# UNITED STATES TAX COURT

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## Record

- **Collection:** Agency decision
- **Document type:** Agency decision

## Text

F CORDID

107 T.C. No. 18

FILES

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.

Filed 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.
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

ERVED .DEC 1 0 1996

- 2 Central Bank and other Brazilian borrowers on their net
loan interest remittances to P.
1.
Held:
The withholding tax paid by non-taximmune 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,
Commissioner,

89 T.C. 765 (1987); Norwest Corp. v.
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
2.

Held,

(7th Cir. 1993), followed.

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, Ra-jiv Madan, Mary Ann Amodeo, and Janice E. Lamartine,
.

for respondent.

JACOBS,
Federal

Judge:

Respondent determined deficiencies in the

income tax of petitioner Riggs National

Corporation

&

- 3 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.
for decision are as follows:

The primary issues

(1) Whether petitioner is legally

liable for the Brazilian withholding tax purportedly.paid by its
Brazilian borrowers on their net

loan interest

petitioner (the .legal liability issue);

remittances

to

(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

through June 28,

1985,

during

the

period

from

January

1,

1980,

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 Carp. v.
Commissioner,

1995);

T.C.

Memo.

1992-282,

First Chicago Corp. v.

affd.

69 F.3d 1404

Commissioner,

T.C. Memo.

(8th Cir.

1991-44;

Continental Ill. Corp. v. Commissioner, T.C. Memo. 1988-318, affd.

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.

.

- 4 without published opinion sub nom. Citizens & S. Corp. & Subs. v.
Commissioner,
revd.

919 F.2d 1492

(11th Cir.

1990),

in part 998 F.2d 513

(7th Cir.

1993)

Corp. v. Commissioner, 89 T. C. 765 (1987) .
cases

affd.

in part and

and Nissho Iwai. Am.

However, none of those

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

accordingly.

the

facts

have

been

The parties have

stipulated

and

are

found

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.

- 5 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

reserves grew larger.

foreign debt

to

its

foreign currency

The Brazilian Government sought to reduce

Brazil's trade deficit by decreasing imports, increasing exports,
and

encouraging

development.

It

foreign

borrowing

for

hoped

increase

the

to

internal

domestic

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

foreign currency in international markets.

was

freely tradeable,

as

a practical

not

convertible

to

Although the cruzeiro

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

term for foreign loans which varied from 5 to 12 years.

Although

•

the

Brazilian

Government

sought

to

inflation through an indexing system,

decrease

the

effects

of

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,
banks.

including some major U.S.

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.
sets

the

Through the registration process, the Central Bank

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.
Brazilian

bank

converted

the

foreign

currency

The

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

withholding

tax

Receitas Federais

law,

the

borrower

by

submitting

a

initiated

Documento

de

payment

of

the

Arrecadacao

de

(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
a completed DARF and payment of the tax as evidence that the proper
amount of the tax had been paid.2

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
( continued. . . )

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

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

2(...continued)
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·.

•

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;

of national interest,

(2) the loan was

(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.
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,

persons

residing or domiciled abroad.

and expenses
•On the

remitted to

same

date

that

Decree-law 1,351 was enacted (October 24, 1974), the Central Bank

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.
.

.

- 10 issued

Resolution

interest,

305,

which

commissions,

temporarily

reduced

the

tax

on

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:
income

tax on interest,

persons

resident

benefits

to

or

commissions,

domiciled

Brazilian

and expenses

abroad,

borrowers

(1) Reduce the

or

(2)

receiving

remitted to

grant

loans

pecuniary

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

reinstated

same day that

the

(i.e.,

5,

August

25-percent
1975),

tax on interest was

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.
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 25percent 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

- 11 -

c. the banking establishment receiving the tax payment
would debit its own account entitled "Pecuniary BenefitD.L. · 1,411, " and would charge the total value of the
pecuniary benefit against the Central Bank.
On July 26,

1979,

percent of the tax.

the pecuniary benefit was reduced to 50

On December 7, 1979, the pecuniary benef it 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.
certain

Brazilian

specific

purpose

banks
of

to

borrow

relending

Resolution 63 permitted

funds

from

(repassing)

abroad

the

for

the

corresponding

borrowed funds in Brazilian currency to Brazilian companies (repass
borrowers).
bank

were

The charges paid by a repass borrower to a Brazilian
in

the

same

proportion

Brazilian bank to the foreign lender.

as

the

charges

paid by the

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

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.

