 56 -
Rule 146 is taken almost verbatim from rule 44.1 of the Federal
Rules of Civil Procedure.23 See Note to Rule 146, 60 T.C. 1137.
23
The 1966 Advisory Committee Notes to rule 44.1 of the
Federal Rules of Civil Procedure, 28 U.S.C. app. at 759 (1994),
state, in pertinent part:
The * * * new rule describes the materials to
which the court may resort in determining an issue of
foreign law. Heretofore, the district courts, applying
Rule 43(a), have looked in certain cases to State law
to find the rules of evidence by which the content of
foreign-country law is to be established. The State
laws vary; some embody procedures which are
inefficient, time consuming and expensive. * * * In
all events the ordinary rules of evidence are often
inapposite to the problems of determining foreign law
and have in the past prevented examination of material
which could have provided a proper basis for the
determination. The new rule permits consideration by
the court of any relevant material, including
testimony, without regard to its admissibility under
Rule 43. * * *
* * * * * * *
In further recognition of the peculiar nature of
the issue of foreign law, the new rule provides that in
determining this law the court is not limited by
material presented by the parties; it may engage in its
own research and consider any relevant material thus
found. The court may have at its disposal better
foreign law materials than counsel have presented, or
may wish to reexamine and amplify material that has
been presented by counsel in partisan fashion or in
insufficient detail. On the other hand, the court is
free to insist on a complete presentation by counsel.
* * * * * * *
The new rule refrains from imposing an obligation
on the court to take "judicial notice" of foreign law
because this would put an extreme burden on the court
in many cases; and it avoids the use of the concept of
"judicial notice" in any form because of the uncertain
meaning of that concept as applied to foreign law.
* * * Rather the rule provides flexible
(continued...)
- 57 -
A. Non-Tax-Immune Borrowers/Liability Issue
In prior cases involving Brazilian withholding tax paid by
non-tax-immune Brazilian borrowers on their net loan interest
remittances to domestic corporations, we and other courts,
including the U.S. Courts of Appeals for the Seventh and Eighth
Circuits, have held those Brazilian withholding tax payments to be
a potentially creditable tax to the domestic corporations for
purposes of section 901. As the Court of Appeals for the Eighth
Circuit explained in Norwest Corp. v. Commissioner, 69 F.3d at
1407:
The Commissioner argues that Norwest is not legally
liable for the local [Brazilian] tax, and thus is not
entitled to * * * [foreign tax credit] for the local
tax, because only the borrower was legally obligated to
withhold it. * * *
We reject this argument as did the tax court below
and the other courts which have addressed this question.
See Continental Ill. Corp. v. Commissioner, 998 F.2d 513,
518-19 (7th Cir. 1993) (Continental) * * * ;
Continental Ill. Corp. v. Commissioner, * * * [T.C.
Memo. 1988-318], affd. sub nom. Citizens & S. Corp. v.
Commissioner, 919 F.2d 1492 (11th Cir. 1990) (per
curiam); Nissho Iwai Am. Corp. v. Commissioner, 89 T.C.
765, 773-74 * * * (1987) (Nissho). It is a well-settled
principle under United States tax law that the person
obligated to pay the tax is not necessarily the same
person to whom legal liability attaches. Nissho, 89 T.C.
at 773 * * * . Nissho, which the tax court here cites,
compared the Brazilian system to the wage withholding
system in the United States under which employees remain
legally liable for income taxes, although the employer is
the person obligated to withhold the tax and pay the tax
to the government. Id. Similarly, the Brazilian
23
(...continued)
procedures for presenting and utilizing material on
issues of foreign law by which a sound result can be
achieved with fairness to the parties.
- 58 -
borrower is only charged with an administrative function.
As explained, under Brazilian law, interest paid to
foreign lenders like Norwest is subject to local tax.
The Brazilian borrower is required to withhold the local
tax from each interest payment. Id. at 774 * * * ,
citing Gleason Works v. Commissioner, 58 T.C. 464, 478
* * * (1972) (noting that liability for taxes "does not
rest upon a search for the person from whom the tax is
collectible but rather for the person upon whom the tax
is imposed"). The Commissioner argues that in Brazil only
borrowers have an enforceable legal obligation because
withholding is the exclusive means of collection. The
Commissioner's argument is unduly formalistic because
Brazilian banking authorities will not allow the
Brazilian borrower to buy foreign currency to pay
interest to foreign lenders without proof it has withheld
and paid the local tax. The lender thus could not escape
liability and the absence of a law specifically applying
to the lender is irrelevant. See Continental, 998 F.2d
at 518. "[T]he [local] tax is 'paid' by the [foreign]
lender * * * even if the [Brazilian government's] tax
enforcement guns are trained on the agent [that is, the
Brazilian borrower,] rather than on the principal [that
is, the foreign lender]." Id. at 519. * * *
Based on the record presented in the instant case, we see no
reason to depart from the above precedents. Brazilian law
indisputably requires non-tax-immune Brazilian borrowers to
withhold with respect to their interest remittances to foreign
lenders. Petitioner is "legally liable" under Brazilian law for
the withholding tax paid by non-tax-immune Brazilian borrowers on
their net loan interest remittances to petitioner. We thus hold
that the Brazilian withholding tax collected from and paid by these
borrowers on their net loan interest payments to petitioner is
potentially creditable to petitioner for 1980 through 1986. Of
course, the actual amount of this withholding tax that is
creditable to petitioner will depend upon our resolution of the
subsidy/pecuniary benefit issue infra.
- 59 -
B. Central Bank/Liability Issue
In the instant case, petitioner was not required to file a
Brazilian tax return and had no obligation itself to pay Brazilian
tax. See Continental Ill. Corp. v. Commissioner, 998 F.2d at 518-
519. Brazilian withholding tax was purportedly collected from and
paid by the Central Bank on its Brazilian restructuring debt
interest remittances to petitioner during the relending periods of
the DFA's and CGA's, beginning in 1984. For these purported
withholding tax payments to be a potentially creditable tax to
petitioner, the Central Bank must have a legal liability under
Brazilian law to pay this "withholding tax". Petitioner cannot be
considered "legally liable" under Brazilian law for Brazilian tax
if there was no legal liability on its and the Central Bank's part
to pay this "withholding tax". Nissho Iwai Am. Corp. v.
Commissioner, 89 T.C. 773-774; sec. 4.901-2(g), Temporary Income
Tax Regs., 45 Fed. Reg. 75655 (Nov. 17, 1980); sec. 1.901-2(f),
Income Tax Regs.; see also Amoco Corp. v. Commissioner, T.C. Memo.
1996-159; Continental Ill. Corp. v. Commissioner, T.C. Memo. 1991-
66 (hereinafter sometimes referred to as the PeMex case), affd. in
part and revd. in part 998 F.2d 513 (7th Cir. 1993).
As we have determined in our findings, until 1984, the Central
Bank paid Brazilian withholding tax on its gross loan interest
remittances abroad, but not on its net loan interest remittances.
This treatment was authorized and sanctioned by SRF 368, an
"officio" that the head of the Brazilian IRS issued to the Central
- 60 -
Bank in June 1980, and was consistent with certain prior decisions
of the Brazilian Supreme Court that are discussed more fully
hereafter. Pursuant to SRF 368, the Central Bank (which in Brazil
serves an instrumental role in ensuring that the withholding tax
due on interest remittances abroad is collected), following its
issuance of FIRCE 80 in May 1981, did not require withholding tax
to be collected from and paid by public-sector entities, like
itself, on their net loan interest remittances abroad. Beginning
in 1984, the Central Bank purportedly paid withholding tax on its
restructuring debt interest remittances during the relending
periods of the DFA's and the CGA's, pursuant to the borrowers-to-be
theory applied in the March 1984 Brazilian IRS private ruling
issued to the Central Bank.
C. Brazilian Supreme Court Decisions
The following Brazilian Supreme Court decisions are apposite
in understanding the respective arguments of the parties and their
experts concerning the Central Bank's liability for the payment of
withholding tax on its net loan interest remittances to foreign
lenders.
