Income Reform: Dividend Taxation and Risks on Retained Earnings

The Federal Senate approved the main text of Bill No. 1,087/2025, which reforms income taxation in Brazil and represents one of the federal government’s main economic priorities. The bill now moves to Presidential approval, with expectations of swift promulgation and effectiveness starting January 1, 2026, if enacted into law before the end of this year.

The approved text significantly amends the Individual Income Tax (IRPF) rules and introduces a minimum income taxation regime, in addition to establishing a 10% withholding income tax (WHT) on dividends paid by Brazilian companies to individuals and non-resident shareholders.

Key provisions of the new legislation:

• Exemption from IRPF for monthly income up to R$ 5,000;
• 10% WHT on dividends exceeding R$ 50,000 paid by the same company to the same individual within the same month;
• 10% WHT on dividends remitted abroad;
• Exemption for dividends paid to foreign governments, sovereign funds, and foreign pension funds, provided the legal requirements are met;
• Minimum annual IRPF taxation on total income above R$ 600,000:
• For income between R$ 600,000 and R$ 1.2 million, the minimum rate will be progressive, ranging from 0% to 10%;
• For income above R$ 1.2 million, a 10% minimum rate applies;
• Income from exempt or zero-rated financial instruments (such as CRIs, CRAs, LCIs, LCAs, incentivized debentures, FIIs, FIAGROs, among others) will not be included in the minimum taxation calculation;
• Profits earned up to 2025 may be distributed tax-free, provided that the corporate resolution approving such distribution takes place by the end of 2025, and payment is made in Brazil in 2026, 2027, or 2028, as stated in the respective resolution. There is no specific deadline established for remittance of these dividends abroad;
• If the combined effective rate of corporate income tax (IRPJ/CSLL) and the minimum IRPF on dividends exceeds 34%, a reduction mechanism will apply to the IRPF rate on such dividends and foreign shareholders might be entitled to a refundable tax credit.

Relevant Discussions

The provision conditioning the exemption of retained earnings on a corporate resolution by the end of 2025 and actual payment in subsequent years is a particularly sensitive point and has been widely questioned.

In practice, several doubts arise, such as:

• Is it possible to calculate 2025 profits and approve their distribution within the same year, considering that, as a rule, dividends distributed based on interim financial statements are only provisional until confirmed by the year-end balance sheet?
• What is the maximum legal period that may be established in the resolution for the remittance of dividends abroad while maintaining the exemption?
• Can dividends be distributed with payment scheduled up to 2028, given that Article 205, §3 of the Brazilian Corporations Law requires that dividends be paid within the same fiscal year in which the resolution was approved?
• What are the effects of recapitalizing the company through shareholder loans, if a dividend is declared? Would interest payments made under this scenario be tax-deductible?
• Considering the operational difficulty of closing 2025 financial statements within the same year, would it be possible to formalize the corporate resolution and file it in January 2026 with retroactive effect?
• Once a dividend is declared, must the liability to shareholders be recorded immediately?
• How will the tax reduction mechanism be calculated, particularly in cases involving deferred taxes or consolidated corporate groups and groups with holding structures?

The new rule creates a significant business constraint, as it effectively forces companies to abruptly modify their dividend and financing policies solely for tax reasons. It also impacts key financial indicators such as leverage ratios and equity levels, potentially distorting the financial profile of companies.

Furthermore, the rule is potentially illegal and unconstitutional, as it effectively creates a “disguised tax” through structural changes to the income tax system, violating key constitutional tax principles, including the Ability to Pay Principle, Legality, Legal Certainty, and Tax Equality.

The Senate’s Committee on Economic Affairs (CAE) itself acknowledged in its official report that the text contains issues of legality and constitutionality, but it was approved without amendments to avoid returning the bill to the House of Representatives and to ensure it takes effect in 2026.

Suggested Next Steps

• Companies should develop an effective plan to protect their retained earnings from future taxation;
• Design a corporate strategy to formally approve and record the allocation of profits earned up to the end of 2025, ensuring preservation of the exemption;
• Consider accounting mechanisms to increase 2025 profits and strengthen retained earnings bases, such as adjusting depreciation rates or recognizing asset revaluations (fair value adjustments);
• Consider corporate restructuring strategies to optimize future positions, including share redemption or buyback mechanisms;
• Judicial alternatives may also be evaluated on a case-by-case basis:
• From the corporate perspective, to secure the right to retain profits within the company without mandatory distribution;
• From the individual or foreign shareholder perspective, to challenge the WHT on amounts characterized as “tax-exempt and non-taxable”;

This judicial position is expected to gain strength given the Senate’s formal acknowledgment of legal flaws in the approved law.