Provisional measure modifies tax regulation regarding investment funds

The Brazilian Government, published on August 28, 2023, Provisional Measure No. 1,184, of August 28, 2023 (“PM 1,184”), amending the tax legislation applicable to investment funds. The MP 1,184 must still be approved by the Brazilian Congress and converted into law within 120 days; otherwise, it will expire.

If PM 1,184 is converted into law, the new regulation will enter into force in January 2024, except for the transitional rule, which already applies in 2023.

Automatic taxation – “come-cotas”

One of the major changes introduced by PM 1,184 is the provision that closed-end funds will be subject to the biannual automatic taxation regime (“come-cotas”) due in May and November of each year. The periodic Withholding Income Tax (“WHT”) will be levied at 15% for long-term funds and 20% for short-term funds. Additionally, a supplementary WHT will be assessed according to the difference between the regressive rates from 22.5% to 15% and the come-cotas rate levied upon the redemption, amortization, or sale of the fund’s shares.

The new rules do not apply to the following funds:

• • Real Estate Investment Funds (“FII”) and Investment Funds in Agroindustrial Production Chains (“FIAGRO”);
  • Investment funds that invest 98% of the portfolio in government bonds;
  • Private Equity Investment Funds (“FIP”), Venture Capital Investment Funds (“FIEE”), Private Equity Funds for Infrastructure Investments (“FIP-IE”), and Private Equity Funds for Investments in Research, Development, and Innovation-Intensive Enterprises (“FIP-PD&I”);
  • Investment funds referred to in Law No. 12,431/11;
  • Investment funds held exclusively by non-resident investors (article 97 of Law 12.973 of 2014); and
  • Fixed Income ETFs.

The provisional measure did not establish an exception for the Credit Rights Investment Fund (“FIDC”). Given that FIDC portfolios might be illiquid, the impact of automatic taxation on FIDC must be considered.

Non-resident investors remain subject to the same tax regime currently in force.

Accrued earnings taxation

MP 1,184 also established that the WHT will be levied on tax earnings accrued by closed-end funds up to December 31, 2023, at a 15% rate. The fund’s administrator will collect WHT in a lump sum in May 2024 or up to 24 monthly installments as of May 31, 2023 (accrues Selic interest).

Brazilian individuals may advance the WHT payment on accrued earnings at a reduced 10% rate. The reduced WHT rate applies if the tax is collected in:

• • Four monthly installments (from December 2023 to March 2024) on the earnings accrued up to June 30, 2023; and

• • A lump sum (in May 2024) for earnings related to the second half of 2023.

Specific rules for FIP, FIA and ETF

FIPs, FIAs, and ETFs of variable income will not be subject to automatic taxation if the funds are classified as investment entities subject to regulation by the Brazilian Monetary Council and the funds meet the allocation requirements provided for in the provisional measure.

In such cases, earnings will be only subject to WHT at a 15% rate upon distribution or disposal.

In addition:

• • As provided for in the current legislation, FIA need to hold at least 67% in shares (or similar assets) effectively traded on the stock exchange – the Executive Branch may modify the percentage;

• • Gains picked up through the equity accounting method (“MEP”) will not be taxed, provided such gains are controlled in separate accounts. Liquidating the assets (which generated the MEP gains) will trigger the WHT taxation.

• • The same rules and exceptions applicable to FIPs, FIAs, and ETFs will also apply to Fund of Funds (“FOFs”) that invest 95% of their portfolio in such funds.

Other changes

MP 1,184 also introduced other significant changes, such as:

• • Corporate restructurings: As of January 2024, corporate reorganizations, such as spin-offs, mergers, and transformations, will be liable to tax. In such cases, the WHT will be levied over the positive difference between the equity value of the quota on the corporate event and its acquisition cost. There is a transition rule applicable for reorganizations implemented in 2023.

• • Liability for WHT collection: The fund´s administrator will collect the WHT. The investor must transfer the funds for payment of the WHT. Shares cannot be transferred if the fund´s administrator has no cash to collect the WHT within the legal term.

• • Exemption for FIIs and FIAGROs: Additional requirements regarding the WHT exemption on income distributed by FIIs and FIAGROs were included. The exemption will only apply to funds with at least 500 investors and whose shares are effectively traded on an exchange or organized over-the-counter market.

• • Taxes by quota classification: Regulation of the tax regime applicable to funds with segregated portfolios (foreseen by ICVM 175). Each class of shares shall be regarded as a separate fund for tax purposes.
  • Financial institutions: Exempt from WHT on investment fund earnings. 

• • Usufruct on fund quotas: Taxation will be determined based on the beneficiary of income.

Demarest’s Tax Team is available to provide any further clarifications that may be necessary.