Originally published in the July 9 edition of World Tax Daily (Copyrights Tax Analysts)
In a binding decision, Brazil’s Superior Court of Justice (STJ) has ruled that Brazil cannot tax indemnification received for either material or immaterial (intangible) damages. The June 23 decision, published in the judiciary’s official gazette on July 1, confirms a similar ruling issued a year ago by the same court (in Special Appeal No. 1068456) and invalidates the position that had been taken by the Federal Revenue Department (FRD).
In July 2007 the FRD issued Private Letter Ruling 267/2007, making a distinction between material (tangible) and immaterial (intangible) damages and providing for different tax treatment for each type of indemnification. The FRD’s position was that indemnification for material damages was tax exempt but that indemnification for immaterial damages was taxable. The rationale behind the FRD’s position was that an award for intangible damages increased the taxpayer’s wealth while indemnification for material damages merely reestablished the taxpayer’s previous material status or wealth.
In its June 23 decision (in Special Appeal No. 1152764), the STJ rejected arguments raised by the Federal Revenue Attorney General’s Office (Procuradoria Geral da Fazenda Nacional) against an earlier ruling by the Federal Regional Appellate Court for the 5th Region, which absolved an individual from paying tax on an intangible damage award he received in a labor claim.
In delivering the opinion, Justice Luiz Fux reviewed the concept and legal nature of income and indemnifications, citing other court precedents and scholars’ opinions. He concluded that for income to be taxable it must increase wealth, and that indemnification for the sole purpose of repairing a damage does not qualify under that criterion.
Although the relevant case dealt only with intangible damages, the STJ decided to put an end to uncertainty about the taxation of indemnifications of any kind, and further ruled that no income tax will apply to any type of indemnification for damages, whether material or intangible. The STJ further decided that the ruling should be binding to prevent identical appeals. As soon as the decision was published, the STJ notified all federal and state appellate courts to follow the same rule as of July 1 (the date of publication).
David Roberto R. Soares da Silva