On September 24, 1974, a panel of the Brazilian Supreme Court
issued its unanimous decision in Federal Govt. v. Highway Dept. of
the State of Parana (hereinafter referred to for convenience as the
Parana I--1st Panel decision), reversing the decision of the lower
Brazilian Federal Court of Appeals and holding that the State of
Parana was required to pay withholding tax on its remittance of
- 61 -
interest abroad with respect to a loan to finance the construction
of State highways, because it was not immune from paying this
withholding tax under Article 19 of the Brazilian Constitution.
The loan involved in the Parana I--1st Panel decision was a gross
loan. The Brazilian Supreme Court Justice reporting the case
reasoned that if constitutional immunity from the withholding tax
were held to apply, then the beneficiary of the immunity would be
the foreign creditor, not the State of Parana. This Justice quoted
with approval the following reasoning given in the dissent to the
lower Brazilian Federal Court of Appeals' majority decision:
If the State of Parana were the beneficiary of an
increase in its assets, on which the Union were demanding
the tax, it would be granted immunity, according to the
Constitution.
But since it appears in a different capacity in the
litigation, namely, as remitter of interest on behalf of
another, I hold that the argument alluding to immunity is
inadmissible.
On October 15, 1975, the full Brazilian Supreme Court issued
its unanimous decision in State of Parana v. Central Bank
(hereinafter for convenience referred to as the Parana II
decision), holding the State of Parana was not required to pay
withholding tax on its remittance of interest abroad with respect
to a loan to finance a railroad, because it was immune from such
withholding tax under Article 19 of the Brazilian Constitution.
The loan involved in the Parana II decision was a net loan. The
Brazilian Supreme Court Justice reporting the case distinguished
the Parana I--1st Panel decision, and reasoned as follows:
- 62 -
There is no further debate on whether [withholding of]
income tax can be demanded in the remittance of interest
to another country, by virtue of art. 11, sole paragraph
of Law-Decree 401, of 30 December 68, coupled with art.
1 of Law-Decree 1215, of 4 May 72, RE 76,792- Plenary
Session (D.J. of 11 October 74, p. 7480), and I ruled
this way in the RE 78,988-SP, on 18 March 75.
What is at issue, however, is the application of the
sole paragraph of art. 11 of the Law-Decree 401/68,
notwithstanding the immunity guaranteed to the remitter
by virtue of art. 19, III, a, by the Federal
Constitution.
The First Division, in RE 79,157 [the Parana I--1st
Panel decision], held as follows:
The tax is payable, even though the
corporation * * * [by] constitutional law is
immune, for otherwise the beneficiary of the
immunity would not be the State, but the
foreign creditor. * * *
I believe that the precedent invoked [the Parana I--
1st Panel decision] does not apply to the present case.
In fact it has been expressly stipulated that, at any
time and for any reason, any fiscal or parafiscal [(i.e.,
tax)] burden shall be the responsibility of the State of
Parana.
It is argued that said contractual provision
* * * does not matter in the unraveling of the
dispute, because the beneficiary of the interest would be
the foreign creditor, which is not immune.
But such is not so, in my opinion, * * * because,
according to the sole paragraph of art. 11 of * * *
[Decree-law 401], the constitutionality of which also is
not at issue, the creditor is not responsible for the
payment of income tax.
The aforementioned sole paragraph states explicitly:
"For purposes of this article, it is
considered that the fact generating taxation
is the remittance to another country and the
remitter is the contribuente."
Now, in the present case, the generating fact is the
remittance of interest on the loan owed by the State of
- 63 -
Parana, and the remittance being done, it is indisputable
that it will be the contribuente.
However, the State is immune by virtue of art. 19
* * * of the Federal Constitution.
In my view, the conclusion is incontrovertible that
the burden of the payment falls on the remitter, and in
the present case, this, a unit of the Federation, is
immune that is, not obligated to pay the tax.
There is no need to fear that the foreign creditor
shall benefit from the immunity of the debtor.
In view of the sole paragraph of art. 11 of Decree-
law 401 * * * , neither is the creditor of the
interest abroad the contribuente, but rather the
remitter, on occasion of the remittance.
In its February 21, 1979, decision in State of Minas Gerais
v. Federative Republic of Brazil (hereinafter for convenience
referred to as the Minas Gerais decision), the full Brazilian
Supreme Court held that the State of Minas Gerais and its State
Highway Department were not required to pay withholding tax on
interest remittances they made as repass borrowers with respect to
their Resolution 63 repass loans, because they were immune from
such withholding tax under Article 19 of the Brazilian
Constitution.24 The reporting Brazilian Supreme Court Justice
24
In Minas Gerais, the reporting Brazilian Supreme Court
Justice stated:
Nowadays there is no further doubt on the subject,
after * * * [Summula No. 586], establishing a
position derived from art. 11 of Decree-law No. 401 of
December 30, 1968 as follows: "[Withholding of] Income
tax is due on interest remitted abroad, based on a loan
agreement."
We must thus now * * * [address the other
(continued...)
- 64 -
reasoned that Resolution 63, which authorizes the repassing of the
foreign loan, confers upon the repass borrower the status of a
foreign currency borrower and concluded that the repass borrower
could avail itself of its tax immunity.25 The Brazilian Supreme
Court in Minas Gerais further held that certain mixed capital
companies were required to pay withholding tax on interest
remittances they made as repass borrowers with respect to their
Resolution 63 repass loans, because these mixed capital companies
did not enjoy immunity from taxation, as they have the same status
under the Brazilian Constitution as private companies.26
On August 30, 1979, the full Brazilian Supreme Court issued
its decision unanimously rejecting the objections of the State of
Parana Highway Department in its appeal from the Parana I--1st
Panel decision (hereinafter for convenience referred to as the
24
(...continued)
argument] invoked by the plaintiffs: the remittances
are from the State of Minas Gerais and thus [enjoy] the
benefit of reciprocal tax immunity granted under art.
19 * * * of the Constitution.
A "summula" is a statement of a legal proposition that the
Brazilian Supreme Court feels is firmly established under
Brazilian law.
25
In the case of a Resolution 63 repass net loan, the
repass borrower generally must also provide the repass lender
with the funds to pay the withholding tax on the repass lender's
interest remittances to the foreign lender. However, as noted in
our findings, if the repass lender is entitled to a pecuniary
benefit, the repass lender must then pass on the benefit to the
repass borrower.
26
The Minas Gerais decision does not specifically state
whether the Resolution 63 repass loans involved were net loans or
gross loans. However, see supra note 25.
- 65 -
Parana I--Full Bench decision). The reporting Brazilian Supreme
Court Justice agreed with the Parana I--1st Panel decision's
reasoning that the remitter's immunity from taxation under Article
19 of the Brazilian Constitution should not prevent the imposition
of the withholding tax on gross loan interest remittances abroad,
because a contrary holding would allow the foreign creditor, and
not the State, to be the beneficiary of the immunity. He concluded
by stating that "As this was the foundation of the challenged
ruling, and since this issue did not consider the ruling cited for
comparison, the claimed divergence does not exist in the present
case."27
On June 17, 1988, a panel of the Brazilian Supreme Court
issued its unanimous decision in Municipality of Santo Andre v.
Federal Union (hereinafter for convenience referred to as the Santo
27
An expert witness for petitioner, Joao Guerra (Guerra),
explained that the State Highway Department appealed the Parana
I--1st Panel decision to the full Brazilian Supreme Court because
the decision's holding appeared to conflict with the Parana II
decision's holding. Although Guerra acknowledged that the
reporting Justice in Parana I--Full Bench concluded that there
was no actual conflict between the two decisions, Guerra
maintained that this did not necessarily mean the reporting
Justice accepted the Parana II decision's net-loan-versus-gross-
loan rationale. Guerra claimed that (1) any points relating to
whether the particular loan in Parana I--Full Bench was a gross
loan or net loan may not have been brought to the Supreme Court's
attention, and (2) the reporting Justice may not have understood
the distinction between a net loan and a gross loan. While we
agree that, in all likelihood, the Brazilian Supreme Court in
Parana I--Full Bench was aware of the holding it reached in
Parana II, we do not accept Guerra's other contentions. If the
Highway Department's appeal were based on Parana II's holding, as
Guerra propounded, then the Supreme Court in Parana I--Full
Bench, in all substantial likelihood, would have had to have
considered Parana II's net-loan-versus-gross-loan rationale.