- 12 -

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

borrowers

were

available.

Brazilian

banks,

foreign

repass
In

loans

making

lenders

if

Resolution

generally

when
63

assumed

Brazilian bank would repass its cost of funds
foreign lender' s loan)

and

local

loans

to

that

the

(the cost of the

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

.

- 13 -

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.
.Beginning in 1974, Resolution 63 funds not utilized in repass

operations could be deposited with the Central Bank.
funds were deposited,

When such

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

- 14 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
thereon;

correspondingly,

the

Brazilian

borrower

taxes

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

authority:

Brazilian tax system is
The

Federal

divided

Constitution

into
of

three

Brazil

types

of

(Federal

- 15 Constitution), the National Tax Code, and ordinary Federal, State,

and municipal legislation."
The Federal Constitution divides the authority to tax among
the

Federal

Brazil.

Government,

the

States,

and the municipalities

of

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.

Article 19 of the Federal Constitution provides that
Federal

Government,

States,

and

municipalities

immunity from taxation of their income,
Article

.

this

assets,

19

further

extends

immunity

"autarquias"

(i.e.,

autonomous governmental

are

to

the

enjoy

and operations.

from

taxation

entities)

like

to
the

Central Bank.
The National Tax Code establishes the parameters within which
the

taxing

authority

of

the

Federal

municipalities may be exercised.

Government,

States,

and

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.

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.

- 16 -

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)

the interest of collection of tax.

in

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
obligated

to make

121

of

the

the

payment

National
of

subject" of the principal obligation.
principal obligation is either:

tax

Tax
is

Code,

called

the
the

person
"passive

The passive subject of the

(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

- 17 -

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.
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

obligation.
Since

the

tax

.
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%
15
20
25
5
25

1944-47
1948-54
1955-58
1959-74
1974-75
1975-Present

- 18 -

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 söurce .
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.

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

governmental agencies.
Subject:

agencies

that

is

binding

upon

the

SRF 368 stated, in pertinent.part:

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:

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.

- 19 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
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.
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:

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.

.

- 20 -

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)];
.
For purposes of clarification,
public-sector entities:

-the
Union,
States,
Municipalities * * * ;
-federal territories

-

*

the following are

Federal
*

District,

and

* ;

-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
(Of f icial Letter SRF no. 368, dated 6/10/80) . "
M.

Latin Debt Crisis

A number of Latin American countries,
Mexico, incurred large foreign debts.

1980's,

including Brazil and

Beginning in about the early

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 ma]or international banks in the G-7 countries) and

- 21 -

the

Mexican Government

agreed to a restructuring of

Mexico's

foreign debt.
Brazil

began experiencing

foreign debt in 1982.

similar problems

In late 1982,

in paying

its

the Brazilian Government

declared a moratorium with respect to the repayment of Brazil' s
foreign debt.
As a practical matter,
Citibank,

the major international banks,

like

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.
one

The banks and the regulators believed that a default by

Latin American

worsening

economic

country on its

conditions

foreign

which

would

debt

could

cause

lead

other

to

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

- 22 -

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

restructuring that took place was divided into three phases:
I, phase II, and phase III.

debt
Phase

Initially, the major international

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

lacked

currency

sufficient

foreign

loan payments because Brazil

effectuate the foreign loan payments.

reserves

with

which

to

This belief of the major

international banks proved to be erroneous, and Brazil continued to

.

require

yet

additional

lenders,

including

the

financial
later

assistance

phase

II

and

from

its

foreign

phase

III

of

the

Brazilian foreign debt restructuring.
Of f icials at the highest le.vels 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

- 23 -

negotiators

were

Finance

Ministry

officials

and

Central

Bank

the

Brazilian

Foreign

Debt

the

borrower

officials.
O.
Mechanics
Restructuring

The

and Negotiations

Central

Bank

served

of

as

under

certain

agreements entered into in connection with phase I, phase II, and
.

