Originally published in the September 3 edition of World Tax Daily (Copyrights Tax Analysts)
Brazil’s Superior Court of Justice (STJ) has recently ruled, in a decision contradictory to the position of the Federal Revenue Department (FRD), that indemnifications received for both material and immaterial (moral) damages are not taxable in Brazil.
The decision was delivered in Special Appeal
no. 1068456 when the court rejected the arguments raised by the Federal Revenue Attorney General’s Office (Procuradoria Geral da Fazenda Nacional, or PGFN). The decision was published in the judiciary’s official gazette July 1. The summary of the decision reads as follows:
1. Receipt of indemnification for material and moral damages is not a taxable event for income tax as the purpose of the indemnification is to repair the material and immaterial wealth of the victim affected by an illegal act.
2. The non application of income tax is not caused by an exemption, but for the absence of new wealth — arising from capital, from work or from both — capable of characterizing accretion to wealth.
3. Indemnification for moral or material damages does not increase the wealth of the injured; it only repairs, via monetary substitution, the status quo ante.
In delivering the court’s opinion, Justice Eliana Calmon argued that for income tax to apply, new income must be generated from work, from application of capital, or from both, as stated in article 43 of the National Tax Code. Indemnifications, whether for material or immaterial damages, do not fall into any of those categories, and, therefore, income tax is not applicable. Calmon cited some similar precedents from the STJ.
The decision conflicts with the FRD’s official position. In July 2007, the FRD issued Private Letter Ruling 267/2007 making a distinction between material and immaterial damages and providing for different tax treatment for each type of indemnification.
The FRD concluded that no Brazilian tax should be imposed on indemnification for material (tangible) damages because such indemnification is aimed at reestablishing the taxpayer’s prior material status and represents no actual accretion of wealth.
However, indemnification for immaterial (nontangible) damages was taxable because it did not serve to reestablish the taxpayer’s wealth. In other words, the FRD concluded that an award for nontangible (moral) damages represented an accretion to the taxpayer’s wealth rather than reestablishment of the taxpayer’s prior material status or wealth.
Comments
The STJ’s position is more logical and seems fairer. But taxpayers receiving indemnifications for moral damages will have to face the FRD in court because the STJ rule is not binding. Although the chances of success are fairly high, such a court challenge is unavoidable if taxpayers wish to avoid paying income tax on indemnifications for moral damages.
David Roberto R. Soares da Silva