- 66 -
Andre I decision), holding that the municipality did not have to
pay withholding tax on its interest remittances as repass borrower
with respect to a Resolution 63 repass loan to construct a
municipal supply center. The loan involved in the Santo Andre I
decision was a net loan. The reporting Brazilian Supreme Court
Justice noted the prior Parana I--1st Panel and Parana II
decisions, but adopted and utilized the Parana II decision's
rationale for distinguishing the Parana I--1st Panel decision.
This Justice stated that the decision rendered in Santo Andre I was
"oriented in the same line of jurisprudence" as the Parana II
decision.
On April 13, 1993, a panel of the Brazilian Supreme Court
issued its ruling not to recognize the Brazilian Government's
appeal in Federal Union v. Municipal Prefecture of Santo Andre
(hereinafter for convenience referred to as the Santo Andre II
decision). The loan to the municipality in Santo Andre II was a
Resolution 63 repass net loan. In its appeal, the Brazilian
Government argued that the Parana II decision was distinguishable
and did not support holding the municipality to be immune from
payment of withholding tax, as the foreign loan in Parana II had
been directly made to the State of Parana.
D. The Parties' Experts
1. Petitioner's Experts.
Petitioner offered testimony on the applicable Brazilian law
concerning the Central Bank's liability for withholding tax on its
- 67 -
restructuring debt interest remittances from four expert witnesses:
(1) Geraldo Ataliba (Ataliba), a Brazilian university professor who
specializes in constitutional taxation, (2) Eivanny da Silva (da
Silva),28 a Brazilian tax lawyer who served as a top-level Brazilian
IRS official from 1982 through 1984 and was one of the principal
authors of the March 1984 private Brazilian IRS ruling issued to
the Central Bank, (3) Joao Guerra (Guerra), a Brazilian tax lawyer,
and (4) Jose Pedreira (Pedreira), a Brazilian tax lawyer.
Petitioner's experts were of the opinion that the applicable
Brazilian law with respect to the Central Bank's payment of
withholding tax on its net loan interest remittances abroad was
correctly presented in the Doniak-Kahan draft ruling that the
Brazilian IRS never issued. In other words, they maintained that
the Central Bank was subject to the same withholding tax collection
and payment rules as non-public-sector entities and was required to
pay withholding tax on all its interest remittances abroad,
including those with respect to the restructuring debt,
irrespective of the relending periods of the DFA's and CGA's.
They were further of the opinion that SRF 368 did not reflect
the applicable Brazilian law and was completely insupportable under
Brazilian law. Except for perhaps da Silva, all of petitioner's
experts opined that, under Brazilian law, there was no such legal
doctrine as the borrowers-to-be theory.
28
Petitioner offered da Silva as both a fact witness and
an expert witness on Brazilian law.
- 68 -
Even da Silva, the principal author of the March 1984 private
Brazilian IRS ruling issued to the Central Bank, acknowledged that
the borrowers-to-be theory was a "new theory" that he devised to
deal with an "atypical situation". He asserted that he and Luiz
Patury Accioly (Patury Accioly), the other top-level Brazilian IRS
official assigned by Dornelles to revise the Doniak-Kahan draft
ruling, were trying to save face for and avoid embarrassment to the
Brazilian IRS, because its prior issuance of SRF 368 lacked "any
legal basis" under Brazilian law.29 According to da Silva, Patury
Accioly (who was serving as a Brazilian IRS official when SRF 368
was issued) told him that SRF 368 had been issued by the Brazilian
IRS because various States and municipalities did not want to be
required to pay withholding tax on their net loan interest
remittances abroad. Most significantly, da Silva further related
that the Doniak-Kahan draft ruling, at the time it was being hotly
debated within the Brazilian IRS and the Brazilian Government,
though supported by certain Brazilian Supreme Court decisions,
29
Da Silva attributed the Brazilian IRS's "illegal"
actions in issuing SRF 368 to the fact that Brazil was under the
control of a military regime. As a result, he claimed, the
executive branch of the Brazilian Government largely could do as
it pleased. The record, however, reflects that Brazil operated
under this military regime until about 1985. Thus, the March
1984 Brazilian IRS private ruling was issued to the Central Bank
during this period of military rule. Further, on cross-
examination, da Silva acknowledged that Dornelles had no
connection to the military regime. More importantly, da Silva
did not address the fact that the position taken in SRF 368 was
consistent with the Brazilian Supreme Court's Parana II and Santo
Andre I decisions. The Santo Andre I decision was issued on June
17, 1988, a date well after the military regime had ended. We
find this aspect of da Silva's testimony not credible.
- 69 -
including the Parana I--1st Panel and Parana I--Full Bench
decisions, was contrary to other Brazilian Supreme Court decisions,
including the Parana II decision.
Petitioner's experts were of the opinion that certain
Brazilian Supreme Court decisions, including the Parana II
decision, holding that public-sector entities were not required to
pay withholding tax on their net loan interest remittances abroad,
were incorrectly decided. They maintained that these Supreme Court
decisions improperly extended and applied the taxation principles
of Decree-law 401 to foreign currency loans. Guerra claimed that
the net-loan-versus-gross-loan rationale used in the Parana II
decision to distinguish the Parana I--1st Panel decision was
erroneous, but he acknowledged that this same rationale was applied
and utilized in the Santo Andre I decision. He claimed that this
was a repetition of the error.
Some of petitioner's experts were further of the opinion that
Article 19 of the Brazilian Constitution would not prevent the
Central Bank and other Federal-level autarquias from being subject
to withholding tax on their net loan interest remittances, as
Article 19 of the Constitution, they claim, prohibits taxation only
between the different governmental levels. According to them,
Article 19 prevents the Federal Government of Brazil from taxing
the assets, revenues, and operations of State and municipal
governmental entities, but not the assets, revenues, and operations
- 70 -
of other Federal-level governmental entities, like the Central
Bank.
2. Respondent's Experts
Respondent offered testimony on the applicable Brazilian law
concerning the Central Bank's liability for withholding tax on its
restructuring debt interest remittances abroad from two expert
witnesses: Paulo Bekin and Sergio Tostes. Both Bekin and Tostes
were Brazilian lawyers.
Respondent's experts were of the opinion that the Central Bank
was not required to pay withholding tax on its net loan interest
remittances because of (1) its immunity from taxation under Article
19 of the Brazilian Constitution, and (2) its exemption from
withholding tax under various ordinary laws, including Decree-law
1,215 and Decree-law 4,595 (under which the Central Bank is to
enjoy the same privileges, immunities, and exemptions as the
National Treasury).30
Tostes was of the opinion that the Central Bank was not
required to pay withholding tax on its net loan interest
remittances abroad, because of its immunity from taxation under
Article 19 of the Brazilian Constitution. He claimed that
Brazilian law distinguishes between net loans and gross loans, and
that withholding tax would have to be paid by a public-sector
30
The parties' experts agree that, in a strict technical
sense, immunity from taxation derives from the Brazilian
Constitution, whereas an exemption from tax typically is provided
by an ordinary law.
- 71 -
entity, like the Central Bank, on its gross loan interest
remittances abroad, but not on its net loan interest remittances.
He cited as authority for this proposition the Brazilian Supreme
Court's Parana II decision.
