107 T.C. No. 18

UNITED STATES TAX COURT

RIGGS NATIONAL CORPORATION & SUBSIDIARIES, 

(f.k.a. RIGGS NATIONAL BANK AND SUBSIDIARIES), Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 24368-89. December 10, 1996.

P regularly made and participated in loans to

borrowers located in foreign countries, including Brazil.

It was one of hundreds of banks that were involved in the

restructuring of Brazil's foreign debt.

As required by Brazilian law, various non-tax-immune

Brazilian borrowers paid Brazilian withholding tax on

their net loan interest remittances to P during 1980

through 1986. Although the Brazilian Supreme Court had

held that, under Article 19 of the Brazilian

Constitution, tax-immune Brazilian governmental entities,

like the Central Bank, were not liable to pay withholding

tax on their net loan interest remittances to foreign

lenders, beginning in 1984, the Central Bank purportedly

paid withholding tax on its Brazilian restructuring debt

interest remittances to P.
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On its income tax returns for 1980 through 1986, P

claimed a foreign tax credit under sec. 901, I.R.C., for

the purported withholding tax payments made by the

Central Bank and other Brazilian borrowers on their net

loan interest remittances to P.

1. Held: The withholding tax paid by non-taximmune Brazilian borrowers is potentially creditable to

P but must be reduced, under sec. 4.901-2(f)(3)(ii),

Temporary Income Tax Regs., 45 Fed. Reg. 75653 (Nov. 17,

1980), and sec. 1.901-2(e)(3)(ii), Income Tax Regs., by

the pecuniary benefit the borrowers received from the

Brazilian Government. Nissho Iwai Am. Corp. v.

Commissioner, 89 T.C. 765 (1987); Norwest Corp. v.

Commissioner, T.C. Memo. 1992-282, affd. 69 F.3d 1404

(8th Cir. 1995); Continental Ill. Corp. v. Commissioner,

T.C. Memo. 1988-318, affd. without published opinion sub

nom. Citizens & S. Corp. & Subs. v. Commissioner, 919

F.2d 1492 (11th Cir. 1990), affd. in part and revd. in

part 998 F.2d 513 (7th Cir. 1993), followed.

2. Held, further: P is not legally liable for

Brazilian tax on the Brazilian restructuring debt

interest remittances it received from the Central Bank.

Under Brazilian law, P was not required to pay Brazilian

tax, and neither it nor the Central Bank had a legal

liability to pay the withholding tax. The purported

Central Bank withholding tax payments are not creditable

to P because these purported payments were noncompulsory

amounts and not a tax to Brazil. Sec. 1.901-2(e)(1),

(5), Income Tax Regs.

Joel V. Williamson, Thomas C. Durham, Scott M. Stewart,

Richard M. Timmel, Patricia Anne Flaming, and Kim Marie Boylan, for

petitioner.

Theodore J. Kletnick, William G. Merkle, Diane P. Thaler, Paul

S. Manning, Rajiv Madan, Mary Ann Amodeo, and Janice E. Lamartine,

for respondent.
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1 Unless otherwise indicated, all statutory references

are to the Internal Revenue Code in effect for the years in

issue, and all Rule references are to the Tax Court Rules of

Practice and Procedure.

JACOBS, Judge: Respondent determined deficiencies in the

Federal income tax of petitioner Riggs National Corporation &

Subsidiaries, formerly known as Riggs National Bank and

Subsidiaries. 

The dispute involves petitioner's entitlement to foreign tax

credit under section 9011 for Brazilian taxes withheld on interest

income petitioner received, during the years 1980 through 1986, as

a result of its loans to Brazilian borrowers. The primary issues

for decision are as follows: (1) Whether petitioner is legally

liable for the Brazilian withholding tax purportedly paid by its

Brazilian borrowers on their net loan interest remittances to

petitioner (the legal liability issue); (2) whether the alleged

withholding tax paid by the Banco do Central Brazil (Central Bank)

on its Brazilian restructuring debt interest remittances to

petitioner is a noncompulsory amount and thus not a tax to Brazil

(the Central Bank issue); and (3) whether a subsidy, equal to a

percentage of the tax withheld, that borrowers received from the

Brazilian Government during the period from January 1, 1980,

through June 28, 1985, reduces the amount of foreign tax credit

allowable to petitioner (the subsidy/pecuniary benefit issue).

To a major extent, the legal liability and subsidy/pecuniary

benefit issues have been previously dealt with in Norwest Corp. v.
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Commissioner, T.C. Memo. 1992-282, affd. 69 F.3d 1404 (8th Cir.

1995); First Chicago Corp. v. Commissioner, T.C. Memo. 1991-44;

Continental Ill. Corp. v. Commissioner, T.C. Memo. 1988-318, affd.

without published opinion sub nom. Citizens & S. Corp. & Subs. v.

Commissioner, 919 F.2d 1492 (11th Cir. 1990), affd. in part and

revd. in part 998 F.2d 513 (7th Cir. 1993) and Nissho Iwai Am.

Corp. v. Commissioner, 89 T.C. 765 (1987). However, none of those

cases involved withholding tax paid by a tax-immune Brazilian

governmental entity/borrower, like the Central Bank here, on its

Brazilian restructuring debt interest remittances.

FINDINGS OF FACT

Some of the facts have been stipulated and are found

accordingly. The parties have further stipulated in evidence

portions of the trial transcripts in the Continental Illinois and

Nissho Iwai cases and various exhibits related to the testimony of

certain witnesses in those cases.

A. Background

Petitioner's principal place of business was in Washington,

D.C., at the time the petition was filed. 

Riggs National Corporation is the parent company of a group of

corporations which filed consolidated income tax returns for the

years in issue. Its wholly owned subsidiary Riggs National Bank

regularly made and participated in loans to borrowers located in

foreign countries, including Brazil.
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B. Foreign Loans and the Brazilian Economy in General

In 1974, Brazil incurred a trade deficit of $4.7 billion as a

result of higher prices charged for oil due to the energy crisis.

At that time, a trade deficit of this size was large for Brazil. 

After 1974, Brazil greatly increased its reliance on foreign debt.

Its foreign debt increased dramatically from 1974 to 1983, and the

ratio of Brazil's total foreign debt to its foreign currency

reserves grew larger. The Brazilian Government sought to reduce

Brazil's trade deficit by decreasing imports, increasing exports,

and encouraging foreign borrowing for internal domestic

development. It hoped to increase the country's productive

capacity by stimulating greater investment in steel, oil, pulp and

paper, aluminum, petrochemical products, fertilizers, capital

goods, and other capital items.

Brazil's currency, the cruzeiro, was not convertible to

foreign currency in international markets. Although the cruzeiro

was freely tradeable, as a practical matter, foreign parties

outside of Brazil would not accept payment in cruzeiros. 

 Brazil needed to maintain adequate foreign currency reserves

to engage in international trade to finance its trade deficit.

During 1974 through 1975, the Brazilian Government sought to

maintain a foreign currency reserve of about $6 billion for this

purpose. 

During 1974, Brazilian borrowers generally were reluctant to

take out foreign loans because the Central Bank required a minimum
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term for foreign loans which varied from 5 to 12 years. Although

the Brazilian Government sought to decrease the effects of

inflation through an indexing system, in taking out a long-term

foreign loan, a Brazilian borrower incurred a substantial risk that

a decline in the exchange rate for the cruzeiro as a result of

domestic inflation could increase the cost of the loan. 

To increase foreign borrowing, the Brazilian Government

provided incentives to Brazilian borrowers in order to overcome

their reluctance to take out foreign loans. These incentives

included the pecuniary benefit, the Resolution 63 loan program, and

the Resolution 432 loan program, all of which are more fully

discussed infra. 

Until about 1982, lending to Brazilian borrowers was quite

profitable for many foreign lenders, including some major U.S.

banks. The interest rate spreads (i.e., the interest rate charged

on a loan, less the cost of the loan funds to the lender) on

Brazilian loans were higher than the interest rate spreads on loans

made in many other countries. In addition, the ability to claim

foreign tax credits significantly enhanced the after-tax income

some foreign lenders derived with respect to their Brazilian loans.

C. Brazilian Regulation of Foreign Lending

Brazil imposes restrictions on the receipt and exchange of

foreign currency. By law, all loans from foreign lenders to

Brazilian borrowers must be registered with and approved by the

Central Bank. Through the registration process, the Central Bank
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sets the range of acceptable interest rates and periodically

establishes the minimum repayment terms of loans. Once the Central

Bank approved a loan, the lender remitted the proceeds in foreign

currency to the borrower via a commercial bank in Brazil. The

Brazilian bank converted the foreign currency into Brazilian

currency by means of an exchange contract, whereby the borrower

sold the foreign currency to the bank for Brazilian currency at the

official exchange rate periodically set by the Central Bank.

The Brazilian borrower received a Certificate of Registration

that enabled the borrower to effect payment of interest and

principal in the foreign currency in which the loan was made. On

each payment date, the borrower purchased foreign currency from a

Brazilian bank at the official exchange rate. The Brazilian bank

then tendered the foreign currency to the foreign lender. 

D. Payment of the Withholding Tax Generally

Where withholding tax is required, Brazilian law prohibited

remittance of an interest payment to a foreign lender without proof

of payment of the withholding tax on interest remitted abroad.

Under Brazilian law, the borrower initiated payment of the

withholding tax by submitting a Documento de Arrecadacao de

Receitas Federais (DARF) and the accompanying tax payment to a

commercial Brazilian bank. Any bank making an interest payment in

foreign currency which was subject to Brazilian tax would require
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2 The borrower prepared the DARF and delivered a copy of

it and the registration certificate to the Brazilian bank

handling the payment of interest through a foreign exchange

contract. The bank recorded the amount of interest and tax on

the Certificate of Registration and submitted the certificate,

exchange contract, and DARF to the Central Bank for approval. 

Upon approval by the Central Bank, the bank remitted the interest

to the foreign lender and returned to the borrower a stamped copy

of the DARF, the Certificate of Registration (stamped), and a

copy of the exchange contract. The borrower sent a copy of the

DARF to the foreign lender which then had proof (the DARF) that

the withholding tax was paid. The lender performed no act in

Brazil for the collection of tax. 

a completed DARF and payment of the tax as evidence that the proper

amount of the tax had been paid.2

E. Net Loans and Gross Loans

In making loans to borrowers in Brazil and other countries, it

was an accepted and common practice among foreign lenders to

require that interest payments be made to them on a "net quoted"

basis. A net loan is a loan in which the lender and the borrower

have agreed that all specified payments of principal and interest

to the lender, under the loan contract, will be made net of any

applicable Brazilian taxes. 

Under Brazilian law, when the Brazilian borrower under a net

loan assumes the burden of the withholding tax, the amount of

interest remitted is considered net of tax and an adjustment known

as a "gross-up" is required to be made for purposes of computing

the withholding tax. This gross-up adjustment would be computed as

follows:

Grossed-up interest = Net interest 

 1 - Withholding tax rate
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3 The National Monetary Council is a Government agency

responsible for economic programs. Its members include the

Finance Minister, the Central Bank's President, and

representatives of the largest Brazilian commercial banks. The

Finance Minister presides over the council's meetings. The

council acts through the Central Bank. 

In contrast to a net loan, a gross loan is a loan in which

there is no contractual agreement between the borrower and foreign

lender to pay taxes imposed by the borrower's country. With a

gross loan, the Brazilian borrower will deduct withholding taxes

that are due from the interest specified under the loan contract

and will pay the lender the gross interest net of taxes. 

From 1970 through 1986, net loans generally were the

predominant type of loan extended by foreign lenders to borrowers

in Brazil. With a net loan, the foreign lender shifts the risk of

any increase in taxes imposed by the borrower's country to the

borrower. Correspondingly, in a net loan, the borrower, not the

foreign lender, will benefit from any reduction in or waiver of

taxes imposed by the borrower's country. 

F. Institution of the Subsidy/Pecuniary Benefit

Under Decree-law 1,215, enacted May 4, 1972, the Brazilian

Minister of Finance was given discretion to grant a reimbursement

or reduction of, or exemption from, the withholding tax on interest

provided: (1) The borrower's costs were reduced; (2) the loan was

of national interest, (3) the loan met the minimum repayment term

set by the National Monetary Council;3 and (4) the loan complied

with other conditions set forth by the Ministry of Finance.
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Decree-law 1,351, which was enacted on October 24, 1974,

authorized the National Monetary Council to temporarily reduce the

income tax on interest, commissions, and expenses remitted to

persons residing or domiciled abroad. On the same date that

Decree-law 1,351 was enacted (October 24, 1974), the Central Bank

issued Resolution 305, which temporarily reduced the tax on

interest, commissions, and expenses received on currency loans

registered with the Central Bank from 25 percent to 5 percent.

Decree-law 1,411, enacted July 31, 1975, amended Decree-law

1,351 and allowed the National Monetary Council to: (1) Reduce the

income tax on interest, commissions, and expenses remitted to

persons resident or domiciled abroad, or (2) grant pecuniary

benefits to Brazilian borrowers receiving loans in foreign

currency.

On August 5, 1975, the Central Bank issued Resolution 334,

which revoked Resolution 305, thereby reinstating the 25-percent

withholding tax on interest, commissions, and expenses paid on

currency loans registered with the Central Bank. 

G. Mechanics and Amount of the Subsidy/Pecuniary Benefit

On the same day that the 25-percent tax on interest was

reinstated (i.e., August 5, 1975), the Central Bank issued

Resolution 335, which provided that borrowers taking out foreign

loans duly registered with the Central Bank would receive a

pecuniary benefit equal to 85 percent of the tax paid on interest,

commissions, and expenses due on such loans.
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4 The parties have stipulated and agreed to use June 28,

1985, as the date for all purposes relating to the reduction of

the subsidy to zero in this case. 

Also on August 5, 1975, the Central Bank issued Circular 266,

which provided in part:

a. a DARF would be used for the payment of the 25-

percent income tax on interest resulting from foreign

currency loans;

b. on the date of payment, the banking establishment

receiving the payment would, by means of a credit to the

borrower's account, pay the borrower the equivalent of 85

percent of the income tax; and 

c. the banking establishment receiving the tax payment

would debit its own account entitled "Pecuniary BenefitD.L. 1,411," and would charge the total value of the

pecuniary benefit against the Central Bank.

On July 26, 1979, the pecuniary benefit was reduced to 50

percent of the tax. On December 7, 1979, the pecuniary benefit was

increased to 95 percent of the tax; on May 8, 1980, the pecuniary

benefit was reduced to 40 percent of the tax; and on June 28,

1985,4 the pecuniary benefit was reduced to zero. 

H. Resolution 63 Loans

Many Brazilian companies that needed working capital were not

able to provide foreign lenders with adequate financial information

or proper guaranties to obtain a loan. To provide Brazilian

companies with the funds needed for their development, and in

keeping with the Brazilian Government's efforts to develop the

country's economy and generate foreign exchange, the Central Bank

issued Resolution 63 on August 21, 1967. Resolution 63 permitted

certain Brazilian banks to borrow funds from abroad for the
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specific purpose of relending (repassing) the corresponding

borrowed funds in Brazilian currency to Brazilian companies (repass

borrowers). The charges paid by a repass borrower to a Brazilian

bank were in the same proportion as the charges paid by the

Brazilian bank to the foreign lender. The loan between the foreign

lender and the Brazilian bank was independent of the loan between

the Brazilian bank and the repass borrower. The foreign lender had

no legal relationship with the repass borrower and in general did

not know the repass borrower's identity.

Foreign loans which were repassed under Resolution 63 were

subject to the same restrictions on the receipt and exchange of

foreign currency as other foreign loans. Circular 266 provided

that in the case of a Resolution 63 loan, the bank receiving the

foreign loan was required to transfer the total value of the

pecuniary benefit to the borrower receiving the repass funds, and

in cases in which the foreign loan was transferred to several

repass borrowers, the pecuniary benefit was transferred

proportionately to each of such borrowers. 

I. Details of Repass Borrowing Under Resolution 63

Generally, a foreign lender was concerned only with the credit

risk of the Brazilian bank. The initiative to borrow foreign funds

for lending to local companies under Resolution 63 was that of the

Brazilian bank, which would repass loans if and when local

borrowers were available. In making Resolution 63 loans to
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Brazilian banks, foreign lenders generally assumed that the

Brazilian bank would repass its cost of funds (the cost of the

foreign lender's loan) and charge a spread or commission to the

repass borrower.

The Brazilian bank was allowed to charge its borrower only a

repass commission. The repass commission was usually calculated as

a set percentage per year of the principal balance of the repass

loan. The amount of the repass commission was the same as the

commission charged for other types of loans. During the years in

issue, there was no limit on repass commissions, and the commission

was as high as 10 percent, depending upon the individual repass

borrower's credit.

Except for the term of the loan, all other financial

conditions of the loan between the Brazilian bank and the repass

borrower had to be the same as those between the foreign lender and

the Brazilian bank. If the interest rate charged by the foreign

lender to the Brazilian bank was net of the Brazilian withholding

tax, then the interest rate payable by the repass borrower was

likewise net of the Brazilian withholding tax. If the Brazilian

bank was entitled to a pecuniary benefit, then it passed on the

benefit to the repass borrower. The transfer of the pecuniary

benefit from the Brazilian bank to the repass borrower reduced the

repass borrower's cost of the repass loan and thus encouraged

foreign borrowing.
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Beginning in 1974, Resolution 63 funds not utilized in repass

operations could be deposited with the Central Bank. When such

funds were deposited, the Central Bank paid the interest on the

foreign loan; and if there was a net loan involved, no withholding

tax was paid with respect to the Central Bank's interest payment.

