Provisional measure reduces withholding income tax rate on investments by non-resident investors

The Brazilian Government published Provisional Measure No. 1,137 on September 22, 2022 (“MP 1,137/2022”), in the Federal Official Gazette of Brazil, which reduces the withholding income tax (“WHT”) rates on income linked to a series of investments carried out by beneficiaries residing or domiciled abroad.

The amendments enter into force on January 01, 2023.

MP 1,137/2022 reduces to zero the WHT levied on income obtained by foreign beneficiaries from bonds or securities (a) publicly offered by legal entities not classified as financial institutions and (b) Receivables Investment Funds (FIDC) whose portfolio originator or assignor is not a financial institution.

In both cases, the securities or quotas must be registered or admitted for trading in registration systems authorized by the Central Bank of Brazil or the Brazilian Securities and Exchange Commission (CVM).

The zero rate also extends to banking credit notes issued by financial institutions and other entities authorized by the Central Bank.

This benefit applies to:

• beneficiaries residing or domiciled abroad who carry out financial operations following the rules established by the National Monetary Council (“CMN”);
• quotas of investment funds that invest exclusively – and in any proportion – in the securities above, assets that yield the referred exempt income, federal government bonds, and repo operations backed by federal government bonds, or quotas of funds that invest in federal government bonds; and
• sovereign wealth funds that invest according to CMN conditions and requirements, even in low-tax jurisdictions.

On the other hand, this reduction does not apply to transactions between related parties, partially following the definition provided under transfer pricing legislation (art. 23 of Law 9,430/1996), including transactions carried out with parent companies, subsidiaries, affiliates, and companies under common control.

MP 1,137/2022 also extends the zero rate that currently exists for income obtained by non-resident beneficiaries from investments in Private Equity Funds (“FIP”), Investment Funds in Quotas of Private Equity Funds (“FIC-FIP”), and Venture Capital Funds (“FIEE”), under the conditions established by the CMN for:

• foreign quota holders of Private Equity Funds for Infrastructure (“FIP-IE”) and Private Equity Funds for Intensive Economic Production in Research, Development, and Innovation (“FIP-PD&I”); and
• sovereign wealth funds, even in low-tax jurisdictions.

MP 1,137/2022 also repealed three relevant provisions of Law No. 11,312/2006, in regard to the regulation of the 15% WHT rate for income from FIP and FIEE, and the zero rate for non-residents in the case of FIP, FIC-FIP, FIEE, FIP-IE and FIP-FD&I:

• the rule that subjects the 15% rate, currently applicable to FIP and FIEE, to the fund’s portfolio that has at least 67% of shares in corporations, convertible debentures, and subscription bonuses. As a result, compliance with the regulatory rules issued by CVM will be sufficient for purposes of application of this tax treatment;
• the rule that subjects the zero rate to confirmation that the quota holder does not hold – alone or jointly with related parties – 40% or more of the quotas issued by the fund, or the right to receive income greater than 40% of the fund’s total income; and
• the rule that subjects the zero rate to confirmation that the fund does not have, in its portfolio, debt securities in a percentage greater than 5% of its shareholder’s equity, except for cases expressly stated and for public securities.

The published text excludes, in specific cases, the application of the zero rates to investors in low-tax jurisdictions or that benefit from preferential tax regimes. The previous legislation (Law 11,312/06) only excluded the zero rate to quotaholders in low-tax jurisdictions, but such provision was replaced by a broader wording that also excludes the residents in tax-privileged frameworks.

It is important to take this limitation into consideration regarding the structures that address assets subject to tax incentives mentioned in MP 1,137/2022 and Law 11,312/2006 (e.g., FIP, FIDC or bonds or securities publicly offered by legal entities).

MP 1,137/2022 provides for benefits similar to those established in Bill No. 4188/2021, approved by the Brazilian House of Representatives in June 2022. The Bill is still pending discussion and approval by the Brazilian Senate.

We are closely following-up on the legislative debates regarding the Bill.

Subsequent to the publication of MP 1,137/2022, the deadlines for converting the Provisional Measure into law will commence before the Brazilian Congress.

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