Jia Hui | Deheng Law Firm
As we all know, the Brazilian tax system is one of the most complex in the world. The Brazilian federal tax levies income from individuals and businesses, as well as various indirect taxes and social contributions (IR, net profit social contribution tax CSLL, industrial product tax IPI, INSS, social integration plan PIS, PASEP, social security credit COFINS , II, CIDE, Financial Transaction Tax (IOF). In addition to the federal tax system, the Brazilian Constitution has also added general regulations on states (IPVA, current value-added tax on sales and services, ICMS) and municipalities (IPTU, ITCMD, ITBI, and service tax ISS) to levy and manage their respective taxes. Tax rates are basically different between states, cities and cities.
According to the Brazilian Federal Tax 1 World Bank and 2 studies, in OECD countries, Brazil's tax burden in 2018 ranked No. 23, is also the most time-consuming tax administration of the country. Among the OCDE member states, Brazil’s tax burden on income, profits and capital gains ("direct taxes") ranks only 34th, but in terms of the tax burden on the sale of goods and services ("indirect taxes" or "consumption taxes"), Brazil's tax burden rose to third place. In this case, Brazil’s tax burden is equivalent to 33% of the country’s GDP, and the burden of tax declarations at all levels of tax authorities requires companies to set up an entire team, which consumes hundreds of working hours. Tax declarations by public tax authorities at the level of the government, and more importantly, because different tax systems have different types of taxes, compensations, deductions, and tax rates, the tax calculation of the amount of tax payable can be extremely challenging.
In order to change this situation and improve the country’s competitiveness, since the beginning of 2019, the Federal Government and the Brazilian Congress have been discussing and promoting the reconstruction of the national tax system. Tax reform is considered to be the main priority of the Brazilian legislature this year, and tax reform is likely to be passed by both houses of the National Assembly before the end of the year.
1. Trends and Contents of Brazil's Tax Reform
(1) Proposal for the reform of turnover tax
The Brazilian Congress discussed three major proposals for the reform of turnover tax, including: Proposal for Constitutional Amendment n.45/2019 ("PEC 45/2019") written by the House of Representatives, Proposal for Constitutional Amendment n.110/2019 ("PEC 110 /2019”) and draft bill n.3,887/2020, which was proposed by the federal government last year (2020).
The goals of these proposals are very similar, but the content is different. Two proposals in Congress aimed to replace several major sales and service taxes with a single value-added tax ("VAT"), the so-called goods and services tax ("IBS"). The Senate Amendment (PEC 110/2019) envisages a broadening of the existing sales and service tax. The tax reform proposes to merge the nine existing taxes into two new taxes. According to the proposal, the following taxes will no longer exist:
- Industrial Product Tax ("IPI");
- Financial Transaction Tax ("IOF");
- Social Integration Project ("PIS");
- Civil Servants’ Legacy Formation Plan ("Pasep");
- Social Security Credit ("COFINS");
- Education salary
- Contributions for economic intervention-fuel ("CIDE–combustíveis");
- Current Value Added Tax ("ICMS") for sales and services;
- Service tax ("ISS").
It is replaced by a goods and services tax ("IBS"), as well as an optional federal tax ("sin tax") levied on certain products (such as alcohol and tobacco). In this sense, goods and services tax (IBS) is a type of value-added tax. In addition, another tax that will no longer exist is the social contribution tax on net profits ("CSLL"), which will be incorporated into the corporate income tax ("CIT") 3 .
In the Senate proposal, taxpayers will have a six-year adjustment period. The first year will be an intermittent period of corporate adjustment. Starting from the second year, the goods and services tax will start at a standard rate of 1% and will gradually increase over the next five years. However, the proposal under consideration by the House of Representatives (PEC n. 45/2019) compared with the Senate proposal (PEC n. 110/2019) only considers a small amount of current taxes. The amendment proposes to merge the existing five types of taxes (industrial product tax, social integration plan, social security credit, sales and service current value-added tax and service tax) into a unified goods and services tax (IBS). Unlike PEC n. 110/2019, the total tax rate of goods and services tax is the result of the sum of three tax rates, which will be determined by the federal government, state government, and municipality respectively.