J. Resolution 432

As a result of the historically high inflation in Brazil and

the periodic currency exchange devaluations, the National Monetary

Council issued, on June 23, 1977, Resolution 432, which authorized

borrowers of registered foreign currency loans to hedge cruzeiros

(intended to be used for payments on the loans) against currency

exchange devaluations by depositing foreign funds at the borrower's

Brazilian bank. Pursuant to Resolution 432, the borrower would

purchase the funds to be deposited at its Brazilian bank at the

official exchange rate. The foreign funds remained on deposit

until such time as the borrower was required to make payment to the

lender. The foreign currency deposited at the borrower's bank was

then transferred to the Central Bank which paid (2 days prior to

the date the borrower was required to make payment to the lender)

interest on the deposited funds at a rate equal to that payable by

the Brazilian borrower to the foreign lender (as set forth in the

certificate of registration). To the extent that interest was paid

to the foreign lender with funds deposited in the Central Bank, the

Brazilian borrower had no obligation to withhold income taxes
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5 The National Tax Code is a complementary law and has an

authoritative status below that of the Federal Constitution but

above that of ordinary laws. Where the National Tax Code

conflicts with an ordinary law, the National Tax Code will

prevail. 

thereon; correspondingly, the Brazilian borrower received no

subsidy. 

If the 432 program loan was a gross loan, the Central Bank

would pay the withholding tax due on the interest payable to the

foreign lender during the period the funds were deposited in the

Central Bank. If the 432 program loan was a net loan, the Central

Bank would pay no withholding tax with respect to the interest

payable to the foreign lender. 

K. Brazilian Tax Law in General

The Brazilian tax system is divided into three types of

authority: The Federal Constitution of Brazil (Federal

Constitution), the National Tax Code, and ordinary Federal, State,

and municipal legislation.5

The Federal Constitution divides the authority to tax among

the Federal Government, the States, and the municipalities of

Brazil. Pursuant to Article 21 of the Federal Constitution, the

Federal Government has authority to impose all types of taxes,

including a tax on income, except as otherwise granted by the

Federal Constitution to the States or municipalities. 
- 16 -

Article 19 of the Federal Constitution provides that the

Federal Government, States, and municipalities are to enjoy

immunity from taxation of their income, assets, and operations.

Article 19 further extends this immunity from taxation to

"autarquias" (i.e., autonomous governmental entities) like the

Central Bank. 

The National Tax Code establishes the parameters within which

the taxing authority of the Federal Government, States, and

municipalities may be exercised. It does not, in and of itself,

create or impose any taxes. 

Article 4 of the National Tax Code specifies that the legal

nature of a tax is determined by its generating factor (that is,

the taxable event); the name and other formal characteristics of

the tax are irrelevant to the legal nature of the tax. 

Article 9 of the National Tax Code generally provides that an

entity's immunity or exemption from tax will not relieve it of its

obligation to collect withholding taxes that are due with respect

to its income remittances to third parties. 

Article 113 of the National Tax Code divides tax obligations

into principal and accessory obligations. The principal obligation

is created by the taxable event and has as an objective the payment

of tax. The accessory obligation is derived from the tax

legislation and has as its objective the performance of specific

acts (e.g., maintaining books and records, filing tax returns) in
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the interest of collection of tax. The taxable event which gives

rise to the tax on income is the economic or legal availability of

such income. 

Under Article 45 of the National Tax Code, the person entitled

to "the economic or legal availability of income" is called the

contribuente, or taxpayer. However, the status of contribuente can

be attributed to the holder of assets producing the income or

earnings. In addition, the source making payment of the income can

be liable for the tax if the source is required by law to withhold

and pay such tax to the Brazilian Treasury. 

Under Article 121 of the National Tax Code, the person

obligated to make the payment of tax is called the "passive

subject" of the principal obligation. The passive subject of the

principal obligation is either: (1) The contribuente, when he has

a direct and personal relationship with the taxable event or (2)

the responsavel (responsible person or person liable) when, without

having the status of contribuente, he has an obligation to pay the

tax by an express provision of law. 

Article 122 of the National Tax Code defines the passive

subject of an accessory obligation as the person obligated to

perform the duties which make up the accessory obligation. 

Article 123 of the National Tax Code specifies that, except as

otherwise provided by law, private agreements concerning the

liability to pay taxes are not binding on the public treasury. 
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6 Prior to Decree-law 401, the Brazilian Supreme Court,

in several decisions, held that remitted interest with respect to

goods purchased abroad on an installment basis could not be

taxed, because the interest was part of the purchase price and

had been earned abroad. Decree-law 401 was passed to clarify

that generally such interest was taxable under Brazilian law. 

Its provision in Article 11 that the taxable event was the

remittance of the interest and the borrower was the contribuente,

generated considerable controversy, because that provision seemed

contrary to the normal rules of Brazilian tax law. In a June 14,

1972, decision, however, the Brazilian Supreme Court upheld the

validity of Decree-law 401. 

Article 128 of the National Tax Code provides that the

liability for a tax claim may be assigned to a third party who is

related to the taxable event which gives rise to the tax

obligation. 

Since 1943, Brazilian Federal legislation generally has

provided for withholding tax imposed on interest paid by Brazilian

borrowers to foreign entities, at the following rates:

Rate Years 

 10% 1944-47

 15 1948-54

 20 1955-58

 25 1959-74

 5 1974-75

 25 1975-Present

Article 11 of Decree-law 401,6 which was enacted on December

30, 1968, provides as follows:

Subject to the deduction of the Income Tax at source

is the value of interest remitted to a foreign country,

payable by virtue of purchase of goods on installment,

even when the beneficiary of the revenue is the actual

seller.
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For purpose of this article, the remittance to a

foreign country is considered the generative fact of tax,

and the remitter is considered the contribuente.

L. SRF 368 and FIRCE 80

On June 10, 1980, Secretary Francisco Dornelles (Dornelles),

the head of the Brazilian equivalent of the Internal Revenue

Service (Brazilian IRS), issued SRF 368 to the head of the Central

Bank's Department of Foreign Capital Fiscalization and Registration

(FIRCE). SRF 368 was an "officio", a formal written communication

between two governmental agencies that is binding upon the

governmental agencies. SRF 368 stated, in pertinent part:

Subject: Notification of waiver of payment of income

tax on remittances abroad

Ref. Off. Let. FIRCE-1-0-80/059, dated 6/3/80

Dear Sir:

In reply to the above mentioned official letter, of

interest to your Department, I hereby inform you, for

such measures as you may deem necessary, that, in the

exercise of the powers delegated to me by MF

Administrative Ruling 648/79, I AUTHORIZE the waiver of

payment of withholding income tax incident on the

remittance of interest and other legal charges on behalf

of Banco do Brasil S/A-Grand Cayman Branch with respect

to the foreign loan transaction in the amount of $60

million contracted by the Federative Republic of Brazil,

Ministry of Foreign Relations at that bank.

 * * * * * * *

2. I would also like to take this opportunity to inform

you of the directive contained in SRF Official Letter no.

1016 dated 12/26/79 addressed to DECAM (Departmento de

Cambio) [Department of Foreign Exchange], according to

which the Central Bank of Brazil, independently of any

prior statements made by this Secratariat, is authorized
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7 Brazil is a civil law, as opposed to a common law,

country. Court decisions are technically binding only upon the

litigants of the case. Prior similar cases are not considered to

be strictly binding as precedents, although both the courts and

litigants will frequently cite such prior cases as representing

the correct legal reasoning to be applied and the proper holding

to be made.

to waive the withholding of said tax on remittances

abroad made by public-sector entities that prove they

have assumed the tax burden [(i.e., have net loans)].

The Brazilian IRS's above position in paragraph 2 of SRF 368

was supported by certain decisions of the Brazilian Supreme Court

which held that public-sector entities were not required to pay

withholding tax with respect to their net loan interest remittances

abroad, because of their immunity from taxation under Article 19 of

the Federal Constitution.7

As a result of receiving SRF 368, the head of FIRCE issued

FIRCE Service Instruction No. 80 (FIRCE 80) on May 19, 1981. FIRCE

80 stated, in pertinent part:

We hereby inform the Central and Regional Divisions

that as per Official Letters SRF no. 368 and DRF

(Departmento da Receita Federal) * * * [Brazilian

IRS] no. 040/81, dated 6/10/80 and 2/4/81 respectively,

the * * * [Brazilian IRS] authorized this bank to

waive the payment/collection of withholding income tax in

the case of remittances abroad of interest and other

charges originating from currency loans and financing for

the importing of goods, when the domestic contracting

party fulfills the following requirements:

(a) it is a public-sector legal entity;

(b) it has proven that it has assumed the tax burden

[(i.e., has a net loan)];
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For purposes of clarification, the following are

public-sector entities:

-the Union, States, Federal District, and

Municipalities * * * ;

-federal territories * * * ;

-federal, state, and municipal autonomous government

agencies * * * .

Consequently, we recommend that, in the case of

transactions with the characteristics outlined above, the

corresponding Certificates be issued with the additional

observation:

"Payment/collection of withholding tax on income

is waived on remittance(s) (indicate the nature of

the remittance) covered by this Certificate 

(Official Letter SRF no. 368, dated 6/10/80)."

M. Latin Debt Crisis

A number of Latin American countries, including Brazil and

Mexico, incurred large foreign debts. Beginning in about the early

1980's, some of these countries experienced problems in paying

their foreign debts. This Latin debt crisis persisted for a number

of years. 

In about 1982, a large number of Mexico's foreign lenders

(including some major international banks in the G-7 countries) and

the Mexican Government agreed to a restructuring of Mexico's

foreign debt. 

Brazil began experiencing similar problems in paying its

foreign debt in 1982. In late 1982, the Brazilian Government

declared a moratorium with respect to the repayment of Brazil's

foreign debt. 
- 22 -

As a practical matter, the major international banks, like

Citibank, that held large amounts of outstanding loans in Latin

American countries were compelled to help Brazil, Mexico, and other

Latin American countries work out their financial problems. These

major international banks and the governmental banking regulators

in the G-7 countries feared that a default by a Latin American

country, especially a major debtor country like Brazil, on its

foreign debt could trigger a collapse of the international banking

system. The banks and the regulators believed that a default by

one Latin American country on its foreign debt could lead to

worsening economic conditions which would cause other Latin

American countries to default on their foreign debts. For instance,

in 1982, Citibank held about $4.6 billion in total outstanding

Brazilian loans, an amount equal to an extremely high percentage of

Citibank's then net equity. Citibank thus could not afford to

write down its Brazilian loans, as such a writedown might lead to

its becoming insolvent for bank regulatory accounting purposes. 

For its part, Brazil had to obtain considerable financial help

from the major international banks in attempting to work out its

financial problems. Brazil was desperately short of the foreign

currency needed for imports to keep its economy functioning. 

N. Brazilian Foreign Debt Restructuring in General

As relevant to this case, the Brazilian foreign debt

restructuring that took place was divided into three phases: Phase

I, phase II, and phase III. Initially, the major international
- 23 -

banks involved in negotiating phase I of the Brazilian foreign debt

restructuring believed that Brazil's financial problems could be

resolved if Brazil were given some relatively short-term financial

assistance in overcoming its present shortage of foreign currency,

as Brazilian borrowers generally were continuing to make payments

in cruzeiros on their foreign loans. In imposing the foreign debt

repayment moratorium, the Brazilian Government and the Central Bank

were blocking remission of these loan payments because Brazil

lacked sufficient foreign currency reserves with which to

effectuate the foreign loan payments. This belief of the major

international banks proved to be erroneous, and Brazil continued to

require yet additional financial assistance from its foreign

lenders, including the later phase II and phase III of the

Brazilian foreign debt restructuring. 

Officials at the highest levels of the Brazilian Government

were concerned with and kept informed of the status of the phase I,

phase II, and phase III restructuring negotiations. Of the

individuals representing the Brazilian Government and the Central

Bank during these negotiations (the Brazilians), the principal

negotiators were Finance Ministry officials and Central Bank

officials. 

O. Mechanics and Negotiations of the Brazilian Foreign Debt

Restructuring

The Central Bank served as the borrower under certain

agreements entered into in connection with phase I, phase II, and
- 24 -

phase III of the Brazilian foreign debt restructuring, with the

Brazilian Government being the guarantor of the Central Bank's

obligations under these agreements. The major international banks

involved in negotiating the Brazilian debt restructuring wanted the

Central Bank to be the borrower, as the Central Bank, unlike the

Brazilian Government, could be sued in foreign courts.

Additionally, the Central Bank held all of Brazil's foreign

currency reserves. 

There were perhaps as many as 600 foreign lenders holding

outstanding Brazilian loans. Collectively, these lenders had

issued thousands of outstanding loans to numerous Brazilian

borrowers. 

As it was not feasible to have the foreign lenders and their

Brazilian borrowers renegotiate all these loans, the deposit

facility agreement (DFA) mechanism was devised. The prior

outstanding loans would be left in place. When a prior loan

borrower made a loan payment, the payment would be deposited with

and held by the Central Bank pursuant to a new loan entered into by

the Central Bank and the foreign lender. 

As a further part of the restructuring, Brazil also needed to

obtain additional foreign capital to enable its economy to

function. Much of this additional foreign capital or new money was

furnished under the credit guaranty agreement (CGA) entered into by

the Central Bank and some of the foreign lenders. Only the 170

foreign lenders holding the largest amounts of outstanding
- 25 -

 

8 No phase III CGA was entered. 

 

9 As part of the later phase III restructuring discussed

more fully infra, the relending period for the phase II DFA was

extended from June 30, 1985, to April 1986, and the relending

period for the phase II CGA was extended from June 30, 1985, to

March 1986. 

Brazilian loans participated in the phase I CGA. In contrast,

almost all of the foreign lenders participated in the phase II

CGA.8

The loans made to the Central Bank under the phase I and phase

II DFA's and CGA's were net loans that had repayment terms of 7 to

9 years. In the phase I and phase II DFA's and CGA's, provision

was made for funds that would otherwise be lent to the Central

Bank, as borrower, to be alternatively lent or relent to other

Brazilian persons and companies. Many of the foreign lenders

wanted to maintain their business relationships with their longtime

Brazilian customers. They thus wanted their customers to have some

ability to borrow and take out loans from the large amount of

foreign exchange and capital to be provided by the foreign lenders

to the Central Bank pursuant to the DFA's and CGA's. The phase I

DFA, phase II DFA, phase I CGA, and phase II CGA each provided that

there would be an initial period of about 16 or 18 months during

which DFA and CGA funds could be alternatively lent or relent to

other Brazilian persons and companies (the relending period).9 

Phase I

After the Brazilian Government imposed its foreign debt

repayment moratorium in December of 1982, Citibank and Morgan Bank,
- 26 -

 

10 Under the phase I and later phase II trade receivable

commitment agreements and interbank commitment agreements the

major international banks pledged to provide short-term credit to

Brazil in connection with certain trade receivables and interbank

lines of credit at the same levels which existed prior to the

Brazilian foreign debt crisis. 

two major international banks holding the largest amounts of

outstanding Brazilian loans, took the lead in negotiating the phase

I restructuring of Brazil's foreign debt. The phase I

restructuring agreements were entered into by Brazil and its

foreign lenders on February 25, 1983. 

The phase I restructuring included: (1) A phase I DFA that

covered the scheduled debt payments due in 1983 on prior

outstanding Brazilian loans, (2) a phase I CGA under which the

Central Bank would be lent up to an additional $4.4 billion in new

money, (3) a phase I trade receivable commitment agreement, and (4)

a phase I interbank commitment agreement.10

As indicated previously, only the 170 foreign lenders holding

the largest amounts of outstanding Brazilian loans participated in

the phase I CGA. Their shares of this $4.4 billion of new money to

be provided to Brazil were based on their relative holdings of

outstanding Brazilian loans. 

In negotiating the phase I restructuring, Citibank, Morgan

Bank, and the Brazilians were under extreme time pressure to

conclude an agreement quickly because of the Brazilian Government's

debt repayment moratorium. If a restructuring agreement were not

concluded, then many of the foreign lenders' Brazilian loans would
- 27 -

have to be placed into nonperforming status. (Generally, for bank

regulatory accounting purposes, once a bank loan is placed into

nonperforming status and a specified period of time elapses, among

other things, previously accrued but uncollected interest income

with respect to the loan must be written down by the bank. Such

writedowns could cause the international financial community to

lose confidence in Brazil's ability to repay its foreign debt.)

Moreover, if any foreign lender were to declare its outstanding

Brazilian loans to be in default, Brazil's foreign debt crisis then

could well escalate out of control, with disastrous consequences

for a number of major international banks and the international

banking system. 

Phase II

During the first half of 1983, Brazil and its foreign lenders

realized that the phase I restructuring would not be sufficient to

solve Brazil's financial problems. They thus began negotiation of

what became known as the phase II restructuring. At about this

time, the head of the International Monetary Fund (IMF) announced

that he was conditioning Brazil's receipt of any further financial

assistance from the IMF upon at least 90 percent of Brazil's

outstanding foreign debt that was owed to private foreign lenders

being restructured. 

