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January 24, 2024
2024-0266

Brazil's new tax law affects individuals residing in Brazil

  • The new tax law broadens the taxation of financial investments abroad, which will be taxed at a rate of 15% upon filing annual Income Tax Returns.
  • The law also ends tax deferrals for controlled entities abroad and mandates annual taxation based on accounting profits, regardless of distribution.
  • Trusts are now taxable, with the assets and rights constituting them treated as the settlor's property, whereas transfers will be treated either as donations or inheritance.
  • Lastly, the law offers an option to update the value of assets and rights abroad and to tax any appreciation at 8%, alongside discontinuing two important tax exemptions.
 

A new law (Law 14,754/2023 or Law) enacted in Brazil on 12 December 2023, and effective beginning 1 January 2024 for individuals domiciled in Brazil, targets investments held abroad, such as financial investments, controlled companies and trusts. The new law also targets closed-end funds in Brazil.

Financial investments

The Law defines financial investments broadly under the new taxation regime to include any financial operations outside the country, such as:

  • Interest-bearing bank deposits
  • Interest-bearing certificates of deposits
  • Virtual assets
  • Digital wallets or checking accounts with income
  • Shares of investment funds, except those treated as controlled entities abroad
  • Financial instruments
  • Insurance policies with principal and income redeemable by the insured or its beneficiaries
  • Investment certificates or capitalization operations
  • Retirement or pension funds
  • Fixed income and variable income securities
  • Credit operations, including financial resource loans, in which the debtor is resident or domiciled abroad
  • Derivatives and equity interests (unless treated as controlled entities abroad), including acquisition rights

In view of this scenario, it is important to note that the taxable event (income tax liability arising from these assets) occurs when the income is effectively made available, resulting in additional basis on the monthly calculation. However, the time of effective payment of the applicable income tax has changed and, therefore, the income will be taxed at rate of 15% at the time the annual Income Tax Return is filed.

Also, the monthly calculation is highly important, because in addition to the possibility of offsetting income tax collected in countries with which Brazil has an agreement to avoid double taxation, the new Law also allows the possibility of offsetting losses incurred in operations of these financial investments, thus leading to planning opportunities for the taxpayer.

Offshore entities — end of tax deferral

The current treatment applied to controlled entities located abroad, which allowed tax deferral for investors (i.e., postponing income taxation to the time of effective distribution of profits and dividends), has been modified to provide that the profits determined in compliance with international accounting standards or Brazilian accounting standards (the latter mandatory if the entity is located in a country with favored taxation or if it benefits from a privileged tax regime) will be taxed on 31 December of each year at the fixed rate of 15% as per the new rules set forth by law. It should be noted that only subsidiaries, direct or indirect, that fall into one or more of the following hypotheses are subject to the new regime: (i) are located in a country or dependency with favored taxation or are beneficiaries of a privileged tax regime or (ii) have their own active income of less than 60% of total income.

Offshore controlled entities — transparent vs. opaque

The law provides for the possibility of reporting entities controlled abroad in a "transparent" manner, (i.e., separating each underlying asset in the Income Tax Return and equating them, from a tax perspective, to assets directly held by the individual) or in an "opaque" manner, following the reporting standard used until then — that is, including the structure as a single asset in the Income Tax Return, regardless of the amount of assets that compose it and subjecting it to annual taxation based on accounting profit. It is important to emphasize that the decision-making process regarding the model to be adopted is irrevocable and irreversible. Therefore, once the individual chooses the reporting model to be adopted, there will be no possibility of change.

Trusts

The new Law puts an end to the legal debate associated with the tax treatment of trusts and establishes that the assets and rights that constitute the trust must be treated, as a general rule, as the property of the settlor, becoming the property of the beneficiary only when a distribution occurs or in case of death or irrevocable abdication of the estate rights by the settlor, whichever occurs first. In accordance with the new Law, a change of ownership will be considered as a donation if it occurred during the life of the settlor, or as an inheritance if it results from his death.

Additionally, for tax purposes, the income and capital gains arising from the assets and rights held by the trust will be considered to have been earned by the holder and, therefore, will be subject to income tax at the level of the individual at a fixed rate of 15%, as per new rules set forth by law. Finally, it is worth mentioning that during a 180-day period, counted from the date of publication of the law, deed of trust or letter of wishes may be amended to include specific wording that requires the responsible party (trustee) to comply with the provisions established by law.

It should also be noted that the trust's assets and rights must be listed, as a general rule, in the holder's Income Tax Return at their respective acquisition cost.