Bekin maintained that the Central Bank would not be required
to pay withholding tax on interest from net loans because it would
be granted exemption from payment of withholding tax under Decree-
law 1,215. He believed that Decree-law 1,215 was the authority for
the Brazilian IRS's issuance of SRF 368. However, on cross-
examination, he acknowledged that, in 1983 and 1984, the National
Monetary Council had set a minimum loan term of 10 years in order
to qualify for exemption under Decree-law 1,215, whereas the phase
I and phase II CGA's and DFA's had loan terms of less than 10
years. Both Bekin and Tostes were of the opinion that the
Central Bank would be exempt under Decree-law 4,595 from payment of
withholding tax with respect to its restructuring debt interest
remittances, as the National Treasury, they maintained, would not
have to pay withholding tax to itself if it, instead, had been the
borrower under the DFA's and CGA's. They pointed out that Decree-
law 4,595 provides that the Central Bank is to enjoy the same
privileges and exemptions as the National Treasury. Tostes further
noted that the March 1984 Brazilian IRS ruling issued to the
Central Bank acknowledged that the Central Bank was acting as an
agent for the National Treasury.
- 72 -
E. Determination of the Applicable Brazilian Law
Petitioner contends that the applicable Brazilian law is
correctly reflected in the Doniak-Kahan draft ruling which was
never issued by the Brazilian IRS. Petitioner asserts that
Brazilian law does not distinguish between gross loans and net
loans. It further maintains that certain Brazilian Supreme Court
decisions, like the Parana II decision, are distinguishable,
because they involved financing of imported goods subject to
Decree-law 401, not foreign currency loans.
Even if Article 19 of the Brazilian Constitution were
applicable to public-sector entities' net loan interest remittances
abroad, petitioner maintains that Article 19 prevents taxation only
between the different governmental levels. Thus, petitioner
contends, while Article 19 might prevent the Brazilian Federal
Government from taxing certain State-level and municipal-level
autarquias (e.g., the Minas Gerais decision), Article 19 would not
prevent the Central Bank and other Federal-level autarquias from
being subject to withholding tax on their net loan interest
remittances abroad.
Alternatively, petitioner maintains that this Court, pursuant
to the act of state doctrine, must accord conclusive effect to the
March 1984 Brazilian IRS private ruling issued to the Central Bank.
As even petitioner's own experts generally acknowledged that the
borrowers-to-be theory applied in the March 1984 Brazilian IRS
- 73 -
ruling did not reflect the applicable Brazilian law, we will deal
with petitioner's act of state argument separately infra.
Respondent, on the other hand, primarily contends that public-
sector entities, like the Central Bank, were not required to pay
withholding tax on their net loan interest remittances abroad
because of their immunity from taxation under Article 19 of the
Brazilian Constitution. Respondent maintains that this was the
applicable law in Brazil both before and after 1984, as reflected
by the Brazilian IRS's issuance of SRF 368 in June 1980 and by
certain Brazilian Supreme Court decisions, including the Parana II
and Santo Andre I decisions. Respondent further asserts that these
Supreme Court decisions involved foreign currency net loans, not
net loans for the financing of imported goods. We agree with
respondent.
The record reflects that to help meet the Brazilian
Government's and the Central Bank's commitment to provide DARF's to
the foreign lenders during the relending periods of the DFA's and
CGA's, top Brazilian IRS officials concocted an elaborate legal
fiction--the borrowers-to-be theory. In light of the States,
municipalities, and other public-sector entities with foreign net
loans, it was not politically feasible for the Brazilian Government
to change the applicable Brazilian law and require all public-
sector entities to pay withholding tax on their net loan interest
remittances abroad. Moreover, as these public-sector entities,
like the Central Bank, were immune from paying withholding tax on
- 74 -
their net loan interest remittances pursuant to Article 19 of the
Brazilian Constitution, a constitutional amendment presumably would
have been required to change the law. As a result, the Doniak-
Kahan draft ruling was never issued.
Top Brazilian IRS officials, instead, devised the borrowers-
to-be theory in an effort to (1) circumvent the Central Bank's tax
immunity, and (2) limit narrowly the scope of the March 1984
private ruling eventually issued as to the Central Bank's interest
remittances during the relending periods under the DFA's and CGA's,
beginning in 1984. By doing so, their ruling would not directly
conflict with existing Brazilian law and would have very little, if
any, potential effect upon other net loan borrowings by public-
sector entities.31 Indeed, in January 1985, during the subsequent
phase III negotiations, the Brazilians, in resisting the efforts of
a number of foreign lenders to have the Central Bank issue DARF's
with respect to all of its net loan interest remittances to them,
advised the BAC that there was "no room for any change * * *
[in the Central Bank's] tax immunity." The Brazilians noted, among
other things, that about 75 percent of the total debt to be
31
On cross-examination, da Silva testified that
Dornelles, upon assigning him and Patury Accioly to revise the
Doniak-Kahan draft ruling, instructed them to adhere to the
"spirit of" the Doniak-Kahan draft ruling but to keep their
opinion within the provisions of SRF 368.
- 75 -
restructured was "exempt from withholding tax on the grounds of
being considered governmental debt."32
Petitioner's reliance upon Article 9 and Article 123 of the
National Tax Code is misplaced. Article 9 generally provides that
an entity's immunity or exemption from tax will not relieve it of
its obligation to collect withholding tax that is due upon its
32
We do not find credible da Silva's testimony that the
entire technical staff of the Brazilian IRS believed that the
Doniak-Kahan draft ruling accurately presented the applicable
Brazilian law with respect to the Central Bank's net loan
interest remittances abroad. Additionally, da Silva claimed that
it was not necessary to publish the March 1984 ruling, because
the Brazilian IRS's technical staff were well aware of the
correctly applicable Brazilian law with respect to public-sector
entities' net loan interest remittances abroad--presumably, as
reflected in the Doniak-Kahan draft ruling that the Brazilian IRS
never issued. We are not convinced by his explanation as to why
the March 1984 Brazilian IRS ruling issued to the Central Bank
was a private ruling. As an expert witness for respondent noted,
although the decision to publish a Brazilian IRS ruling in the
Brazilian Government's Official Gazette is discretionary, the
March 1984 ruling's position represented such a drastic departure
from existing law that, in his opinion, this ruling should have
been published to provide public guidance--if the Brazilian IRS
indeed was changing its interpretation and position with respect
to the applicable law pertaining to public-sector entities' net
loan interest remittances abroad. Da Silva was silent about
what, if any, immediate efforts the Brazilian IRS took either to
(1) revoke SRF 368, or (2) at minimum, publicize, prospectively
apply, and enforce its alleged "new position" on the applicable
Brazilian law concerning public-sector entities' net loan
interest remittances abroad. We do not entirely understand
petitioner's contention, on brief, that SRF 368 was revoked upon
the Brazilian IRS's issuance of the March 1984 private ruling, as
this private ruling applied only to the Central Bank, and not to
other public-sector entities. See infra note 33. In fact,
petitioner's failure to offer evidence concerning such Brazilian
IRS actions to enforce the latter's alleged "new position",
reasonably contemporaneous to its issuance of the March 1984
private ruling to the Central Bank, leads us to conclude that
this evidence would have been harmful to petitioner's case. See
Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158, 1165
(1946), affd. 162 F.2d 513 (10th Cir. 1947).
- 76 -
income remittances to third parties. Article 123 generally
provides that private agreements concerning the liability to pay
taxes are not binding upon the National Treasury. However, the
National Tax Code is a complementary law and cannot override a
public-sector entity's immunity from taxation under Article 19 of
the Brazilian Constitution.
Similarly, petitioner's reliance upon certain "normative"
rulings33 that were issued by the Brazilian IRS from 1971 through
1974 is also misplaced. These rulings generally hold that immune
or exempt entities are required to withhold with respect to their
remittances of income to third parties. The rationale employed in
these rulings is that although the remitter is immune or exempt
from payment of Brazilian income taxes on its income, this immunity
or exemption of the remitter does not extend to the beneficiary or
recipient of the income. Thus, withholding taxes must be paid by
the remitter on behalf of the recipient, unless the recipient of
the income is itself immune or exempt from Brazilian income tax.
