By David Roberto R. Soares da Silva
In a recently published ruling, the São Paulo Treasury Department ruled for the first time about the Inheritance and Donations Tax (ITCMD) aspects related to foreign trusts, especially regarding its levy and taxable event.
Published on April 4, 2023, Ruling (Resposta à Consulta) No. 25343/2022 is the first official manifestation of the São Paulo State Treasury Department on the tax aspects of foreign trusts when they have beneficiaries residing within the limits.
Upon filing the request for ruling, the taxpayer reports they were a beneficiary of a trust established in 2017 by a non-resident legal entity. There is no information on the domicile of this legal entity nor under which jurisdiction the trust was established. The trust would be irrevocable and with a duration of 150 years.
The core of the question involving this ruling can be summarized in two distinct aspects: (1) the legal nature of the transfers made by the trust to the beneficiaries and (2) whether this transfer would be subject to ITCMD in the state of São Paulo.
Initially, the taxpayer clarified that the trust’s assets were “autonomous and distinct from the assets of the settlor, the trustee, and the beneficiaries so that none of them have real rights over the trust’s assets. Furthermore, these assets and rights do not respond to the trustee’s personal debts and can neither be used by the trustee for reasons other than those defined in the trust deed.”
It further reports that distributions made by a trust to beneficiaries occur as a gratuitous act, like a donation. According to the taxpayer, there would be “an accretion to the beneficiaries’ wealth due to a gratuitous act. The increase is gratuitous because it does not result from any effort made by the beneficiary or the employment of any property or right over the beneficiary holding title or possession. Moreover, in the situation at hand, there is no provision for consideration or counter-performance by the beneficiaries [towards the trust].“
Being a donation (gift) and the trust being abroad, the taxpayer questioned the levy of ITCMD, emphasizing the 2021 decision of Brazil’s Supreme Court (STF) that found unconstitutional the levy of ITCMD on donations of assets located abroad and by a foreign donor (Extraordinary Appeal No. 851.108/SP – General Repercussion Topic 825).
In its ruling, the São Paulo Treasury Department provides a brief summary of the existing controversies regarding the nature of the rights of trust beneficiaries. Without going into detail on the merits of this analysis, the tax authority seems to conclude that the relationships in a trust are of an obligatory nature, that is, contractual or business-like between individuals, not revealing a property right or right in rem nature.
Advancing in its analysis, the ruling concludes that “regarding the basic structure of the trust (…), the assets delivered by the settlor do not become part of the trustee’s own assets but are under their control for the benefit of the beneficiary. In this sense, it is possible to understand that the actual recipient of the rights over these assets is always the beneficiary.”
This part of the ruling is of extreme relevance, as it reveals that the São Paulo tax authority understands that the assets of a trust are only under the management of the trustee but are ultimately destined for the trust’s beneficiaries. In other words, there is a donation – albeit imperfect – from the settlor to the beneficiary, with the trustee as the administrator.
This is what the following excerpt reveals:
“When the settlor delivers the assets for the establishment of the trust, there is not merely an intention to make financial investments or simply safeguard their assets, but rather to make these assets reach the beneficiary. Except where the establishment of the trust facilitates some payment due to the beneficiary, the assets are transferred gratuitously, with the animus donandi, with the intention of performing a gratuitous act, which reveals a true donation, with the enrichment of the beneficiary as the settlor becomes impoverished.”
Based on this observation, the São Paulo tax authority undertakes the position that there is not a donation from the trustee to the beneficiary but rather a donation from the settlor to the beneficiary.
The ruling reads:
“Thus, at the moment indicated by the settlor, the beneficiary becomes the holder of rights over the trust, becoming the donee of the advantages defined in the trust deed. On the other hand, there is no freedom nor impoverishment on the part of the trustee when delivering assets or making income payments to the beneficiary. In fact, the trust’s actions are predetermined in the trust deed.”
Therefore, the tax administration concludes that there is a donation from the settlor to the beneficiary when the settlor establishes the trust, not at the moment the trust makes a distribution to the beneficiary.
Having concluded that a donation exists, the ruling when over the question about the levy of ITCMD on donations from abroad, considering the STF’s decision on the unconstitutionality of the tax. At this point, the position adopted was that São Paulo Law No. 10,705/2000[1] remains in force, and ITCMD is due.
Remarks:
The position of the São Paulo tax authority is unusual due to the unprecedented approach adopted so far by Brazilian authorities.
Recalling: the ruling takes the position that, in an irrevocable trust, there is a donation from the settlor to the beneficiary at the moment of the trust’s establishment, regardless of whether there has been a subsequent distribution to the beneficiary. And that ITCMD is due at the moment the irrevocable trust is established.
Based on this position, some points are worth noting, as follows:
- If, in an irrevocable trust, the donation occurs at the moment of its establishment because the settlor/donor incurs a “loss” of property in favor of the beneficiary, in a revocable trust, there would be no such donation since there is no loss of assets by the settlor. In this case, the right to revoke the trust would guarantee the “maintenance” of the assets within the settlor’s sphere.
- Moreover, revocable trust structures usually contemplate the settlor as their first beneficiary. Well, there is no donation to oneself, which would corroborate the understanding that there is no donation in revocable trusts when the settlor is the first beneficiary.
- The levy of ITCMD in creating the irrevocable trust is only supported because the state tax authority is not applying the STF’s decision that ruled the tax unconstitutional in donations with donors abroad. Thus, it would be possible to avoid paying the tax through legal action.
- The understanding of the São Paulo tax authority conflicts with the position of the Federal Revenue Department expressed in Ruling COSIT No. 41/2020, in which the federal tax administration ruled that distributions from foreign trusts are ordinary income for tax purposes. For one to understand this conflict, constitutional rules provide that donations are not ordinary income for tax purposes and cannot be taxable by income tax but only by ITCMD.
If we were to conform to the positions of the federal and São Paulo tax authorities, we would have the worst situation of all: simultaneous levy of income tax and ITCMD, which violates other legal and constitutional rules.
The message that remains, at least for now, is the legal uncertainty brought by trust structures for residents in Brazil. The lack of adequate understanding by Brazilian authorities may turn this powerful international estate planning tool into a source of insecurity and concern. Finally, it is worth noting that the position adopted by the São Paulo tax authority closely resembles the tax treatment proposed in Complementary Law Project No. 145/2022, which was the subject of two recent articles I authored[2].
In conclusion, the São Paulo tax authority’s stance on trusts reveals the complexities and uncertainties surrounding trust structures for Brazilian residents. The lack of a comprehensive understanding by the Brazilian authorities may render this valuable international estate planning tool a source of concern and legal insecurity.
It is crucial for those involved in trusts, especially beneficiaries residing in Brazil, to closely monitor the evolving legal and regulatory landscape and seek professional advice to navigate the complexities and mitigate potential risks.
It remains to be seen whether Brazilian authorities will eventually adopt a more consistent and comprehensive approach to trusts, addressing the legal and tax uncertainties currently faced by residents. In the meantime, a deeper analysis of the tax authority’s position and its implications for trust structures is warranted, as well as continued vigilance regarding any potential changes to the legal and regulatory landscape.
[1] The São Paulo ITCMD Act.
[2] Available in English at https://www.b18.com.br/en/tax-treatment-of-foreign-trusts-in-brazil-a-commentary-to-bill-145-2022-part-1/ and https://www.b18.com.br/en/tax-treatment-of-foreign-trusts-in-brazil-a-commentary-to-bill-145-2022-part-2/.
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 editor 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.
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