Step-up of assets

The new Law gives individuals residing in Brazil the option to update the value of assets and rights abroad, regularly reported in the Income Tax Return (fiscal year 2022), to the market value on 31 December 2023, taxing any appreciation in value from the acquisition cost at 8%. The election to update the assets and rights must be carried out through a specific filing; the form and deadlines will be provided by the Brazilian Federal Revenue Service (RFB), and the tax due must be paid by 31 May 2024. It is important to note that assets acquired during the 2023 calendar year cannot be updated.

Closed-end funds

Among the various changes brought about by the Law, it is important to highlight that closed-end funds are now subject to a semi-annual taxation regime known as "come-quotas," that will require a minimum withholding income tax on unrealized gains to be collected in May and November each year, as it already occurs in open-ended investment funds.

End of exemptions

The new Law also revokes two important tax exemptions of great relevance to individuals residing in Brazil with assets acquired during a period of non-tax residence or acquired with income originally earned in foreign currency, namely: (i) a tax exemption on capital gains income earned on the sale of assets and rights acquired during the period of non-tax residence in Brazil; and ii) an exemption for tax on the exchange variation computed in the sale of assets originally acquired in foreign currency.

Regulations

Although recently enacted, Law 14,754/2023 lacks regulations providing practical details on the implementation of the new taxation regime, as well as the step-up of assets and other actions that may be necessary for taxpayers. So far, the following provisions/consultation materials have been disclosed:

  • Normative Instruction 2,166/2023, providing for the payment of income tax levied on income calculated on quotas of investment funds referred to in articles 27 and 28 of Law 14,754/2023
  • CODAR Executive Declaratory Act No. 23, establishing the internal code for the collection of income tax levied on the step-up of the value of assets and rights abroad — code: 7238
  • Questions and Answers, providing relevant clarifications about the new Law.

Before and after — what changes with law 14.754/2023?

Description

Until 31 December 2023

Law 14.754/2023 (as of 1 January 2024)

Dividends received abroad

  • Monthly Income Tax calculated according to progressive rates ranging from 0% to 27.5% or according to the progressive rates ranging from 15% to 22.5%, depending on the nature of the income from abroad
  • Taxable income tax event continues to be the moment of effective availability of income
  • Tax due must be calculated monthly
  • Payment of income tax now has a single 15% rate to be made annually with the Income Tax Return
  • New law provides for compensation of losses incurred abroad with the income earned

Interest received abroad

Capital gain on the sale of assets and rights abroad acquired during the period of non-tax residence

  • Exempt from capital gains tax
  • For taxable capital gain, nature of asset governs which rules apply

Sale of financial investments abroad originally acquired in national currency

  • Taxed according to progressive rates — capital gain (15% to 22.5%), with capital gain calculated as the difference between the sale value (in Brazilian Real or BRL) and acquisition cost (in BRL)
  • Any exchange rate variation perceived in the transaction also subject to tax
  • No possibility of compensation for damages
  • Capital gain income, including exchange-rate variation, earned on the sale is subject to a single 15% rate, paid annually through the Income Tax Return
  • New law provides for compensation of losses in relation to the gains obtained
  • Possible to claim income tax paid abroad as a tax credit in Brazil (if in compliance with the legal requirements)

Sale of financial investments abroad originally acquired in foreign currency

  • Taxed according to progressive rates — capital gain (15% to 22.5%) based on difference between sale value (in US dollars) and acquisition cost (in US dollars)
  • Any exchange rate variation between Brazilian currency (BRL) and foreign currency (USD) perceived in the transaction not subject to tax
  • No possibility of compensation for damages

Controlled entities offshore

  • Taxation deferred (according to progressive rates — 0% to 27.5%) until funds are effective availability to individuals residing in Brazil
  • End of deferral, with profits and dividends taxed at 15%, whether or not distributed to individuals resident in Brazil, on 31 December each year
  • Legal provision for optional tax treatment of assets and rights held by controlled entity, as if held directly by the individual

Trust

  • No legal provision
  • Assets and rights subject to trust generally considered owned by the settlor and income earned will be taxed at 15% (tax transparency)
  • Transfer of assets and rights to beneficiary (change of ownership) considered a donation if during the life of the settlor, or inheritance if the settlor dies
* * * * * * * * * *
Contact Information

For additional information concerning this Alert, please contact:

EY Assessoria Empresarial Ltda, São Paulo

Ernst & Young LLP (United States), Latin American Business Center, New York

Ernst & Young Tax Co., Latin American Business Center, Japan & Asia Pacific

Published by NTD’s Tax Technical Knowledge Services group; Carolyn Wright, legal editor
 
 

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