Law 14,754/2023 was published, which changes the taxation of investments, controlled entities and trusts abroad held by individuals who are tax residents in Brazil and investment funds in Brazil

In brief

On December 12, 2023, the President Luiz Inácio Lula da Silva sanctioned with only one veto the Law 14,754 of 2023, proceeding from Bill of Law 4,173 of 2023 (“PL”), which provides for the taxation of income earned by Brazilian individuals in financial investments, controlled entities and Trusts abroad, as well as the taxation of investment funds in Brazil.

The law entered into force on the date of its publication, December 12, 2023 and will take effect from January 1st, 2024, with minor exceptions such as the possibility for individuals to anticipate the payment of the tax levied on the “inventory” of exclusive investment funds subject to the six-monthly periodic tax regime.

We highlighted, below, the main points that may impact individuals who are tax residents in Brazil.

Financial investments abroad

• Tax rate: application of the 15% tax rate on income earned abroad (i.e., financial income, controlled entities and trusts abroad);
• Financial investments abroad: any financial operations outside the country, including, but not limited to, interest-bearing bank deposits, cryptoassets, digital wallets and insurance policies whose principal and income are redeemable by the insured or their beneficiaries;
• The law also exemplifies the income subject to this rule. Income from financial investments should be taxed when it is earned (effectively realized) by the individual, on a cash basis;
• Possibility of offsetting income tax paid abroad, provided that the offset is provided for in a treaty to avoid double taxation or there is a reciprocity agreement (limited to the amount of tax paid abroad);
  • Income tax paid abroad that is subject to refund, refund, reimbursement or compensation abroad cannot be deducted from the IRPF
  • The tax paid abroad not deducted in the calendar year cannot be deducted from the IRPF in subsequent or previous calendar years
• Exchange variation of foreign currency in cash will not be subject to taxation up to the limit of U$ 5,000.00. Exceeding this limit, the full amount will be subject to a 15% tax rate.
• Highlight: possibility for the individual to offset losses incurred in financial investments abroad with:
  • (i) income earned on financial investments abroad in the same period, or
  • (ii) if the amount of losses in the calculation period exceeds the gains, this portion of the losses may be offset with profits and dividends from entities controlled abroad, which have been computed in the income tax return in the same calculation period;
  • If, at the end of the calculation period, there is an accumulation of uncompensated losses, these losses may be carry forwarded.
• Losses can be offset only once.

Controlled Entities abroad

• Creation of an anti-deferral rule for individuals residing in the country, on profits earned by entities controlled abroad.
• Definition of Controlled Entity:
  • The entities subject to the automatic taxation regime are companies and other entities, incorporated or not, including investment funds and foundations, controlled by an individual resident in Brazil alone or jointly with related persons, such as close family members, in which they hold:
    • rights that ensure preponderance in corporate deliberations or the power to elect/dismiss managers, or
    • more than 50% stake in the share capital.
  • Two criteria to submit to the taxation of the automatic taxation rule of profits on December 31 of each year:
    • Jurisdictional criterion: entity incorporated in a favored tax jurisdiction or under a privileged tax regime, or
    • Passive income criterion: the rule includes companies abroad with their own active income of less than 60% of total income, including royalties.
  • Clarification that the calculation of the profit of the controlled entity abroad will follow: (i) the standards of International Financial Reporting Standards (IFRS), or Brazilian accounting standards, at the taxpayer’s discretion; or (ii) Brazilian accounting standards, if it is located in a country or dependency with favored taxation or is a beneficiary of a privileged tax regime.
• The profits of the controlled entities will be calculated individually, in the annual balance sheet of the entity, directly or indirectly controlled abroad, excluding from the results of the direct or indirect entity the portion related to the interests of this entity in other entities, including the situations when they are organized as an investment fund;
• Allowed to offset losses calculated from 2024 onwards with subsequent profits, and the possibility of offsetting income tax paid abroad on the profit and income of the controlled entity;
• Exchange variation of the main value invested in the entity abroad will compose the taxable capital gain at the time of disposal, write-off or liquidation of the investments, including through the return of capital;
• Exemption on the exchange variation verified between the resolution and distribution of dividends: the gain or loss of exchange variation resulting from the difference between the amount in Real of the income taxed on December 31 and recorded as the cost of acquisition of the credit of the dividend receivable, and the amount in Real of the dividend distributed subsequently, it will not be taxed or deducted in the IRPF calculation;
• Disregarded entities: Possibility of treating the controlled entity as transparent for tax purposes. Under this option, the taxpayer must report the assets and rights held by the offshore entity as if they were held directly by the individual, submitting them to the individual taxation regime. Regarding this option:
  • It can be done separately for each controlled entity, direct or indirect;
  • It will be irrevocable and irreversible for the entire period in which the individual holds that controlled entity abroad;
  • When there is more than one partner or shareholder, the option must be exercised by all those who are individuals residing in Brazil;
  • With respect to the declaration of assets in the income tax return, the individual must replace the interest in the entity with the assets and rights for the acquisition cost for each one;
  • You must inform in the form of debts and real encumbrances the underlying obligations, at a zero value;
  • Assets and rights transferred in any capacity by the individual, or by a controlled entity held by the individual under the above tax regime, to another controlled entity in relation to which the option for the tax regime has not been exercised, must be valued at market value at the time of transfer and the value of the difference calculated in relation to its acquisition cost will be considered income of the individual subject to taxation.
• Specific safeguards to avoid applying the rules of periodic taxation of profits for companies with operating activities abroad, for financial institutions, holding companies with their own active income greater than 60% and real estate companies.

