Taxpayers are no longer subject to the increased tax rate on interest on net equity, beginning March 9, 2016, due to the Brazilian Congress' failure to convert Provisional Measure 694 into law. Constitutional considerations may also prevent taxpayers from being subject to the increased rate for the brief period in 2016 that PM 694 applied.

The Brazilian Congress failed to convert Provisional Measure (PM) 694 into law by March 8, 2016, which was the deadline for conversion. PM 694, which became effective September, 2015, is no longer in force.

PM 694 increased the withholding income tax rate on interest on net equity (INE) from 15% to 18% and limited the calculation and deduction of INE to the lower of the official bench-mark yield for long-term debt (known by the acronym of TJLP) and 5%.The rules on INE originally established its calculation based on the TJLP, without any limit to the percentage. Under PM 694, these tax changes would apply as of January 1, 2016.

The President issued PM 694 in September 2015. Following the rules on provisional measures set by the Brazilian Constitution,¹ the deadline to convert PM 694 into law was March 8, 2016. Under Brazil's Constitution, however, the tax increase on INE set by PM 694 could only apply January 1, 2016, if it was converted into law before the close of 2015.²

PM 694 was not converted into law by the March 8, 2016 deadline. As a result, PM 694 is no longer effective.

Implications

By the terms of PM 694, the INE provisions applied from January 1, 2016, through PM 694's expiration date of March 8, 2016. Under Brazil's Constitution, however, the withholding income tax rate increase on INE could apply as of January 1, 2016, only if PM 694 was converted into law by the end of 2015, which did not happen. In addition, Congress never issued any regulations to govern the transactions that occurred from January 1, 2016, through March 8, 2016, while PM 694 applied. Given the clear conflict with the Constitution and the absence of regulations, it seems very unlikely that tax authorities will try to enforce the withholding tax rate increase on INE for the brief period that PM 694 applied.

In contrast, it is debatable whether the new 5% limit for the calculation and deduction of INE from January 1, 2016 to March 8, 2016 is actually a tax increase such that its application during that period would conflict with the Constitution. Such enforcement would have no practical effect, however, as the TJLP in 2016 did not reach 5% during the brief period that the limit applied.

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ENDNOTES

¹ Under specific circumstances, Brazil's constitution permits the President to issue provisional measures, which temporarily have the effect of law as of their issuance. To become permanent, provisional measures must be "converted" into law within 60 days, which can be extended to another 60 days. As part of the conversion process, Congress must approve the PM, with or without adjustments, and the President must sanction it to convert the PM into law. If the PM is not converted/approved by the Congress by its expiration date, it ceases to be effective.

² For provisional measures involving tax increases, Brazil's constitution prohibits the increase from applying in the same year that the PM is converted into law. Accordingly, tax increases enacted via PM apply in the year following the PM's conversion into law.