D.C. Circuit finds that Central Bank of Brazil is "a person" other than Brazilian state for tax purposes where Bank "stood in" for ultimate beneficiaries of loan made by U.S. Company, thus removing need to apply Act of State doctrine
During the 1970s and early 1980s, Brazil used tax breaks to encourage its citizens to borrow from foreign lenders. After a financial crisis in 1982, Brazil entered into a debt restructuring plan and borrowed additional sums. PNC Financial Services Group, Inc. (Plaintiff) lent a portion of the additional sums. In 1984 and 1985 Plaintiff paid the Brazilian interest income tax of 25%, however, another provision of Brazilian law gave subsidies for these taxes worth 40% of the tax due.
The relevant provision of Treasury Regulations provides that "When a U.S. bank makes a loan abroad, the interest income is susceptible to tax in both the United States and the foreign state. Congress avoids double taxing international business by giving a credit for taxes paid to the foreign government, less any credit, refund, or subsidy given the taxpayer by the foreign government. I. R. C. § 901; Treas. Reg. § 1.901 2(e)." [Slip op. 2]
Plaintiff claims a foreign tax credit for taxes paid on its behalf in Brazil. The Internal Revenue Service (Defendant) claims that it has to reduce the credit by the amount of the indirect subsidy received from the Brazilian Government. The Tax Court agreed with the Internal Revenue Service.
The U.S. Court of Appeals for the District of Columbia Circuit affirms the Tax Court. Three additional factors complicate this case: "First, [Plaintiff's] loans to the Central Bank were "net,' not "gross.' [Riggs Nat'l Corp. & Subsidiaries v. Commissioner of Internal Revenue Service, 163
F.3d 1363, 333 U.S.App.D.C. 371, 83 A.F.T.R.2d 99 438, 99 1 USTC P 50,185 (D.C. 1999) ("Riggs II')] gives a matchless explanation of the difference, which we will not belabor here. Suffice it to say that in a gross loan agreement, the lender pays local (Brazilian) taxes on his interest income (or the borrower withholds it), while in a net loan, the borrower
"contractually agrees not only to pay interest to the lender, but also to pay any local (Brazilian) tax that the lender owes on that interest income.' [Cite]."
The second factor stems from the unique character of the borrower. "Created by law to implement Brazil's monetary and fiscal policies (including issuing currency), required to act on behalf of Brazil's government and prohibited from acting on behalf of anyone else, able to contract in the name of the National Treasury, responsible for managing foreign lending to Brazilian borrowers, and under the control of the Minister of Finance, the Central Bank is 100% a part of Brazil's federal government, as all parties agree.
The Federal Constitution of Brazil makes the Central Bank immune from tax on its own income, and in fact, until 1988, the Central Bank operated, along with the National Treasury and the Banco de Brasil (in which Brazil's government held a controlling share), a centralized system for funding Brazil's government that jointly controlled Brazil's tax revenue (although it was the Banco de Brasil that actually held the government's tax revenue in its coffers)." [Slip op. 3].
"We must pause at this point to understand PNC's and the Central Bank's (or rather, Brazil's) interests on the eve of their lending arrangement. Only if the Central Bank was subjected to compulsory tax payments on PNC's behalf could PNC qualify for the § 901 credit."
"Only the Central Bank's constitutional immunity from taxes stood in the way, and the third complexity in this case concerns how that immunity was overcome." Brazil's Minister of Finance issued a binding private letter ruling stating that, "The Minister deemed it appropriate to "look through' the Central Bank to those ultimate private borrowers " so called "borrowers to be' for purposes of deciding the proper tax treatment of the loans. And it was settled Brazilian law that a private borrower in a net loan was required to pay the tax obligation it had contractually assumed from the lender." [Slip op. 4]
"Brazil had a subsidies system (sometimes called a "pecuniary benefits' system in this litigation) that effectively returned 40% of any tax payment Brazilian borrowers in international net loans made on their foreign lenders' behalf. Mechanically, the two halves of the transaction " making the tax payments and receiving the subsidy " were "simultaneous[],' both occurring "before paying the interest to the foreign lender' and in such a way as to credit Brazil's national treasury' only with the amount by which the withholding tax exceeded the subsidy.' [Cite]. In the Tax Court, no one doubted that this arrangement would have amounted to an indirect subsidy and properly reduced PNC's foreign tax credit had the borrower been a private party." [Slip op 5 6]
"As a threshold matter, we must determine what it means for the recipient of a subsidy to be "another person' we shall assume for purposes of this appeal that PNC's § 901 credit should be reduced if, and only if, the recipient of the subsidy (the Central Bank) is a person other than the Brazilian government." [Slip op 7]
In a previous case, this Court had applied the Act of State doctrine to the Minister of Finance's letter ruling and found that "whether or not it can be said that the Brazilian Minister of Finance's interpretation of Brazilian law qualifies as an Act of State, the Minister's order to the Central Bank to withhold and pay the income tax on the interest paid to the Bank goes beyond a mere interpretation of law. The Minister, after all, ordered that the Central Bank "must, in substitution of the future not yet identified debtors of the tax [i.e., the borrowers to be], pay the income tax' Such an order has been treated as an Act of State." [Slip op. 9]
"Put in the affirmative, the holding here is that American courts must accept as given that the Brazilian government levied a compulsory tax payment on the Central Bank, where the Central Bank stood in for borrowers to beThat resolves the present appeal, for if the Central Bank stood in for borrowers to be when it paid PNC's taxes, it also stood in for them when it received 40% of those tax payments back in subsidies." [Slip op. 9]
"In concluding that the Central Bank is "another person' in the sense of the Treasury Regulation, we need not apply the Act of State doctrine. Rather, in the interest of consistency, we need only adhere, as a law of the case matter, to the necessary implications of [our precedent]. There, the court held that, based on the act of state doctrine, American courts had to accept the Minister's determination that the Brazilian government had compelled the Central Bank to remit tax payments on PNC's behalf, standing in for the borrowers to be. In that role, the Central Bank was distinct from the Brazilian government. Thus, as the payment and the subsidy are both part of the same indivisible transaction, [precedent] necessarily implies [that] the Central Bank is likewise distinct for purposes of the subsidy." [Slip op. 10]
Citation: PNC Financial Services Group, Inc. v. Commissioner of Internal Revenue, 2007 WL 2403550 (D.C. Cir. 2007).
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