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,

Additionally,

the

could

Central

be

Bank

sued

held

in

foreign

courts.

of

Brazil's

foreign

all

currency reserves.
There were perhaps as many as 600 foreign lenders holding

outstanding Brazilian

loans.

issued

outstanding

thousands

of

Collectively,
loans

to

these

lenders

numerous

had

Brazilian

borrowers.
As it was not feasible to have the foreign lenders and their
Brazilian

borrowers

renegotiate

facility

agreement

(DFA)

all

mechanism

outstanding loans would be left

these
was

loans,

devised.

in place.

the
The

deposit
prior

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

- 24 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.
foreign

lenders

holding

the

largest

amounts

of

Brazilian loans participated in the phase I CGA.

Only the 170
outstanding

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) .
8

No phase III CGA was entered.

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
( continued. . . )

- 25 -

Phase I
After

the

Brazilian

Government

imposed

its

foreign

debt

repayment moratorium in December of 1982, Citibank and Morgan Bank,
two

major

international

banks

holding

the

largest

amounts

of

outstanding Brazilian loans, took the lead in negotiating the phase
I

restructuring

restructuring

of

Brazil's

agreements

were

foreign
entered

debt.

The

phase

I

and

its

into by Brazil

foreign lenders on February 25, 1983.
The phase I restructuring included:
covered

the

scheduled

debt

outstanding Brazilian loans,

payments
(2)

(1) A phase I DFA that
due

in

1983

on

prior

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.¹°
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,
Bank,

and the Brazilians were under extreme

Citibank,

Morgan

time pressure. to

9 ( . . . continued)
March 1986.

¹°
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.

.

- 26 -

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
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.

.

- 27 -

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

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
lenders .

II restructuring on behalf of the

The BAC was formed on June 16 , 19 8 3 .

foreign

I t had 14 members ,

Citibank, Morgan Bank, Lloyd' s Bank, Arab Banking Corporation, Bank
of America, Bank of Montreal,
Chase Manhattan Bank,

the Bank of Tokyo, Bankers Trust,

Chemical Bank,

Credit Lyonnais,

Deutsche

•

- 28 -

Bank, Manufacturers Hanover Trust, and Union Bank of Switzerland.
Citibank served as the BAC' s chairman; Morgan Bank and Lloyd' s Bank
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.
the

Brazilians

only

those

It would further negotiate with

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

- 29 to Brazil. Under the proposed phase II CGA, all foreign lenders
holding outstanding Brazilian loans were being asked to contribute
their pro rata share of the new money.
foreign

lenders

were

reluctant

to

However,

contribute

a number of

any

new

money

whatsoever.

The BAC then informed the foreign lenders that, in its

negotiation

of

a

phase

II

restructuring

deal

on

. lenders' behalf, there would be "no free riders".

the

foreign

Although each

foreign lender would still have to consent to the terms of any
restructuring deal

Brazilians,

the

the BAC negotiated on

BAC's

official

position was

restructuring would be "all or none".
large number of

foreign lenders

its

behalf

with the

that

phase

a

II

The BAC feared that if a

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.

- 30 -

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.
foreign

lenders,

Prior to and during this period,. some

including

Commercial

subsidiary of Control Data Corporation,

Credit

Corporation,

a

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

Brazilians

contemplated

1986.