In the House of Representatives proposal, taxpayers will have a 10-year adjustment period. The first two years will be the intermittent period of company adjustments. Starting from the third year, the goods and services tax will start at an undetermined tax rate and will gradually increase in the following seven years. The two proposals of Congress do not necessarily reduce the tax burden, but clearly recommend simplifying the cost and time of tax calculation and reporting.
(2) The tax reform proposal of the Federal Government of Brazil-Draft n.3,887/2020
The Brazilian federal government also proposed a tax reform plan. According to the government's plan, the tax reform is to reduce costs, simplify the tax system, and bring more legal certainty, transparency, and equality between taxpayers. From this perspective, the government's tax reform proposal can be divided into four steps.
1. The first step of tax reform: draft bill n.3,887/2020
The first step in the reform of the federal government’s tax system is the establishment of a goods and services tax, which unifies social contributions (social integration programs and social security credits) at a fixed rate of 12%.
Draft bill n.3,887/2020 proposed by the federal government creates a goods and services tax by unifying two Brazilian social contributions (the social integration plan and social security credit). The social integration plan and social security credit levy on the company’s total operating income are the two most discussed taxes in Brazilian courts. In 2019, these two taxes together accounted for 20.8% of federal taxes.
The draft bill plans to simplify the Brazilian tax system after reducing the number of social contributions and ending the above-mentioned double taxation system. It is expected that the goods and services tax will also allow faster and more effective tax collection, which will help reduce tax disputes between administrative and judicial courts.
Article 8 of the draft bill stipulates that the fixed tax rate for goods and services tax is 12%. The government's plan is to keep the tax revenue generated by the social integration program and social security credit unchanged. However, the goods and services tax will not remain neutral for all economic sectors, because certain sectors, such as the service industry, are generally not likely to incur the expenditures and costs of tax credits. In addition, tax incentives and tax incentives related to goods and services taxes are expected to decrease.
Goods and services tax will be calculated based on the total income of all goods and services (including imports and excluding exports) produced by each entity, minus taxes collected in the first few stages of production. This new tax credit will be value-added tax, and will adopt the concept of non-cumulative collection and use of credits.
2. The second step of tax reform
The second step of the federal government's tax reform is to simplify industrial product taxes. Industrial product tax will be converted into "crime tax", that is, it will only be levied on specific products (such as cigarettes, alcoholic beverages, sugar, etc.) that are deemed unsuitable for consumption by government authorities. Industrial product tax is a federal tax imposed by Brazil on industrialized products. The draft bill proposes to narrow the scope of taxation to only levy specific products. The Brazilian Federal Government has not yet proposed any bill on this reform.
3. The third step of tax reform
The reformulation of income tax (for companies and individuals) is the third step of the federal government's proposed tax reform. The government's intention is to lower the corporate income tax rate. On the other hand, after the end of the tax system reform, certain tax benefits and allowable deductions applicable to individual income tax (IRPF) will be eliminated, and profits and dividends paid by Brazilian entities to shareholders (ie Brazilian residents and non-residents) will be levied taxi. According to government data, its goal is to reduce the current profit tax of about 34% (corporate income tax is 25%, and net profit social contribution tax is 9%).
The Brazilian Congress is still analyzing laws and bills dealing with the above issues, including:
(1) Draft bill n.1,952/2019
Draft bill n.1,952/2019 is intended to: (i) change the progressive tax rate related to IRPF; (ii) establish the taxation of dividends paid by entities; (iii) reduce the corporate income tax rate; (iv) abolish net equity The amount of interest deduction. The corporate income tax rate is 12.5%, and profits exceeding 20,000.00 rupees are subject to an additional 7.5%. The draft bill maintains the net profit social contribution tax rate at 9%. Therefore, the effective tax rate is approximately 29%. In addition, the dividend tax rate will be 15%. Currently, the draft bill is being evaluated by the Senate Economic Affairs Committee.
(2) Draft bill n.2,015/2019
The specific objective of Draft Bill No. 2,015/2019 is to tax the dividends paid by corporate entities to their shareholders. The draft bill expects a tax rate of 15%. The bill has no provisions on reducing corporate tax rates. Currently, the draft bill is being evaluated by the Senate Economic Affairs Committee.
