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Doc 2009-19674 (2 pgs)

Indemnifications Not Taxable, Brazil's Superior Court Rules

(C) Tax Analysts 2009. All rights reserved. Tax Analysts does not claim copyright in any public domain or third party content.
by David Roberto R. Soares da Silva

Brazil's Superior Court of Justice (STJ) has recently ruled, in a decision

contradictory to the position of the Federal Revenue Department (FRD), that
indemnifications received for both material and immaterial (moral) damages are not
taxable in Brazil.

The decision was delivered in Special Appeal no. 1068456 when the court rejected
the arguments raised by the Federal Revenue Attorney General's Office (Procuradoria
Geral da Fazenda Nacional, or PGFN). The decision was published in the judiciary's
official gazette July 1. The summary of the decision reads as follows:

1. Receipt of indemnification for material and moral damages is not a taxable event
for income tax as the purpose of the indemnification is to repair the material and
immaterial wealth of the victim affected by an illegal act.

2. The non application of income tax is not caused by an exemption, but for the
absence of new wealth -- arising from capital, from work or from both -- capable
of characterizing accretion to wealth.

3. Indemnification for moral or material damages does not increase the wealth of
the injured; it only repairs, via monetary substitution, the status quo ante.

In delivering the court's opinion, Justice Eliana Calmon argued that for income tax
to apply, new income must be generated from work, from application of capital, or from
both, as stated in article 43 of the National Tax Code. Indemnifications, whether for
material or immaterial damages, do not fall into any of those categories, and, therefore,
income tax is not applicable. Calmon cited some similar precedents from the STJ.

The decision conflicts with the FRD's official position. In July 2007, the FRD issued
Private Letter Ruling 267/2007 making a distinction between material and immaterial
damages and providing for different tax treatment for each type of indemnification. (For
prior coverage, see Doc 2007-19106 or 2007 WTD 161-5.)

The FRD concluded that no Brazilian tax should be imposed on indemnification

for material (tangible) damages because such indemnification is aimed at reestablishing
the taxpayer's prior material status and represents no actual accretion of wealth.
However, indemnification for immaterial (nontangible) damages was taxable because
it did not serve to reestablish the taxpayer's wealth. In other words, the FRD concluded
that an award for nontangible (moral) damages represented an accretion to the
taxpayer's wealth rather than reestablishment of the taxpayer's prior material status or
Doc 2009-19674 (2 pgs)


(C) Tax Analysts 2009. All rights reserved. Tax Analysts does not claim copyright in any public domain or third party content.
The STJ's position is more logical and seems fairer. But taxpayers receiving
indemnifications for moral damages will have to face the FRD in court because the
STJ rule is not binding. Although the chances of success are fairly high, such a court
challenge is unavoidable if taxpayers wish to avoid paying income tax on
indemnifications for moral damages.

David Roberto R. Soares da Silva, tax partner, Azevedo Sette Advogados, São