Originally,

restructuring

the

the

BAC

scheduled

and

the

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.
DFA,

Under the phase III

any 1985 debt payments would be available for relending to

other Brazilian persons and companies during a specified relending
period;

1986

debt

payments,

available for relending.

on

the

other

hand,

would

not

be

- 31 -

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 B.razilians 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,
respect to their Brazilian loans.

loan,

the U.S.

with

Although, in the case of a net

lender would have to pay U.S.

income tax with

respect to the additional interest income resulting from the grossup, 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
77.2-773

See Nissho Iwai Am. Corp. v. Commissioner, 89 T. C. 765,
(1987) .

- 32 -

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,

international

including

certain

major

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

interest remittances

I

DFA and phase

(the withholding issue).

I

CGA

These intensified

efforts by the foreign lenders to have the Central Bank issue them

such

DARF' s

continued

until

about

the

time

the

phase

II

- 33 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

interest

on

the

Central

Bank's

restructuring

debt

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

private ruling that ultimately was issued by the Brazilian IRS to
the Central Bank are discussed more fully infra.
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.·

- 34 -

During

the

phase

II

negotiations,

some

foreign

lenders,

including Citibank, wanted the BAC to negotiate the withholding
issue with the Brazilians.
negotiate

the

withholding

withholding

issue,

The BAC decided that it could not
issue

although

with

the

important

to

Brazilians,
a

number

of

as

the

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.¹³ 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.
Until
agreements

about
in

the

signing

January

1984,

of

the

Citibank

phase

II

continued

restructuring
to

press

the

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.
¹³
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 CitibankBrazil), and not Rhodes, would represent and present Citibank's
position.

- 35 -

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

Commercial

issue.¹'

Credit

other

Corporation,

foreign

lenders,

also pressed the

including

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
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
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.

- 36 -

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
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

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.

- 37 -

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 counsell
(1)

(3)
(4)

.(5)

Tax owed by anyone paying interest or fees
abroad.
Authority that remits charged with deduction
& paying.
Cent Bk agrees to pay on acct of Banks.
Only way CB can pay is if law is interpreted
to require payment.
Interpretation is from
Treasury which has issued the interpretation.
Treasury legal opinion applies to 1984 but
not to 1983.

Waiting for
-----(1)
_____

XXXXXX

Delfim [the Brazilian Planning
Minister] says decree will be solved by
inserting limit.

(2) Wh tax.
Phase I and
during reborrowing period.

1/1/84

on

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.

1

phase

II

from

Agreement of Delfim.

#2.

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:

.

-

38

-

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
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:

.

- 39 -

.(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.
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-

- 40 -

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 toplevel Brazilian IRS officials to redraft and revise the DoniakKahan 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.
draft

ruling,

these

two

Brazilian

In revising the Doniak-Kahan
IRS

officials

devised

and

formulated a new theory that the Central Bank was required to pay
withholding tax on itss restructuring debt

interest remittances

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,

future,

had

to

pay

withholding

unidentified "borrowers-to-be"

tax

on

behalf

of

(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.

- 41 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

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]

- 42 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;

(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

- 43 -

.

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
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.

- 44 -

(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
wotild 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,
relationship * *

therefore, the peculiarity . of the
* the Central Bank/Federal Union and

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:

tax

is

due

calculation base should be adjusted
grossed-up] ;

(a)

payment

of

withholding

*

*

and
*

the

[i.e.,

(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

.

- 45 *

*

*

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 * * * .
e

(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 * * * .
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

issue DARF's

to have

the Central Bank

to the

foreign

- 46 -

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.

some

However, the Brazilians did indicate

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.
. 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

- 47 -

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,

financial operations, and social security taxes.

taxes

on

The withholding

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

- 48 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,

and distribution of currency,
clearing.
as:

and

(4)

(3) management control

responsibility for bank

Like.the Central Bank, Banco do Brazil also functioned

(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

managed the Brazilian Government's budget.

authority that

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.¹³
To perform its various governmental functions, Banco do Brazil
needed access to funds.
Bank.