On January 27, 1984, Brazil and its foreign lenders entered

into four agreements to effectuate the phase II restructuring of

Brazil's foreign debt: (1) A phase II DFA that covered the
- 28 -

scheduled debt payments due in 1984 on prior outstanding Brazilian

loans, (2) a phase II CGA under which the Central Bank would be

lent up to an additional $6.5 billion in new money, (3) a phase II

trade receivable commitment agreement, and (4) a phase II interbank

commitment agreement. 

During the phase II restructuring negotiations, Brazil did not

declare another moratorium with respect to the repayment of its

foreign debt. As a result, although there was pressure for Brazil

and its foreign lenders to conclude a phase II restructuring deal,

the time pressure they were under was not as severe as that which

they had experienced during the phase I restructuring negotiations.

Many of the foreign lenders were unhappy with Citibank's and

Morgan Bank's negotiation of the phase I restructuring. They felt

that they had no input into the phase I negotiations and that the

phase I restructuring agreements had been forced upon them by

Citibank and Morgan Bank. 

As a result, the major international banks and Brazil decided

that a Bank Advisory Committee for Brazil (BAC) should be formed to

negotiate the phase II restructuring on behalf of the foreign

lenders. The BAC was formed on June 16, 1983. It had 14 members,

Citibank, Morgan Bank, Lloyd's Bank, Arab Banking Corporation, Bank

of America, Bank of Montreal, the Bank of Tokyo, Bankers Trust,

Chase Manhattan Bank, Chemical Bank, Credit Lyonnais, Deutsche

Bank, Manufacturers Hanover Trust, and Union Bank of Switzerland.

Citibank served as the BAC's chairman; Morgan Bank and Lloyd's Bank
- 29 -

served as its deputy chairmen. A senior executive at Citibank,

William Rhodes (Rhodes), represented Citibank in its role as the

BAC's chairman. 

The BAC also appointed certain coordinating banks in various

sectors of the international financial community. The BAC members

and coordinating banks would advise foreign lenders of the status

of the negotiations. Also, any foreign lender could raise any

issue in connection with the proposed phase II restructuring that

it wished with the BAC. 

The BAC adopted a set of operating rules concerning its

deliberations and its negotiation of the phase II restructuring.

The BAC would formulate its position only by reaching a unanimous

consensus among the BAC members. It would further negotiate with

the Brazilians only those issues pertaining to the phase II

restructuring that it considered to be of importance to all of the

foreign lenders, as a group, in effectuating the restructuring; it

would not negotiate with the Brazilians those issues that it felt

concerned only some of the foreign lenders. However, on those

issues which it would not negotiate, but which it believed were

important issues to certain foreign lenders, the BAC would advise

the Brazilians of the issue's existence and its importance to some

of the foreign lenders. 

During the phase II negotiations, perhaps the most contentious

issue the BAC dealt with was the issue of new money to be provided

to Brazil. Under the proposed phase II CGA, all foreign lenders
- 30 -

holding outstanding Brazilian loans were being asked to contribute

their pro rata share of the new money. However, a number of

foreign lenders were reluctant to contribute any new money

whatsoever. The BAC then informed the foreign lenders that, in its

negotiation of a phase II restructuring deal on the foreign

lenders' behalf, there would be "no free riders". Although each

foreign lender would still have to consent to the terms of any

restructuring deal the BAC negotiated on its behalf with the

Brazilians, the BAC's official position was that a phase II

restructuring would be "all or none". The BAC feared that if a

large number of foreign lenders refused to contribute any new

money, its (the BAC's) efforts to conclude a phase II restructuring

deal between Brazil and Brazil's foreign lenders might unravel and

fail. While the BAC could not be certain that all of the foreign

lenders would ultimately agree to participate, it hoped to obtain

as close to 100 percent participation as possible, as any shortfall

of new money resulting from some foreign lenders' nonparticipation

and refusal to contribute would have to be made up by the other

participating foreign lenders. 

On October 6, 1983, 60 major international banks agreed on a

framework for the phase II restructuring. Under this framework,

Brazil would be provided $6.5 billion in new money. 

On October 12, 1983, the BAC issued to the foreign lenders its

term sheet with respect to the proposed phase II restructuring.
- 31 -

The term sheet outlined the major terms of the proposed

restructuring that the BAC had negotiated with the Brazilians.

From about November 1983 through January 27, 1984, virtually

all of the foreign lenders submitted their individual written

commitments to the term sheet that the BAC had negotiated on their

behalf with the Brazilians. Prior to and during this period, some

foreign lenders, including Commercial Credit Corporation, a

subsidiary of Control Data Corporation, initially indicated that

their approval of the term sheet would be conditional upon the

Brazilians' resolving the withholding issue favorably to them,

which issue is discussed more fully infra. 

Phase III

The phase III negotiations began in about the fall of 1984 and

continued through July 1986. Originally, the BAC and the

Brazilians contemplated restructuring the scheduled Brazilian

foreign debt payments due in the 7-year period from January 1,

1985, through December 31, 1991. However, no such 7-year

restructuring agreement was ultimately concluded. 

On July 25, 1986, Brazil and its foreign lenders signed the

phase III DFA. The phase III DFA covered the scheduled Brazilian

foreign debt payments due in 1985 and 1986. Under the phase III

DFA, any 1985 debt payments would be available for relending to

other Brazilian persons and companies during a specified relending

period; 1986 debt payments, on the other hand, would not be

available for relending. 
- 32 -

 

11 See Nissho Iwai Am. Corp. v. Commissioner, 89 T.C. 765,

772-773 (1987).

The phase I DFA and the phase II DFA did not cover foreign

debt payments that were due after January 1, 1985. During the

phase III negotiations, Brazil and its foreign lenders agreed to

about six interim loan arrangements under which debt payments due

after January 1, 1985, being made by Brazilian borrowers would be

held by the Central Bank as "interim deposits". These interim

arrangements required the Central Bank to pay the foreign lenders

interest on such interim deposits, on a "net quoted" basis. The

interim arrangements themselves did not provide for any relending

period, as the Brazilians and the BAC envisioned that these interim

deposits would ultimately be rolled over into and covered under the

phase III DFA they anticipated would be concluded. 

P. Various Foreign Lenders' Efforts During the Phase I and Phase

II Restructuring Negotiations To Have the Central Bank Issue Them

DARF's With Respect to Its Net Loan Interest Remittances

For certain U.S. and other foreign lenders who were in a

position to claim and utilize them, foreign tax credits potentially

represented a significant further source of tax benefits, with

respect to their Brazilian loans. Although, in the case of a net

loan, the U.S. lender would have to pay U.S. income tax with

respect to the additional interest income resulting from the grossup, a foreign tax credit equal in amount to the additional interest

income could be utilized to reduce the lender's U.S. income tax

liability on a dollar-for-dollar basis.11
- 33 -

As indicated previously, the Central Bank paid withholding tax

on its gross loan interest remittances abroad, but not on its net

loan interest remittances, including its Resolution 432 loan

program net loan interest remittances. Prior to 1982, some foreign

lenders, including certain major international banks, like

Citibank, sought to have the Central Bank pay withholding tax and

issue them DARF's with respect to the Central Bank's 432 loan

program net loan interest remittances, as this would enable these

foreign lenders to claim potential foreign tax credits. However,

their efforts were unsuccessful, as officials at the Central Bank

rejected the foreign lenders' requests to have the Central Bank

issue such DARF's to them. Central Bank officials advised the

foreign lenders that the Central Bank was not required to pay

withholding tax with respect to its net loan interest remittances

abroad because it was a tax-immune governmental entity under the

Brazilian Constitution. 

At about the time of the negotiation of the phase I Brazilian

debt restructuring, a number of foreign lenders (including some

major international banks, like Citibank) intensified their efforts

to have the Central Bank issue DARF's on its net loan interest

remittances to them, including DARF's with respect to (1) the

Central Bank's 432 loan program net loan interest remittances and

(2) the Central Bank's proposed phase I DFA and phase I CGA

interest remittances (the withholding issue). These intensified

efforts by the foreign lenders to have the Central Bank issue them
- 34 -

 

12 Alexandre Leite (Leite), the head of Citibank-Brazil's

tax division, testified that he and Citibank had been seeking

DARF's from the Central Bank on 432 program net loan interest

remittances since at least 1979. Leite related that the Central

Bank officials he met with rejected Citibank's request to have

the Central Bank issue such DARF's to it. Following the Central

Bank's issuance of FIRCE 80 in May 1981, Leite had concluded that

Citibank would not be able to persuade the Central Bank to issue

such DARF's, as FIRCE 80 was authorized and sanctioned by SRF

368. 

 

13 The parties disagree over whether the Central Bank was

legally liable for and actually paid withholding tax with respect

to its restructuring debt interest remittances during the

relending periods of the DFA's and CGA's. The terms "payment"

and "withholding tax" are used herein for convenience and are not

intended as ultimate findings or conclusions concerning the

Central Bank's liability for and payment of such withholding tax. 

Similarly, the use herein of terms indicating that DARF's or

withholding receipts were issued by the Central Bank to the

foreign lenders should not be construed as our conveying any

legal conclusion concerning the Central Bank's liability for and

payment of such withholding tax.

such DARF's continued until about the time the phase II

restructuring agreements between Brazil and its foreign lenders

were entered into in late January 1984.12

During the phase I negotiations, the Brazilians indicated that

they would have the Central Bank issue DARF's to the foreign

lenders on the Central Bank's restructuring debt interest

remittances on some limited basis, but they also indicated that

they needed additional time in which to study and arrange for the

implementation of the Central Bank's payment of such withholding

tax.13 On or about December 28, 1982, the Central Bank requested

a ruling from the Brazilian IRS with respect to its payment of

withholding tax during the relending periods of the proposed phase

I DFA and phase I CGA. The ruling request and the March 1984
- 35 -

 

14 Some foreign lenders operated in countries which did

not allow foreign tax credits with respect to Brazilian

withholding tax payments. Still other lenders were not in a tax

position to benefit from claiming potential foreign tax credits. 

 

15 To a significant extent, Citibank sought to segregate

the activities and functions of Rhodes (the Citibank senior

executive who acted as the BAC's chairman) from the individual

concerns and matters which Citibank pursued during the phase II

restructuring negotiations. At various BAC meetings, other

Citibank employees (principally the top employees of CitibankBrazil), and not Rhodes, would represent and present Citibank's

position. 

private ruling that ultimately was issued by the Brazilian IRS to

the Central Bank are discussed more fully infra.

During the phase II negotiations, some foreign lenders,

including Citibank, wanted the BAC to negotiate the withholding

issue with the Brazilians. The BAC decided that it could not

negotiate the withholding issue with the Brazilians, as the

withholding issue, although important to a number of foreign

lenders, did not concern all of the foreign lenders.14 Even those

BAC members, like Citibank and Lloyd's Bank, that would

substantially benefit from being able to claim potential foreign

tax credits realized that they could not afford to be accused of

using their positions on the BAC to further their own individual

interests at the expense of other foreign lenders.15 The BAC,

instead, advised the Brazilians that the withholding issue was a

very important issue to a number of foreign banks, and that the

Brazilians would have to resolve the withholding issue as a matter

of the applicable Brazilian law. The BAC further created a

subcommittee to study the withholding issue. 
- 36 -

 

16 Job Maats, who functioned as Citibank-Brazil's

financial controller, served on the BAC's withholding issue

subcommittee and played a central role in Citibank's efforts to

obtain DARF's from the Central Bank, testified that Brazilian

officials were told that a favorable resolution of the

withholding issue would also benefit Brazil and be in Brazil's

interest, because it would improve the climate to conclude a

restructuring deal. 

 

17 Citibank estimated that, for 1979 through 1983, a

potential foreign tax credit of $30 million could be claimed by

Citibank with respect to the Central Bank's 432 program net loan

interest remittances. 

Until about the signing of the phase II restructuring

agreements in January 1984, Citibank continued to press the

Brazilians to reach a favorable resolution of the withholding

issue. Top employees of Citibank-Brazil utilized virtually every

opportunity available to them, outside of the BAC's meetings, to

lobby Brazilian Government officials and Central Bank officials on

the withholding issue.16 Other foreign lenders, including

Commercial Credit Corporation, also pressed the Brazilians to

resolve the withholding issue favorably to these foreign lenders.

On December 8, 1983, Citibank's in-house tax counsel met with

the general counsel of the Central Bank and presented Citibank's

position on the withholding issue. During the meeting, the Central

Bank's general counsel indicated that DARF's would be issued by the

Central Bank on its restructuring debt interest remittances but

refused to address whether the Central Bank would issue DARF's on

its 432 loan program net loan interest remittances.17

On January 22, 1984, the Brazilian Planning Minister, the

Central Bank's general counsel, and other Brazilian officials met
- 37 -

 

18 The foreign lenders who were seeking DARF's from the

Central Bank wanted to receive DARF's with respect to the 1983

restructuring debt interest payments made to them. In addition

to enabling them to claim potential foreign tax credits for 1983,

they believed that the Internal Revenue Service was more likely

to challenge the foreign tax credits claimed by them with respect

to the 1984 restructuring debt interest payments if no similar

foreign tax credits had been claimed by them for 1983.

with Rhodes (the Citibank senior executive who functioned as the

BAC's chairman) and certain other BAC members to advise the BAC

with respect to how the Brazilians had decided to resolve the

withholding issue. During the meeting, the Planning Minister

initially asked the Central Bank's general counsel to review and

discuss the generally applicable Brazilian law with respect to the

payment of withholding tax on interest remittances made abroad.

The Planning Minister then telephoned the Brazilian Finance

Minister to find out whether the applicable Brazilian law had been

clarified with respect to the Central Bank's payment of withholding

tax on its restructuring debt interest remittances. He learned

that the Brazilian IRS would issue a ruling to the Central Bank,

which would hold that the Central Bank was required to withhold on

interest remittances during the relending periods of the phase I

DFA, phase II DFA, phase I CGA, and phase II CGA, beginning January

1, 1984.18 The Planning Minister advised Rhodes and the other BAC

members of this anticipated ruling. He indicated that the Finance

Ministry would shortly send a telex to the BAC confirming this,

which telex was received by Rhodes on or about January 24, 1984.

This anticipated ruling discussed at the January 22, 1984, meeting
- 38 -

was the March 1984 private ruling that the Brazilian IRS ultimately

issued to the Central Bank, which ruling is more fully discussed

below.

Notes of the January 22, 1984, meeting taken by the lead

attorney of the law firm that served as the BAC's counsel, 

stated: 

Rhodes

(1) Banks think 83 will be solved.

(2) IRS won't accept 84 if don't get 83.

(3) negative feeling for banks in the future.

Sobreira [Central Bank's general counsel]

(1) Tax owed by anyone paying interest or fees 

abroad.

(2) Authority that remits charged with deduction

 & paying.

(3) Cent Bk agrees to pay on acct of Banks.

(4) Only way CB can pay is if law is interpreted

 to require payment. Interpretation is from 

 Treasury which has issued the interpretation.

(5) Treasury legal opinion applies to 1984 but 

 not to 1983.

 Waiting for XXXXXX 

(1) Delfim [the Brazilian Planning 

Minister] says decree will be solved by 

inserting limit.

(2) Wh tax. Phase I and phase II from 1/1/84 on

 during reborrowing period.

o Agreement of Delfim.

Rhodes + Coleman [the Morgan Bank senior 

executive who functioned as the BAC's deputy 

chairman] accept #1.

Rhodes says he can't guarantee Bank acceptance of

#2. 
- 39 -

Q. The Brazilian IRS's March 1984 Private Ruling to the Central

Bank

On or about December 28, 1982, the head of FIRCE submitted a

"consulta" or ruling request by the Central Bank to the Brazilian

IRS. The December 28, 1982, consulta stated, in pertinent part:

Subject: Withholding tax levied on interest on 

* * * [proposed phase I DFA and phase I CGA].

Mr. Secretary,

In the next few days, the Central Bank of Brazil will

enter into, with the international financial community,

* * * [the proposed phase I DFA and phase I CGA].

 * * * * * * *

2. In contracting these * * * [agreements], the

Central Bank * * * will act in the capacity of Agent

of the Federal Government in implementing the foreign

exchange policy determined by the National Monetary

Council.

3. Therefore, all the financing charges resulting from

the above agreements will be for the account of the

National Treasury, which will be responsible for the

respective services related to payments and remittances.

4. During the negotiations for such Agreements, the

Brazilian Authorities assumed the commitment to provide

the creditors with withholding receipts (DARF's) for the

withholding tax paid on the interest payable by the

Central Bank on the funds of * * * [the phase I DFA

and phase I CGA], during the period in which such funds

remain deposited at the Central Bank and available for

relending to borrowers in Brazil.

5. In view of the special characteristics of these

transactions, we hereby request your opinion on the

matter, pointing out that the following has already been

negotiated with the creditor bankers:

(a) issuance of the DARF's in the names of

the agent bank of * * * [the proposed

phase I DFA and phase I CGA], considering that
- 40 -

the large number of lender bankers makes it

impractical to issue one DARF in the name of

each of them;

(b) the payments are to be made individually

per agent/taxable event/tax rate in view of

the different tax rates available under

double-taxation treaties.

