On August 28 this year, Brazil published its Provisional Measure (Medida Provisória/MP) 1,184/2024 – which presents relevant changes to investment fund taxation rules, especially closed-end funds with a fixed income profile.
The new rules apply to closed-end funds even if their portfolio is illiquid (e.g., in Brazil, FIDC NP and FIM that hold investments in FIPs and FIAs), but the MP does provide exceptions, as follows:
Come-cotas: The main change is periodical taxation by Brazil’s Withheld at Source Income Tax (Imposto de Renda Retido na Fonte/IRRF), also known in the country as “come-cotas” (or, in a free translation, quota-gobbler), as currently occurs with open-ended investment funds: on the last business day of the months of May and November – or on the date of income distribution, amortization, redemption or sale of shares, if earlier.
Rate: Applicable rates will be 20% for short-term funds and 15% for long-term funds; the IRRF will supplement the applicable regressive rate to the distribution of income, amortization, redemption or sale of shares ( from 22.5% to 15%).
Stock: Although the new rules will only come into force in 2024, the MP foresees the incidence of IRRF on the stock of income that was not subject to come-cotas at a fixed rate of 15%, to be calculated pro-rata on the value accumulated by December 31, 2023.
The MP provides that the stock will be taxed by applying the 15% rate, to be collected in the first quota payment, on May 31, 2024 (or in 24 monthly installments plus the SELIC interest), and, if there is a chance of carrying out of income, the payment deadline is anticipated.
Alternatively and optionally, individual shareholders living in Brazil may tax stock at the advantageous rate of 10%, provided that the income accumulated up to June 2023 is paid in up to four monthly installments starting on December 21, 2023. With regard to income accumulated between July 2023 and December 2023, payment must be made alongside the quota contribution, on May 31, 2024.
In both cases, the responsibility for collecting the IRRF will lie with the fund administrator; the shareholder will be responsible for transferring resources to the administrator to cover the payment, in the absence of liquidity to do so.
Even though the MP regulates a more beneficial rate for stock taxation, it is worth highlighting that this is a controversial topic, since possible violation of the principle of non-retroactivity of the tax law could be questioned, leading to the matter being brought to justice.
Funds not subject to periodic taxation: In general, funds with a variable income profile (FIPs, FIAs and ETFs) remain subject to IRRF at a rate of 15% only on the date of income distribution, amortization, redemption or sale of shares (i.e., without shares), as long as they qualify as “investment entities” and meet the following requirements:
- FIAs: a portfolio made up of at least 70% of shares, or similar assets, effectively traded in the stock exchange’s spot market, in Brazil or abroad.
- AIFs: have a portfolio made up of at least 70% shares, or similar assets, effectively traded on the stock exchange spot market, in the country or abroad.
- ETFs: compliance with portfolio allocation, framing and reframing requirements established in Brazil’s Securities and Exchange Commission regulations; and having shares effectively traded in a stock exchange or organized over-the-counter market, with the exception of Fixed Income ETFs.
“Investment entities” are funds with a professional management structure, represented by agents or service providers with power to make investment and divestment decisions on a discretionary basis. This is a concept already applicable to FIPs today and will be regulated in more detail.
In turn, Investment Funds in Shares (FICs) of FIA, FIP and ETF receive the same treatment as their underlying funds, as long as 95% of their assets are made up of shares of the invested funds.
Funds with a variable-income profile subject to periodic taxation: FIPs, FIAs and ETFs not covered by the above requirements (property entities) will be subject to IRRF under the quota regime, limited to a rate of 15%.
In this case, fair value assessment (FIA) and equity equivalence (FIP) gains and losses will not be taxed by come-cotas, as long as they are controlled through subaccounts. These gains will only be included in the IRRF calculation basis at the time of realization of the assets held by the fund or if income is distributed to shareholders, and any losses cannot be deducted from the gross income subject to IRRF.
Reorganizations involving funds: Mergers, incorporations, spin-offs and transformations of funds become taxable events as of 2024 at the rate that is applicable to the shareholder. The MP provides for a tax neutrality rule for events occurring up to December 31, 2023, as long as the fund is not subject to the quota increase in 2023 and the resulting fund's rate is equal to or greater than the rate prior to the event.
Investors resident or domiciled abroad: They remain subject to IRRF at a rate of 15%. According to the current wording, the come-cotas would not be applicable to quota holders living abroad, which may represent a lack of equality between investments by residents in Brazil and abroad.
Exceptions to the new rules: The new rules do not apply to FII, FIAGRO, investments by residents or living abroad in investment funds in public securities referred to in art. 1st of Law 11,312/2006, investments by residents or domiciled abroad in FIPs and FIEE referred to in art. 3 of Law No. 11,312/2006, FIP-IE, FIP-PD&I, investment funds referred to in Law No. 12,431/2011, investment funds with shareholders exclusively resident or domiciled abroad, in accordance with the provisions of art. 97 of Law No. 12,973/2014, and Fixed Income ETFs.
Specific rules (FII and FIAGRO): The MP changes the rules for exemption in the distribution of income by FII and FIAGRO for individual shareholders living in Brazil, now conditioned to the existence of at least 500 shareholders (and no longer 50), as well as provision that shares will be effectively traded in the stock exchange or in the organized over-the-counter market (and not just admitted to trading).
Entry into force and conversion into law: With a few exceptions referring to (i) alternative regime for taxation of stock by individuals residing in the country, (ii) non-incidence of come-cotas for funds that expressly provide in their regulations for its extinction and non-extendable settlement until November 30, 2024; and (iii) non-incidence of IRRF in the merger, spin-off, incorporation or transformation occurring until December 31, 2023 (provided that the above requirements are observed), which come into force immediately, the MP comes into force on January 1, 2024. To take effect, it must be converted into law within 120 days.
For more information, contact the Tax Advisory and Capital Markets teams at Barcellos Tucunduva Advogados ([email protected] e [email protected]).