September 11, 2023
Brazil introduces individual income tax bill affecting taxation of foreign investment income
- According to the new bill, starting from 1 January 2024, foreign investments by Brazilian residents will be reported annually and at tax rates range from 0% to 22.5% based on annual income.
- Profits of entities controlled by Brazilians abroad would be taxed annually, starting from 1 January 2024, regardless of distribution.
- Trust assets must be declared by the settlor and will be taxed similarly to financial investments or foreign-controlled entities; transfers will be treated either as donations or inheritance.
- The bill repeals some tax exemptions and changes the methodology for calculating gains on foreign assets.
- The bill must be approved within 45 days to avoid the suspension of the lower house's agenda.
Following the rejection of measures aimed at altering the taxation of investments made abroad by individual Brazilian taxpayers (Provisional Measure No. 1,171/2023), a new bill (Bill No. 4,173 of 2023 (PL 4,173)) has been presented that essentially addresses the same topics, making minor changes (highlighted in italics, below).
The bill was introduced under an urgent regime and must therefore be approved by the lower house of the Brazilian Congress (i.e., Chamber of Deputies) within 45 days (14 October 2023) to avoid the suspension of the lower house's agenda.
The main modifications introduced by the bill include:
1. Taxation of investments abroad by individual residents in Brazil
Starting on 1 January 2024, financial investments, profits and dividends from entities controlled abroad (e.g., Offshore Holdings, Private Investment Companies or "PICs") will be reported annually (previously, a monthly declaration). The gains will be reported separately from domestic income and capital gains in the individual income tax return (DIRPF), following the rules below:
1.1 Financial investments abroad
- Subject to income tax in the annual adjustment with the following rates:
- 0% for the annual portion of income up to R$6,0001
- 15% for the annual portion of income between R$6,000 and R$50,000
- 22.5% for the annual portion of income exceeding R$50,000
- Income will be included in the DIRPF and subject to income tax upon realization (i.e., redemption, amortization, sale, maturity or liquidation).
- The bill defines financial investments and income subject to the new regime, such as:
- Financial investments — interest-bearing bank deposits, interest-bearing certificates of deposit, cryptocurrencies, digital wallets, or interest-bearing current accounts, retirement and pension funds, fixed and variable income securities, derivatives, credit operations (including mutual financial resource loans with a foreign resident debtor), among others
- Income — earnings generated by financial investments, including those arising from foreign currency exchange fluctuations or cryptocurrency fluctuations against the national currency, earnings on deposits in digital wallets or interest-bearing current accounts, interest, premiums, commissions, premiums, among others
- Foreign currency exchange variations in current accounts and foreign currency in cash up to US$5,000 in the calendar year are exempt. Gains exceeding this amount will be taxed according to the general rule (0% to 22.5%).
- Provided certain requirements are met, it will be possible to offset income tax paid in the country of origin of the income.
- The bill provides for the possibility of offsetting losses incurred in financial investments abroad in the same calendar year or subsequent years, provided they are duly proven by appropriate and reliable documentation.
1.2 Foreign-controlled entities
- Profits determined by certain entities controlled by individuals abroad will be subject to taxation on 31 December each year, at the rates applicable to foreign financial investments (item 1.1 above), regardless of distribution to individuals.
- For purpose of applying the rules, the concept of entities is broad, including holdings, PICs, investment funds, foundations and other nonincorporated entities.
- The above rules only apply to controlled entities that: (i) are located in countries with favorable taxation (i.e., tax havens) or privileged tax regimes; (ii) generate passive income that exceeds 40% of their total income.
- The change applies to profits generated from 1 January 2024.
- Profits determined up to 2023 will only be taxed upon realization.
- Losses incurred from 1 January 2024, can be offset against gains realized by the same entity in subsequent years.
- For companies, investment funds and other entities abroad with segregated unit classes or shares, each class will be considered a separate entity.
- Profits must be determined on an annual balance sheet prepared in accordance with Brazilian commercial accounting standards.
- The individual controller may choose to treat the entity as transparent with respect to all financial assets held by the entity, applying the rules applicable to foreign financial investments (item 1.1 above).
1.3 Foreign trusts
- The settlor of the trust must declare assets and rights until the settlor's death or complete distribution of the assets and rights; after the settlor's death, they will be declared by the beneficiary.
- Transfers to beneficiaries made during the settlor's lifetime will be treated as donations and as inheritance transfers in case of death.
- Assets and rights taxed in the settlor will follow the rules described above applicable to financial investments (item 1.1) or foreign-controlled entities (item 1.2), depending on the trust's qualification as a financial investment or a controlled entity.
- The bill introduced two procedural requirements for trusts, namely:
- The settlor or beneficiary must request the trustee to provide the financial resources and information necessary to facilitate the payment of taxes and compliance with other tax obligations in the country.
- The settlor of the trust, if alive, or the trust beneficiaries, if aware of the trust, must within 180 days from the date of publication of the Law arrange the amendment of the trust deed or the respective letter of wishes to include language that obliges the trustee, in an irrevocable and irreversible manner, to comply with the provisions of Brazilian law.
1.4 Updating assets and rights abroad
- Assets and rights abroad reported in the DIRPF for the 2022 calendar year (submitted by 31 May 2023) may have their values updated to their market value on 31 December 2023.
- Gains resulting from the update will be subject to a final income tax rate of 10%, which must be paid by 31 May 2024.
- Assets held by foreign-controlled entities, whether or not subject to the new rule, can also be updated under the same conditions.
- Assets or rights that were not declared in the DIRPF for the 2022 calendar year or acquired during the 2023 calendar year cannot be updated. Certain types of assets and rights cannot be updated, such as jewelry, precious stones and metals, and works of art.
Finally, Bill No. 4,173 also repeals paragraph 4 of article 25 of Law No. 9,250, dated 26 December 1995, and article 24 of Provisional Measure No. 2,158-35, dated 24 August 2001, making these important changes:
- Ends the tax exemption for gains obtained from the sale, liquidation, and redemption of assets and rights located abroad, as well as financial investments, acquired under any condition as a nonresident taxpayer
- Alters the methodology for calculating capital gains realized from the sale, liquidation, or redemption of assets and rights originally acquired in foreign currency, which will now be calculated in Brazilian Reals (and no longer in US Dollars) if the bill is approved.
For additional information with respect to this Alert, please contact the following:
EY Assessoria Empresarial Ltda, São Paulo
Ernst & Young LLP (United States), Latin American Business Center, New York
Ernst & Young Tax Co., Latin American Business Center, Japan & Asia Pacific
Published by NTD's Tax Technical Knowledge Services group; Carolyn Wright, legal editor
1 R$ denotes the Brazilian Real.