On Friday, June 25th, the executive branch sent to Congress a bill proposing significant changes in the tax legislation that are undeniably relevant in the M&A and in the cross-border realms. Below is a concise and still preliminary attempt to summarize some of the key elements
Note that Congress will deliberate on this bill as a part of the legislature process. The final text will likely have differences in relation to this original proposal. Yet, prudence and wisdom advise proactivity. KPMG can certainly work with you in trying to assess and model qualitatively and quantitively the most probable scenarios and how to react accordingly.
1. Corporate Income Tax (CIT):
2. Profit Distributions:
a) Dividends - No longer tax exempt. They will be subject to 20% WHT. The rate goes to 30% if the beneficiary is in a tax haven jurisdiction or enjoys a “privileged tax regime”.
- Treaty provisions should be carefully assessed due to different rates, possible reliefs, and possible tax sparing clauses.
- Brasil has not signed the MLI. Yet the overall concept of UBO (ultimate beneficial owner) should be minded. PPT (Principal Purpose Test) should be considered as it has been included already in some treaties and will likely be included in all of them.
b) Interest on net Equity (INE) - Interest paid to shareholders based on the invested entity’s net equity, which consists in a very effective means for profit distribution, should no longer be deductible.
- Careful reassessment of the debt / equity strategy adopted so far to fund the BR Subsidiary is highly necessary. A higher debt to equity ratio may be a tendency, though other debt related variables should be minded as well (mainly, thin cap, transfer pricing rules, w/h income tax on interest).
c) Holding Cos and FIPs - the 20% w/h income tax should apply as well when the invested entity distributes dividends to other HoldCos or FIPs in Brazil.
d) DDL Rule: It represents a type of domestic transfer pricing rule and seek to curb tax driven reallocation of profits among companies in Brazil deemed as related parties (since there is no tax consolidation in Brazil). The bill strengthens it with implications to CIT and WHT on dividends. This topic, hence, may be of great relevance for operations in Brazil that make use of several legal entities.
3. Capital Gain – Non-residents:
a) Indirect transfer of shares - Rules on indirect transfer of shares are introduced. They kick in if:
- The business in Brazil represents at least 50% of the fair value of the overall business sold abroad and if at least 10% thereof is to be sold; or
- The business in Brazil has a total fair value of at least USD 100mm and the offshore transaction involves at least 10% of the overall business sold abroad.
- Seller, or legal representative, will have to notify the sale and disclose its details to RFB (Federal Revenue Service).
- Buyer is the one liable for withholding the applicable capital gain tax (15% to 22.5%). Its legal representatives, as well as those of seller, and the entity in Brazil being sold are also jointly liable.
b) This is likely to have a significant impact on acquisitions of or investments in Brazilian based entities (some in the digital economy) that ultimately aim for an IPO abroad (e.g. Nasdaq) since, currently, such IPOs tend to be out of reach of Brazil’s capital gain rules. The relevance of this new rule will also be felt in general, for, within many global transactions, the size of the overall business in Brasil tends to be substantial. Please refer also to the next topic, also relevant to this business goal (offshore IPOs).
4. “Exit Tax”:
a) Individuals or legal entities that are resident in Brazil will be subject to a kind of “exit tax”. If such residents contribute assets into legal entities (personified or not) abroad, they must do it based on the fair value of the contributed asset. The difference between the transferred asset’s fair value and its tax basis will be treated as a capital gain and taxed as such.
b) The payment of the capital gain tax can be made in 60 monthly installments. This payment is anticipated should liquidity events, as stated in the proposed legislation, take place.
c) As highlighted on the preceding topic, this new rule is of great relevance for companies in Brazil (as well as their founds and investors), which are trying to attract institutional investors (i.e. PE and VC funds) and aim for IPOs abroad (e.g. Nasdaq).
5. M&A – Goodwill and Asset Step-up:
a) Goodwill - The possibility that buyers / investors use the goodwill originated from an investment in, or acquisitions of a company (share deal) will cease to exist. It will be available only for acquisitions / investments until Dec 31st, 2021 – and provided merger with target is carried out until Dec 31st, 2022.
b) Asset Step-up - As a result of share deals and following some requirements, Brazil legislation allows an “asset step-up for tax purposes” – provided the investing legal entity and the invested target are merged. This possibility is maintained but the rules are made more stringent. For instance:
- In case of Intangibles, tax deduction (on a straight-line basis) should be in 20 years (mandatorily on a straight-line basis), whereas, currently, the amortization period should follow the forecasted useful life of the intangible (which, in many cases, are shorter than 20 years). This rule does not apply to concessions (or any other intangible whose useful life is contractually or legally defined), in which case the duration of the concession should be adopted.