Trusts

• Revocable Trust – transparency for tax purposes: assets and rights held by the trust will remain as the personal assets of the settlor, and will pass to the personal assets of the beneficiaries only when the trust is distributed to the beneficiaries.
  • The distribution will have the legal nature of inheritance or donation, depending on the nature of the event;
• Distinction between revocable and irrevocable trusts. In an irrevocable trust, there may be a transfer of ownership by the settlor to the beneficiary at a time prior to those provided for in the general rule, provided that the settlor irrevocably relinquishes his right over the trust’s assets;
• Income and capital gains related to the assets and rights subject to the trust shall be taxed by the person who is considered to be the holder on the date of the taxable event;
• Trustee’s Responsibility:
  • The trustee shall make available to the settlor or beneficiaries, as applicable, the financial resources and information necessary to enable the payment of the tax and the fulfillment of other tax obligations in Brazil.
  • The settlor of the trust, if he is alive, or the beneficiaries of the trust, if they have knowledge of the trust, must provide, within 180 (one hundred and eighty) days from the date of publication of this Law, the amendment of the deed of trust or the respective letter of wishes, to include wording that obliges, irrevocably and irreversibly, the compliance, by the trustee, with the provisions established in Brazilian Law.
  • For trusts in which the settlor has already died or has lost powers in relation to changes to the trust and the beneficiaries also do not have powers to amend the deed or letter of wishes, the beneficiaries must send the trustee a formal communication regarding the obligation to comply with the provisions of the Law and request the availability of the information and financial resources necessary to comply with the provisions of the Law.
• The same rules of the trust apply to contracts with similar characteristics

Update of the base value of assets and rights abroad

Update of the base value of assets and rights abroad: option to update the value of assets and rights abroad reported in the income tax return to the market value on December 31, 2023 and tax the difference to the acquisition cost, by the IRPF, at the definitive rate of 8%;

Income from investments in investment funds will be subject to Withholding Income Tax (IRRF):

1. At the rate of 15%, on the last business day of the months of May and November (“come-quotas”); and
2. By the complementary percentage necessary to total the regressive rates from 22.5% to 15%, on the date of distribution of income, amortization, redemption or sale of quotas.

The IRRF will cover all investment funds constituted in the form of open or closed condominiums, except in the cases expressly provided for in the Law and in special legislation.

In the case of investments in short-term investment funds (i.e. securities portfolio with an average maturity equal to or less than 365 days), the come-quotas will be 20%. There may be additional taxation at the rate of 22.5% on the date of income distribution, amortization, redemption or sale of quotas.

Losses incurred at the time of amortization, redemption or sale of shares may be offset exclusively with gains incurred in the distribution of income, amortization, redemption or sale of shares of the same investment fund, or in another investment fund managed by the same legal entity, provided that the fund is subject to the same tax regime.

In the event of the sale of the fund’s quotas, the quotaholder must previously provide the fund administrator with the financial resources necessary for the payment of the IRRF, and the fund administrator may waive the contribution of new resources, and the transfer of the quotas is prohibited if the administrator does not have the necessary resources to pay the tax within the legal deadline.

Investment funds classified as investment entities, not subject to come-quotas

The income earned from the investments of the following investment funds, which are classified as investment entities and comply with the other legal requirements provided for in the Law, will be subject to IRRF at the rate of 15% on the date of income distribution, amortization, redemption or sale of quotas:

• Private Equity Investment Funds – FIP;
• Equity Investment Funds – FIA;
• Market Index Investment Funds (ETFs), with the exception of Fixed Income ETFs;
• Investment funds that invest at least 95% of their net worth in funds that are not subject to the six-monthly periodic taxation regime and;
• Receivables Investment Funds (FIDC)

Income earned from investments in these funds will not be subject to come-quotas in the months of May and November.

