The reform will gradually lower corporate tax
The Brazilian federal government presented a new tax reform proposal to Congress on June 25, 2021, focusing on income tax. The draft law (PL 2.337 / 2021) highlights relevant changes in connection with corporate income tax (CIT). Subsequently, on July 13, 2021, Deputy Celso Sabino presented a number of changes to the draft law. As part of the legislative process, the bill must be voted on by Congress and can be changed.
Important changes
The tax reform, as amended by MEP Celso Sabino, will gradually reduce the rates of the Imposto de Renda da Pessoa Jurídica (IRPJ), the corporate income tax, from 15% to 5% in 2022 and to 2.5% in 2023.
The IRPJ is also subject to a 10% surcharge on annual profits exceeding BRL 240,000 and a 9% social contribution tax (CSLL), which remains unchanged. While the corporate tax rate will be reduced from 34% to 24% (in 2022) and to 21.5% (in 2023), dividends paid to shareholders (legal entities, individuals, residents and non-residents) will no longer be tax free.
Dividends are subject to withholding tax (WHT) at a flat rate of 20%. If the beneficiary is in a tax haven or subject to a privileged tax regime or if there are hidden / constructive dividends, the rate is 30%.
Under the government’s original proposal, holding companies and other legal entities investing in other companies will have a possible tax loss from the WHT on dividends to be used to offset dividends that the controlling company pays to its shareholders (thereby potentially creating tax credits on the plane of these holding companies that are difficult to collect / refund before the federal tax authorities).
However, that point was changed in the Deputy Celso Sabino’s amendment, and as long as the Brazilian legal entity receiving the dividend is identified as a controlling company or part of the same controlling group, there would be no WHT.
Therefore, the company’s reduced tax burden due to changes in the CIT rate will be offset and exceeded by the new dividend rates. Ultimately, with a full dividend payout, total income tax on corporate profits could rise from 34% (currently) to 39% (in 2022) or 37% (in 2023).
Withholding tax on dividends at a rate of 20% is higher than most of the limited WHT rates provided in the international double taxation treaties entered into by Brazil. With dividend taxation, international tax planning becomes much more important than in the current scenario (tax savings clauses, exemptions, reliefs, etc.). It’s important to note that dividends paid out of cumulative profits (those before 2022) would also be taxed under the proposed bill.
The CIT calculation is also affected by the new draft law, the annual option no longer applies and all companies are subject to the quarterly calculation. This means that the net operating losses (NOL) can be fully offset (without the 30% limit) in the three immediately following quarters.
The Brazilian version of a corporate equity allowance (Juros sobre Capital Próprio or Interest on Net Equity (INE) is no longer tax deductible for CIT but would be subject to a WHT of 15% versus the 20% rate for dividends.
Relevant changes to the draft law include capital reductions which, from a tax point of view, would have to be made at market value (as opposed to current legislation which allows book value to be used), resulting in taxation.
According to the government’s original draft law, the goodwill resulting from the acquisition of Brazilian companies would no longer be amortized in five years; acquisitions that were made by December 2021 would have to be merged by December 2022 in order to be able to deduct tax from goodwill .
As this measure would have a major impact on M&A activity in Brazil, Deputy Celso Sabino suggests that the current treatment provided for by law be maintained.
In addition to these measures, which tend not to make corporate restructuring tax neutral, stock option plans would only be tax deductible if an employee was the beneficiary (ie not tax deductible for executive employees).
Private equity funds
Private equity funds (FIPs) would also be subject to the new rules and would only be an attractive vehicle if they were qualified as an investment company by the Brazilian Securities Commission (CVM).
In addition, under current regulations, when selling an asset, a FIP can postpone taxation until the proceeds are paid out to its investors (cota holders).
looking ahead
It is important to note that the originally proposed tax law (PL 2337/2021) is likely to be modified and supplemented during congressional discussions and several different drafts of the proposed new law should be published until a final wording is aligned that has already started as out changes proposed by Congressman Sabino.
In our view, many of the measures are unlikely to be implemented into law, however income tax reform is expected and could be implemented in 2021.
Alice Oliveira
Lawyer, Finocchio & Ustra
Pedro Buffalo
Partner, Finocchio & Ustra
Bruno Santo
Partner, Finocchio & Ustra
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