6. In view of the foregoing, we hereby ask also for

your opinion regarding the following aspects:

(a) if the Central Bank, in this case, is

entitled to the pecuniary benefit * * * ;

(b) the possibility of establishing a period

of 15 (fifteen) days for the payment of the

tax, such period to start as of the date of

remittance of the interest to the foreign

creditors, on account of the complex

calculation of the interest and consequently

of the tax itself;

(c) the possibility of indicating "Brazilian

Financing Plan" as the reference in space 31

of the DARF as there is no Certificate of

Registration for these transactions;

(d) in the event that the withholding tax is

paid late:

(i) whether the Central Bank would

nevertheless be entitled to such

pecuniary benefit;

(ii) whether it would be possible to

waive the ancillary charges (default

interest and monetary correction),

particularly as regards the penalty.

(e) whether the position to be adopted by

your Office can be extended to agreements of

identical characteristics that may be executed

in the future in a possible development of the

present negotiation phase.

(7) Finally, we point out that the matter is of special

importance for the completion of the mentioned

Agreements. 
- 41 -

Following the Central Bank's submission of the above ruling

request, by around June or July 1983, certain employees of the

Brazilian IRS prepared a proposed draft ruling which held that the

Central Bank was required to pay withholding tax on its

restructuring debt interest remittances to the foreign lenders

during the relending periods of the DFA's and CGA's, because it was

subject to the same withholding tax collection and payment rules

that were applicable to non-public-sector entities (the DoniakKahan draft ruling). The Doniak-Kahan draft ruling was hotly

debated within the Brazilian IRS and the Brazilian Government

because of its conflict with SRF 368 and existing Brazilian Supreme

Court decisions. As a result, Dornelles (the head of the Brazilian

IRS) decided he could not approve the issuance of the Doniak-Kahan

draft ruling to the Central Bank. 

In about early January of 1984, Dornelles directed two toplevel Brazilian IRS officials to redraft and revise the DoniakKahan draft ruling. He instructed them to reach the same holding

as in the Doniak-Kahan draft ruling (i.e., that the Central Bank

was required to pay withholding tax on its restructuring debt

interest remittances to the foreign lenders during the relending

periods of the DFA's and CGA's) but to keep their revised ruling

within the provisions of SRF 368. In revising the Doniak-Kahan

draft ruling, these two Brazilian IRS officials devised and

formulated a new theory that the Central Bank was required to pay

withholding tax on its restructuring debt interest remittances
- 42 -

during the relending periods of the DFA's and CGA's because until

the expiration of the applicable relending period the loan funds

were not yet irrevocably committed to the Central Bank, and it,

therefore, had to pay withholding tax on behalf of future,

unidentified "borrowers-to-be" (the borrowers-to-be theory). They

incorporated this borrowers-to-be theory into the revised draft

ruling they prepared, which revised draft ultimately became the

final version of the ruling the Brazilian IRS issued to the Central

Bank in March 1984. 

By letter dated March 14, 1984, the Brazilian Finance Minister

forwarded to the Central Bank's President the Finance Minister's

decision on the ruling request and the ruling the Brazilian IRS had

issued. The March 14, 1984, letter stated, in pertinent part:

I refer to the inquiry made by your Bank regarding the

tax treatment for the Agreements called * * * [CGA

and DFA].

2. In this respect, I enclose a copy of the opinion of

* * * [the Brazilian IRS] on the matter, as well as of

the decision I issued on this date on account of the

discussions I had jointly with you for the negotiation of

such agreement.

The ruling issued to the Central Bank was a private ruling that was

given limited circulation. The ruling was not made available to

the public and was not published in the Brazilian Government's

Official Gazette. 

The Finance Minister's decision stated:

Case No.:

Interested Party: CENTRAL BANK OF BRAZIL
- 43 -

DECISION: I agree fully with the conclusions of the

attached opinion of the * * * [Brazilian IRS]. In

view of item 13 of said opinion, I direct the Central

Bank of Brazil to implement the payment of income tax on

or before the last business day of the month following

the month in which the withholding is made.

Brasilia, March 14, 1984

/Ernane Galveas/

ERNANE GALVEAS

Minister of Finance

The Brazilian IRS ruling, which he enclosed to the Central

Bank, stated:

Federal Government Service

Ministry of Finance

* * * [Brazilian IRS]

OPINION

Income tax withheld on interest due

 to parties resident or domiciled

 abroad

* * * [FIRCE] of the Central Bank of Brazil requests

an opinion about the tax treatment of Agreements called

* * * [CGA and DFA] under which such government agency

[autarquia] is liable for the payments and remittances

pertaining to them, in the period of availability of such

funds for relending.

(2) By virtue of the special characteristics of these

transactions, the question arises as to whether there is

an incidence of income tax, in view of the government

agency's [autarquia's] assumption of the burden, and if

so whether,

(a) the DARF's may be issued in the name of the agent

bank centralizing each project, considering that the

large number of lenders makes it impractical to complete

one DARF for each of them;

(b) the tax rates established in the treaties signed by

Brazil to avoid double taxation may be applied;

(c) the pecuniary benefit * * * applies;
- 44 -

(d) it is possible to establish another period for the

payment of the tax, as from the date of remittance of the

interest to the foreign lenders, because of the complex

calculation of the interest and consequently of the tax

itself;

(e) it is possible, in space 31 of the DARF, to indicate

"Brazilian Financing Plan" as a reference, given the

absence of a Certificate of Registration for these

transactions;

(f) in the event that the income tax is paid late:

(f)(1) whether the Bank will nevertheless be entitled

to the above-mentioned pecuniary benefit;

(f)(2) whether it would be possible to waive the

monetary correction, delinquent interest and penalty.

(3) Interest received by individuals or legal entities,

resident or domiciled abroad, from individuals or

entities resident or domiciled in Brazil, or received

from a permanent establishment located in Brazil, owned

by individuals or legal entities resident or domiciled

abroad, is subject to withholding tax at the rate of 25%

* * * . The * * * [contribuente] of this tax is an

individual or legal entity, resident or domiciled abroad,

which has the legal availability of the interest. Said

tax must be withheld at the time of payment or credit by

the interest paying source bearing in mind that the * *

* [contribuente] individual or legal entity, resident or

domiciled abroad - does not file an income tax return in

Brazil. Said tax must be withheld even if the paying

source is a legal entity of public law with tax immunity,

because this is not a tax on the entity of public law

that has immunity but rather on parties resident or

domiciled abroad.

(4) It is obvious that, if the party resident or

domiciled abroad, the interest creditor, is immune or

exempt from this tax, on account of international treaty

or domestic legislation, the tax should not be withheld.

In the case of the interest paid by the Central Bank of

Brazil * * * , there is an atypical situation. * *

* [The Central Bank] is a federal government agency

[autarquia] responsible, among other duties, for issuing

currency, acting as depositary of the official gold and

foreign currency reserves, providing for the placement of

domestic and foreign loans, furthering the normal

function of the exchange market, acting as a monetary
- 45 -

policy instrument of the Government and exercising

control over credit in all its forms.

(5) The financial transactions conducted by * * *

[the Central Bank] are, in general, conducted on behalf

of the Federal Union or in its interest. In loan

transactions, agreed upon with a net interest rate, the

financial burden of the tax is transferred to the

borrower. When the borrower assumes the tax burden, what

actually happens is a gross-up of the income of the

beneficiary lender. For this reason and in order to

calculate the gross income obtained, the law determines

that the basis of calculation of the tax - the amount of

interest - be grossed up. In this way, the borrower pays

the income tax to the Union on behalf of the lender,

ensuring the net rate promised to the lender by means of

the payment of a greater amount.

(6) Following the same reasoning, * * * it is

possible to deduct, as an expense of a legal entity, the

amount of tax incident on income tax paid to third

parties, when the legal entity contractually assumes the

burden as it is a supplemental expense and not a

withholding tax.

(7) Now, when * * * [the Central Bank] acts on

behalf of the interest of the Federal Union, in cases of

transactions agreed upon with net interest rates, it

could claim a reimbursement for the amount paid in the

form of income tax. In reality, * * * [the Central

Bank] would pay the tax to the Federal Union and the

Federal Union could return it to * * * [the Central

Bank]. Under this scenario, the payment of tax, as it

would be a simple accounting transaction, could be

waived.

(8) It should be noted that, as regards the possibility

mentioned - loans of funds which must be relent to

borrowers in Brazil - said Bank must, in substitution of

the future not yet identified debtors of the tax, pay the

income tax on the interest paid during the period in

which the funds remained available for relending. The

fact is that, since the loan benefits persons which have

not yet been identified from whom the payment of

withholding tax is stipulated law, * * * [the Central

Bank] must in practice perform these acts on behalf of

such persons.

(9) Considering, therefore, the peculiarity of the

relationship * * * the Central Bank/Federal Union and
- 46 -

the Central Bank/Final borrowers of the relent funds, I

believe that, as regards the funds that must be released

to those as yet unidentified borrowers in Brazil, * *

* [the Central Bank] must as a substitute for such

borrowers pay the income tax incident on the interest

from January 1, 1984 to the end of the period of

availability for such funds to be relent.

(10) On account of the foregoing, there are the following

consequences to the transactions in question:

(a) payment of withholding tax is due and the

calculation base should be adjusted * * * [i.e.,

grossed-up];

(b) as there are innumerable lenders and income is

received through an agent bank which will then distribute

it, the DARF may be issued in the name of the agent to

simplify the payment;

(c) if there is a Convention to avoid double income

taxation signed with countries in which beneficiaries are

domiciled, the rates established in the conventions shall

be applied to that portion of the income corresponding to

each;

(d) once the tax has been made, the pecuniary benefit

* * * is applicable * * * ;

(e) in completing the DARF, the code to be used is code

0393 and, as no certificate of registration is issued in

these transactions, "Brazilian Financing Plan" may be

indicated in the appropriate space, as the reference to

the certificate is merely a control requirement.

(11) As regards the delay in paying the tax not withheld,

if the taxable event occurs while the inquiry is pending,

the tax must be paid with monetary correction and without

penalties * * * .

(12) As the term for payment of the tax is suspended, as

far as the taxable events occurring while the inquiry is

pending are concerned, as a consequence, the pecuniary

benefit will be applicable in relation to the tax paid by

the thirtieth day from the date of knowledge of the

decision.

(13) As far as the extension of the tax payment period is

concerned, this matter falls under the authority of the

Minister of Finance * * * .
- 47 -

For higher consideration.

Brasilia,

/Eivany Antonio da Silva/

Assistant Secretary of * * * [the Brazilian IRS]

I agree with the above Opinion, which I approve.

For the consideration of the Minister of Finance.

Brasilia,

/Luiz Romero Patury Accioly/

Acting Secretary of * * * [the Brazilian IRS]

R. Foreign Lenders' Efforts During the Phase III Negotiations To

Have the Central Bank Issue Them DARF's in Other Situations Not

Covered in the March 1984 Brazilian IRS Ruling

During the phase III negotiations, a number of foreign lenders

sought to have the Central Bank issue them DARF's with respect to

all of its net loan interest remittances to them, and not just on

its restructuring debt interest remittances during the relending

periods of the DFA's and the CGA's. The Brazilians rejected these

efforts to have the Central Bank issue DARF's to the foreign

lenders in additional situations outside the scope of the

borrowers-to-be theory employed in the March 1984 Brazilian IRS

ruling to the Central Bank. However, the Brazilians did indicate

some willingness to negotiate a longer relending period with

respect to the proposed phase III DFA. 

On January 5, 1985, the Brazilians submitted their written

comments to a proposed draft of certain phase III basic business

terms that had been prepared by the BAC. Their comments with

respect to the Central Bank's provision of DARF's were as follows:

WITHHOLDING TAX RECEIPTS

In the first place, Pricing and Withholding Tax Receipts

are intimately linked and shall be dealt with altogether.
- 48 -

There is no room for any change as regards * * * [the

Central Bank's] tax immunity. As on Phases I and II,

withholding tax receipts shall only be provided to the

creditors for the initial period during which the amounts

remain deposited with the Central Bank for relending to

borrowers in Brazil (Relending Period), based on the

concept of "borrowers to be". No withholding tax shall be

collected on amounts redeposited with the Central Bank as

a result of the relending flexibility referred to above,

as occurs with other similar deposits held by the Central

Bank. Politically speaking, there is no ground for any

material change in the Brazilian withholding tax system,

when Mexico negotiated their debt rescheduling without

having to make any change on their fiscal policies. In

fact, around 75% (US $36 billion) of the total amount of

debt to be rescheduled (US $48 billion) is exempt from

withholding tax on the grounds of being considered

governmental debt.

Furthermore, were the Central Bank to provide the

creditors with tax receipts during the Relending Period,

this would disencourage [sic] the relendings themselves,

with negative consequences over the necessary regular

flow of funds for the financing of the Public and Private

Sectors. As to the subject of withholding tax on loans

with Phase III funds, the possibility of determination of

a higher limit (over 10 years) for withholding is under

consideration and tax exemption shall be dealt with

altogether with the level of spread. It must always be

kept in mind that it is essential to keep in relation

both the domestic interest rates and the financial costs

of external borrowing. The increase in the latter will

lead to an increase in domestic interest rates, in real

terms, which is detrimental to the economic development

and to the degree of freedom of monetary policies.

S. Central Bank's Payment of Withholding Tax on Its Restructuring

Debt Interest Remittances and the Caixa Unico System

In Brazil, Banco do Brazil, which among other things operated

as a commercial bank, was the Brazilian National Treasury's agent

for payment of taxes. During the years in issue, the Central Bank

collected and paid over to Banco do Brazil, for the account of the

National Treasury, withholding taxes, export taxes, taxes on

financial operations, and social security taxes. The withholding
- 49 -

taxes the Central Bank collected and paid over included withholding

tax on the salaries of its employees and withholding tax on its

interest remittances to foreign lenders. 

Prior to 1980, the Central Bank made tax payments to Banco do

Brazil by issuing an administrative check. The check would be

physically delivered to Banco do Brazil and then cashed through the

normal check liquidation and payment procedure. Beginning in 1980,

there was a change in the manner by which the Central Bank made tax

payments to Banco do Brazil. Rather than issuing an administrative

check, the Central Bank credited Banco do Brazil's Banking Reserves

Account at the Central Bank with the amount of the tax payment. 

By law, all commercial banks were required to maintain a

Banking Reserves Account at the Central Bank with a minimum balance

equal to 20 percent of their demand deposits. Banco do Brazil,

however, was not subject to this requirement because the Central

Bank would, on a frequent basis, credit and advance substantial

funds to Banco de Brazil's Banking Reserves Account, due to the

governmental functions and operations Banco do Brazil carried out.

Until 1965 when the Central Bank was formed, Banco do Brazil

served as the country's sole monetary authority. During the times

relevant to this case, Banco do Brazil was owned 51 percent by the

Brazilian Government and 49 percent by private shareholders. From

1965 through 1986, Banco do Brazil had four primary functions: (1)

A commercial bank, (2) a monetary authority, (3) management control

and distribution of currency, and (4) responsibility for bank
- 50 -

 

19 The Brazilian term "caixa unico" means a unified system

of cash or financial management. 

clearing. Like the Central Bank, Banco do Brazil also functioned

as: (1) A lender of last resort to public-sector entities, (2) a

development bank responsible for various subsidized credit programs

of the Brazilian Government, and (3) a fiscal authority that

managed the Brazilian Government's budget. Together, Banco do

Brazil and the Central Bank performed a number of governmental

functions, including their unified management and operation of

Brazil's monetary and financial system under what was known as the

caixa unico system.19

To perform its various governmental functions, Banco do Brazil

needed access to funds. Such funding was provided by the Central

Bank. When Banco do Brazil, in carrying out its governmental

functions, would draw down its Banking Reserves Account at the

Central Bank below the legally required minimum level, the Central

Bank would advance Banco do Brazil sufficient funds to replenish

and maintain its reserves account at the required level. The

Central Bank would level Banco do Brazil's reserves account on a

daily basis. Banco do Brazil and the Central Bank each maintained

a movement account in which they kept track of the funds the

Central Bank advanced to Banco do Brazil. 

The Central Bank financed the Brazilian Government's

operations and the governmental functions that Banco do Brazil

carried out, through its issuance of (1) Brazil's currency and (2)
- 51 -

 

20 The record is not entirely clear whether daily

surpluses or excess funds in the Banking Reserves Account were

turned back over to Banco do Brazil or whether the Central Bank

kept such surpluses in repayment of the funds it had advanced. 

When the caixa unico system was ended in 1987, the Central Bank

was owed several billions of dollars by Banco do Brazil as a

result of its advancement of funds to Banco do Brazil over the

years. This liability of Banco do Brazil to the Central Bank,

however, was offset by an equivalent liability that the National

Treasury owed to Banco do Brazil. In ending the caixa unico

system, a novation was effected whereby Banco do Brazil's

liability to the Central Bank was canceled and the National

Treasury directly assumed the previous liability that Banco do

Brazil had owed to the Central Bank. 

governmental securities in the name of the National Treasury.

Essentially, the automatic transfer mechanism described above,

whereby the Central Bank provided funds to Banco do Brazil through

crediting its Banking Reserves Account, recognized and reflected

that, under the caixa unico system, the Brazilian Government

ultimately financed the governmental functions and operations Banco

do Brazil and the Central Bank carried out.20

On its books, Banco do Brazil made entries reflecting the

following: (1) Transfers of Central Bank tax payments to Banco do

Brazil's Banking Reserves Account at the Central Bank, (2)

collections of Federal Government tax receipts, and (3) deposits of

Federal Government revenues payable upon demand to the National

Treasury. 