However, these rulings were issued prior to October 15, 1975, and
June 10, 1980, the respective dates upon which the Brazilian
Supreme Court's Parana II decision and SRF 368 were issued.34
33
Normative rulings are published in the Brazilian
Government's Official Gazette and are intended to furnish
guidance to and be applicable to the public at large. In
contrast, the March 1984 Brazilian IRS ruling issued to the
Central Bank was a private ruling that applied only to the
Central Bank and not to other public-sector entities.
34
The earlier rulings do not distinguish between gross
(continued...)
- 77 -
On brief, petitioner argues that the Brazilian Supreme Court
decisions, like the Parana II decision, which hold that public-
sector entities are not required to pay withholding tax on their
net loan interest remittances abroad, are distinguishable.
Petitioner maintains that these Brazilian Supreme Court decisions
involved financing of imported goods covered under Decree-law 401,
not foreign currency loans. Thus, it contends that these Supreme
Court decisions are not applicable to the Central Bank's
restructuring debt interest remittances, because the DFA and CGA
loans to the Central Bank were foreign currency loans. However,
some of petitioner's own experts agreed that the loans involved in
these Brazilian Supreme Court cases were foreign currency loans.
One of petitioner's experts further acknowledged that several of
these cases involved repass loans under Resolution 63. See infra
note 36. Indeed, in the Minas Gerais decision, the reporting
34
(...continued)
loan interest remittances and net loan interest remittances by
the immune or exempt entities. However, the most recent of these
rulings, CST Normative Opinion No. 193/74, which was issued on
Oct. 25, 1974, dealt specifically with net loan interest
remittances of tax-exempt foundations. This ruling noted that
these foundations are generally subject to the same tax law rules
as other private entities, except that certain legislation
exempts them from income tax if prescribed requirements are met.
It held that, notwithstanding their exemption from income tax,
the foundations were still required to pay withholding taxes,
even where they have contractually assumed the tax burden. This
last ruling deals with foundations that are exempt pursuant to a
provision of ordinary law and not with public-sector entities
that are immune from taxation pursuant to Article 19 of the
Brazilian Constitution. In the case of a foundation with an
ordinary law exemption from income tax, Articles 9 and 123 of the
National Tax Code may well apply to override the foundation's
ordinary law exemption.
- 78 -
Justice reasoned that Resolution 63 conferred upon the public-
sector entity/repass borrower the status of a foreign currency
borrower.35
Petitioner's experts were of the opinion that those Brazilian
Supreme Court decisions, like the Parana II decision, which hold
that public-sector entities are immune from having to pay
withholding tax on their net loan interest remittances abroad, were
incorrectly decided. They maintain that the legal reasoning
employed by the Brazilian Supreme Court Justices is technically
wrong, because foreign currency loans, not import financing loans,
were involved. According to petitioner's experts, Decree-law 401,
by its terms, applies only to import financing loans, and not to
foreign currency loans.36 In our view, the crux of Parana II was
35
It is further to be noted that pursuant to its receipt
of SRF 368, the Central Bank issued FIRCE 80 and did not require
public-sector entities to pay withholding tax on their net loan
interest remittances abroad, regardless of whether such interest
remittances originated from a currency loan or from financing for
the importation of goods.
36
Petitioner's expert Guerra testified, on cross-
examination, as follows:
Q. All right. However, your view is inconsistent
with at least some of the [Brazilian] Supreme Court
cases that we discussed yesterday, correct?
A. No, I don't think it is because if you pay
attention to the * * * [Parana I--1st Panel
decision], it's--the quotation that I made says like--
is exactly that.
What you have there quoted from * * * [the
dissent to the lower Brazilian Federal Court of
Appeals' majority decision] is that if--were the state
(continued...)
- 79 -
36
(...continued)
of--were the state of Parana the recipient of the
interest on which the union would claim a tax, I would
recognize the immunity. However, we are in a different
situation in this case in which the recipient of the
interest is a third party, and in this case the
immunity does not apply.
Q. I wasn't particularly talking about the
* * * [Parana I--1st Panel and Parana I--Full
Bench decisions]; I was talking about some of the other
cases we discussed.
A. Oh, the other, the two, I would say they
should be approached with two qualifications. The
first one is that they all concern, except for one,
Resolution 63 loans, which is a different thing. And
most important in that, none of these loans which were
dealt with in these other cases were import financing;
they were all, the three or the five of them, if you
compute all of them, straightforward currency loans.
And as we were discussing yesterday, the Decree Law
401, which the court applied or argued in all these
cases, only * * * [applies] to import financing and not
to currency loans.
That's the two main reservations or qualifications
that apply to these precedents of the Supreme Court.
Q. So you acknowledge that the Supreme Court
cases we discussed yesterday did not involve import
financing, correct?
A. Yes. In the--my--the main criticism they may
be subject to is that although they do not involve
import financing, they apply one legal provision which
applies only to import financing. That's the big
contradiction of these decisions, and that's their weak
point.
Q. That's the reason you think the decisions are
wrong or you [are in] disagreement with them, right?
A. Well, I disagree with them, yes. Sure.
Q. Okay.
(continued...)
- 80 -
the distinction it drew between a net loan and a gross loan in
order to distinguish the previous holding reached in the Parana I--
1st Panel decision.37 Although the Parana II decision cited and
discussed the provision in Decree-law 401 that deems the
borrower/remitter to be the contribuente where imported goods are
purchased on an installment basis, that discussion was in rebuttal
of the losing party's argument that the actual beneficiary of the
interest was the foreign lender, not the State of Parana.
Moreover, if the 1975 Parana II decision was incorrectly decided,
as petitioner's experts claim, we then find it puzzling that, over
the years, no successful challenge to its holding has been made,
and that the Brazilian Supreme Court has continued to utilize and
36
(...continued)
A. Except for the * * * [Parana I--1st Panel
and Parana I--Full Bench decisions], I do disagree.
Q. You disagree with all the ones that held the
borrower was immune?
A. These are the ones. They are not different
ones.
37
Da Silva indicated in his testimony that he believed
the Parana I--1st Panel decision involved a gross loan, whereas
the Parana II decision involved a net loan. Pedreira testified
that the Parana II decision definitely involved a net loan.
Guerra maintained that the Parana I--1st Panel decision possibly
did not involve a gross loan. He claimed that if the case
involved a gross loan, there then would be no reason for the
State Highway Department to litigate and dispute payment of the
withholding tax, as a victory would not benefit the Highway
Department but only the foreign lender. However, Guerra did
agree that the Parana II and Santo Andre I decisions involved net
loans. We note that both the Parana II and Santo Andre I
decisions utilized a net-loan-versus-gross-loan rationale to
distinguish the Parana I--1st Panel holding.
- 81 -
apply the case's net-loan-versus-gross-loan rationale in similar
cases involving foreign currency loans.
The evidence reflects that this particular point petitioner's
experts raise involves an area of Brazilian law in which there has
been considerable controversy. Although Article 11 of Decree-law
401, by its terms, seems to be applicable only to import financing
loans, even petitioner's experts acknowledge that Decree-law 401
and the 1972 Brazilian Supreme Court decision that upheld the law's
validity have caused a great deal of confusion and generated
controversy in the area. As petitioner's expert Gurerra related:
some key legal principles in connection with the taxation
of interest remitted by * * * [Brazilian borrowers]
to * * * [foreign lenders]--namely the * * *
[National Tax Code] definitions of taxable event,
taxpayer, tax base and tax responsible and the scope of
the * * * [constitutional] tax immunity--were neither
adequately nor consistently applied by the * * *
[Brazilian Supreme Court].
* * * The source of this problem was * * * [the
1972 Brazilian Supreme Court decision that upheld the
validity of Decree-law 401], while * * * [Article 11
of Decree-law 401 in defining the borrower remitting the
interest abroad to be the contribuente] clearly violates
the * * * [National Tax Code] definitions of taxable
event and taxpayer; the majority opinions varied largely
and did not express a precise understanding of the * *
* [National Tax Code] on the main issues of the case.
Subsequently, in addressing other cases dealing with
these topics, the * * * [Brazilian Supreme Court] was
confronted with its conclusion in * * * [its 1972
decision] and found no guidance in the varied opinions
that had formed the majority in * * * [that
precedent].