Investment entities will be classified as FIPs, FIDCs, FIAs and ETFs (except fixed income EFTs) that have a professional management structure, at the level of the fund or its quotaholders (when organized as funds or investment vehicles, in Brazil or abroad), represented by agents or service providers with powers to make investment and divestment decisions on a discretionary basis, with the purpose of obtaining a return through appreciation of invested capital, income or both, in the manner to be regulated by the National Monetary Council – CMN.

Real Estate Investment Funds (FII) and Investment Funds in Agroindustrial Production Chains (Fiagro), also remain subject to their current tax regime, but the tax exemption will only be valid for those with at least 100 quota holders, in addition to additional requirements.

Funds subject to periodic taxation with equity valuation sub-account

Income from investments in FIPs, FIDCs, FIAs and ETFs that do not comply with the requirements of the Law to be considered investment entities will be subject to IRRF at the rate of 15% on the last business day of the months of May and November or, if it occurs first, on the date of distribution of income, amortization, redemption or sale of quotas.

In such cases, the provisions of the Law relating to the cost of acquisition of quotas and the IRRF calculation basis shall apply, with the following exceptions:

• For the purposes of calculating the IRRF calculation basis, the gain or loss of equity arising from the valuation of equity interests in controlled or affiliated legal entities will not be computed (article 243 of the Brazilian Corporation Law).
• Such gain or loss shall be shown in a sub-account in the fund’s financial statements.
• Investment funds that hold shares of other investment funds must register, in the equity, a reflex sub-account equivalent to the sub-account registered in the equity of the invested fund.
• At the time of the realization of the respective asset by the fund, including through the sale, write-off, liquidation, amortization or redemption, or at the time of the distribution of income to the quotaholders, in any form, including the amortization or redemption of quotas, the sub-account will be reversed and its balance will be included in the IRRF calculation basis.

The absence of control in a sub-account for any asset of the fund will result in the taxation of the income from the investment in the fund’s quota in full and if a loss without control in a sub-account is ascertained, this loss cannot be deducted from the gross income subject to the IRRF levy.

Transition rules and IRRF payment on “stock”

• Rule

With respect to the “stock” of income calculated until December 31, 2023 in investment funds that were not subject to the “come-quotas”, this income will be appropriated pro rata tempore until December 31, 2023 and taxed at the rate of 15%.

The IRRF on the “stock” (i) must be retained by the investment fund administrator and collected in cash until May 31, 2024 or (ii) it can be collected in up to 24 successive monthly installments, with payment of the first installment by May 31, 2024.

If the taxpayer chooses to pay in installments, the amount of each monthly installment will be adjusted with SELIC interest and cannot be less than 1/24 (one twenty-fourth) of the total tax due on the stock.

• Options for individuals – installments at a rate of 8%

As an alternative to the payment option above, the individual residing in the country may choose to pay the IRRF on the income accumulated in the stock at the rate of 8%, in two steps:

• First stage: payment of income tax assessed until November 30, 2023, which may be paid in 4 equal monthly and successive installments, due on December 29, 2023, January 31, 2024, February 29, 2024 and March 29, 2024 and
• Second stage: payment of the tax on income calculated from December 1, 2023 to December 31, 2023, which must be paid in cash, within the same due date as the IRRF due in periodic taxation.

Investment funds that, on the date of publication of the Law, expressly provide in their regulations for their extinction and non-extendable liquidation until November 30, 2024 will not be subject to periodic taxation.

The provisions of this topic are already in force and producing effects since the publication of the Law

Merger, spin-off, merger or transformation of an investment fund

In cases of merger, spin-off, incorporation or transformation of an investment fund, the Law provides two provisions:

(1)  the fund subject to the transaction is not subject to periodic taxation in the months of May and November in the year 2023, and

(2) the rate to which  its shareholders are subject in the fund resulting from the transaction is equal to or higher than the rate to which they were subject on the date immediately preceding the transaction.

Common provisions

• Financial institutions, including insurance, pension and capitalization companies, securities, securities and exchange brokerage companies, securities and securities distribution companies or leasing companies, will be exempt from withholding tax on income from investments in investment funds.
• Investment funds held by non-residents in the country: subject to IRRF at a rate of 15%, except in the case of AIFs whose rate will be 10% (except for non-residents in a favored tax jurisdiction);
• Usufruct: the taxable treatment will take into account the beneficiary of the income, even if he is not the owner of the quota.
• Funds with classes of quotas: each class of quotas will be considered as an investment fund for the purposes of applying the taxation rules provided for in the Law.