On the record presented in this case it is impossible to

determine what entries were made on the respective books of the

Central Bank and the National Treasury to reflect the Central

Bank's payment of withholding tax on the restructuring debt
- 52 -

 

21 An expert witness for petitioner acknowledged that the

Central Bank might be entitled to reimbursement from the National

Treasury for its restructuring debt withholding tax payments, as

the Central Bank was acting on the Brazilian Government's behalf

and in the national interest. However, he claimed that the

Central Bank would have to ask the Brazilian Government for

reimbursement and that any such expenditure would require the

Brazilian Congress' approval. 

interest remittances. We are unable to ascertain what, if any,

entries were made to determine: (1) Whether the Central Bank was

reimbursed by the National Treasury for its withholding tax

payments; or (2) whether the Central Bank received the pecuniary

benefit based on those withholding tax payments. The Central

Bank's ruling request raised these two matters, and the March 1984

Brazilian IRS ruling discussed the two possibilities.21

Beginning in 1984, the Central Bank issued DARF's to the agent

banks of the foreign lenders to whom it transmitted loan payments

under the DFA's and CGA's, reflecting its withholding tax payments

on restructuring debt interest remittances during the relending

periods of the DFA's and CGA's. From 1984 through 1988 the Central

Bank issued a total of 324 DARF's to these agent banks. 

T. Foreign Tax Credit Claimed by Petitioner in Dispute Between The

Parties

On its 1980 through 1986 income tax returns, petitioner

generally reported its interest income and withholding tax payments

with respect to its Brazilian loans on a cash basis. Petitioner

claimed a foreign tax credit and reported interest income gross-up

when it received a DARF. On its returns covering the period from

1980 through June 28, 1985, petitioner reduced the amount of
- 53 -

foreign tax credit it claimed in connection with its Brazilian

loans by an amount equal to the pecuniary benefit provided by the

Brazilian Government to Brazilian borrowers. 

In its amended petition, petitioner asserted, among other

things, that the foreign tax credit otherwise allowable to it for

1980 through 1986 should not be reduced by the pecuniary benefit

provided to Brazilian borrowers. 

The total foreign tax credit claimed by petitioner for 1980

through 1986 that is still in dispute between the parties, and the

amounts of the disputed credit attributable to the legal liability,

Central Bank, and subsidy/pecuniary benefit issues, are as follows:

 Issues 

 Total Subsidy/Pecuniary

Year Credit Legal Liability Central Bk Benefit 

1980 $53,358 $53,358 -- $21,343

1981 545,462 545,462 -- 218,185

1982 814,969 814,969 -- 325,988

1983 489,341 489,341 -- 195,736

1984 312,353 312,353 $166,415 124,941

1985 242,781 242,781 181,272 93,506

1986 355,679 355,679 317,019 --

OPINION

Section 901 allows a domestic corporation to claim as a credit

against its Federal income tax (subject to certain limitations not

applicable herein) the amount of any income taxes paid on behalf of

the taxpayer to a foreign country. Sec. 4.901-2(a), Temporary

Income Tax Regs., 45 Fed. Reg. 75648 (Nov. 17, 1980); sec. 1.901-
- 54 -

 

22 In November 1980, the Internal Revenue Service issued

temporary regulations which set forth requirements for, and

limitations on, the amount of foreign tax credit. Secs. 4.901-2

to 4.903-1, Temporary Income Tax Regs., 45 Fed. Reg. 75647-75658

(Nov. 17, 1980). These temporary regulations generally were made

applicable to taxable years ending after June 15, 1979. Final

regulations under sec. 901 were made effective for taxable years

beginning after Nov. 14, 1983.

2(a), Income Tax Regs.22 The purpose of the credit is to reduce

international double taxation. American Chicle Co. v. United

States, 316 U.S. 450, 452 (1942). U.S. tax principles are applied

in deciding whether a foreign levy is a creditable income tax.

Goodyear Tire & Rubber Co., 493 U.S. 132 (1989); Biddle v.

Commissioner, 302 U.S. 573 (1938); United States v. Phillips

Petroleum Co. v. Commissioner, 104 T.C. 256, 295 (1995). However,

the law of the foreign state is first looked at to determine the

nature of the obligations and rights which form the basis of the

claim of a foreign tax credit. Cf. Phillips Petroleum Co. v.

Commissioner, supra; H.H. Robertson Co. v. Commissioner, 8 T.C.

1333 (1947), affd. 176 F.2d 704 (3d Cir. 1949). Although prior

cases involving other U.S. taxpayers' entitlement to foreign tax

credits for Brazilian withholding tax paid on interest remittances

to them have generally held the Brazilian withholding tax to be a

creditable foreign income tax for purposes of section 901, e.g.,

Continental Ill. Corp. v. Commissioner, 998 F.2d at 518-519; Nissho

Iwai Am. Corp. v. Commissioner, 89 T.C. at 773-774, none of those

cases squarely dealt with the legal liability and Central Bank

issues to be resolved by us infra. 
- 55 -

I. The Legal Liability Issue

A foreign tax is generally creditable for purposes of section

901 only if the domestic corporation is legally liable under

foreign law for the tax. Nissho Iwai Am. Corp. v. Commissioner,

supra at 773-774; sec. 4.901-2(g), Temporary Income Tax Regs., 45

Fed. Reg. 75655 (Nov. 17, 1980); sec. 1.901-2(f), Income Tax Regs.

However, it is recognized that legal liability for the tax and the

obligation to pay are not necessarily the same. For example, under

a withholding system, legal liability for the tax and the

obligation to pay the tax are different. The Federal wage

withholding system illustrates this difference--the employer is the

person obligated to withhold the tax and to pay the withheld tax to

the Government; the employee is the person legally liable for the

tax. Nissho Iwai Am. Corp. v. Commissioner, supra at 773.

To resolve the legal liability issue, we must examine

Brazilian law. In this regard, Rule 146 provides, in pertinent

part:

RULE 146. DETERMINATION OF FOREIGN LAW

* * * The Court, in determining foreign law, may

consider any relevant material or source, including

testimony, whether or not submitted by a party or

otherwise admissible. The Court's determination shall be

treated as a ruling on a question of law.
- 56 -

 

23 The 1966 Advisory Committee Notes to rule 44.1 of the

Federal Rules of Civil Procedure, 28 U.S.C. app. at 759 (1994),

state, in pertinent part:

The * * * new rule describes the materials to

which the court may resort in determining an issue of

foreign law. Heretofore, the district courts, applying

Rule 43(a), have looked in certain cases to State law

to find the rules of evidence by which the content of

foreign-country law is to be established. The State

laws vary; some embody procedures which are

inefficient, time consuming and expensive. * * * In

all events the ordinary rules of evidence are often

inapposite to the problems of determining foreign law

and have in the past prevented examination of material

which could have provided a proper basis for the

determination. The new rule permits consideration by

the court of any relevant material, including

testimony, without regard to its admissibility under

Rule 43. * * *

 * * * * * * *

In further recognition of the peculiar nature of

the issue of foreign law, the new rule provides that in

determining this law the court is not limited by

material presented by the parties; it may engage in its

own research and consider any relevant material thus

found. The court may have at its disposal better

foreign law materials than counsel have presented, or

may wish to reexamine and amplify material that has

been presented by counsel in partisan fashion or in

insufficient detail. On the other hand, the court is

free to insist on a complete presentation by counsel.

* * * * * * *

The new rule refrains from imposing an obligation

on the court to take "judicial notice" of foreign law

because this would put an extreme burden on the court

in many cases; and it avoids the use of the concept of

"judicial notice" in any form because of the uncertain

meaning of that concept as applied to foreign law. 

 * * * Rather the rule provides flexible

(continued...)

Rule 146 is taken almost verbatim from rule 44.1 of the Federal

Rules of Civil Procedure.23 See Note to Rule 146, 60 T.C. 1137.
- 57 -

 

23(...continued)

procedures for presenting and utilizing material on

issues of foreign law by which a sound result can be

achieved with fairness to the parties.

A. Non-Tax-Immune Borrowers/Liability Issue

In prior cases involving Brazilian withholding tax paid by

non-tax-immune Brazilian borrowers on their net loan interest

remittances to domestic corporations, we and other courts,

including the U.S. Courts of Appeals for the Seventh and Eighth

Circuits, have held those Brazilian withholding tax payments to be

a potentially creditable tax to the domestic corporations for

purposes of section 901. As the Court of Appeals for the Eighth

Circuit explained in Norwest Corp. v. Commissioner, 69 F.3d at

1407:

The Commissioner argues that Norwest is not legally

liable for the local [Brazilian] tax, and thus is not

entitled to * * * [foreign tax credit] for the local

tax, because only the borrower was legally obligated to

withhold it. * * *

We reject this argument as did the tax court below

and the other courts which have addressed this question.

See Continental Ill. Corp. v. Commissioner, 998 F.2d 513,

518-19 (7th Cir. 1993) (Continental) * * * ;

Continental Ill. Corp. v. Commissioner, * * * [T.C.

Memo. 1988-318], affd. sub nom. Citizens & S. Corp. v.

Commissioner, 919 F.2d 1492 (11th Cir. 1990) (per

curiam); Nissho Iwai Am. Corp. v. Commissioner, 89 T.C.

765, 773-74 * * * (1987) (Nissho). It is a well-settled

principle under United States tax law that the person

obligated to pay the tax is not necessarily the same

person to whom legal liability attaches. Nissho, 89 T.C.

at 773 * * * . Nissho, which the tax court here cites,

compared the Brazilian system to the wage withholding

system in the United States under which employees remain

legally liable for income taxes, although the employer is

the person obligated to withhold the tax and pay the tax

to the government. Id. Similarly, the Brazilian
- 58 -

borrower is only charged with an administrative function.

As explained, under Brazilian law, interest paid to

foreign lenders like Norwest is subject to local tax.

The Brazilian borrower is required to withhold the local

tax from each interest payment. Id. at 774 * * * ,

citing Gleason Works v. Commissioner, 58 T.C. 464, 478

* * * (1972) (noting that liability for taxes "does not

rest upon a search for the person from whom the tax is

collectible but rather for the person upon whom the tax

is imposed"). The Commissioner argues that in Brazil only

borrowers have an enforceable legal obligation because

withholding is the exclusive means of collection. The

Commissioner's argument is unduly formalistic because

Brazilian banking authorities will not allow the

Brazilian borrower to buy foreign currency to pay

interest to foreign lenders without proof it has withheld

and paid the local tax. The lender thus could not escape

liability and the absence of a law specifically applying

to the lender is irrelevant. See Continental, 998 F.2d

at 518. "[T]he [local] tax is 'paid' by the [foreign]

lender * * * even if the [Brazilian government's] tax

enforcement guns are trained on the agent [that is, the

Brazilian borrower,] rather than on the principal [that

is, the foreign lender]." Id. at 519. * * *

Based on the record presented in the instant case, we see no

reason to depart from the above precedents. Brazilian law

indisputably requires non-tax-immune Brazilian borrowers to

withhold with respect to their interest remittances to foreign

lenders. Petitioner is "legally liable" under Brazilian law for

the withholding tax paid by non-tax-immune Brazilian borrowers on

their net loan interest remittances to petitioner. We thus hold

that the Brazilian withholding tax collected from and paid by these

borrowers on their net loan interest payments to petitioner is

potentially creditable to petitioner for 1980 through 1986. Of

course, the actual amount of this withholding tax that is

creditable to petitioner will depend upon our resolution of the

subsidy/pecuniary benefit issue infra.
- 59 -

B. Central Bank/Liability Issue

In the instant case, petitioner was not required to file a

Brazilian tax return and had no obligation itself to pay Brazilian

tax. See Continental Ill. Corp. v. Commissioner, 998 F.2d at 518-

519. Brazilian withholding tax was purportedly collected from and

paid by the Central Bank on its Brazilian restructuring debt

interest remittances to petitioner during the relending periods of

the DFA's and CGA's, beginning in 1984. For these purported

withholding tax payments to be a potentially creditable tax to

petitioner, the Central Bank must have a legal liability under

Brazilian law to pay this "withholding tax". Petitioner cannot be

considered "legally liable" under Brazilian law for Brazilian tax

if there was no legal liability on its and the Central Bank's part

to pay this "withholding tax". Nissho Iwai Am. Corp. v.

Commissioner, 89 T.C. at 773-774; sec. 4.901-2(g), Temporary Income

Tax Regs., 45 Fed. Reg. 75655 (Nov. 17, 1980); sec. 1.901-2(f),

Income Tax Regs.; see also Amoco Corp. v. Commissioner, T.C. Memo.

1996-159; Continental Ill. Corp. v. Commissioner, T.C. Memo. 1991-

66 (hereinafter sometimes referred to as the PeMex case), affd. in

part and revd. in part 998 F.2d 513 (7th Cir. 1993).

As we have determined in our findings, until 1984, the Central

Bank paid Brazilian withholding tax on its gross loan interest

remittances abroad, but not on its net loan interest remittances.

This treatment was authorized and sanctioned by SRF 368, an

"officio" that the head of the Brazilian IRS issued to the Central
- 60 -

Bank in June 1980, and was consistent with certain prior decisions

of the Brazilian Supreme Court that are discussed more fully

hereafter. Pursuant to SRF 368, the Central Bank (which in Brazil

serves an instrumental role in ensuring that the withholding tax

due on interest remittances abroad is collected), following its

issuance of FIRCE 80 in May 1981, did not require withholding tax

to be collected from and paid by public-sector entities, like

itself, on their net loan interest remittances abroad. Beginning

in 1984, the Central Bank purportedly paid withholding tax on its

restructuring debt interest remittances during the relending

periods of the DFA's and the CGA's, pursuant to the borrowers-to-be

theory applied in the March 1984 Brazilian IRS private ruling

issued to the Central Bank.

C. Brazilian Supreme Court Decisions

The following Brazilian Supreme Court decisions are apposite

in understanding the respective arguments of the parties and their

experts concerning the Central Bank's liability for the payment of

withholding tax on its net loan interest remittances to foreign

lenders.

On September 24, 1974, a panel of the Brazilian Supreme Court

issued its unanimous decision in Federal Govt. v. Highway Dept. of

the State of Parana (hereinafter referred to for convenience as the

Parana I--1st Panel decision), reversing the decision of the lower

Brazilian Federal Court of Appeals and holding that the State of

Parana was required to pay withholding tax on its remittance of
- 61 -

interest abroad with respect to a loan to finance the construction

of State highways, because it was not immune from paying this

withholding tax under Article 19 of the Brazilian Constitution.

The loan involved in the Parana I--1st Panel decision was a gross

loan. The Brazilian Supreme Court Justice reporting the case

reasoned that if constitutional immunity from the withholding tax

were held to apply, then the beneficiary of the immunity would be

the foreign creditor, not the State of Parana. This Justice quoted

with approval the following reasoning given in the dissent to the

lower Brazilian Federal Court of Appeals' majority decision:

If the State of Parana were the beneficiary of an

increase in its assets, on which the Union were demanding

the tax, it would be granted immunity, according to the

Constitution.

But since it appears in a different capacity in the

litigation, namely, as remitter of interest on behalf of

another, I hold that the argument alluding to immunity is

inadmissible.

On October 15, 1975, the full Brazilian Supreme Court issued

its unanimous decision in State of Parana v. Central Bank

(hereinafter for convenience referred to as the Parana II

decision), holding the State of Parana was not required to pay

withholding tax on its remittance of interest abroad with respect

to a loan to finance a railroad, because it was immune from such

withholding tax under Article 19 of the Brazilian Constitution.

The loan involved in the Parana II decision was a net loan. The

Brazilian Supreme Court Justice reporting the case distinguished

the Parana I--1st Panel decision, and reasoned as follows:
- 62 -

There is no further debate on whether [withholding of]

income tax can be demanded in the remittance of interest

to another country, by virtue of art. 11, sole paragraph

of Law-Decree 401, of 30 December 68, coupled with art.

1 of Law-Decree 1215, of 4 May 72, RE 76,792- Plenary

Session (D.J. of 11 October 74, p. 7480), and I ruled

this way in the RE 78,988-SP, on 18 March 75.

What is at issue, however, is the application of the

sole paragraph of art. 11 of the Law-Decree 401/68,

notwithstanding the immunity guaranteed to the remitter

by virtue of art. 19, III, a, by the Federal

Constitution.

The First Division, in RE 79,157 [the Parana I--1st

Panel decision], held as follows:

The tax is payable, even though the

corporation * * * [by] constitutional law is

immune, for otherwise the beneficiary of the

immunity would not be the State, but the

foreign creditor. * * *

I believe that the precedent invoked [the Parana I--

1st Panel decision] does not apply to the present case.

In fact it has been expressly stipulated that, at any

time and for any reason, any fiscal or parafiscal [(i.e.,

tax)] burden shall be the responsibility of the State of

Parana.

It is argued that said contractual provision 

* * * does not matter in the unraveling of the

dispute, because the beneficiary of the interest would be

the foreign creditor, which is not immune.

But such is not so, in my opinion, * * * because,

according to the sole paragraph of art. 11 of * * *

[Decree-law 401], the constitutionality of which also is

not at issue, the creditor is not responsible for the

payment of income tax.