It is neither necessary nor appropriate for us to decide
whether certain Brazilian Supreme Court decisions, including the
Parana II decision, were technically "wrong" in part of their legal
- 82 -
reasoning because, as petitioner's experts assert, the Brazilian
Supreme Court Justices failed to appreciate that Decree Law 401
applies only to import financing loans, not foreign currency
loans.38 Of significance for our purposes in determining the
applicable Brazilian law is that these Brazilian Supreme Court
decisions, notwithstanding petitioner's experts' criticism of them,
represent the Brazilian Supreme Court's legal position. Over the
years, the Brazilian Supreme Court, in Parana II and other similar
cases involving foreign currency loans, has consistently held that
public-sector entities, like the Central Bank, are immune from
paying withholding tax on their net loan interest remittances
abroad under Article 19 of the Brazilian Constitution.
We do not accept petitioner's contention that Brazilian law
fails to distinguish between net loans and gross loans, in
situations in which the borrower/remitter is a public-sector entity
having an immunity from taxation pursuant to Article 19 of the
Brazilian Constitution. In addition to the expert testimony the
parties have offered and the Brazilian Supreme Court cases
discussed above, other evidence in the record confirms that the
38
We are hesitant to substitute our judgment on a matter
of Brazilian law for that of the Brazilian Supreme Court Justices
who reported these decisions. In any event, this is a matter
which we need not resolve, as in its subsequent decisions (which
petitioners' experts agree involved foreign currency loans) the
Brazilian Supreme Court has continued to utilize and apply Parana
II's net-loan-versus-gross-loan rationale. We further note that
even the Brazilian Government and the Brazilian IRS appear to
have attached little, if any, practical significance to the fact
that the loans made to the Central Bank under the DFA's and CGA's
were currency loans and not import financing loans.
- 83 -
Central Bank, under Brazilian law, was constitutionally immune from
having to pay withholding tax with respect to its net loan interest
remittances abroad. Pursuant to its receipt of SRF 368 from
Dornelles (the head of the Brazilian IRS), the Central Bank, in May
1981, issued FIRCE 80 and did not require public-sector entities,
like itself, to pay withholding tax on their net loan interest
remittances abroad, regardless of whether the interest remittances
originated from a currency loan or from an import financing loan.
Da Silva (a fact witness, as well as petitioner's expert witness,
and the author of the March 1984 Brazilian IRS private ruling
issued to the Central Bank) essentially confirmed that, during
1983, when the Brazilian IRS's proposed issuance of the Doniak-
Kahan draft ruling that conflicted with SRF 368 was being hotly
debated within the Brazilian Government and the Brazilian IRS,
certain existing Brazilian Supreme Court decisions, including the
Parana II decision, supported the position taken in SRF 368. As a
result of this debate, Dornelles decided that he could not approve
the issuance of the Doniak-Kahan draft ruling to the Central Bank.
Instead, in the March 1984 Brazilian IRS ruling that eventually was
issued to the Central Bank, top Brazilian IRS officials contrived
to get around the constitutional tax immunity of the Central Bank
and other public-sector entities, through applying the novel
borrowers-to-be theory. As indicated by the Brazilians' comments
to the BAC in January 1985, during the phase III negotiations,
although the Brazilians were willing to continue applying the
- 84 -
borrowers-to-be theory and to negotiate a longer relending period
for the phase III DFA, they were unwilling to make any change in
the Central Bank's tax immunity. In their comments, the Brazilians
also advised the BAC that about 75 percent of the phase III debt to
be restructured was not subject to withholding tax because it was
governmental debt.
Lastly, we reject petitioner's contention that Article 19 of
the Brazilian Constitution does not prohibit the Brazilian Federal
Government from taxing the assets, revenues, and operations of
Federal-level autarquias, like the Central Bank, as Article 19,
petitioner maintains, precludes taxation only between the different
governmental levels. Although some of petitioner's experts did
give opinions to that effect, we agree with respondent's expert
Tostes that such an interpretation of the constitutional tax
immunity of public-sector entities is contrary to the provisions of
Article 19, and is an unreasonable and questionable construction of
Article 19.39 If petitioner's interpretation of Article 19 were
39
Article 19 of the Brazilian Constitution provides, in
pertinent part:
Article 19. The Union, the states, the Federal
District, and the Municipalities, are forbidden to:
* * * * * * *
III. Establish a tax on:
a. The assets, revenues, or services of one
another.
* * * * * * *
(continued...)
- 85 -
correct, then a Brazilian State would be free to tax the assets,
revenue, and operations of other Brazilian States. Similarly, a
Brazilian municipality could tax other Brazilian municipalities.
Petitioner has cited no persuasive Brazilian legal authority for
this proposition. We further note other convincing evidence of
record. The Central Bank, following its issuance of FIRCE 80 in
May 1981, did not require withholding tax to be collected with
respect to the net loan interest remittances abroad of all public-
sector entities, including "federal, state, and municipal
autonomous governmental agencies". In January 1985, during the
phase III negotiations, the Brazilians, in resisting the efforts of
foreign lenders to have the Central Bank issue them DARF's and
ostensibly pay withholding tax on all its net loan interest
remittances abroad, advised the BAC that there was "no room for any
change * * * [in the Central Bank's] tax immunity."
In our opinion, the applicable Brazilian law with respect to
the Central Bank's restructuring debt interest remittances is as
reflected in SRF 36840 and in certain Brazilian Supreme Court
39
(...continued)
Paragraph 1. The provisions of letter a of item
III above extends to the autonomous governmental
entities, as regards the assets, revenues, and services
connected with their essential purpose or resulting
therefrom * * *
40
On brief, petitioner asserts that, to the best of its
knowledge, "no banks lending to Brazil were aware of SRF 368
until March 18, 1994, when Respondent produced a copy in its
(continued...)
- 86 -
decisions, like the Parana II decision. Consequently, we conclude
that, under Brazilian law, public-sector entities, like the Central
Bank, are not required to pay withholding tax on their net loan
interest remittances abroad, because of their immunity from
taxation under Article 19 of the Brazilian Constitution.
F. The Act of State Doctrine
As indicated previously, we have determined that SRF 368 and
certain Brazilian Supreme Court decisions, including the Parana II
decision, correctly reflect the applicable Brazilian law that
public-sector entities are not required to collect and pay over
withholding tax with respect to their net loan interest remittances
40
(...continued)
Status Report filed on that date. Respondent has never explained
how or where she obtained SRF 368." Petitioner also notes
certain testimony of employees and representatives of various
major international banks that the banks' Brazilian counsel had
advised them that the Central Bank was required to pay
withholding tax on its net loan interest remittances abroad. The
record does not support petitioner's assertion that none of the
banks were aware of SRF 368 until Mar. 18, 1994. Alexandre
Leite, who headed Citibank-Brazil's tax division, testified that
after the Central Bank's issuance of FIRCE 80 in May 1981, he
concluded that Citibank would not be able to persuade the Central
Bank to issue DARF's with respect to its 432 program net loan
interest remittances. He stated that with FIRCE 80 "there was a
ruling from the tax revenue service * * * that any immune
entity would not be obliged to * * * [issue withholding
receipts in remitting interest]." See supra note 12. We thus do
not believe that the major international banks, like Citibank,
that were seeking DARF's with respect to the Central Bank's net
loan interest remittances to them, much less these banks'
Brazilian counsel, were unaware of SRF 368 until Mar. 18, 1994.
The record further fails to disclose what specifically the banks'
Brazilian counsel told the banks or did not tell the banks with
respect to SRF 368.
- 87 -
abroad.41 Petitioner, nevertheless, contends that the March 1984
Brazilian IRS private ruling issued to the Central Bank must be
accorded conclusive effect under the act of state doctrine. On
brief, petitioner asserts:
Even if Respondent were correct and * * * [the
March 1984 Brazilian IRS private ruling] represented a
change in the * * * [Brazilian IRS's] historical
position, this would not affect * * * [the March 1984
ruling's] validity. * * * [Respondent] regularly
defends her ability to revise her rulings as necessary
and appropriate in the circumstances.
