By Carolina Becman, Senior Associate, Gaia Silva Gaede Advogados & Kassia Paulo, Senior Associate, Gaia Silva Gaede Advogados
The Brazilian government presented on June 25 the second phase of its proposed tax reform, which aims to change the income tax legislation for individuals and legal entities, as well as establish new rules for the taxation of profits, dividends, and financial investments.
Almost a year after the first phase was presented, the new bill will now proceed to the National Congress and may be modified before the final version is approved – if not totally rejected, considering that the proposal increases the corporate tax burden for most Brazilian companies.
The main measures proposed include various individual, corporate, and investment provisions.
Corporate provisions
With respect to corporations, the Corporate Income Tax (IRPJ) and the Social Contribution on Net Income (CSLL) would be calculated on a quarterly basis and there would be a standardization of the calculation bases of these two taxes. In this model, corporations would be allowed to offset 100% of a loss incurred in one quarter in the following three.
The initial version of the bill submitted to the National Congress suggests reducing the general income tax rate from 15% to 12.5% in 2022 and to 10% in 2023. There was no proposed change in the incidence of the 9% CSLL rate and the additional 10% rate of IRPJ (if the net income exceeds BRL 20,000 per month).
In the context of acquisition of investments, the bill would introduce rules to limit tax planning and corporate reorganizations. These rules would affect the taxation of capital gains generated by offshore companies in indirect disposals of assets located in the country and would prohibit the deductibility of goodwill in operations of acquisition from 2022. They would also require tax amortization of intangible assets over a minimum of twenty years, except when there is a determined legal or contractual term. In addition, they would change the methodology for calculating the capital gain earned on capital returns and capital payment with assets and rights to require that operations be carried out at market value.
Other relevant points are the inclusion of new situations that would result in disguised profit distribution (for example, the cost of personal expenses of partners or related persons) and the prohibition of the deductibility of bonus payments and profit sharing to partners and directors made with shares of the company.
However, the measures that would most impact investors and are being widely discussed in Brazil are the provisions ending the possibility of deducting interest on equity in the calculation of IRPJ and CSLL – in Portuguese, Juros sobre o Capital Próprio, or JCP – and imposing withholding income tax on the distribution of profits and dividends (they are exempt under current law).
In this respect, the bill proposes a withholding income tax at the rate of 20% on profits and dividends paid to residents in the country and abroad, and 30% when the beneficiary of the resources is resident in a tax haven or subject to a privileged tax regime.
However, profits or dividends that are capitalized (reinvested) will not be subject to tax, except if capital is reduced in the five years prior to payment or in the five years following payment. Profits and dividends distributed to micro and small businesses up to the amount of BRL 20,000 per month (approximately USD 3,900) would also be exempt.
Investment fund provisions
Currently, income earned from fixed-income investments, such as direct treasury and CDB, for example, are subject to income tax according to a regressive table that varies in accordance with the investment time – the longer the redemption time, the lower the applicable rate. In this sense, the applicable rates range from 22.5% to 15%.
The new bill would end the rate regression depending on the duration of the investment and provide that income earned from fixed income investments would be taxed at a single rate of 15% as of January 1, 2022.
Open-ended and closed-ended funds would also be taxed at a single rate of 15%, rather than under the regressive tables.
Furthermore, changes were proposed to the method of tax payment known as “come-cotas” for investment funds. In this modality, there is a mandatory anticipation of income tax on the investment’s profit, with a reduction in the number of investor shares equivalent to the minimum percentage of tax due on the investment’s income, even if there have been no redemptions.
The presented text proposes the extinction of the “come-cotas” for open funds in the month of May, with only the portion corresponding to the month of November being maintained, at a single rate of 15%. As for closed-ended funds, the come-cotas is now applied, observing the same rules provided for open-ended funds, that is, occurring only in November, at a rate of 15%.
Moreover, the bill would eliminate the withholding income tax exemption for distributions received by individuals from real estate investment funds with shares traded on the stock exchange, which would be subject to a 15% withholding tax.
Measures for the taxation of stock, commodity and futures exchanges are also proposed. Under current law, operations carried out on the spot, forward, options and futures markets are subject to a 15% rate and day trade operations to a 20% rate. The proposed text would apply a 15% rate for all markets and would allow the offsetting of losses between all operations, including day trades.
There is no proposed change on the income tax exemption on net gains earned by individuals on sales made with shares, in the spot market on stock exchanges or over-the-counter markets that do not exceed the amount of BRL 60,000 (approximately USD 11,730) in the quarter.
Exemptions related to investments in savings accounts of individuals and those specifically granted to income earned by residents and domiciled abroad were also maintained.
The Brazilian government contends that the proposed amendments to the taxation of financial investments would simplify and harmonize the tax treatment for all funds and asset classes, so that taxation no longer defines the investment choice.
Individual provisions
The bill proposes to increase the amount of income exempt from income taxes from BRL 1,903.98 to BRL 2,500 (approximately USD 372 to USD 488), including retirement and pension income and the wage reserve of taxpayers over 65 years old.
Additionally, the government suggested a limit to the use of the simplified method, which allows taxpayers to deduct a presumed percentage of 20% expenses from their taxable income. In accordance with the bill presented, this option would only apply to taxpayers with taxable income of up to BRL 40,000 (approximately USD 7,820) in the calendar year.
The bill would also allow updating the value of properties acquired before December 31, 2020, in the annual individual income tax return, at a 4% rate on the difference between the updated value and the acquisition cost. According to the Ministry of Economy, this measure aims to reduce the tax impact at the time of the good’s sale (capital gain taxation).
The bill would also institute an automatic taxation regime on profits earned by individuals through a company resident in a tax haven or subject to a privileged tax regime (a sort of Brazilian controlled foreign corporation rule for individuals). This rule is intended to prevent individuals from preventing their offshore income from being taxed in Brazil.
Next steps
If approved this year, the income tax reform would be effective as of January 1, 2022.
It is worth remembering that the first phase of the tax reform, presented in July 2020, aims to create a new indirect tax, the Contribution on Goods and Services (CBS), which would replace PIS and COFINS and is still pending approval in the National Congress.
Likewise, the second phase also still needs to be discussed and approved in the Chamber of Deputies and the Senate, and possible changes to the current wording of the bill may be made.
The proposed changes represent a clear effort by the federal government to adapt Brazil to OECD standards with an aim to joining the organization as a member.
However, the tax burden of Brazilian companies is still very high, and the corporate tax reduction measures proposed in the bill would not be sufficient to balance the incidence of income tax on dividends. According to experts, the current proposal raises the corporate tax burden from 34% to 37%.
Furthermore, the simple announcement of the proposal to extinguish the exemption for income from real estate investment funds was enough to cause the fall of the IFIX – the main index of funds in this category in Brazil. In this scenario, other “side effects” can occur, such as investors leaving Brazil and corporations undertaking reorganizations with the sole purpose of reducing their tax burden.
The Ministry of Economy and the bill’s rapporteur in the Chamber of Deputies have already announced that the original text is going to be altered to further reduce the corporate income tax rate. The expansion of the range of individuals who will be able to use the simplified method is also being evaluated, as well as other measures that were severely criticized.
It is safe to say that the second phase of the tax reform proposal will continue to evolve (or be completely changed) and that new measures are likely to be introduced. This is especially true given that some important issues were not addressed at this stage, such as transfer pricing rules and thin capitalization rules.
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