The aforementioned sole paragraph states explicitly:

"For purposes of this article, it is

considered that the fact generating taxation

is the remittance to another country and the

remitter is the contribuente."

Now, in the present case, the generating fact is the

remittance of interest on the loan owed by the State of
- 63 -

 

24 In Minas Gerais, the reporting Brazilian Supreme Court

Justice stated:

Nowadays there is no further doubt on the subject,

after * * * [Summula No. 586], establishing a

position derived from art. 11 of Decree-law No. 401 of

December 30, 1968 as follows: "[Withholding of] Income

tax is due on interest remitted abroad, based on a loan

agreement."

We must thus now * * * [address the other

(continued...)

Parana, and the remittance being done, it is indisputable

that it will be the contribuente.

However, the State is immune by virtue of art. 19 

* * * of the Federal Constitution.

In my view, the conclusion is incontrovertible that

the burden of the payment falls on the remitter, and in

the present case, this, a unit of the Federation, is

immune that is, not obligated to pay the tax.

There is no need to fear that the foreign creditor

shall benefit from the immunity of the debtor.

In view of the sole paragraph of art. 11 of Decreelaw 401 * * * , neither is the creditor of the

interest abroad the contribuente, but rather the

remitter, on occasion of the remittance.

In its February 21, 1979, decision in State of Minas Gerais

v. Federative Republic of Brazil (hereinafter for convenience

referred to as the Minas Gerais decision), the full Brazilian

Supreme Court held that the State of Minas Gerais and its State

Highway Department were not required to pay withholding tax on

interest remittances they made as repass borrowers with respect to

their Resolution 63 repass loans, because they were immune from

such withholding tax under Article 19 of the Brazilian

Constitution.24 The reporting Brazilian Supreme Court Justice
- 64 -

 

24(...continued)

argument] invoked by the plaintiffs: the remittances

are from the State of Minas Gerais and thus [enjoy] the

benefit of reciprocal tax immunity granted under art.

19 * * * of the Constitution. 

A "summula" is a statement of a legal proposition that the

Brazilian Supreme Court feels is firmly established under

Brazilian law. 

 

25 In the case of a Resolution 63 repass net loan, the

repass borrower generally must also provide the repass lender

with the funds to pay the withholding tax on the repass lender's

interest remittances to the foreign lender. However, as noted in

our findings, if the repass lender is entitled to a pecuniary

benefit, the repass lender must then pass on the benefit to the

repass borrower.

 

26 The Minas Gerais decision does not specifically state

whether the Resolution 63 repass loans involved were net loans or

gross loans. However, see supra note 25.

reasoned that Resolution 63, which authorizes the repassing of the

foreign loan, confers upon the repass borrower the status of a

foreign currency borrower and concluded that the repass borrower

could avail itself of its tax immunity.25 The Brazilian Supreme

Court in Minas Gerais further held that certain mixed capital

companies were required to pay withholding tax on interest

remittances they made as repass borrowers with respect to their

Resolution 63 repass loans, because these mixed capital companies

did not enjoy immunity from taxation, as they have the same status

under the Brazilian Constitution as private companies.26 

On August 30, 1979, the full Brazilian Supreme Court issued

its decision unanimously rejecting the objections of the State of

Parana Highway Department in its appeal from the Parana I--1st

Panel decision (hereinafter for convenience referred to as the
- 65 -

 

27 An expert witness for petitioner, Joao Guerra (Guerra),

explained that the State Highway Department appealed the Parana

I--1st Panel decision to the full Brazilian Supreme Court because

the decision's holding appeared to conflict with the Parana II

decision's holding. Although Guerra acknowledged that the

reporting Justice in Parana I--Full Bench concluded that there

was no actual conflict between the two decisions, Guerra

maintained that this did not necessarily mean the reporting

Justice accepted the Parana II decision's net-loan-versus-grossloan rationale. Guerra claimed that (1) any points relating to

whether the particular loan in Parana I--Full Bench was a gross

loan or net loan may not have been brought to the Supreme Court's

attention, and (2) the reporting Justice may not have understood

the distinction between a net loan and a gross loan. While we

agree that, in all likelihood, the Brazilian Supreme Court in

Parana I--Full Bench was aware of the holding it reached in

Parana II, we do not accept Guerra's other contentions. If the

Highway Department's appeal were based on Parana II's holding, as

Guerra propounded, then the Supreme Court in Parana I--Full

Bench, in all substantial likelihood, would have had to have

considered Parana II's net-loan-versus-gross-loan rationale.

Parana I--Full Bench decision). The reporting Brazilian Supreme

Court Justice agreed with the Parana I--1st Panel decision's

reasoning that the remitter's immunity from taxation under Article

19 of the Brazilian Constitution should not prevent the imposition

of the withholding tax on gross loan interest remittances abroad,

because a contrary holding would allow the foreign creditor, and

not the State, to be the beneficiary of the immunity. He concluded

by stating that "As this was the foundation of the challenged

ruling, and since this issue did not consider the ruling cited for

comparison, the claimed divergence does not exist in the present

case."27 

On June 17, 1988, a panel of the Brazilian Supreme Court

issued its unanimous decision in Municipality of Santo Andre v.

Federal Union (hereinafter for convenience referred to as the Santo
- 66 -

Andre I decision), holding that the municipality did not have to

pay withholding tax on its interest remittances as repass borrower

with respect to a Resolution 63 repass loan to construct a

municipal supply center. The loan involved in the Santo Andre I

decision was a net loan. The reporting Brazilian Supreme Court

Justice noted the prior Parana I--1st Panel and Parana II

decisions, but adopted and utilized the Parana II decision's

rationale for distinguishing the Parana I--1st Panel decision.

This Justice stated that the decision rendered in Santo Andre I was

"oriented in the same line of jurisprudence" as the Parana II

decision. 

On April 13, 1993, a panel of the Brazilian Supreme Court

issued its ruling not to recognize the Brazilian Government's

appeal in Federal Union v. Municipal Prefecture of Santo Andre

(hereinafter for convenience referred to as the Santo Andre II

decision). The loan to the municipality in Santo Andre II was a

Resolution 63 repass net loan. In its appeal, the Brazilian

Government argued that the Parana II decision was distinguishable

and did not support holding the municipality to be immune from

payment of withholding tax, as the foreign loan in Parana II had

been directly made to the State of Parana. 

D. The Parties' Experts

1. Petitioner's Experts. 

Petitioner offered testimony on the applicable Brazilian law

concerning the Central Bank's liability for withholding tax on its
- 67 -

 

28 Petitioner offered da Silva as both a fact witness and

an expert witness on Brazilian law.

restructuring debt interest remittances from four expert witnesses:

(1) Geraldo Ataliba (Ataliba), a Brazilian university professor who

specializes in constitutional taxation, (2) Eivanny da Silva (da

Silva),28 a Brazilian tax lawyer who served as a top-level Brazilian

IRS official from 1982 through 1984 and was one of the principal

authors of the March 1984 private Brazilian IRS ruling issued to

the Central Bank, (3) Joao Guerra (Guerra), a Brazilian tax lawyer,

and (4) Jose Pedreira (Pedreira), a Brazilian tax lawyer.

Petitioner's experts were of the opinion that the applicable

Brazilian law with respect to the Central Bank's payment of

withholding tax on its net loan interest remittances abroad was

correctly presented in the Doniak-Kahan draft ruling that the

Brazilian IRS never issued. In other words, they maintained that

the Central Bank was subject to the same withholding tax collection

and payment rules as non-public-sector entities and was required to

pay withholding tax on all its interest remittances abroad,

including those with respect to the restructuring debt,

irrespective of the relending periods of the DFA's and CGA's. 

They were further of the opinion that SRF 368 did not reflect

the applicable Brazilian law and was completely insupportable under

Brazilian law. Except for perhaps da Silva, all of petitioner's

experts opined that, under Brazilian law, there was no such legal

doctrine as the borrowers-to-be theory. 
- 68 -

 

29 Da Silva attributed the Brazilian IRS's "illegal"

actions in issuing SRF 368 to the fact that Brazil was under the

control of a military regime. As a result, he claimed, the

executive branch of the Brazilian Government largely could do as

it pleased. The record, however, reflects that Brazil operated

under this military regime until about 1985. Thus, the March

1984 Brazilian IRS private ruling was issued to the Central Bank

during this period of military rule. Further, on crossexamination, da Silva acknowledged that Dornelles had no

connection to the military regime. More importantly, da Silva

did not address the fact that the position taken in SRF 368 was

consistent with the Brazilian Supreme Court's Parana II and Santo

Andre I decisions. The Santo Andre I decision was issued on June

17, 1988, a date well after the military regime had ended. We

find this aspect of da Silva's testimony not credible.

Even da Silva, the principal author of the March 1984 private

Brazilian IRS ruling issued to the Central Bank, acknowledged that

the borrowers-to-be theory was a "new theory" that he devised to

deal with an "atypical situation". He asserted that he and Luiz

Patury Accioly (Patury Accioly), the other top-level Brazilian IRS

official assigned by Dornelles to revise the Doniak-Kahan draft

ruling, were trying to save face for and avoid embarrassment to the

Brazilian IRS, because its prior issuance of SRF 368 lacked "any

legal basis" under Brazilian law.29 According to da Silva, Patury

Accioly (who was serving as a Brazilian IRS official when SRF 368

was issued) told him that SRF 368 had been issued by the Brazilian

IRS because various States and municipalities did not want to be

required to pay withholding tax on their net loan interest

remittances abroad. Most significantly, da Silva further related

that the Doniak-Kahan draft ruling, at the time it was being hotly

debated within the Brazilian IRS and the Brazilian Government,

though supported by certain Brazilian Supreme Court decisions,
- 69 -

including the Parana I--1st Panel and Parana I--Full Bench

decisions, was contrary to other Brazilian Supreme Court decisions,

including the Parana II decision. 

Petitioner's experts were of the opinion that certain

Brazilian Supreme Court decisions, including the Parana II

decision, holding that public-sector entities were not required to

pay withholding tax on their net loan interest remittances abroad,

were incorrectly decided. They maintained that these Supreme Court

decisions improperly extended and applied the taxation principles

of Decree-law 401 to foreign currency loans. Guerra claimed that

the net-loan-versus-gross-loan rationale used in the Parana II

decision to distinguish the Parana I--1st Panel decision was

erroneous, but he acknowledged that this same rationale was applied

and utilized in the Santo Andre I decision. He claimed that this

was a repetition of the error. 

Some of petitioner's experts were further of the opinion that

Article 19 of the Brazilian Constitution would not prevent the

Central Bank and other Federal-level autarquias from being subject

to withholding tax on their net loan interest remittances, as

Article 19 of the Constitution, they claim, prohibits taxation only

between the different governmental levels. According to them,

Article 19 prevents the Federal Government of Brazil from taxing

the assets, revenues, and operations of State and municipal

governmental entities, but not the assets, revenues, and operations
- 70 -

 

30 The parties' experts agree that, in a strict technical

sense, immunity from taxation derives from the Brazilian

Constitution, whereas an exemption from tax typically is provided

by an ordinary law. 

of other Federal-level governmental entities, like the Central

Bank. 

2. Respondent's Experts 

Respondent offered testimony on the applicable Brazilian law

concerning the Central Bank's liability for withholding tax on its

restructuring debt interest remittances abroad from two expert

witnesses: Paulo Bekin and Sergio Tostes. Both Bekin and Tostes

were Brazilian lawyers. 

Respondent's experts were of the opinion that the Central Bank

was not required to pay withholding tax on its net loan interest

remittances because of (1) its immunity from taxation under Article

19 of the Brazilian Constitution, and (2) its exemption from

withholding tax under various ordinary laws, including Decree-law

1,215 and Decree-law 4,595 (under which the Central Bank is to

enjoy the same privileges, immunities, and exemptions as the

National Treasury).30

Tostes was of the opinion that the Central Bank was not

required to pay withholding tax on its net loan interest

remittances abroad, because of its immunity from taxation under

Article 19 of the Brazilian Constitution. He claimed that

Brazilian law distinguishes between net loans and gross loans, and

that withholding tax would have to be paid by a public-sector
- 71 -

entity, like the Central Bank, on its gross loan interest

remittances abroad, but not on its net loan interest remittances.

He cited as authority for this proposition the Brazilian Supreme

Court's Parana II decision. 

Bekin maintained that the Central Bank would not be required

to pay withholding tax on interest from net loans because it would

be granted exemption from payment of withholding tax under Decreelaw 1,215. He believed that Decree-law 1,215 was the authority for

the Brazilian IRS's issuance of SRF 368. However, on crossexamination, he acknowledged that, in 1983 and 1984, the National

Monetary Council had set a minimum loan term of 10 years in order

to qualify for exemption under Decree-law 1,215, whereas the phase

I and phase II CGA's and DFA's had loan terms of less than 10

years. Both Bekin and Tostes were of the opinion that the

Central Bank would be exempt under Decree-law 4,595 from payment of

withholding tax with respect to its restructuring debt interest

remittances, as the National Treasury, they maintained, would not

have to pay withholding tax to itself if it, instead, had been the

borrower under the DFA's and CGA's. They pointed out that Decreelaw 4,595 provides that the Central Bank is to enjoy the same

privileges and exemptions as the National Treasury. Tostes further

noted that the March 1984 Brazilian IRS ruling issued to the

Central Bank acknowledged that the Central Bank was acting as an

agent for the National Treasury. 
- 72 -

E. Determination of the Applicable Brazilian Law

Petitioner contends that the applicable Brazilian law is

correctly reflected in the Doniak-Kahan draft ruling which was

never issued by the Brazilian IRS. Petitioner asserts that

Brazilian law does not distinguish between gross loans and net

loans. It further maintains that certain Brazilian Supreme Court

decisions, like the Parana II decision, are distinguishable,

because they involved financing of imported goods subject to

Decree-law 401, not foreign currency loans. 

Even if Article 19 of the Brazilian Constitution were

applicable to public-sector entities' net loan interest remittances

abroad, petitioner maintains that Article 19 prevents taxation only

between the different governmental levels. Thus, petitioner

contends, while Article 19 might prevent the Brazilian Federal

Government from taxing certain State-level and municipal-level

autarquias (e.g., the Minas Gerais decision), Article 19 would not

prevent the Central Bank and other Federal-level autarquias from

being subject to withholding tax on their net loan interest

remittances abroad. 

Alternatively, petitioner maintains that this Court, pursuant

to the act of state doctrine, must accord conclusive effect to the

March 1984 Brazilian IRS private ruling issued to the Central Bank.

As even petitioner's own experts generally acknowledged that the

borrowers-to-be theory applied in the March 1984 Brazilian IRS
- 73 -

ruling did not reflect the applicable Brazilian law, we will deal

with petitioner's act of state argument separately infra.

Respondent, on the other hand, primarily contends that publicsector entities, like the Central Bank, were not required to pay

withholding tax on their net loan interest remittances abroad

because of their immunity from taxation under Article 19 of the

Brazilian Constitution. Respondent maintains that this was the

applicable law in Brazil both before and after 1984, as reflected

by the Brazilian IRS's issuance of SRF 368 in June 1980 and by

certain Brazilian Supreme Court decisions, including the Parana II

and Santo Andre I decisions. Respondent further asserts that these

Supreme Court decisions involved foreign currency net loans, not

net loans for the financing of imported goods. We agree with

respondent. 

The record reflects that to help meet the Brazilian

Government's and the Central Bank's commitment to provide DARF's to

the foreign lenders during the relending periods of the DFA's and

CGA's, top Brazilian IRS officials concocted an elaborate legal

fiction--the borrowers-to-be theory. In light of the States,

municipalities, and other public-sector entities with foreign net

loans, it was not politically feasible for the Brazilian Government

to change the applicable Brazilian law and require all publicsector entities to pay withholding tax on their net loan interest

remittances abroad. Moreover, as these public-sector entities,

like the Central Bank, were immune from paying withholding tax on
- 74 -

 

31 On cross-examination, da Silva testified that

Dornelles, upon assigning him and Patury Accioly to revise the

Doniak-Kahan draft ruling, instructed them to adhere to the

"spirit of" the Doniak-Kahan draft ruling but to keep their

opinion within the provisions of SRF 368. 

their net loan interest remittances pursuant to Article 19 of the

Brazilian Constitution, a constitutional amendment presumably would

have been required to change the law. As a result, the DoniakKahan draft ruling was never issued.