* * * Therefore, the * * * [Brazilian IRS would
not have been required to follow an erroneous prior
practice any more than * * * [respondent] would be
required to follow such a practice.
* * * * * * *
Respondent's argument would require this Court to
disregard * * * [the March 1984 Brazilian IRS ruling
issued to the Central Bank] and the Minister of Finance's
directive that taxes be withheld on the DFA and CGA
interest payments. Respondent argues that the * * *
[Brazilian IRS] "compromised" Brazilian tax law, and that
this Court must rule against the * * *[Brazilian IRS] on
a question of Brazilian tax law. Thus, Respondent
invites the Court to violate the Act of State doctrine by
"declar[ing] invalid, and thus ineffective as 'a rule of
decision for the courts of this country,' the official
act of a foreign sovereign." W.S. Kirkpatrick & Co. v.
Environmental Tectonics Corp. Int'l., 493 U.S. 400, 405
(1990) * * *.
41
In Amoco Corp. v. Commissioner, T.C. Memo. 1996-159, we
held that an Egyptian Tax Department determination reflected the
applicable Egyptian law and rejected the Commissioner's argument
that this Tax Department determination could have been
successfully challenged. We stated that whether the Tax
Department's determination could have been successfully
challenged was unclear, because, at the time, there was no
existing precedent that focused on the precise issue involved.
We further stated that, on the facts presented, we perceived no
reason to delve into the motives of a foreign government in
connection with its tax determinations. The instant case is
distinguishable from Amoco.
- 88 -
In the principal contemporary formulation of the act of state
doctrine, the U.S. Supreme Court in Banco Nacional de Cuba v.
Sabbatino, 376 U.S. 398, 428 (1964), stated:
rather than laying down or reaffirming an inflexible and
all-encompassing rule in this case, we decide only that
the Judicial Branch will not examine the validity of a
taking of property within its own territory by a foreign
sovereign government, extant and recognized by this
country at the time of suit, in the absence of a treaty
or other unambiguous agreement regarding controlling
legal principles, even if the complaint alleges that the
taking violates customary international law.
The act of state doctrine thus generally precludes judicial
examination of the lawfulness of a taking by a foreign sovereign of
property located in its territory, whether under the law of that
foreign country, under international law, or under the law or
policy of the forum. 1 Restatement, Foreign Relations Law 3d, sec.
443, cmt. d (1986).42
Although the act of state doctrine has predominantly been
applied in cases involving a foreign sovereign's expropriation of
private property, the doctrine has also been applied to other types
of acts by foreign sovereigns. Id. cmt. c & reporter's note 7.
The burden of establishing the act and its character as an act
of state is on the party invoking the doctrine. Republic of the
Philippines v. Marcos, 806 F.2d 344, 356-357, 359-360 (2d Cir.
1986); 1 Restatement, supra sec. 443, cmt. i & reporter's note 3.
42
The act of state doctrine is to be contrasted with the
U.S. courts' well-established refusal to enforce a foreign
country's penal or revenue laws. Banco Nacional de Cuba v.
Sabbatino, 376 U.S. 398, 413-415 (1964); 1 Restatement, Foreign
Relations Law 3d, sec. 443, cmt. i & reporter's note 10 (1986).
- 89 -
The act of state doctrine applies to acts such as constitutional
amendments, statutes, decrees, and proclamations, and in certain
circumstances, to physical acts. 1 Restatement, supra sec. 443,
cmt. i & reporter's note 3.
In the instant case, the March 1984 Brazilian IRS ruling
issued to the Central Bank was a private ruling. Petitioner's
experts did not elaborate on whether the Central Bank, under
Brazilian law, was legally compelled to accept and follow the
ruling. Thus, it appears that the Central Bank possibly could have
disputed that it was subject to withholding tax on its
restructuring debt interest remittances during the relending
periods of the DFA's and CGA's, and sought review in the Brazilian
courts. In light of favorable existing Brazilian Supreme Court
precedents, such as the Parana II decision, in all substantial
likelihood, any effort by the Central Bank to dispute the ruling by
resorting to the Brazilian judicial system would have been
successful, particularly since even petitioner's own experts
generally acknowledged that there was no such legal doctrine as the
borrowers-to-be theory under Brazilian law. The borrowers-to-be
theory itself contravened a number of rules of Brazilian taxation.
The record further reflects that although Brazil was under a
military regime until about 1985, the Brazilian courts still
functioned during this period of military rule.43 Moreover, the
43
Although petitioner's expert da Silva testified that
SRF 368 was issued in June 1980, when Brazil was under a military
(continued...)
- 90 -
March 1984 private ruling still conflicted with SRF 368, despite
the efforts of top Brazilian IRS officials, in devising the
borrowers-to-be theory, to distinguish from SRF 368 the Central
Bank's restructuring debt interest remittances during the relending
periods of the DFA's and CGA's.44
We conclude that petitioner has failed to establish that the
act of state doctrine is applicable. Petitioner has not shown that
the March 1984 Brazilian IRS ruling was anything more than perhaps
an administrative advisory opinion.45 We are thus not required to
accord conclusive effect to the March 1984 Brazilian IRS ruling
issued to the Central Bank. Rule 142(a); Republic of the
Philippines v. Marcos, supra.
G. Conclusion
We hold that the Central Bank was not required, under
Brazilian law, to pay withholding tax on its restructuring debt
43
(...continued)
regime, he also indicated that the Brazilian courts had more
leeway than the Brazilian Congress. He related that Brazil had
been under this military regime from 1964 through March 1985. We
note that the Brazilian Supreme Court's Parana II and Minas
Gerais decisions were issued, respectively, in 1975 and in 1979,
during this period when Brazil was under military control.
44
As indicated above, the record does not reflect that
the Brazilian IRS ever revoked SRF 368. See supra note 32.
45
Although the Finance Minister "directed" the Central
Bank to begin "paying" this "withholding tax" by the last
business day of the month following the month in which the
Central Bank started "withholding", his action was merely in
response to the Central Bank's request, in the consulta, that it
be granted a waiver of any late payment "penalties", as only the
Finance Minister had the authority to extend the time for
"payment" and to waive such "penalties".
- 91 -
interest remittances to petitioner during the relending periods of
the DFA's and CGA's. Petitioner is thus not "legally liable" for
these alleged Central Bank "withholding tax payments". Nissho Iwai
Am. Corp. v. Commissioner, 89 T.C. 773-774; sec. 1.901-2(f),
Income Tax Regs.; see the PeMex case.
II. Central Bank Issue
Our holding on the Central Bank/liability issue requires us to
decide the Central Bank issue against petitioner. As petitioner is
not "legally liable" for the Brazilian tax, we hold that the
"withholding tax" purportedly paid by the Central Bank on its
restructuring debt interest remittances to petitioner is a
noncompulsory amount and not a tax to Brazil under section 1.901-
2(e)(5), Income Tax Regs., and is not creditable to petitioner.
Sec. 1.901-2(e)(1), Income Tax Regs. Petitioner has not argued
that, even if these alleged withholding tax payments were not
required and exceed the amount of petitioner's actual Brazilian tax
liability, they are still potentially creditable to petitioner
pursuant to section 1.901-2(e)(5)(i), Income Tax Regs.46 We do not
46
The regulations provide relief, in certain limited
circumstances, to taxpayers who reasonably interpret foreign law
but overpay their actual foreign tax liability. Among other
things, the amount of foreign tax paid must be determined by the
taxpayer in a manner that is consistent with a reasonable
interpretation and application of the substantive and procedural
provisions of foreign law. Further, an interpretation of foreign
law is not considered reasonable if there is actual or
constructive notice (e.g., a published court decision) to the
taxpayer that the interpretation is likely erroneous. Also,
while a taxpayer generally may rely on advice obtained in good
faith from competent foreign tax advisers, the taxpayer must have
(continued...)
