Rev. Rul. 59-70

Advice has been requested whether the tax on royalties withheld pursuant to Brazilian Decree No. 36,773 of January 13, 1955, and the regulations ratified therein, and the additional `tax' imposed by Article 3 of Brazilian law No. 1,474 are allowable as a credit against United States Federal income taxes under section 901 of the Internal Revenue Code of 1954.

The taxpayer, a domestic corporation, has contracts with licensees in Brazil under which royalties are paid to it. In connection with such royalty payments, deductions are made by the licenses for taxes required to be withheld at source under Brazilian income tax law and the regulations thereunder. The corporation is also subject to an income tax which it pays directly and to an additional `tax' or surtax imposed by Article 3 of Law No. 1,474.

Section 901 of the Code, relating to taxes of foreign countries and possessions of the United States, provides, in part, as follows:

* * * If the taxpayer chooses to have the benefits of this subpart relating to foreign tax credits , the tax imposed by this chapter shall, subject to the limitation of section 904, be credited with the amounts provided in the applicable paragraph of subsection (b) * * *.

Section 1.901-1 of the Income Tax Regulations provides, in general, as follows:

* * * Citizens of the United States, domestic corporations, and certain aliens resident in the United States or Puerto Rico may choose to claim a credit, as provided in section 901, against the tax imposed by chapter 1 for taxes paid or accrued to foreign countries and possessions of the United States * * *.

Under Revenue Ruling 54-14, C.B. 1954-1, 129, the taxes imposed on corporation by Article 96 of Brazilian Law No. 4178, as amended by Law No. 1,474 of November 26, 1951, are allowable as a credit against United States income tax to the extent provided by section 131(a) of the Internal Revenue Code of 1939, which corresponds to section 901(a) of the Internal Revenue Code of 1954. I.T. 4013, C.B. 1950-1, 65, holds that the taxes imposed under Articles 96 and 97 of Brazilian Income Tax Law No. 4178, dated March 13, 1942, as amended, revised, and consolidated by Decree Law No. 5844 of September 23, 1943, and Law No. 154 of November 25, 1947, are allowable as a credit against the United States income tax under section 131(a) of the 1939 Code. Article 96 provides that certain types of income are subject to withholding of tax at the source and at the rates specified therein, such rates to be imposed upon the gross earnings. Article 97 provides that the income received by individuals or corporate bodies, among others, residing or domiciled abroad, is subject to withholding of tax at the rate of 15 percent.

By Decree No. 36,773 of January 13, 1955, which was published in the `Official Bulletin' of January 17, 1955, the President of Brazil ratified new regulations for the collection and auditing of the income tax. The Regulations for the Collection and Auditing of the Income Taxes, ratified by Decree No. 36,773, supra , provides of allows:

From the Income of Parties Residing or Domiciled in Foreign Countries Art. 97-There shall be subject to the tax discount (Law No. 2,354):

2. At the rate of 25%(twenty-five percent)-the income of the persons mentioned in the preceding paragraph, which falls under `royalties,' such as payments on the exploitation of trademarks (literally `marks of industry and commerce'), on patents of invention, on manufacturing processes or formulas.

Article 3 of Law No. 1,474, supra , provides, in part as follows:

The tax dealt with in Law No. 154 of November 25, 1947 and governed by decree No. 24,239 of December 22, 1947 shall, during the fiscal years of 1952 to 1956, be increased by a surtax which shall be calculated on the amounts due by the taxpayers, * * * as follows:

(a) 15%(fifteen percent) on the tax amount to be paid;

(b) 3%(three percent) on the reserves and profits pending or undistributed, in possession of legal persons * * *.

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No. 3. The amounts originating from the collection of the surtax dealt with in this Article shall, after the sixth fiscal year be elapsed and after the year of the respective collection, be restituted with a bonus in the form of federal bonds * * *.

Regulations for Article 3 of Law No. 1,474 were promulgated by Article 4 of Decree No. 30,812 of May 2, 1952. Chapter IV of the Regulations of the Collection and Auditing of the Income Taxes, ratified by decree No. 36,773, supra , provides as follows:

Art. 210-The collection of the repayable surcharge mentioned in Art. 3 of Law No. 1,474 of November 28, 1951 shall continue in force.

Under Brazilian law, the taxpayer pays the income tax in four installments. The additional `tax of 15 percent imposed by Article 3 of Law No. 1,474, supra is payable as a fifth installment. The latter amount constitutes a special fund and is used for the execution of the program of re-equiping ports and railroads, enhancing warehouse, cold storage and other facilities, increasing the electric power potential and developing basic industries and agriculture. Economic reequipment bonds, issued by the Brazilian Government in the sixth year to taxpayers who have paid the additional `tax,' bear five percent interest and are redeemable by the government in 20 annual installments beginning with the first installment in the year in which the bonds are issued. Taxable entities, but not individuals, may deduct income taxes in determining their taxable income for Brazilian tax purposes. The additional tax of 15 percent is not allowed as a deduction but is carried on the taxpayers' books as an asset.

In view of the above, it is held that the Brazilian tax of 25 percent on royalties withheld pursuant to Brazilian Decree No. 36,773 of January 13, 1955, ratifying Regulations for the Collection and Auditing of the Income Taxes, constitutes an income tax and is allowable as a credit against United States income tax under section 901 of the Code, subject to the limitation contained in section 904 of the Code. However, the additional `tax' imposed by Article 3, Law No. 1,474, regulated by Article 4, Decree No. 30,812 of May 2, 1952, and Article 210 of the Regulations ratified by Decree No. 36,773 of January 15, 1955, is refundable with interest (or, `restituted with a bounds in the form of federal bonds') and, therefore, is not allowable as a credit against United States income tax within the meaning of section 901 of the Code. See I.T. 3624, C.B. 1943, 438.