Such funding was provided by the Central

When Banco do Brazil,

functions,

in carrying out

its governmental

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

¹S
The Brazilian term "caixa unico" means a unified system
of cash or financial management.
.

e

- 49 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
e

carried out, through its issuance of (1) Brazil's currency and (2)
governmental

securities

Essentially,

the

in the name of

automatic

the National

Treasury.

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.2°
On its books,

following:
Brazil's

.

Banco do Brazil made entries reflecting the

(1) Transfers of Central Bank tax payments to Banco do
Banking

Reserves

Account

at

the

Central

Bank,

(2)

2°
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.

- 50 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

interest remittances.

by

the

on

the

restructuring

We are unable to ascertain what,

entries were made to determine:
reimbursed

tax

National

debt

if any,

(1) Whether the Central Bank was

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 rulirig 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.

.

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.

•

- 51 -

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.
1980

through June

28,

On its returns covering the period from
1985,

petitioner reduced the

amount

of

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

Year

Total
Credit

Legal Liability

Central Bk

Subsidy/Pecuniary
Benefit

1980
1981
1982
1983
1984
1985
1986

$53,358
545,462
814,969
489, 341
312,353
242,781
355,679

$53,358
545,462
814,969
489, 341
312,353
242,781
355,679

----$166,415
181,272
317,019

$21,343
218,185
325,988
195, 736
124,941
93,506
--

.

- 52 -

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-

2 (a) ,

Income Tax Regs.22

international

double

The purpose of the credit is to reduce

taxation.

American Chicle

States, 316 U.S. 450, 452 (1942).

Co.

v.

United

U.S. tax principles are applied

in deciding whether a foreign levy is a creditable income tax.
Goodyear

Tire

Commissioner,

&

Rubber

302

U.S.

Co.,

573

493

U.S.

(1938);

132

United

(1989);

States

Biddle

v.

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.

Commissioner,

supra; H.H. Robertson Co.

1333

affd.

(1947),

176 F.2d 704

(3d Cir.

v.

Commissioner,

1949).

v.

8 T. C.

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
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.

- 53 -

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. at 773-774, none of those
cases squarely dealt with the legal liability and Central Bank
issues to be resolved by us infra.

I.

.

The Legal Liability Issue
A foreign tax is generally creditable for purposes of section

901

only if

the . domestic

foreign law .for the tax.

corporation

is

legally liable

under

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

the

tax

and

the

The

Federal

wage

withholding

obligation

to

system,

legal

pay

tax

the

liability

are

for

different.

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

Brazilian law.

the

legal

liability

issue,

we

In this regard, Rule 146 provides,

must

examine

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.

- 54 -

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 permi.ts 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
procedures for presenting and utilizing material on
issues of foreign law by which a sound result can be
(continued...)

.

- 55 -

A.

Non-Tax-Immune Borrowers/Liability Issue

In prior cases involving Brazilian withholding tax paid by
non-tax-immune
remittances

to

Brazilian borrowers
domestic

on

corporations,

their net
we

and

loan

interest

other

courts,

including the U.S. Courts cif Appeals for the Seventh and Eighth

Circuits, have held those Brazilian withholding tax payments to be

•

a potentially creditable

tax to the domestic

purposes of section 901.

As the Court of Appeals for the Eighth

Circuit explained in Norwest Corp.

v.

corporations

Commissioner,

for

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.
IL
Similarly, the Brazilian
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

23 ( . . . continued)
achieved with fairness to the parties.

.

- 56 -

tax from each interest payment.
E 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] . " & at 519. * * *
Based on the record presented in the instant case, we see no
reason

to

depart

indisputably

from

requires

the

above

precedents.

non-tax-immune

Brazilian

Brazilian

law

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,

is

the

actual

amount

of

this

withholding

tax

that

creditable to petitioner will depend upon our resolution of the
subsidy/pecuniary benefit issue infra.
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

- 57 -

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. 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.; see also Amoco Corp. v. Commissioner, T.C. Memo.
1996-159; Continental Ill. Corp. v. Commissioner, T. C. Memo. 199166

(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
Bank in June 1980, and was consistent with certain prior decisions
.

of

the

Brazilian Supreme

hereafter.