- 92 -
decide whether these alleged withholding tax payments, in fact,
were made by the Central Bank.47
46
(...continued)
disclosed to them the relevant facts. See sec. 1.901-2(e)(5)(i),
Income Tax Regs. In any event, on the record presented in the
instant case, petitioner has failed to establish it would be
eligible for such relief. As previously discussed, petitioner's
assertion that no banks lending to Brazil were aware of SRF 368
until Mar. 18, 1994, is untrue. We do not believe that certain
major international banks, like Citibank, much less these major
international banks' Brazilian counsel, were unaware of SRF 368
and the Brazilian Supreme Court's Parana II decision. See supra
note 40. Moreover, notwithstanding the March 1984 Brazilian IRS
private ruling issued to the Central Bank, even some of the
employees and representatives of these major international banks
who testified at trial indicated that they were skeptical of the
ruling's borrowers-to-be theory.
47
The parties disagree over whether the Central Bank
actually paid "withholding tax" on its restructuring debt
interest remittances to foreign lenders during the relending
periods of the CGA's and DFA's, beginning in 1984. At trial,
petitioner offered the testimony of an employee of Banco do
Brazil, the Brazilian National Treasury's agent for payment of
taxes. The Banco do Brazil employee was offered by petitioner as
an expert witness with respect to the manner in which Banco do
Brazil accounted for its withholding tax payment collections. He
examined one purported withholding tax payment of the Central
Bank on its restructuring debt interest remittances, which he
selected at random, and verified that certain entries had been
made on Banco do Brazil's books reflecting Banco do Brazil's
receipt of the Central Bank's purported withholding tax payment.
However, as we noted in our findings, it is not known: (1)
Whether the Central Bank was reimbursed by the National Treasury
for its restructuring debt "withholding tax payments", or (2)
whether the Central Bank received the pecuniary benefit based on
such "withholding tax payments". Petitioner's expert
acknowledged that he had not inquired into whether the Central
Bank received the pecuniary benefit or whether any other
transactions took place resulting in a "refund" being made of the
Central Bank's "withholding tax payments". Although we do not
decide the payment issue, the Central Bank's actual receipt of
the pecuniary benefit would be highly probative evidence
confirming its actual payment of this "withholding tax". If the
Brazilian Government reimbursed the Central Bank for these
"withholding tax payments", because the Central Bank was acting
(continued...)
- 93 -
III. Subsidy/Pecuniary Benefit Issue
Section 4.901-2(f)(3), Temporary Income Tax Regs., 45 Fed.
Reg. 75653-75654 (Nov. 17, 1980), provides:
(f) Amount of income tax paid or accrued-(1)
In general. A credit is allowed under section 901 for
the amount of income tax * * * that is paid or
accrued to a foreign country, subject to the provisions
of paragraph (f). The amount of income tax paid or
accrued is determined separately for each taxpayer.
* * * * * * *
(3) Subsidies-(i) General rule. An amount is not
income tax paid or accrued to a foreign country to the
extent that-
(A) The amount is used, directly or indirectly, by
the country to provide a subsidy by any means (such as
through a refund or credit) to the taxpayer; and
(B) The subsidy is determined directly or indirectly
by reference to the amount of income tax, or the base
used to compute the income tax, imposed by the country on
the taxpayer.
(ii) Indirect subsidies. A foreign country is
considered to provide a subsidy to a person if the
country provides a subsidy to another person that-
(A) Is owned or controlled, directly or indirectly,
by the same interests that own or control, directly or
indirectly, the first person; or
(B) Engages in a business transaction with the first
person, but only if the subsidy received by such other
person is determined directly or indirectly by reference
to the amount of income tax, or the base used to compute
the income tax, imposed by the country on the first
person with respect to such transaction.
47
(...continued)
as the Brazilian Government's agent, then the Central Bank, in
all likelihood, would not receive the pecuniary benefit based on
such "tax payments".
- 94 -
Substantially identical provisions are made in section 1.901-
2(e)(3), Income Tax Regs.
Pursuant to section 4.901-2(f)(3)(ii), Temporary Income Tax
Regs., supra, and section 1.901-2(e)(3)(ii), Income Tax Regs., the
existence of an indirect subsidy does not depend upon a finding
that the U.S. taxpayer derived an actual economic benefit. It is
sufficient that another person who engages in a transaction with
the U.S. taxpayer has received a subsidy that was based on the
amount of tax paid. Norwest Corp. v. Commissioner, 69 F.3d at
1409-1410; Continental Ill. Corp. v. Commissioner, 998 F.2d at
519-520; Bankers Trust New York Corp. v. United States, 36 Fed. Cl.
30 (1996). Thus, subsidies received by Resolution 63 repass lenders
and repass borrowers also fall "within the letter as well as the
spirit of" the indirect subsidy provision of the temporary and
final regulations, as the repass lender is required by Brazilian
law to pass along the pecuniary benefit to the repass borrowers.
Norwest Corp. v. Commissioner, 69 F.3d at 1410; Continental Ill.
Corp. v. Commissioner, 998 F.2d at 520, affg. on this issue T.C.
Memo. 1988-318; Bankers Trust New York Corp. v. United States,
supra at 36. Further, this Court and other courts, including the
U.S. Courts of Appeals for the Seventh and Eighth Circuits, have
upheld the validity of the indirect subsidy provision of the
temporary regulations, and have held that U.S. taxpayer-lenders
are required to reduce the amount of their potentially creditable
Brazilian withholding taxes by the pecuniary benefit the Brazilian
- 95 -
Government provided to their Brazilian borrowers. Norwest Corp. v.
Commissioner, 69 F.3d at 1408-1410; Continental Ill. Corp. v.
Commissioner, 998 F.2d at 519-520; Nissho Iwai Am. Corp. v.
Commissioner, 89 T.C. 775-777 (1989); Bankers Trust New York
Corp. v. United States, supra at 35.48
Petitioner argues that the "subsidy * * * to the taxpayer"
language in the temporary and final regulations requires an
economic benefit analysis and asserts that petitioner itself
received no economic benefit from the pecuniary benefit the
Brazilian Government provided to Brazilian borrowers. Petitioner
points out that, in the case of Resolution 63 repass loans, it did
not even know the identity of the repass borrowers who received the
pecuniary benefit. It contends that if the regulations are applied
to require reduction of the Brazilian withholding tax potentially
creditable to petitioner by the pecuniary benefit the Brazilian
borrowers received, then the regulations are invalid. We disagree.
We hold that pursuant to section 4.901-2(f)(3)(ii), Temporary
Income Tax Regs., supra, and section 1.901-2(e)(3)(ii), Income Tax
Regs., the Brazilian withholding tax potentially creditable to
petitioner must be reduced by the pecuniary benefit the non-tax-
immune borrowers received. We further hold that the indirect
48
The position set forth in the temporary and final
regulations has been codified in sec. 901(i), which is effective
for foreign taxes paid or accrued in taxable years beginning
after Dec. 31, 1986. Tax Reform Act of 1986, Pub. L. 99-514, sec.
1204(a), 100 Stat. 2532; see Nissho Iwai Am. Corp. v.
Commissioner, 89 T.C. 777 n.17.
- 96 -
subsidy provisions of the temporary and final regulations are
valid. Norwest Corp. v. Commissioner, 69 F.3d at 1408-1410;
Continental Ill. Corp. v. Commissioner, 998 F.2d at 519-520; Nissho
Iwai Am. Corp. v. Commissioner, supra at 775-777. In light of our
holdings on the legal liability and Central Bank issues (i.e., that
the "withholding tax" purportedly paid by the Central Bank on its
restructuring debt interest remittances to petitioner is not a
potentially creditable tax to petitioner), we need not reach the
issue of whether any pecuniary benefit the Central Bank received
represents an indirect subsidy for purposes of section 1.901-
2(e)(3)(ii), Income Tax Regs. Compare the PeMex case with Amoco
Corp. v. Commissioner, T.C. Memo. 1996-159.
To reflect concessions by the parties,
Decision will be entered
under Rule 155.