Top Brazilian IRS officials, instead, devised the borrowersto-be theory in an effort to (1) circumvent the Central Bank's tax

immunity, and (2) limit narrowly the scope of the March 1984

private ruling eventually issued as to the Central Bank's interest

remittances during the relending periods under the DFA's and CGA's,

beginning in 1984. By doing so, their ruling would not directly

conflict with existing Brazilian law and would have very little, if

any, potential effect upon other net loan borrowings by publicsector entities.31 Indeed, in January 1985, during the subsequent

phase III negotiations, the Brazilians, in resisting the efforts of

a number of foreign lenders to have the Central Bank issue DARF's

with respect to all of its net loan interest remittances to them,

advised the BAC that there was "no room for any change * * *

[in the Central Bank's] tax immunity." The Brazilians noted, among

other things, that about 75 percent of the total debt to be
- 75 -

 

32 We do not find credible da Silva's testimony that the

entire technical staff of the Brazilian IRS believed that the

Doniak-Kahan draft ruling accurately presented the applicable

Brazilian law with respect to the Central Bank's net loan

interest remittances abroad. Additionally, da Silva claimed that

it was not necessary to publish the March 1984 ruling, because

the Brazilian IRS's technical staff were well aware of the

correctly applicable Brazilian law with respect to public-sector

entities' net loan interest remittances abroad--presumably, as

reflected in the Doniak-Kahan draft ruling that the Brazilian IRS

never issued. We are not convinced by his explanation as to why

the March 1984 Brazilian IRS ruling issued to the Central Bank

was a private ruling. As an expert witness for respondent noted,

although the decision to publish a Brazilian IRS ruling in the

Brazilian Government's Official Gazette is discretionary, the

March 1984 ruling's position represented such a drastic departure

from existing law that, in his opinion, this ruling should have

been published to provide public guidance--if the Brazilian IRS

indeed was changing its interpretation and position with respect

to the applicable law pertaining to public-sector entities' net

loan interest remittances abroad. Da Silva was silent about

what, if any, immediate efforts the Brazilian IRS took either to

(1) revoke SRF 368, or (2) at minimum, publicize, prospectively

apply, and enforce its alleged "new position" on the applicable

Brazilian law concerning public-sector entities' net loan

interest remittances abroad. We do not entirely understand

petitioner's contention, on brief, that SRF 368 was revoked upon

the Brazilian IRS's issuance of the March 1984 private ruling, as

this private ruling applied only to the Central Bank, and not to

other public-sector entities. See infra note 33. In fact,

petitioner's failure to offer evidence concerning such Brazilian

IRS actions to enforce the latter's alleged "new position",

reasonably contemporaneous to its issuance of the March 1984

private ruling to the Central Bank, leads us to conclude that

this evidence would have been harmful to petitioner's case. See

Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158, 1165

(1946), affd. 162 F.2d 513 (10th Cir. 1947).

restructured was "exempt from withholding tax on the grounds of

being considered governmental debt."32

Petitioner's reliance upon Article 9 and Article 123 of the

National Tax Code is misplaced. Article 9 generally provides that

an entity's immunity or exemption from tax will not relieve it of

its obligation to collect withholding tax that is due upon its
- 76 -

 

33 Normative rulings are published in the Brazilian

Government's Official Gazette and are intended to furnish

guidance to and be applicable to the public at large. In

contrast, the March 1984 Brazilian IRS ruling issued to the

Central Bank was a private ruling that applied only to the

Central Bank and not to other public-sector entities. 

 

34 The earlier rulings do not distinguish between gross

(continued...)

income remittances to third parties. Article 123 generally

provides that private agreements concerning the liability to pay

taxes are not binding upon the National Treasury. However, the

National Tax Code is a complementary law and cannot override a

public-sector entity's immunity from taxation under Article 19 of

the Brazilian Constitution. 

Similarly, petitioner's reliance upon certain "normative"

rulings33 that were issued by the Brazilian IRS from 1971 through

1974 is also misplaced. These rulings generally hold that immune

or exempt entities are required to withhold with respect to their

remittances of income to third parties. The rationale employed in

these rulings is that although the remitter is immune or exempt

from payment of Brazilian income taxes on its income, this immunity

or exemption of the remitter does not extend to the beneficiary or

recipient of the income. Thus, withholding taxes must be paid by

the remitter on behalf of the recipient, unless the recipient of

the income is itself immune or exempt from Brazilian income tax. 

However, these rulings were issued prior to October 15, 1975, and

June 10, 1980, the respective dates upon which the Brazilian

Supreme Court's Parana II decision and SRF 368 were issued.34
- 77 -

 

34(...continued)

loan interest remittances and net loan interest remittances by

the immune or exempt entities. However, the most recent of these

rulings, CST Normative Opinion No. 193/74, which was issued on

Oct. 25, 1974, dealt specifically with net loan interest

remittances of tax-exempt foundations. This ruling noted that

these foundations are generally subject to the same tax law rules

as other private entities, except that certain legislation

exempts them from income tax if prescribed requirements are met. 

It held that, notwithstanding their exemption from income tax,

the foundations were still required to pay withholding taxes,

even where they have contractually assumed the tax burden. This

last ruling deals with foundations that are exempt pursuant to a

provision of ordinary law and not with public-sector entities

that are immune from taxation pursuant to Article 19 of the

Brazilian Constitution. In the case of a foundation with an

ordinary law exemption from income tax, Articles 9 and 123 of the

National Tax Code may well apply to override the foundation's

ordinary law exemption.

On brief, petitioner argues that the Brazilian Supreme Court

decisions, like the Parana II decision, which hold that publicsector entities are not required to pay withholding tax on their

net loan interest remittances abroad, are distinguishable.

Petitioner maintains that these Brazilian Supreme Court decisions

involved financing of imported goods covered under Decree-law 401,

not foreign currency loans. Thus, it contends that these Supreme

Court decisions are not applicable to the Central Bank's

restructuring debt interest remittances, because the DFA and CGA

loans to the Central Bank were foreign currency loans. However,

some of petitioner's own experts agreed that the loans involved in

these Brazilian Supreme Court cases were foreign currency loans.

One of petitioner's experts further acknowledged that several of

these cases involved repass loans under Resolution 63. See infra

note 36. Indeed, in the Minas Gerais decision, the reporting
- 78 -

 

35 It is further to be noted that pursuant to its receipt

of SRF 368, the Central Bank issued FIRCE 80 and did not require

public-sector entities to pay withholding tax on their net loan

interest remittances abroad, regardless of whether such interest

remittances originated from a currency loan or from financing for

the importation of goods.

 

36 Petitioner's expert Guerra testified, on crossexamination, as follows:

Q. All right. However, your view is inconsistent

with at least some of the [Brazilian] Supreme Court

cases that we discussed yesterday, correct?

A. No, I don't think it is because if you pay

attention to the * * * [Parana I--1st Panel

decision], it's--the quotation that I made says like--

is exactly that.

What you have there quoted from * * * [the

dissent to the lower Brazilian Federal Court of

Appeals' majority decision] is that if--were the state

(continued...)

Justice reasoned that Resolution 63 conferred upon the publicsector entity/repass borrower the status of a foreign currency

borrower.35

Petitioner's experts were of the opinion that those Brazilian

Supreme Court decisions, like the Parana II decision, which hold

that public-sector entities are immune from having to pay

withholding tax on their net loan interest remittances abroad, were

incorrectly decided. They maintain that the legal reasoning

employed by the Brazilian Supreme Court Justices is technically

wrong, because foreign currency loans, not import financing loans,

were involved. According to petitioner's experts, Decree-law 401,

by its terms, applies only to import financing loans, and not to

foreign currency loans.36 In our view, the crux of Parana II was
- 79 -

 

36(...continued)

of--were the state of Parana the recipient of the

interest on which the union would claim a tax, I would

recognize the immunity. However, we are in a different

situation in this case in which the recipient of the

interest is a third party, and in this case the

immunity does not apply.

Q. I wasn't particularly talking about the

 * * * [Parana I--1st Panel and Parana I--Full

Bench decisions]; I was talking about some of the other

cases we discussed.

A. Oh, the other, the two, I would say they

should be approached with two qualifications. The

first one is that they all concern, except for one,

Resolution 63 loans, which is a different thing. And

most important in that, none of these loans which were

dealt with in these other cases were import financing;

they were all, the three or the five of them, if you

compute all of them, straightforward currency loans. 

And as we were discussing yesterday, the Decree Law

401, which the court applied or argued in all these

cases, only * * * [applies] to import financing and not

to currency loans.

That's the two main reservations or qualifications

that apply to these precedents of the Supreme Court.

Q. So you acknowledge that the Supreme Court

cases we discussed yesterday did not involve import

financing, correct?

A. Yes. In the--my--the main criticism they may

be subject to is that although they do not involve

import financing, they apply one legal provision which

applies only to import financing. That's the big

contradiction of these decisions, and that's their weak

point.

Q. That's the reason you think the decisions are

wrong or you [are in] disagreement with them, right?

A. Well, I disagree with them, yes. Sure.

Q. Okay.

(continued...)
- 80 -

 

36(...continued)

A. Except for the * * * [Parana I--1st Panel

and Parana I--Full Bench decisions], I do disagree.

Q. You disagree with all the ones that held the

borrower was immune?

A. These are the ones. They are not different

ones.

 

37 Da Silva indicated in his testimony that he believed

the Parana I--1st Panel decision involved a gross loan, whereas

the Parana II decision involved a net loan. Pedreira testified

that the Parana II decision definitely involved a net loan. 

Guerra maintained that the Parana I--1st Panel decision possibly

did not involve a gross loan. He claimed that if the case

involved a gross loan, there then would be no reason for the

State Highway Department to litigate and dispute payment of the

withholding tax, as a victory would not benefit the Highway

Department but only the foreign lender. However, Guerra did

agree that the Parana II and Santo Andre I decisions involved net

loans. We note that both the Parana II and Santo Andre I

decisions utilized a net-loan-versus-gross-loan rationale to

distinguish the Parana I--1st Panel holding.

the distinction it drew between a net loan and a gross loan in

order to distinguish the previous holding reached in the Parana I--

1st Panel decision.37 Although the Parana II decision cited and

discussed the provision in Decree-law 401 that deems the

borrower/remitter to be the contribuente where imported goods are

purchased on an installment basis, that discussion was in rebuttal

of the losing party's argument that the actual beneficiary of the

interest was the foreign lender, not the State of Parana.

Moreover, if the 1975 Parana II decision was incorrectly decided,

as petitioner's experts claim, we then find it puzzling that, over

the years, no successful challenge to its holding has been made,

and that the Brazilian Supreme Court has continued to utilize and
- 81 -

apply the case's net-loan-versus-gross-loan rationale in similar

cases involving foreign currency loans.

The evidence reflects that this particular point petitioner's

experts raise involves an area of Brazilian law in which there has

been considerable controversy. Although Article 11 of Decree-law

401, by its terms, seems to be applicable only to import financing

loans, even petitioner's experts acknowledge that Decree-law 401

and the 1972 Brazilian Supreme Court decision that upheld the law's

validity have caused a great deal of confusion and generated

controversy in the area. As petitioner's expert Gurerra related:

some key legal principles in connection with the taxation

of interest remitted by * * * [Brazilian borrowers]

to * * * [foreign lenders]--namely the * * *

[National Tax Code] definitions of taxable event,

taxpayer, tax base and tax responsible and the scope of

the * * * [constitutional] tax immunity--were neither

adequately nor consistently applied by the * * *

[Brazilian Supreme Court].

* * * The source of this problem was * * * [the

1972 Brazilian Supreme Court decision that upheld the

validity of Decree-law 401], while * * * [Article 11

of Decree-law 401 in defining the borrower remitting the

interest abroad to be the contribuente] clearly violates

the * * * [National Tax Code] definitions of taxable

event and taxpayer; the majority opinions varied largely

and did not express a precise understanding of the * *

* [National Tax Code] on the main issues of the case.

Subsequently, in addressing other cases dealing with

these topics, the * * * [Brazilian Supreme Court] was

confronted with its conclusion in * * * [its 1972

decision] and found no guidance in the varied opinions

that had formed the majority in * * * [that

precedent].

It is neither necessary nor appropriate for us to decide

whether certain Brazilian Supreme Court decisions, including the

Parana II decision, were technically "wrong" in part of their legal
- 82 -

 

38 We are hesitant to substitute our judgment on a matter

of Brazilian law for that of the Brazilian Supreme Court Justices

who reported these decisions. In any event, this is a matter

which we need not resolve, as in its subsequent decisions (which

petitioners' experts agree involved foreign currency loans) the

Brazilian Supreme Court has continued to utilize and apply Parana

II's net-loan-versus-gross-loan rationale. We further note that

even the Brazilian Government and the Brazilian IRS appear to

have attached little, if any, practical significance to the fact

that the loans made to the Central Bank under the DFA's and CGA's

were currency loans and not import financing loans. 

reasoning because, as petitioner's experts assert, the Brazilian

Supreme Court Justices failed to appreciate that Decree Law 401

applies only to import financing loans, not foreign currency

loans.38 Of significance for our purposes in determining the

applicable Brazilian law is that these Brazilian Supreme Court

decisions, notwithstanding petitioner's experts' criticism of them,

represent the Brazilian Supreme Court's legal position. Over the

years, the Brazilian Supreme Court, in Parana II and other similar

cases involving foreign currency loans, has consistently held that

public-sector entities, like the Central Bank, are immune from

paying withholding tax on their net loan interest remittances

abroad under Article 19 of the Brazilian Constitution.

We do not accept petitioner's contention that Brazilian law

fails to distinguish between net loans and gross loans, in

situations in which the borrower/remitter is a public-sector entity

having an immunity from taxation pursuant to Article 19 of the

Brazilian Constitution. In addition to the expert testimony the

parties have offered and the Brazilian Supreme Court cases

discussed above, other evidence in the record confirms that the
- 83 -

Central Bank, under Brazilian law, was constitutionally immune from

having to pay withholding tax with respect to its net loan interest

remittances abroad. Pursuant to its receipt of SRF 368 from

Dornelles (the head of the Brazilian IRS), the Central Bank, in May

1981, issued FIRCE 80 and did not require public-sector entities,

like itself, to pay withholding tax on their net loan interest

remittances abroad, regardless of whether the interest remittances

originated from a currency loan or from an import financing loan.

Da Silva (a fact witness, as well as petitioner's expert witness,

and the author of the March 1984 Brazilian IRS private ruling

issued to the Central Bank) essentially confirmed that, during

1983, when the Brazilian IRS's proposed issuance of the DoniakKahan draft ruling that conflicted with SRF 368 was being hotly

debated within the Brazilian Government and the Brazilian IRS,

certain existing Brazilian Supreme Court decisions, including the

Parana II decision, supported the position taken in SRF 368. As a

result of this debate, Dornelles decided that he could not approve

the issuance of the Doniak-Kahan draft ruling to the Central Bank.

Instead, in the March 1984 Brazilian IRS ruling that eventually was

issued to the Central Bank, top Brazilian IRS officials contrived

to get around the constitutional tax immunity of the Central Bank

and other public-sector entities, through applying the novel

borrowers-to-be theory. As indicated by the Brazilians' comments

to the BAC in January 1985, during the phase III negotiations,

although the Brazilians were willing to continue applying the
- 84 -

 

39 Article 19 of the Brazilian Constitution provides, in

pertinent part:

Article 19. The Union, the states, the Federal

District, and the Municipalities, are forbidden to:

* * * * * * *

III. Establish a tax on:

 a. The assets, revenues, or services of one

 another.

* * * * * * *

(continued...)

borrowers-to-be theory and to negotiate a longer relending period

for the phase III DFA, they were unwilling to make any change in

the Central Bank's tax immunity. In their comments, the Brazilians

also advised the BAC that about 75 percent of the phase III debt to

be restructured was not subject to withholding tax because it was

governmental debt.

Lastly, we reject petitioner's contention that Article 19 of

the Brazilian Constitution does not prohibit the Brazilian Federal

Government from taxing the assets, revenues, and operations of

Federal-level autarquias, like the Central Bank, as Article 19,

petitioner maintains, precludes taxation only between the different

governmental levels. Although some of petitioner's experts did

give opinions to that effect, we agree with respondent's expert

Tostes that such an interpretation of the constitutional tax

immunity of public-sector entities is contrary to the provisions of

Article 19, and is an unreasonable and questionable construction of

Article 19.39 If petitioner's interpretation of Article 19 were
- 85 -

 

39(...continued)

Paragraph 1. The provisions of letter a of item

III above extends to the autonomous governmental

entities, as regards the assets, revenues, and services

connected with their essential purpose or resulting

therefrom * * *

 

40 On brief, petitioner asserts that, to the best of its

knowledge, "no banks lending to Brazil were aware of SRF 368

until March 18, 1994, when Respondent produced a copy in its

(continued...)

correct, then a Brazilian State would be free to tax the assets,

revenue, and operations of other Brazilian States. Similarly, a

Brazilian municipality could tax other Brazilian municipalities.

Petitioner has cited no persuasive Brazilian legal authority for

this proposition. We further note other convincing evidence of

record. The Central Bank, following its issuance of FIRCE 80 in

May 1981, did not require withholding tax to be collected with

respect to the net loan interest remittances abroad of all publicsector entities, including "federal, state, and municipal

autonomous governmental agencies". In January 1985, during the

phase III negotiations, the Brazilians, in resisting the efforts of

foreign lenders to have the Central Bank issue them DARF's and

ostensibly pay withholding tax on all its net loan interest

remittances abroad, advised the BAC that there was "no room for any

change * * * [in the Central Bank's] tax immunity."

In our opinion, the applicable Brazilian law with respect to

the Central Bank's restructuring debt interest remittances is as

reflected in SRF 36840 and in certain Brazilian Supreme Court
- 86 -

 

40(...continued)

Status Report filed on that date. Respondent has never explained

how or where she obtained SRF 368." Petitioner also notes

certain testimony of employees and representatives of various

major international banks that the banks' Brazilian counsel had

advised them that the Central Bank was required to pay

withholding tax on its net loan interest remittances abroad. The

record does not support petitioner's assertion that none of the

banks were aware of SRF 368 until Mar. 18, 1994. Alexandre

Leite, who headed Citibank-Brazil's tax division, testified that

after the Central Bank's issuance of FIRCE 80 in May 1981, he

concluded that Citibank would not be able to persuade the Central

Bank to issue DARF's with respect to its 432 program net loan

interest remittances. He stated that with FIRCE 80 "there was a

ruling from the tax revenue service * * * that any immune

entity would not be obliged to * * * [issue withholding

receipts in remitting interest]." See supra note 12. We thus do

not believe that the major international banks, like Citibank,

that were seeking DARF's with respect to the Central Bank's net

loan interest remittances to them, much less these banks'

Brazilian counsel, were unaware of SRF 368 until Mar. 18, 1994. 

