Finocchio & Ustra Sociedade de Advogados | View firm profile
Updates on Brazil’s potential income tax reform are brought by Finocchio and Ustra’s Tax Team.
Brazil is in a moment that important reforms are being discussed before the Congress. Approval of the Labour reform in the past years, then changes to Social Security regulations and now a proposal for an Administrative Reform and several bills about Taxation are under discussion and on advanced stages.
Among the Tax Reforms bills, two have attract most attention one proposing more in-depth changes to the tax system as a whole and also to tax on consumption (Proposition to Amend the Constitution n. 110/19 and n. 45/2019) and the one proposing fundamental changes to Income Tax (Bill of Law n. 2,337/21), which has been presented by the federal government to Congress on June 2021 and is already approved by the Chamber of Deputies and now under discussions within the Brazilian Senate.
Comparing the initial framework proposed by the Federal Government in June and the draft approved by the Chamber of Deputies in September 1st 2021, the bill of law as it is today has faced considerable changes.
Arguably the most relevant change addressed by the proposal is the taxation of dividends, which was excluded from the Brazilian Tax System in 1996. A withholding income tax of 15% (opposed to a 20% rate in the initial draft) would be applied on dividends paid, including when payments made to non-resident shareholders and also on dividends paid based on retained earnings from periods prior to 2022 (i.e. year when the law, is passed, would come into force).
Indeed, if approved, the taxation of retained earnings is likely to cause extensive litigation, due to tax principles in the Brazilian Constitution that prevent retroactive taxation of income.
Some exceptions for dividends paid (i) by Brazilian legal entities which elect the Simples Nacional tax regime (usually small sized companies); (ii) by Brazilian legal entities to local individual shareholders provided that the company elects the Lucro Presumido tax regime and have less than BRL 4,8mm or (iii) to other Brazilian legal entities that own control in the company paying the dividend or are subjected to common corporate control, and to companies owing at least 10% share in the company paying the dividend.
There is also exception of taxation on capitalisation of profits as long as no capital reduction is done within 5 years and no capital reduction has been implemented in the previous 5 years. In this case the shares or quotas will have an acquisition cost equal to zero at the level of the shareholder.
As a compensatory measure to the new taxation of dividends, the proposal reduces tax rate at the level of the company (i.e. in Brazil the corporate income tax is comprised of a corporate income tax per se and a social contribution levied on net profits). The Corporate Income Tax (IRPJ) would be reduced from 15% to 8% its additional tax rate surcharged on yearly profits that exceed BRL 240,000 would be kept at 10% and the Social Contribution on Net Profits (CSLL) from 9% to 8%. As result, the current nominal corporate tax rate of 34% would be reduced to 26%.
It is important to mention that the overall taxation considering corporate income tax and the withholding tax on dividends would potentially cause a tax increase from 34% to 37,1%, if one assumes a dividend pay-out policy of 100%.
Others relevant changes addressed by the reform that impacts directly the taxation of Brazilian entities are the extinction of the interest on net equity (JCP), the introduction of a mandatory quarterly computation period corporate tax, changes to the 30% limitation on tax losses on a quarterly basis (with a limit then applied after three quarters) and the uniformization between the IRPJ and CSLL calculation basis.
Furthermore, with the return of dividends taxation, the proposal also brings an improvement of rules to prevent hidden profit distribution (distribuição disfarçada de lucros or DDL), rules that weren’t relevant since 1996 when dividends were no longer taxed. Some of the improvements relates to trades carried out for values below or above the market value between partners and the company; interest, rental, royalties or technical assistance payment below market value to related parties; personal expenses of partners or relatives, paid by the company; cancellation of debt; and, loan to shareholders when entity has retained earnings from periods 2022 on.
Corporate reorganizations and private equity funds also may face changes if the proposal is approved. For instance, payment of dividends with company assets and capital reductions with delivery of goods and rights to the shareholders must be valuated at market value. Some exceptions for that are the capital reduction in the context of a corporate reorganisation involving local shareholders and capital reduction from a foreign entity to a local shareholder.
For the private equity industry, it must be highlighted the taxation on profit stock of exclusive or closed-end funds, by a tax rate of 6% if integral payment is made until May 31st, 2022, or a tax rate of 15% if the payment occur until November 15th, 2022. The famous “Come-quotas” (advanced payment of withholding income tax applicable to investment funds in Brazil) would be extended to exclusive or closed-end funds, and the taxation of FIP and FIEE would occur in the month following any divestment, regardless if distributions are effectively paid or not to the investors.
Summarizing all the above, important modifications could arise from the reform, some positive ones and other that could cause harm to the Brazilian business environment. The proposal is under responsibility of the Senate for discussion and deliberation and, for now, amendments with important modifications have already been presented on this house, which will need to be appreciated with the actual text submitted by the Chamber of Deputies.