- In case of tangibles (e.g. fixed assets), the amount of the step-up will no longer correspond to that of when the acquisition took place, but to the remaining amount at the time of the merger of both (investing entity and invested target). Thus, in case the required merger demands some time to be fully implemented, a portion of asset step-up will be forfeited.
6. In-kind Capital Return:
a) In-kind capital returns (i.e. with assets) to investors (including foreign investors) are often a means through which tax-free reorgs can be implemented in Brazil. The new proposed legislation ends with this possibility (use of book value) and requires that any of such a capital return be carried out based on the returned asset’s fair value. The difference between the returned asset’s fair value and its book value/tax basis must be treated as a capital gain by the entity returning the capital.
b) Accordingly, the interposition of any additional layer of legal entities (e.g. HoldCos), unless absolutely necessary, should be carefully assessed since it may harden any future reorganization necessary, for instance, for a liquidity event.
7. FIP – PE and VC funds, and other Institutional Investors:
a) Investment Entity vs regular legal entity - FIPs will only enjoy their beneficial tax rules if they are qualified as “investment entities”, as per Security Commission (CVM) rules, which are very similar to the overall concept of “investment entity” under IFRS. FIPs that do not fall under this concept will be treated as a regular legal entity and taxed accordingly. Needless to say, the proper implementation of a FIP structure should require a careful assessment of whether or not (or how) a FIP should be qualified as an investment entity.
b) FIP’s portfolio – Tax rules aligned with CVM rules - The tax rules are adjusted to align with CVM regulations concerning FIP’s permitted portfolio. Thus, investments abroad, in non-convertible debentures, quotas of LTDA (limited liability companies) for instance become possible as well from a tax perspective (along with the usual stocks, warrants, and convertible debentures).
c) The role of the Funds GP (General Partner) - The legislation tries to clarify that the presence of a GP managing foreign funds abroad that invest in a FIP should not jeopardize the tax exemption on income or capital gains distributed by FIPs to such foreign funds. In other words, the fact that a GP works as a fund manager should not be construed as a situation where the GP and the Funds under its management are altogether related parties, an interpretation that would cause distributions made by the FIP to be subject to 15%, instead of 0% (which, as a matter of fact, applies to investors holding less than 40% in the FIP quotas and economics, and are not located in tax havens).
d) “Pecking order” and Deemed Distributions - Interestingly, the proposed legislation defines that gains earned by FIPs (defined as investment entities) due to the sale of their assets are deemed distributed to the investors in the month following the sale. Taxation (if applicable) will then be triggered even if the proceeds are to be reinvested by the FIP into other assets. On the other hand, deemed or real distributions made by FIPs will follow a sort of “pecking order”: firstly they will be deemed as return of capital, and only after the exhaustion thereof distributions will treated as gains and thus subject to the applicable 15% w/h income tax.
8. Real Estate and FII (Real Estate Investment Fund):
a) Presumed Profit Method - In certain instances, Real Estate businesses in Brazil wind up operating through several real estate entities (Real Estate Cos), each of them electing PPM (presumed profit method) as their tax computation method. This tax advantage might not be available with the approval of new bill if, in the previous calendar year, the Real Estate Co has earned more than 50% of its revenues from rental or buy and sell of real estate properties. This limitation shall not apply in case Real Estate Development (“Incorporações Imobiliárias”).
b) FII – mandatory distribution - Given the current legislation, FII’s must distribute their profits (calculated on a cash basis) at least twice a year. This mandatory distribution will be reduced to only once a year.
c) FII – WHT rate - FII’s profit distributions to local investors is subject to 20%. This rate will be reduced to 15%, which is the same as that applicable to profit distributions to foreign investors (not located in tax haven jurisdictions).
d) FII – Exemption on capital gain - The proposed bill ends the exemption on income paid by FII traded on the local stock exchange to individuals resident in Brazil. This is relevant since this “exemption” is usually an incentive for certain real estate players to seek to IPO their FII in Brazil.
9. Stock Options (SOP):
a) Tax deduction - The proposed legislation attempts to limit the deduction of expenses associated with stock option plans to those expenses derived from plans awarded to employees only. It is intended that the deduction should not be allowed in case of plans awarded to others (including officers, board members, and service providers).
For more information, contact a tax professional with KPMG Brazil:
Head of Tax, KPMG in Brazil and South America
Head of International and M&A Tax, KPMG in Brazil
Head of National Tax, KPMG in Brazil