Provisions of the Pending U.S.-Brazil Tax Treaty

An income tax treaty between the United States and Brazil has been discussed for decades but remains unfulfilled. A treaty would establish clear rules for taxing cross-border income, prevent double taxation, and create a framework to combat tax evasion.

The absence of a treaty means that the tax obligations of individuals and companies operating in both countries are governed by each nation’s domestic tax laws. Both countries have internal mechanisms to provide relief from double taxation. The U.S. and Brazil have also entered into more limited agreements, such as a Totalization Agreement to coordinate social security taxes and a Tax Information Exchange Agreement to improve compliance.

Scope and Residency Under the Treaty

Since no income tax treaty exists, the rules defining who is subject to tax are determined independently by U.S. and Brazilian domestic law. For the United States, tax residency is established for individuals who are U.S. citizens, hold a green card, or meet the Substantial Presence Test. This test is met if an individual is physically present in the U.S. for at least 31 days in the current year and a combined 183 days over a three-year period. Corporations are considered U.S. residents if they are created or organized in the United States.

Brazil primarily bases tax residency on an individual’s physical presence. An individual becomes a tax resident upon arriving in Brazil with a permanent visa or, if on a temporary visa, after remaining in the country for more than 183 days within any 12-month period. A consequence of having no treaty is the lack of “tie-breaker” rules. Without these provisions, an individual can be considered a tax resident by both countries simultaneously, subjecting their worldwide income to taxation in both jurisdictions.

Taxation of Business Income

The treaty concept of a “Permanent Establishment” (PE), which requires a significant physical presence like an office or factory to create a taxable presence, does not apply. Instead, a Brazilian enterprise is subject to U.S. income tax if it is “engaged in a trade or business in the United States” (ETBUS), a lower threshold than a PE that can be triggered by regular and continuous business activities. Once a business is considered ETBUS, the U.S. imposes tax on its “Effectively Connected Income” (ECI), which includes income generated by the U.S. business activities.

For U.S. enterprises, the rules are more encompassing. The United States taxes the worldwide income of its domestic corporations, regardless of where the income is earned. The company must then rely on U.S. domestic law to mitigate double taxation on profits earned in Brazil.

Taxation of Personal and Investment Income

For individuals, the absence of a treaty results in the application of default statutory tax rates, which are often higher than negotiated treaty rates. A Brazilian resident who receives U.S.-source income, such as dividends, interest, and royalties, is subject to a flat 30% withholding tax. This tax is collected by the U.S. payer and remitted to the IRS on what is known as Fixed, Determinable, Annual, or Periodical (FDAP) income.

From the Brazilian perspective, its tax residents are taxed on their worldwide income. This means income earned from U.S. sources is also reportable and taxable in Brazil, with progressive tax rates for individuals. Capital gains are also taxed based on each country’s domestic rules, which can lead to complex outcomes when an asset is sold that has a connection to both jurisdictions.

Mechanism for Preventing Double Taxation

The primary method for a U.S. person to avoid double taxation on income earned in Brazil is the U.S. foreign tax credit (FTC). The FTC allows U.S. citizens and resident aliens to reduce their U.S. income tax liability on a dollar-for-dollar basis for the income taxes they have already paid to a foreign government. The credit is limited to the amount of U.S. tax that would have been owed on that same foreign-source income. Any unused portion of the FTC can be carried back one year or carried forward for up to ten years.

Brazil provides a similar form of relief. Brazilian law permits a resident to credit the amount of income tax paid to the United States against the tax due in Brazil on the same income. This unilateral relief in both countries is the main tool preventing the same income from being fully taxed twice.

Limitation on Benefits

The “Limitation on Benefits” (LOB) article is a provision found only within tax treaties. Its purpose is to prevent “treaty shopping,” a practice where residents of a third country structure their investments through a company in a treaty country merely to gain access to that treaty’s benefits, such as reduced withholding tax rates. Since there is no U.S.-Brazil income tax treaty, there is no LOB article to apply.

Instead of treaty-based anti-abuse rules, each country relies on its domestic laws to challenge arrangements perceived as abusive. For example, the IRS might use doctrines like “substance over form” or “economic substance” to deny tax benefits from a transaction that lacks a genuine business purpose. These domestic rules, however, may not be as clear or targeted as a modern LOB article, which provides objective tests for determining whether an entity has a sufficient connection to a treaty country to qualify for its benefits.