Court

that

are

discussed more

fully

Pursuant to SRF 368, the Central Bank (which in Brazil

serves an instrumental role in ensuring that the withholding tax

- 58 -

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,
itself, on their net loan interest remittances abroad.

like

Beginning

in 1984, the Central Bank piirportedly 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
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

- 59 -

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

(hereinafter
decision) ,

decision

in

State

for. convenience

of

referred

Parana
to

as

v.

Central
the

Parana

Bank
II

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:
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

- 60 by virtue of
Constitution.

art. ·19,

III,

a,

by

the

Federal

.

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
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
* òf the Federal Constitution.

In my view, the conclusion is incontrovertible that
the burden of the payment f alls 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.

.

- 61 In view of the sole paragraph of art. 11 of Decreelaw 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

referred to as the Minas Gerais decision),

for

the

convenience

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

Constitution.24

tax

The

under

Article

19

of

reporting Brazilian Supreme

the

Brazilian

Court

Justice

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

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
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.

•

- 62 -

could avail itself of its tax immunity.25
Court

in Minas Gerais

companies

were

The Brazilian Supreme

further held that certain mixed capital

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

Parana I--Full Bench decision).

.The reporting Brazilian Supreme

Court

Parana

Justice

agreed with the

I--1st

Panel

decision's

reasoning that the remitter' s immunity from taxation ùnder 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.
by stating that

He concluded

"As this was the foundation of the challenged

ruling, and since this issue did not consider the ruling cited for

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.

- 63 -

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
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

Parana

noted

the

prior

I--1st

decisions,

but

adopted and utilized

the

rationale

for distinguishing the Parana

Panel

and

Parana

II

Parana

II

decision's

I--1st Panel

decision.

This Justice stated that the decision rendered in Santo Andre I was

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-grossloan 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.

- 64 -

"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 Prefec'ture 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
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.

28
Petitioner offered da Silva as both a fact witness and
an expert witness on Brazilian law.

- 65 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

Brazilian IRS never issued.

ruling that

the

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

including

tax

those

on

with

all

its

respect

interest

remittances

to

restructuring . debt,

the

abroad,

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.
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

2
Da Silva attributed the Brazilian IRS's "illegal"
actions in issuing SRF 368 to the fact that Brazil was under the
(continued...)

- 66 -

.

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

remittances abroad.

tax

on

their

net

loan

interest

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,
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
Brazilian

Supreme

experts

were

of

Court

decisions,

the

opinion

including

that
the

certain

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

2 (...continued)
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 crossexamination, 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.

- 67 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

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

- 68 withholding tax under various ordinary laws, including Decree-law

1,215 and Decree-law 4,595

(under which the Central Bank is tio

enjoy

immunities,

the

same

privileges,

and

exemptions

as

the

National Treasury) .3°

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

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 Decreelaw 1,215.
the

He believed that Decree-law 1,215 was the authority for

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

3°
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.

- 69 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.
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,
because

like

the

Parana

they involved

II

decision,

financing of

are

imported

distinguishable,
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

- 69 -

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.
noted that

the March 1984

Tostes further

Brazilian IRS ruling issued to the

Central Bank acknowledged that the Central Bank was acting as an

agent for the National Treasury.
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

Brazilian law does not

lo.ans.

IRS.

Petitioner

distinguish between gross

asserts

that

loans and net

It further maintains that certain Brazilian Supreme Court

decisions,
because

like

they

the

Parana

involved

II

decision,

financing of

are

distinguishable,

imported goods

subject

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3Ad267358ebef0e447. Public record. Not legal advice.