Ayres Ribeiro Advogados

Market roundup: Brazil wants to tax offshore investments

Gilberto Ayres Moreira / Tributário

17 de junho de 2023

Por Fabiane Ziolla Menezes publicado no The Brazilian Report

A decree pending in Congress seeks to radically change the tax rules on theincome of individuals abroad as a way to compensate for revenue lossesresulting from the expansion of the domestic income tax exemption threshold

Lula administration seeks to tax investments abroad

Late in April, President Luiz Inácio Lula da Silva signed a decree slightly raising the threshold for income tax exemption for individuals, up to a monthly income of BRL 2,112 — while taxing capital income from offshore financial investments owned by citizens who reside in Brazil, including investments made through offshore companies, trust funds, and other formally constituted entities located in tax havens.

Why the change? Experts in the Finance Ministry estimate that raising the threshold for income tax exemption will have a negative impact of BRL 3.2 billion (USD 663 million) on public accounts in 2023, BRL 5.88 billion in 2024, and BRL 6.27 billion in 2025.

• At the same time, the government estimates that by taxing investments abroad, it could raise BRL 3.25 billion (USD 673 million) in 2023, BRL 3.59 billion in 2024, and BRL 6.75 billion in 2025. 
• Taxing individuals’ investments abroad is therefore necessary to  offset the impacts of broader tax exemptions.

State of play. The decree is viewed as a sample of the government’s intentions for the second part of its tax reform plan, which will be focused on income taxes. The Brazilian Congress is now discussing the first part of the reform , regarding taxes on consumption.

• During last year’s campaign, Lula pledged to raise the income taxthreshold to a monthly salary of BRL 5,000 (90 percent of Brazilian workers earn up to this amount). Taxing dividends is also on the president’s radar.

How it works today. Currently, investments made by individuals abroad can be taxed as income (recurring gains from dividends,shares, interest, or property rentals, for example) or as capital gains(sale, redemption, or liquidation of assets).

But, but, but … This only effectively happens upon the sale or maturity of assets and when taxpayers bring their money to Brazil.

How would it be? If Congress passes the decree, Brazilian investors residing in the country would have to declare and pay taxes annually on income obtained abroad, whether or not they bring that money into Brazil.

• Income up to BRL 6,000 would be tax exempt, while income ranging from BRL 6,000 to BRL 50,000 would be taxed at 15 percent; the tax rate would rise to 22.5 percent on income exceeding BRL 50,000.

Why it matters. Experts say there are more downsides than upsides to the government’s proposal and that some of the proposed changes are far from what could be considered reasonable — as it also creates questionable anti -deferral  rules for taxing legal entities controled abroad and includes trust funds as taxable investments.

• That tis highly debatable as the trustee of such funds is the one who really holds power over the investments , not teh fund creator ( settlor ) nor the beneficiary .

A practical example. One of the most common structures for investments by Brazilians abroad are the so-called private investment companies, also referred to as “offshore.”

• In these structures, mechanisms are used for income from these foreign assets to be retained abroad — for example, income is reinvested  and for years the profits are not distributed to the Brazilian partner, who therefore doesn’t pay taxes. 
• If the decree is approved, the profits earned by offshore companies located in low-tax jurisdictions (tax havens) would have to be declared and taxed on December 31 of each year, regardless of whether or not they have been distributed to the individual holder.The taxation rate would be the same as general income tax, up to a maximum of 22.5 percent.

What the government says. The government argues that Brazil is one of the only countries in the world where residents can still use offshore structures to indefinitely defer tax payments — a practice that causes a breach of tax equality and impairs the state’s collection capacity.

• If approved, the changes provided for in the decree would come into effect in 2024, without retroactive impact.

Yes, but… Half of the 120-day period Congress has to vote on the decree has already passed, more than 50 amendments have been suggested in the Lower House , and no special committee to review the proposal  has  been formed.

• “It is not the first time that such changes have been proposed or sent to Congress for discussion. In fact, this has been going on for at least 40 years and no attempt has yet been successful,” says Gilberto Ayres Moreira, a partner at Ayres Ribeiro Advogados and a tax law specialist.“I also think it is somewhat inconsistent to make these changes now and not in the second part of the tax reform.”

Watch out, startups. Taxing offshore companies as the government proposes could cause some damage to the innovation ecosystem, as many startups in Latin America use a three-layer structure to move money coming from global investors that includes a Cayman holding company.