Provisional Measure eliminates income tax of non residents’ financial investments

In brief

On September 22, 2022 the Brazilian Federal Government published Provisional Measure (“MP”) No. 1,137 reducing to zero the rate of the Withholding Income Tax (“WHT”) levied over income earned on several financial investments by non-residents investors.

The MP will be submitted to the National Congress for analysis and voting. If converted into law, will become effective on January 1, 2023.

The Brazilian Federal Government justified the issuing of the MP as a mechanism to increase the attractiveness of Brazilian debt instruments to foreign investors. To this end, it proposed an isonomic tax treatment for operations of debt securities issuance concerning capital operations, which means a reduction in the tax burden.  More details

The reduction of the WHT rates as determined by MP applies:

To the following beneficiaries:

• Residents or domiciled abroad who carry out financial operations under the rules established by the National Monetary Council (“CMN”);
• Quotas of investment funds that invest exclusively – and in any proportion – in the mentioned bonds or securities, assets that produce exempt income as per the benefit, federal government bonds and operations backed by federal government bonds or quotas of funds that invest in federal government bonds;
• Sovereign wealth funds that invest according to CMN conditions, even if resident in countries with favored taxation.

To the following financial investments:

• Securities subject to public distribution by private legal entities that are not classified as financial institutions;
• Credit rights investment funds (“FIDC”), regulated by the Securities and Exchange Commission of Brazil (CVM), whose originator or assignor of the credit rights portfolio is not a financial institution and other institutions authorized to operate by Central Bank (BACEN);
• Financial bills issued by financial institutions and institutions authorized by the BACEN.

It is worth mentioning that the reduction of the tax rate provided by the MP does not apply to transactions entered into between related parties, including also those entered into with parent companies, subsidiaries, affiliates, and companies under common control.

In addition, the MP provides that the zero tax rate benefit does not apply to beneficiaries located in privileged tax regimes (grey list). Prior to this change, such restriction was applicable only to beneficiaries resident or domiciled in jurisdictions with favored taxation (black list). This is an important aspect to be noted since it was common to see investment structures in Private Equity Investment Funds (“FIP”) through investment vehicles that could eventually be included in the grey list.

The MP revokes three important provisions of Law no. 11. 312/2006, all related to the application of a 15% WHT rate on income from FIP and Investment Funds in Emerging Companies (“FIEE”), as well as to the zero rates for non-residents in the case of FIP, Investment Funds in Quotas of Private Equity Investment Funds (“FIC-FIP”), FIEE, FIP-IE and Investment Funds in Participation in Economic Production in R&D (“FIP-PD&I”). In summary, it was revoked:

• The rule that conditioned the 15% tax rate for FIP and FIEE to the portfolio of funds that held at least 67% of shares in joint stock companies, debentures convertible into shares, and subscription warrants. Thus, compliance with the rules issued by the “CVM” will be sufficient for applying the aforementioned tax treatment;
• The rule that conditioned the incidence of zero tax rate to the verification that the quota holder was not the holder – alone or together with related persons – of 40% or more of the quotas issued by the fund or the right to receive income superior to 40% of the total income of the fund; and
• The rule that conditioned the incidence of zero tax rate to the verification that the fund did not have in its portfolio debt securities in a percentage superior to 5% of its net worth, except for the cases expressly mentioned and public securities.

Finally, the MP standardizes the hypotheses for applying a zero tax rate to income earned by beneficiaries who are not resident in Brazil on investments in FIP, FIC-FIP, and FIEE, under the conditions established by the National Monetary Council:

• Residents abroad who are shareholders of FIP-IE and Investment Funds in Participation in Economic Production Intensive in R&D (“FIP-PD&I”);
• Sovereign Wealth Funds, even if they are resident and/or domiciled in a country with favored taxation.

Trench Rossi Watanabe’s tax team is available to discuss the opportunities and risks related to the changes proposed by MP.