(3) PEC 128/2019
This is a constitutional amendment proposal (PEC), the main goal of which is to reduce turnover tax and increase income tax and profit tax. PEC 128 stipulates that the tax rate on dividends is 4%. On the other hand, PEC 128 plans to reduce income tax by the same percentage. PEC 128 established a new tax, that is, a tax on financial transactions ("IMF") to compensate for the reduction in social security contributions paid by business entities, but the bill does not specify specific tax rates. Like the draft bill No. 3,887/2020, PEC 128 also aims to convert industrial product tax into a "crime tax" to encourage/inhibit the consumption of certain products.
Similar to the content mentioned in the draft bill, PEC 128 proposes two value-added taxes ("IBS") levied on goods and services, unifying three federal taxes, namely, social integration plan, social security credit and financial transaction tax . The new tax will be of a non-cumulative type (similar to value-added tax), that is, the tax payable for each transaction can be deducted from the tax previously collected. The government may also grant tax or financial exemptions, tax incentives or benefits. PEC 128 will be voted on by the Brazilian Constitution, Judicial and Civil Rights Commission (CCJ).
4. The fourth step of tax reform
The federal government intends to reduce the total tax burden imposed on company wages and stimulate job creation. Payroll taxes (such as social security taxes) currently represent a large portion of federal government revenue. If the payroll tax disappears, how the federal government will replace this income has not yet been officially announced. There are reports that the federal government plans to impose new taxes on digital funds transfer transactions. However, the Brazilian Congress seems very resistant to accepting this tax.
Judging from all the above steps, the third step is the most noteworthy step, because it aims to reorganize the calculation method of the entire enterprise tax sum and requires careful verification. In addition, the third step proposes to levy a tax on profit distribution. Currently, Brazil does not levy a tax on profit distribution.
2. As an international investor, how to plan ahead?
China has maintained sustained economic growth in the past few decades. Similarly, relations with Brazil have also been significantly strengthened in the past few years. Today, China is Brazil's most important economic partner. In the following topics, we will analyze the impact of the above tax reforms on Chinese investments. These Chinese investments include: (1) Directly by Chinese companies registered in China; (2) Directly by Chinese companies registered in Luxembourg and the Netherlands (3) through an equity fund ("FIP"); and (4) through an infrastructure equity fund ("FIP-IE").
(1) Directly conducted by a Chinese company registered in China
In this context, the distribution of dividends by Brazilian entities to its parent company in China will fall within the scope of Article 10 of the Double Taxation Agreement between Brazil and China ("DTC-BC"). According to Article 10 of the DTC-BC, dividends paid by Brazilian companies to shareholders located in China can be taxed in Brazil. Once Brazil starts to levy taxes on dividends, the Brazilian company will be taxed in accordance with domestic laws, with a tax rate of up to 15%. According to Article 23 of the DTC-BC, taxes paid in Brazil should be deemed to be creditable in Chinese taxes. The deductible includes not only dividend tax, but also corporate income tax paid by Brazilian companies.
However, if the country where the parent company is located does not have a double taxation agreement with Brazil, the dividend may be double taxed.
(2) Directly conducted by Chinese companies registered in Luxembourg and the Netherlands
First, we will analyze the 1980 Double Taxation Agreement ("DTC-BL") between Brazil and Luxembourg, which entered into force in Brazil. DTC-BL stipulates that if the beneficial owner is a company that directly holds at least 10% of the capital of the dividend-paying company, the maximum dividend tax rate is 15% of the total dividend. According to Article 24 of the Double Taxation Agreement, if the parent company is located in Luxembourg and holds more than 25% of the share capital of the Brazilian corporate entity, the dividends it receives are exempt from taxation. If the shareholding ratio in the Brazilian corporate entity is less than 25%, Luxembourg will grant a tax credit equivalent to 25%, even though Brazil’s tax is actually only 15%.
