In a context marked by the implementation of the ATAD I and II directives and the global approach of the BEPS Plan, hybrid financial instruments and the asymmetries they generate remain fertile ground for tax controversy. The legal, accounting, and tax classification of these instruments (debt vs. equity) and the regime applicable to the income derived from them are issues that, even with repeated criteria from tax authorities and courts, continue to spark debate.

A paradigmatic example of this complexity is the case of "juros sobre o capital próprio" (JSCP), a financial instrument created by the Brazilian government in 1995 to mitigate the well-known "debt bias" or fiscal bias toward debt financing. This bias arises because, in most tax systems, debt interest is deductible, while dividends are not, incentivizing companies to finance themselves through debt rather than equity. Thus, the introduction of JSCP encouraged corporate capitalization to improve the solvency and resilience of the Brazilian economy, reducing pressure on debt markets and contributing to monetary stability and inflation control.

In Spain, the Corporate Income Tax Law (CIT Law) explicitly regulates the tax treatment of some hybrid instruments, such as participative loans, classifying them as equity when granted by entities within the same group. However, the diversity and complexity of hybrid financial instruments, especially those issued in other jurisdictions, make comprehensive regulation challenging.

To address these situations, the ATAD I and II directives establish general rules to neutralize the tax effects of hybrid mismatches without defining specific criteria for classifying instruments as debt or equity. This generic approach leaves room for uncertainty, especially in cases like JSCP, which combine debt characteristics (the distribution generates a tax-deductible expense in Brazil) and equity characteristics (it is a form of equity remuneration).

Brazilian tax law allows Brazilian companies to deduct the profits distributed to their shareholders in the form of JSCP, provided certain requirements are met.

In Spain, the Supreme Court, in its rulings of March 16 and December 15, 2016, confirmed that JSCP has the tax characterization of dividends, as they do not remunerate loans, derive from profits, and the right to receive them stems from shareholder status. Thus, the Supreme Court's decision focused on the legal nature of the financial instrument, disregarding its tax classification under Brazilian law. This approach wisely avoided allowing the interpretation of a Spanish rule to be conditioned by tax criteria established in the legislation of a foreign jurisdiction.

Once confirmed as dividends for Spanish tax purposes, the next step is to determine the method to avoid double taxation that Spanish companies receiving this type of remuneration can apply: the exemption method or the tax credit method, with the exemption method generally being more favorable for the investor.

For dividends received from Brazil, a Spanish taxpayer could generally choose to apply (i) the exemption to avoid double taxation provided in Article 21 of the CIT Law, currently limited to 95%, resulting in an effective taxation in Spain of 1.25%; or (ii) the exemption provided in Article 23.3 of the Spain-Brazil Double Taxation Agreement (DTA), which, unlike the domestic exemption, completely eliminates taxation in Spain as it is not subject to any limitation.

The first option (Article 21 CIT Law) would be unfeasible under the current wording of the law, which prevents applying the exemption to profit distributions that generate a tax-deductible expense, as is the case with the Brazilian entity paying the JSCP. 

The second option (Article 23.3 of the Spain-Brazil DTA) had been denied by the Spanish General Directorate for Taxes (GDT) in its binding rulings number V2960-16 and V2962-16.

In these rulings, the GDT introduced additional uncertainty by distinguishing between the tax classification of JSCP remuneration in Spain (dividend), the legal and accounting classification of the instrument in Brazil (dividend), the tax classification of the instrument in Brazil (interest, according to the GDT), and the tax classification of the instrument for the purposes of the Spain-Brazil DTA (interest, according to the GDT). In this case, as it involves the application of the benefits of a DTA, the financial instrument's classification must be made according to Brazilian tax criteria by express reference in Article 11.5 of the Spain-Brazil DTA.

Based on this, the GDT concluded that Spanish investors could not apply the exemption provided in Article 23.3 of the Spain-Brazil DTA, as, for DTA purposes, JSCP would be considered interest, not dividends. This same criterion was upheld by the Spanish Central Economic-Administrative Court (CEAC) in its resolution of October 24, 2022.

This dual reality proposed by the GDT and CEAC, considering JSCP simultaneously as dividends and interest for tax purposes, has contributed to legal uncertainty for Spanish investors earning income in Brazil through JSCP.

In its ruling of May 22, 2025, the Spanish National Court corrected the GDT and CEAC's criteria, concluding that JSCP should be considered dividends for the purposes of the Spain-Brazil DTA, whose provisions are integrated into and form part of Spanish law. The ruling highlights that:

• The GDT and CEAC's criteria contradict the spirit of the Spain-Brazil DTA, which classifies these incomes as dividends, not interest.
• The Brazilian administration, both in negotiating the DTA and in its practical application, has treated JSCP as dividends, not interest.
• Brazilian legislation (Law 9.249/1995) and resolutions such as that of the Brazilian Securities Commission of June 15, 2022, reinforce this classification.

This ruling by the National Court provides clarity and legal certainty by recognizing that JSCP are dividends also for DTA purposes, not only for domestic purposes, and allowing Spanish investors to apply the exemption in Article 23.3 of the DTA to JSCP.

It should be noted that the National Court's criterion validates the existence of a hybrid mismatch (deduction in Brazil without inclusion in Spain) favorable to the taxpayer, which cannot be neutralized by Spain's anti-hybrid rules transposing the ATAD II Directive, as this mismatch arises from the interpretation of the Spain-Brazil DTA, which takes precedence over domestic legislation.

This ruling opens the door to greater tax efficiency for Spanish investors with interests in Brazil and strengthens legal certainty in applying the Spain-Brazil DTA. However, it should be interpreted cautiously, as a possible Supreme Court ruling is still pending. The matter is far from fully resolved or free of controversy, as generally occurs with any issue related to hybrid instruments or structures.