The record further fails to disclose what specifically the banks'

Brazilian counsel told the banks or did not tell the banks with

respect to SRF 368.

decisions, like the Parana II decision. Consequently, we conclude

that, under Brazilian law, public-sector entities, like the Central

Bank, are not required to pay withholding tax on their net loan

interest remittances abroad, because of their immunity from

taxation under Article 19 of the Brazilian Constitution.

F. The Act of State Doctrine

As indicated previously, we have determined that SRF 368 and

certain Brazilian Supreme Court decisions, including the Parana II

decision, correctly reflect the applicable Brazilian law that

public-sector entities are not required to collect and pay over

withholding tax with respect to their net loan interest remittances
- 87 -

 

41 In Amoco Corp. v. Commissioner, T.C. Memo. 1996-159, we

held that an Egyptian Tax Department determination reflected the

applicable Egyptian law and rejected the Commissioner's argument

that this Tax Department determination could have been

successfully challenged. We stated that whether the Tax

Department's determination could have been successfully

challenged was unclear, because, at the time, there was no

existing precedent that focused on the precise issue involved. 

We further stated that, on the facts presented, we perceived no

reason to delve into the motives of a foreign government in

connection with its tax determinations. The instant case is

distinguishable from Amoco.

abroad.41 Petitioner, nevertheless, contends that the March 1984

Brazilian IRS private ruling issued to the Central Bank must be

accorded conclusive effect under the act of state doctrine. On

brief, petitioner asserts:

Even if Respondent were correct and * * * [the

March 1984 Brazilian IRS private ruling] represented a

change in the * * * [Brazilian IRS's] historical

position, this would not affect * * * [the March 1984

ruling's] validity. * * * [Respondent] regularly

defends her ability to revise her rulings as necessary

and appropriate in the circumstances.

 * * * Therefore, the * * * [Brazilian IRS would

not have been required to follow an erroneous prior

practice any more than * * * [respondent] would be

required to follow such a practice.

 * * * * * * *

Respondent's argument would require this Court to

disregard * * * [the March 1984 Brazilian IRS ruling

issued to the Central Bank] and the Minister of Finance's

directive that taxes be withheld on the DFA and CGA

interest payments. Respondent argues that the * * *

[Brazilian IRS] "compromised" Brazilian tax law, and that

this Court must rule against the * * *[Brazilian IRS] on

a question of Brazilian tax law. Thus, Respondent

invites the Court to violate the Act of State doctrine by

"declar[ing] invalid, and thus ineffective as 'a rule of

decision for the courts of this country,' the official

act of a foreign sovereign." W.S. Kirkpatrick & Co. v.

Environmental Tectonics Corp. Int'l., 493 U.S. 400, 405

(1990) * * *. 
- 88 -

 

42 The act of state doctrine is to be contrasted with the

U.S. courts' well-established refusal to enforce a foreign

country's penal or revenue laws. Banco Nacional de Cuba v.

Sabbatino, 376 U.S. 398, 413-415 (1964); 1 Restatement, Foreign

Relations Law 3d, sec. 443, cmt. i & reporter's note 10 (1986).

In the principal contemporary formulation of the act of state

doctrine, the U.S. Supreme Court in Banco Nacional de Cuba v.

Sabbatino, 376 U.S. 398, 428 (1964), stated:

rather than laying down or reaffirming an inflexible and

all-encompassing rule in this case, we decide only that

the Judicial Branch will not examine the validity of a

taking of property within its own territory by a foreign

sovereign government, extant and recognized by this

country at the time of suit, in the absence of a treaty

or other unambiguous agreement regarding controlling

legal principles, even if the complaint alleges that the

taking violates customary international law.

The act of state doctrine thus generally precludes judicial

examination of the lawfulness of a taking by a foreign sovereign of

property located in its territory, whether under the law of that

foreign country, under international law, or under the law or

policy of the forum. 1 Restatement, Foreign Relations Law 3d, sec.

443, cmt. d (1986).42

Although the act of state doctrine has predominantly been

applied in cases involving a foreign sovereign's expropriation of

private property, the doctrine has also been applied to other types

of acts by foreign sovereigns. Id. cmt. c & reporter's note 7.

The burden of establishing the act and its character as an act

of state is on the party invoking the doctrine. Republic of the

Philippines v. Marcos, 806 F.2d 344, 356-357, 359-360 (2d Cir.

1986); 1 Restatement, supra sec. 443, cmt. i & reporter's note 3.
- 89 -

 

43 Although petitioner's expert da Silva testified that

SRF 368 was issued in June 1980, when Brazil was under a military

(continued...)

The act of state doctrine applies to acts such as constitutional

amendments, statutes, decrees, and proclamations, and in certain

circumstances, to physical acts. 1 Restatement, supra sec. 443,

cmt. i & reporter's note 3.

In the instant case, the March 1984 Brazilian IRS ruling

issued to the Central Bank was a private ruling. Petitioner's

experts did not elaborate on whether the Central Bank, under

Brazilian law, was legally compelled to accept and follow the

ruling. Thus, it appears that the Central Bank possibly could have

disputed that it was subject to withholding tax on its

restructuring debt interest remittances during the relending

periods of the DFA's and CGA's, and sought review in the Brazilian

courts. In light of favorable existing Brazilian Supreme Court

precedents, such as the Parana II decision, in all substantial

likelihood, any effort by the Central Bank to dispute the ruling by

resorting to the Brazilian judicial system would have been

successful, particularly since even petitioner's own experts

generally acknowledged that there was no such legal doctrine as the

borrowers-to-be theory under Brazilian law. The borrowers-to-be

theory itself contravened a number of rules of Brazilian taxation.

The record further reflects that although Brazil was under a

military regime until about 1985, the Brazilian courts still

functioned during this period of military rule.43 Moreover, the
- 90 -

 

43(...continued)

regime, he also indicated that the Brazilian courts had more

leeway than the Brazilian Congress. He related that Brazil had

been under this military regime from 1964 through March 1985. We

note that the Brazilian Supreme Court's Parana II and Minas

Gerais decisions were issued, respectively, in 1975 and in 1979,

during this period when Brazil was under military control. 

 

44 As indicated above, the record does not reflect that

the Brazilian IRS ever revoked SRF 368. See supra note 32. 

 

45 Although the Finance Minister "directed" the Central

Bank to begin "paying" this "withholding tax" by the last

business day of the month following the month in which the

Central Bank started "withholding", his action was merely in

response to the Central Bank's request, in the consulta, that it

be granted a waiver of any late payment "penalties", as only the

Finance Minister had the authority to extend the time for

"payment" and to waive such "penalties". 

March 1984 private ruling still conflicted with SRF 368, despite

the efforts of top Brazilian IRS officials, in devising the

borrowers-to-be theory, to distinguish from SRF 368 the Central

Bank's restructuring debt interest remittances during the relending

periods of the DFA's and CGA's.44

We conclude that petitioner has failed to establish that the

act of state doctrine is applicable. Petitioner has not shown that

the March 1984 Brazilian IRS ruling was anything more than perhaps

an administrative advisory opinion.45 We are thus not required to

accord conclusive effect to the March 1984 Brazilian IRS ruling

issued to the Central Bank. Rule 142(a); Republic of the

Philippines v. Marcos, supra.

G. Conclusion

We hold that the Central Bank was not required, under

Brazilian law, to pay withholding tax on its restructuring debt
- 91 -

 

46 The regulations provide relief, in certain limited

circumstances, to taxpayers who reasonably interpret foreign law

but overpay their actual foreign tax liability. Among other

things, the amount of foreign tax paid must be determined by the

taxpayer in a manner that is consistent with a reasonable

interpretation and application of the substantive and procedural

provisions of foreign law. Further, an interpretation of foreign

law is not considered reasonable if there is actual or

constructive notice (e.g., a published court decision) to the

taxpayer that the interpretation is likely erroneous. Also,

while a taxpayer generally may rely on advice obtained in good

faith from competent foreign tax advisers, the taxpayer must have

(continued...)

interest remittances to petitioner during the relending periods of

the DFA's and CGA's. Petitioner is thus not "legally liable" for

these alleged Central Bank "withholding tax payments". Nissho Iwai

Am. Corp. v. Commissioner, 89 T.C. at 773-774; sec. 1.901-2(f),

Income Tax Regs.; see the PeMex case.

II. Central Bank Issue

Our holding on the Central Bank/liability issue requires us to

decide the Central Bank issue against petitioner. As petitioner is

not "legally liable" for the Brazilian tax, we hold that the

"withholding tax" purportedly paid by the Central Bank on its

restructuring debt interest remittances to petitioner is a

noncompulsory amount and not a tax to Brazil under section 1.901-

2(e)(5), Income Tax Regs., and is not creditable to petitioner.

Sec. 1.901-2(e)(1), Income Tax Regs. Petitioner has not argued

that, even if these alleged withholding tax payments were not

required and exceed the amount of petitioner's actual Brazilian tax

liability, they are still potentially creditable to petitioner

pursuant to section 1.901-2(e)(5)(i), Income Tax Regs.46 We do not
- 92 -

 

46(...continued)

disclosed to them the relevant facts. See sec. 1.901-2(e)(5)(i),

Income Tax Regs. In any event, on the record presented in the

instant case, petitioner has failed to establish it would be

eligible for such relief. As previously discussed, petitioner's

assertion that no banks lending to Brazil were aware of SRF 368

until Mar. 18, 1994, is untrue. We do not believe that certain

major international banks, like Citibank, much less these major

international banks' Brazilian counsel, were unaware of SRF 368

and the Brazilian Supreme Court's Parana II decision. See supra

note 40. Moreover, notwithstanding the March 1984 Brazilian IRS

private ruling issued to the Central Bank, even some of the

employees and representatives of these major international banks

who testified at trial indicated that they were skeptical of the

ruling's borrowers-to-be theory. 

 

47 The parties disagree over whether the Central Bank

actually paid "withholding tax" on its restructuring debt

interest remittances to foreign lenders during the relending

periods of the CGA's and DFA's, beginning in 1984. At trial,

petitioner offered the testimony of an employee of Banco do

Brazil, the Brazilian National Treasury's agent for payment of

taxes. The Banco do Brazil employee was offered by petitioner as

an expert witness with respect to the manner in which Banco do

Brazil accounted for its withholding tax payment collections. He

examined one purported withholding tax payment of the Central

Bank on its restructuring debt interest remittances, which he

selected at random, and verified that certain entries had been

made on Banco do Brazil's books reflecting Banco do Brazil's

receipt of the Central Bank's purported withholding tax payment. 

However, as we noted in our findings, it is not known: (1)

Whether the Central Bank was reimbursed by the National Treasury

for its restructuring debt "withholding tax payments", or (2)

whether the Central Bank received the pecuniary benefit based on

such "withholding tax payments". Petitioner's expert

acknowledged that he had not inquired into whether the Central

Bank received the pecuniary benefit or whether any other

transactions took place resulting in a "refund" being made of the

Central Bank's "withholding tax payments". Although we do not

decide the payment issue, the Central Bank's actual receipt of

the pecuniary benefit would be highly probative evidence

confirming its actual payment of this "withholding tax". If the

Brazilian Government reimbursed the Central Bank for these

"withholding tax payments", because the Central Bank was acting

(continued...)

decide whether these alleged withholding tax payments, in fact,

were made by the Central Bank.47
- 93 -

 

47(...continued)

as the Brazilian Government's agent, then the Central Bank, in

all likelihood, would not receive the pecuniary benefit based on

such "tax payments".

III. Subsidy/Pecuniary Benefit Issue

Section 4.901-2(f)(3), Temporary Income Tax Regs., 45 Fed.

Reg. 75653-75654 (Nov. 17, 1980), provides:

(f) Amount of income tax paid or accrued-(1)

In general. A credit is allowed under section 901 for

the amount of income tax * * * that is paid or

accrued to a foreign country, subject to the provisions

of paragraph (f). The amount of income tax paid or

accrued is determined separately for each taxpayer.

* * * * * * *

(3) Subsidies-(i) General rule. An amount is not

income tax paid or accrued to a foreign country to the

extent that-

(A) The amount is used, directly or indirectly, by

the country to provide a subsidy by any means (such as

through a refund or credit) to the taxpayer; and 

(B) The subsidy is determined directly or indirectly

by reference to the amount of income tax, or the base

used to compute the income tax, imposed by the country on

the taxpayer.

(ii) Indirect subsidies. A foreign country is

considered to provide a subsidy to a person if the

country provides a subsidy to another person that-

(A) Is owned or controlled, directly or indirectly,

by the same interests that own or control, directly or

indirectly, the first person; or

(B) Engages in a business transaction with the first

person, but only if the subsidy received by such other

person is determined directly or indirectly by reference

to the amount of income tax, or the base used to compute

the income tax, imposed by the country on the first

person with respect to such transaction.
- 94 -

Substantially identical provisions are made in section 1.901-

2(e)(3), Income Tax Regs.

Pursuant to section 4.901-2(f)(3)(ii), Temporary Income Tax

Regs., supra, and section 1.901-2(e)(3)(ii), Income Tax Regs., the

existence of an indirect subsidy does not depend upon a finding

that the U.S. taxpayer derived an actual economic benefit. It is

sufficient that another person who engages in a transaction with

the U.S. taxpayer has received a subsidy that was based on the

amount of tax paid. Norwest Corp. v. Commissioner, 69 F.3d at

1409-1410; Continental Ill. Corp. v. Commissioner, 998 F.2d at

519-520; Bankers Trust New York Corp. v. United States, 36 Fed. Cl.

30 (1996). Thus, subsidies received by Resolution 63 repass lenders

and repass borrowers also fall "within the letter as well as the

spirit of" the indirect subsidy provision of the temporary and

final regulations, as the repass lender is required by Brazilian

law to pass along the pecuniary benefit to the repass borrowers.

Norwest Corp. v. Commissioner, 69 F.3d at 1410; Continental Ill.

Corp. v. Commissioner, 998 F.2d at 520, affg. on this issue T.C.

Memo. 1988-318; Bankers Trust New York Corp. v. United States,

supra at 36. Further, this Court and other courts, including the

U.S. Courts of Appeals for the Seventh and Eighth Circuits, have

upheld the validity of the indirect subsidy provision of the

temporary regulations, and have held that U.S. taxpayer-lenders

are required to reduce the amount of their potentially creditable

Brazilian withholding taxes by the pecuniary benefit the Brazilian
- 95 -

 

48 The position set forth in the temporary and final

regulations has been codified in sec. 901(i), which is effective

for foreign taxes paid or accrued in taxable years beginning

after Dec. 31, 1986. Tax Reform Act of 1986, Pub. L. 99-514, sec.

1204(a), 100 Stat. 2532; see Nissho Iwai Am. Corp. v.

Commissioner, 89 T.C. at 777 n.17.

Government provided to their Brazilian borrowers. Norwest Corp. v.

Commissioner, 69 F.3d at 1408-1410; Continental Ill. Corp. v.

Commissioner, 998 F.2d at 519-520; Nissho Iwai Am. Corp. v.

Commissioner, 89 T.C. at 775-777 (1989); Bankers Trust New York

Corp. v. United States, supra at 35.48

Petitioner argues that the "subsidy * * * to the taxpayer"

language in the temporary and final regulations requires an

economic benefit analysis and asserts that petitioner itself

received no economic benefit from the pecuniary benefit the

Brazilian Government provided to Brazilian borrowers. Petitioner

points out that, in the case of Resolution 63 repass loans, it did

not even know the identity of the repass borrowers who received the

pecuniary benefit. It contends that if the regulations are applied

to require reduction of the Brazilian withholding tax potentially

creditable to petitioner by the pecuniary benefit the Brazilian

borrowers received, then the regulations are invalid. We disagree.

We hold that pursuant to section 4.901-2(f)(3)(ii), Temporary

Income Tax Regs., supra, and section 1.901-2(e)(3)(ii), Income Tax

Regs., the Brazilian withholding tax potentially creditable to

petitioner must be reduced by the pecuniary benefit the non-taximmune borrowers received. We further hold that the indirect
- 96 -

subsidy provisions of the temporary and final regulations are

valid. Norwest Corp. v. Commissioner, 69 F.3d at 1408-1410;

Continental Ill. Corp. v. Commissioner, 998 F.2d at 519-520; Nissho

Iwai Am. Corp. v. Commissioner, supra at 775-777. In light of our

holdings on the legal liability and Central Bank issues (i.e., that

the "withholding tax" purportedly paid by the Central Bank on its

restructuring debt interest remittances to petitioner is not a

potentially creditable tax to petitioner), we need not reach the

issue of whether any pecuniary benefit the Central Bank received

represents an indirect subsidy for purposes of section 1.901-

2(e)(3)(ii), Income Tax Regs. Compare the PeMex case with Amoco

Corp. v. Commissioner, T.C. Memo. 1996-159. 

To reflect concessions by the parties,

Decision will be entered

under Rule 155.