If the Chinese company invests through a holding company located in the Netherlands, the effect of the above arrangement may be different once Brazil's tax reform is approved. Brazilian law stipulates that any holding company established in the Netherlands with no substantive activities is subject to a special tax system and may set a higher tax rate on dividends paid by companies located in tax-friendly countries. However, Article 10 of the "Brazil and Dutch Double Taxation Convention" ("DTC-BN") stipulates that if the beneficial owner of the dividend is a Dutch resident, the tax rate is capped at 15%.
(3) Potential solutions-FIP investment structure
According to Brazilian regulations, the investment structure defined as "FIP" (Fundo de Investimento em Participações) uses an equity fund with an asset pool without legal personality. FIP mainly invests in shares, bonds, warrants or other securities that can be converted into shares issued by Brazilian public or private companies.
Since FIP does not have legal personality in Brazil, it is not regarded as a legal entity in terms of Brazilian taxation and needs to enjoy special income tax treatment. In this case, all income and capital gains of the FIP investment portfolio do not need to pay corporate income tax (CIT), nor do they need to pay tax on total income (such as PIS and COFINS, social security fees that companies usually need to pay). FIP can invest in Brazilian companies or sell investments to obtain income. The income does not need to pay Brazilian tax, but it needs to be paid when distributed to investors. This is the main difference between FIP and regular corporate entities.
The taxation of FIP accrued income is only carried out at the level of FIP investors. The corresponding tax treatment will depend on the investor, the form of compensation and the FIP's investment portfolio. According to Article 2 of Act 11,312/2006, FIP investors’ income will be subject to withholding income tax at a rate of 15%. Under certain tax treatments, No. n.11,312/2006 stipulates that foreign investors will be subject to withholding income tax at a rate of 0% on the income recognized by foreign investors due to the amortization or redemption of FIP shares (at the time of fund liquidation). The conditions for the above-mentioned special tax treatment are: (1) The share of FIP held by foreign investors directly or through related parties shall not exceed 40% of FIP or the income shall not exceed 40% of FIP income; (2) FIP shall not invest more than 40% of FIP income at any time Bonds with 5% of its net assets (excluding public bonds and convertible securities); and (3) Foreign investors must not live in countries where the income tax is less than 20%.
(4) Through the Infrastructure Equity Fund (FIP-IE)
For FIP, considering that Chinese investment in Brazil is highly concentrated in infrastructure, Brazilian regulations also allow the development of infrastructure to adopt the investment structure of FIP-IE. FIP-IE is an initiative of the Federal Government to develop measures to attract private capital into Brazil's infrastructure sector. At present, FIP-IE is applicable to Law No. 11,478/2007 and CVM Ruling No. 578/2016. The former stipulates the general concepts and legal framework applicable to such investment funds, while the latter deals with FIP-IE's supervision and more practical problem.
According to current laws and regulations, FIP-IE should have at least five investors, and each investor's share of fund shares shall not exceed 40% of the fund's issued shares, and their income shall not exceed 40% of the total funds raised by FIP-IE. According to Law No. 11,478/2007, at least 90% of the funds in the FIP-IE investment portfolio must be invested in stocks, warrants, bonds (convertible to stocks or other) or other securities issued by the company, regardless of whether the company is public or not The company must be engaged in the development of new infrastructure projects in the priority investment areas (energy, transportation, water treatment, basic sanitation, agricultural irrigation, etc.) listed in paragraph 1 (1) of the above-mentioned law. In addition, Article 8 of Section 1 of Law No. 11,478/2007 stipulates that FIP-IE shall play an active role in the business decision-making of the invested company and exert an effective influence on the strategic decision-making and business management of the invested company.
Considering that the main purpose of the federal government when FIP-IE was established was to encourage private capital to invest in Brazil's infrastructure sector, one of the measures taken by legislators to achieve the above purpose was to provide tax incentives for personal income subscribing to FIP-IE shares. In view of this, Brazilian legislators exempt Brazilian or foreign individual investors in FIP-IE from personal withholding income tax and other income taxes.
Currently, the tax treatment of FIP-IEs investment portfolio is regulated by Section 2 of Law No. 11,478/2007 and Section 33 of Normative Ruling No. 1,585/2015 issued by the Brazilian Federal Taxation Agency ("RFB"). Generally, the income from redemption of FIP-IE shares shall be subject to personal withholding income tax at a tax rate of 15%, which is the positive difference between the redemption price and the cost of redemption of the shares.
