Executive summary

Spain's Ministry of Finance has published a note reporting that Spain and Brazil have reached a mutual agreement clarifying the treaty treatment of Brazilian interest on net equity (INE, juros sobre o capital próprio in Portuguese). Under this interpretative agreement, INE is to be treated as "interest," and should not enjoy participation exemption as provided for in Article 23 of the Spain-Brazil Tax Treaty (the Treaty).

Detailed discussion

The classification of INE as either (tax-exempt) dividends or (taxable) interest has been the subject of ongoing debate in Spain. Historically, numerous Spanish multinational companies asserted that INE should be considered as dividends and consequently applied the exemption to their remittance. Tax authorities consistently rejected this exemption but permitted the use of a double tax credit for the 15% withholding tax (WHT) imposed in Brazil - an amount later increased to 20% under the matching credit clause of the Spain-Brazil Tax Treaty. This matter appeared to be resolved following two rulings by the Spanish Supreme Court issued on 16 March 2016, and 15 December 2016, which established that INE payments were analogous to profit distributions rather than interest payments.

In 2015, Spanish domestic legislation explicitly prohibited applying the participation exemption if dividends or participations in profits received constituted a deductible expense for the distributing entity, as is the case with INE.

Despite the 2015 tax reform, certain technical arguments persisted supporting the view that INE payments should continue to qualify for participation exemption, relying on the Spain-Brazil treaty provisions - specifically Article 23, which provides for full exemption on dividend income.

The published note constitutes another (and likely final) step in the prolonged controversy and indicates that the competent authorities of Spain and Brazil have agreed that INE should be characterized as interest for treaty purposes. As a result, the Treaty provisions applicable to interest (rather than dividends) are expected to govern the taxation at source and the residence-state relief mechanism.

The agreement will not affect source State taxation in Brazil, as Brazil has consistently applied a 15% withholding rate on interest payments in accordance with Article 11 of the Treaty. However, the note definitively concludes any further debate concerning the classification of INE in Spain and eliminates the possibility for Spanish companies to claim the exemption outlined in Article 23(1) of the Treaty on INE remittances received in Spain.

Because the clarification is presented as an interpretative agreement under Article 25(3), it is not framed as a formal amendment to the Treaty wording. Accordingly, the agreement is intended to operate as a clarification of the existing provisions, which seems to imply that the agreement supports a "dynamic" interpretation for open years. Nonetheless, depending on specific facts, a "static" interpretation might be plausible, for instance to seek penalty protection if prior positions were taken based on previously prevailing interpretations and available guidance.

Implications

The interpretative agreement effectively resolves the longstanding controversy regarding the Treaty's characterization of INE payments and the applicable relief method in Spain. While this clarification brings finality and certainty, it does so to the disadvantage of taxpayers, as it confirms that INE payments will be treated as interest for Treaty purposes and precludes access to the participation exemption in Spain. Taxpayers with Spanish investments in Brazil (or Brazilian payers with Spanish shareholders) should carefully assess the impact of this outcome on their WHT, Spanish relief claims and documentation for open years, as well as consider the interaction with any domestic anti-hybrid or participation exemption limitations relevant to their specific circumstances.

Despite the interpretative agreement, Spanish and foreign multinationals doing business in Brazil should not discard using INE because it still provides an efficient tool to finance operations and repatriate funds. This is because of the notional 20% tax credit against the effective 15% effective WHT and the 10% WHT that was introduced on dividends paid to nonresident shareholders effective 1 January 2026.

Additional considerations (MLI)

As a reminder, once Brazil ratifies the Multilateral Instrument (MLI) and it enters into effect for the Spain-Brazil Treaty, the current full exemption regime for dividends is expected to cease and the credit method (foreign tax credit relief) would generally apply. Groups receiving cross-border distributions should monitor Brazil's ratification and entry-into-effect timelines and assess the potential impact on cash tax and reporting positions.

Groups should also consider assessing whether the MLI not only eliminates the exemption as a mean to prevent double taxation on dividends, but also fully replaces Article 23 of the Spain-Brazil Treaty, thereby also removing the tax-sparing clause. Although the interpretation that the matching credit clause remains is supported by the literal wording of the relevant texts, this issue requires further monitoring of future developments.