By David Roberto R. Soares da Silva
At the end of the 2022 legislative year (Dec. 14), the Finance and Taxation Commission (CFT) of Brazil’s House of Representatives approved a bill that ends the tax deferral of profits from offshore companies to individuals (CFC rules).
This subject is relevant because, if converted into law, Bill No. 3,489/2021 (Bill 3489) will radically change the way individuals must treat the profits from their offshore companies, ending the opportunity (currently in force) to defer income tax for the moment of the effective distribution of profits.
However, it is worth highlighting two essential points: 1) this is still a bill whose appreciation still needs to be finalized in the House of Representatives and, later, in the Federal Senate; and 2) the bill is flawed and leaves many doubts about its extension and application.
Regarding the first point, one should note that the CFT approved Bill 3489 and now follows to the House’s Commission of Constitution and Justice (CCJ). If approved by the CCJ, it goes straight to the Federal Senate without review and vote of the full House of Representatives. However, if the CCJ rejects it, Bill 3489 must be submitted to a vote by the full House before being sent to the Senate.
The CCJ received Bill 3489 on Dec. 15, 2022, and its appreciation will be for 2023. For 2023, nothing changes regarding the CFC rules for the individual taxpayer.
But let’s go to Bill 3489, whose wording is simplistic and precarious, covering such a complex matter in just two articles.
First, it establishes that the profits of CFCs owned by Brazilian resident individuals will be considered available and taxed (monthly at the rate between zero and 27.5%) on the balance sheet date. This rule, however, only applies to companies located in tax havens, which are only those expressly listed by the Federal Revenue Department (RFB)as having ‘favored taxation’ and included in Normative Instruction No. 1037/2010, as amended. In addition, the rule also applies to companies that benefit from the so-called ‘differentiated tax regime,’ also listed by the RFB in the same regulation.
Therefore, CFCs established in non-listed locations or subject to non-listed tax regimes would not be subject to the new CFC rules, with deferral being allowed until the effective distribution of profits, as currently occurs.
The positive exchange variation verified between the balance sheet date and the effective receipt of profits will also be taxed but treated as a capital gain, with rates ranging from 15% to 22.5%.
The rules of Bill 3489 apply to ‘controlled’ foreign , meaning the legal entities or non-incorporated entities in which the Brazilian resident individual:
- is the holder of rights that ensure, permanently, preponderance in corporate decisions and the power to elect most of its officers; or
- holds more than 50% interest in the share capital, or equivalent, in the rights to receive its profits or assets in the event of liquidation.
At first glance, one might think that three individuals who each hold 1/3 of an offshore company would be outside the Bill’s reach and could remain in the tax deferral regime.
Although this may happen in some cases, Bill 3489 limits the abusive use of this type of maneuver by saying that it applies “to resident individuals (…) who, together with other related individuals or legal entities resident in Brazil or abroad, hold an interest of more than 50% of the CFC’s voting capital”.
The definition of a “related person” is borrowed from the tax legislation and includes the following situations:
- the natural person who is the spouse, partner or relative, consanguineous, or similar, up to the third degree, of the Brazilian resident taxpayer;
- the legal entity whose officers or administrators are spouses, partners, or relatives, consanguineous or similar, up to the third degree, of the Brazilian resident taxpayer
- the legal entity of which the Brazilian resident taxpayer is a shareholder, owner, or member;
- the individual who is a shareholder, board member, or member of the CFC of which the Brazilian resident taxpayer is a shareholder, owner, or member; and
- the individual or legal entity, resident or domiciled in Brazil or abroad, which is associated with any legal entity in which the Brazilian resident taxpayer is a shareholder, owner, or member, in the form of a consortium or condominium, as defined in Brazilian legislation, in any enterprise.
The rules of items 3 to 5 apply to holdings representing more than 10% of the voting capital.
Going back to the example and considering the Bill’s related person definitions, it would be fair to say that three friends or three cousins (4th-degree relatives under Brazil’s Civil Law) could be shareholders of the same CFC in a listed tax haven, provided that none of them has permanent preponderance in the company’s decisions or holds more than 50% of the company’s capital or in the perception of the company’s profits.
Even with this possibility, note that Bill 3489 does not address several relevant issues that may lead to legal disputes and challenges if not resolved until its conversion into law.
Perhaps the most relevant unclear point relates to profits earned (but not yet distributed) before the law’s enactment. Unfortunately, Bill 3489 is silent on this aspect, and it would not be surprising if the tax administration took the position that past profits should be taxable, causing legal disputes.
Still, on the profit issue, offshore accounting often shows realized and unrealized profits during the year. Realized profits are those already determined, such as, for example, the sale of a share on the Stock Exchange at a profit. On the other hand, unrealized profit is a theoretical profit that exists on paper, resulting from an investment that has yet to be sold for cash. It is a potential profit, very common in CFCs with financial investments. Another form of unrealized profit results from investments in other controlled or affiliated companies held by the CFC.
Regarding subsidiaries (control held by the CFC) and affiliates (control not held by the CFC), Bill 3489 does not address this issue either. What should happen, for example, with a CFC that invests in private equity abroad, holding minority stakes in several companies? The CFC may not have access to the financial statements of these invested companies and, worse, may not receive dividends from them before the taxpayer in Brazil has to pay income tax in the month following the balance sheet date.
We must remember that Brazil adopts the cash basis regime for individual income tax, which means that the tax is due only when income is available to the taxpayer. In the case of a CFC with money invested in the financial market, it is possible that the taxpayer controls the company and may cause it to distribute profits to comply with the CFC tax obligation. But this alternative may not be available in a CFC with private equity investments. Even controlling the CFC, the taxpayer may not control the flow of profits from the invested entities and may not have enough cash to pay the tax in Brazil.
Another point is loss carryforward. Bill 3489 does not address the matter to allow, limit, or prohibit it. For example, assume a CFC with a loss of USD 150,000 before Bill 3489 enters into force that makes a profit of USD 50,000 after the law. Is the taxpayer able to offset the past loss with future profit? In my opinion, if the law does not prohibit it, loss carryforward should be allowed, given that “no one shall be compelled to do or refrain from doing something except by reason of law” (Article 5, item II of the Federal Constitution).
Finally, Bill 3489 leaves open the definition and extension of the expression “holdings in controlled entities” abroad. Would its provisions apply to smart funds or other types of exclusive or restricted investment funds? And what about trust and private foundations? Trusts are not held or owned, as are foreign private foundations.
Will Bill 3489 leave the door open for some planning? Let us wait and see.
David Roberto R. Soares da Silva is an expert in tax, estate, and succession planning, founding partner of BLS Advogados, author of Brazil Tax Guide for Foreigners (2021), and coauthor of Planejamento Patrimonial: Família, Sucessão e Impostos (2022), Renda Variável: Tipos de investimentos, tributação e como declarar (2021), and Tributação da Economia Digital no Brasil (2020), published by Editora B18.
LEARN MORE ABOUT BRAZILIAN TAXATION OF INDIVIDUALS AND COMPANIES WITH OUR BEST SELLER: BRAZIL TAX GUIDE FOR FOREIGNERS (free shipping worldwide):