Regarding the income from the sale of FIP-IE shares, Law n.11,478/2007 stipulates: (1) Personal income, regardless of whether the transaction is conducted on a stock exchange, the applicable withholding tax rate is 0%; The income obtained by non-resident investors outside the low tax jurisdictions, regardless of whether the transaction is conducted on a stock exchange, is also applicable to withholding income tax at a rate of 0%; and (3) For Brazilian investors, regardless of Whether the share is carried out in the stock exchange, a 15% withholding income tax applies.
Therefore, although the purpose of the Brazilian tax reform is to lower the tax rate, each specific situation must be carefully analyzed to confirm whether the reform has a negative impact on the initial expected internal rate of return of investors, and if so, what are the possible legal alternatives to this Avoid further tax burden on foreign investors.
 "Carga Tributária no Brasil 2018". Receita Federal. (https://receita.economia.gov.br/dados/receitadata/estudos-e-tributarios-e-aduaneiros/estudos-e-estatisticas/carga-tributaria -no-brasil/ctb-2018-publicacao-v5.pdf).
 World Bank "Business Environment Report 2018"
 Please note that Brazilian corporate income tax consists of two different types of taxes, namely corporate income tax ("IRPJ") and net profit social contribution tax ("CSLL"), which can basically be levied in two systems. Under the actual profit system, the amount of taxable profits determined in accordance with general accounting principles, after adjustments required by law, is subject to corporate income tax at a tax rate of 34%.
Author of this article:
Jia Hui is a partner in DeHeng Beijing office; his main practice areas are mergers and acquisitions and insurance. Attorney Jia Hui is qualified to practice law in New York State and China. Attorney Jia Hui is a lawyer in charge of international investment legal affairs of the Ministry of Commerce, and was selected into the “National Talent Pool of Thousands of Foreign Lawyers” by the Ministry of Justice and the leading foreign lawyers of the National Lawyers Association. Attorney Jia Hui is also the assistant to the chairman and secretary-general of the Belt and Road Service Mechanism, the deputy secretary-general of the New Energy Overseas Development Alliance, the representative of the Chief Lawyers Advisory Group of the China Insurance Industry Association, and a member of the Legal Compliance Committee and the Foreign Investment Committee of the China Insurance Asset Management Association. Attorney Jia Hui is also a member of the "One Belt One Road" Standing Committee of the Asia Pacific Law Association, and was selected as the chief lawyer team of the "Thousand Talents Program" of the Chinese insurance industry and the Chambers Asia Pacific and Legal 500 list lawyers.
(Lee Yijin's assistant also contributed to this article.)
Luiz Eduardo Vidal Rodrigues , foreign legal counsel of DeHeng Law Firm, Brazilian lawyer. He has 13 years of work experience, including 8 years of consulting for Chinese state-owned and private enterprises. Provide legal advice to clients in infrastructure projects and investment negotiations. The content of the advice covers areas such as construction law, public administration law, contract law, and company law. He has experience in mergers and acquisitions transactions, and has extensive experience in alternative dispute resolution in cooperation with China's overseas investment (ODI) energy and infrastructure and foreign direct investment (FDI). Served at the BNRSC One Belt One Road Service Mediation Center and was an advisor to the Ibero-American Institute of Law and Public Policy at the China University of Political Science and Law (CUPL).
Celso Costa, an attorney at Machado Meyer Advogados Law Firm, has extensive experience in mergers and acquisitions, restructurings, cross-border transactions, transfer pricing and general consulting. Have a solid background in corporate law. Accounting skills acquired in a leading accounting firm. Have in-depth knowledge of administrative litigation. Continue to participate in several of the largest mergers and acquisitions, restructuring and IPO companies. His business includes financial and insurance services, infrastructure, information technology, manufacturing and mining consulting.
This article was originally created by the lawyers of DeHeng Law Firm. It only represents the author's own views and should not be regarded as a formal legal opinion or suggestion issued by DeHeng Law Firm or its lawyers. If you need to reprint or quote any content in this article, please indicate the source.
DeHeng Law – 20.07.2021