Originally published in the August 20 edition of World Tax Daily (Copyrights Tax Analysts – www.taxanalysts.com)
Brazil’s Federal Revenue Department (FRD) issued a private letter ruling that clarifies the FRD’s official position on taxation of indemnification received by taxpayers. The ruling makes a distinction between material and immaterial damages and provides for different tax treatment for each type of indemnification.
Private letter ruling (Solução de Consulta) No. 267/2007 was issued by the FRD’s Regional Superintendence Office for the 8th Fiscal Region, with jurisdiction over the state of São Paulo. The ruling was published in the official gazette of July 6.
The ruling deals with indemnification payable by the Peruvian government to a Brazilian individual awarded by the Inter-American Court of Human Rights, headquartered in San Jose, Costa Rica. The award included indemnification both for tangible and nontangible (moral) damages.
The ruling adopted different tax treatments for each type of damage. For tangible damages, it concluded that no Brazilian tax should apply because such indemnification aims at reestablishing the taxpayer’s prior material status, representing no actual accretion to the taxpayer’s wealth. As for the nontangible damages, the Federal Revenue Department said the award was taxable because it represented no reestablishment of the taxpayer’s wealth. In other words, the FRD concluded that an award for nontangible damages represented an accretion to the taxpayer’s wealth rather than reestablishment of the taxpayer’s prior material status or wealth.
The issue is complex, and the FRD’s ruling was simplistic as it took into consideration only the material (tangible) aspect of damage suffered by the taxpayer. In fact, the ruling only accepted the exclusion of taxation for the portion of the indemnification award that clearly represented a concrete damage to the taxpayer or, better yet, a reestablishment of a material loss suffered by the taxpayer.
It clearly denies the same tax treatment when the award was granted for nonmaterial (nontangible) damages. The simplistic nature of the ruling may adversely affect many taxpayers, both individuals and corporate, who are awarded indemnification for any damage that is nontangible, such as copyright violation, wrongful accusation, or offenses to the honor and image of persons and companies.
In an extreme application of the ruling, an individual who has suffered a car accident and lost a part of his/her body would be taxable upon any amount received for the bodily injury, but no tax would apply on amounts received to fix the vehicle. In other words, the ruling would consider that the individual, who suffered a bodily injury, has incurred an accretion to wealth for tax purposes, never mind the bodily injury. For the ruling, damage to a car would be more important than that inflicted on a human being.
David Roberto R. Soares da Silva