Brazilian Federal Law No. 14.754: Updates on Taxation for Foreign Investments and Entities

In May 2023, the Provisional Measure (a temporary legislative decree) No. 1,171/2023 concerning the taxation of income earned by Brazilian tax residents on financial investments, controlled entities, and trusts abroad, was published, introducing significant alterations in the taxation of foreign investments for Brazilian tax residents.

On December 12th, 2023, Brazilian Federal Law No. 14,754/2023 was enacted after the Provisional Measure was no longer in effect, establishing the new regulations for Brazilian tax residents with foreign investments as definitive. This legislation applies to all Brazilian tax residents who are natural persons and earn income, directly or indirectly, from foreign financial investments, controlled foreign entities, and trusts.

Among the significant changes in Brazilian legislation was the introduction of a fixed tax rate of 15% on annual income from foreign investments. Prior to this amendment, a variable tax rate ranging from 0% to 27.5% was applied.

Another significant alteration in Brazilian legislation concerns the adjustment of the timeframe for tax payment: taxes on income from foreign investments must now be settled during the period in which the income is generated. Prior to the enactment of this new law, Brazilian tax residents would invest abroad and only be subject to income tax on their profits upon the sale of the investment or upon the actual distribution of profits.

Next, we will discuss the key amendments concerning income derived from foreign trusts and from foreign controlled corporations.

Trusts

The Federal Law No. 14.754 provides crucial definitions to determine the tax liability regarding income derived from foreign trusts. According to it, assets and rights subject to a foreign trust will:

  • belong to the grantor/settlor after the trust’s establishment;
  • belong to the beneficiaries upon distribution by the trust to them or upon the grantor’s death, whichever comes first.

For irrevocable trusts, asset transfer to the beneficiaries occurs before distribution or the grantor’s death.

Assets and rights subject to the trust will be subject to Personal Income Tax (IRPF) at the fixed rate of 15%. The tax must be paid by the person who was considered the owner of the asset or right on December 31st of the previous year.

Other provisions also include important rules regarding the taxation of assets and rights subject to foreign trusts:

  • If the trust controls a foreign entity (i.e. if the trust holds more than 50% of a foreign entity), this foreign entity will be considered as directly held by the owner of the assets and rights subject to the trust.
  • The grantor or the beneficiary must request from the trustee the provision of financial resources and necessary information to enable tax payment and compliance with other tax obligations in Brazil.
  • For foreign trusts where either the beneficiaries or grantors are tax residents in Brazil, the trust deed or letter of wishes must mandate the trustee, in an irrevocable and irreversible manner, to comply with the provisions established in Brazilian Federal Law No. 14.754.
  • Assets and rights subject to the trust, regardless of acquisition date, must be declared directly by the owner in the DAA, at acquisition cost, in relation to the base date of December 31, 2023. If the owner had previously reported the trust in their DAA, the trust must be replaced by the underlying assets and rights, allocating the acquisition cost accordingly. If the person who previously reported the trust in their DAA is different from the owner established by this Law, the declarant may exceptionally be considered as the owner for IRPF purposes.
Imagem: Canva

Foreign Controlled Entities

Before the new law came into effect, profits or revenues earned by Brazilian tax residents from foreign controlled entities remained untaxed until repatriated to Brazil. However, under the new law, taxation is triggered not by the repatriation of funds, but by the determination of income.

Now, under the new legislation, Brazilian tax residents must declare and pay taxes on profits from offshore companies they control as soon as they are distributed, regardless of whether the funds are in Brazil or abroad.

It’s crucial to understand two key definitions to assess the applicability of these new provisions:

  • Offshore companies: Brazilian law categorizes offshore companies as those situated in countries with no income tax or with a maximum income tax rate of 17%.
  • Control: as previously mentioned, control over a company entails owning more than 50% of its interests.

Therefore, if a Brazilian tax resident owns more than 50% of a company located in a tax-free jurisdiction or with a maximum income tax rate of 17%, they are liable to pay income tax on the company’s profits, regardless of whether these profits have been distributed to the company’s members or shareholders.

Opening Foreign Companies in Offshore Jurisdictions under the New Law

Considering all the changes to the Brazilian tax laws, is it still worthwhile to establish a foreign company in offshore jurisdictions in order to make a FLIP. (if you want to learn more about FLIPs, check the following links: What is FLIP?’ and ‘How to do a FLIP?’)

Briefly, a FLIP happens when a Brazilian company becomes a wholly owned subsidiary of the foreign company. This corporate reorganization is especially common when it comes to startup companies.

If only tax considerations are taken into account, the answer may tend towards ‘no’. However, Brazilian companies, especially startups, do not solely consider opening a foreign company and making a FLIP for its tax advantages.

It is important to note that foreign investors often prefer investing in foreign companies rather than Brazilian ones. Foreign investors and funds or even Brazilian funds structured outside the country, usually require for an international holding structure for the execution and centralization of the capital contribution. Therefore, opening a foreign company that will control a Brazilian company may still be beneficial in attracting foreign investment.


Written by Mariana Tavares, Associate Lawyer at Drummond Advisors

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