BRAZIL: An Introduction to Private Wealth Law

The coming semesters will bring to Brazilian families the reality of the beginning of a process of significant changes in the tax environment, especially for high-net-worth individuals and those with substantial passive income from financial investments held in Brazil and/or abroad.

For years, we have witnessed the maturation of governmental measures aimed at reducing alleged tax benefits provided by our legislation, thereby seeking to raise tax revenue without the need to deal with the political burden of creating new taxes. The evolution of these measures and the recurrence of these attempts, even under governments with very distinct ideological spectrums, demonstrate a consistent intention of the legislator and the Brazilian Federal Revenue Service to target certain segments of society.

In this context, some important changes are expected to occur in the near future, regardless of the exact timing and path chosen by the government:

• the introduction of automatic annual taxation on profits earned by foreign legal entities controlled by resident individuals in Brazil, even if not distributed to shareholders;

• changes in the taxation of income earned by individuals residing in Brazil from financial investments and capital gains abroad;

• changes in the taxation of income and gains earned through investment funds in Brazil and abroad, including the introduction of semi-annual taxation on gains earned by closed-end funds that have not yet been distributed;

• reintroduction of taxation on dividends paid by Brazilian legal entities to their shareholders, whether in Brazil or abroad;

• regulation in Brazil of foreign fiduciary instruments (trusts, foundations), especially regarding their reporting and taxation requirements; and

• an increase in the rates of gift and inheritance tax, based on the alleged understanding that these rates are low compared to those charged in other countries, which, according to the tax authorities' narrative, would avoid the need to introduce a wealth tax.

Regarding the taxation of profits earned by foreign legal entities controlled by resident individuals in Brazil, this is not the first time that the Brazilian government has sought to eliminate the more than fair deferral of income tax on earned but undistributed profits. After several failed attempts, the federal government continues to strive in this direction, which may lead to a loss of attractiveness of foreign structures based on private investment companies in their current form, forcing taxpayers to seek modifications in the structure mechanism and even the allocation of foreign assets in different structures that, in some way, maintain the currently existing tax benefits.

In addition to this change, the federal government has been studying for years to amend the tax legislation applicable to income earned by individuals residing in Brazil from financial investments and capital gains abroad. Currently, then relevant legislation suffers from gaps, inconsistencies, and gray areas that generate legal uncertainty and judicialization of cases. Examples of these are controversial issues such as the taxation (nature and rate) on capital redemption or dissolution of foreign entities, the maintenance and redemption of non-interest-bearing deposits abroad, and the receipt of interest from financial investments abroad. The simplification and unification of these concepts, without increasing the tax burden, would seem like positive measures to increase taxpayers' legal certainty. Nevertheless, the essentially revenue-driven bias present in the latest draft bills presented by the federal government (even by allegedly less interventionist governments) raises doubts about the true intentions of these measures.

Regarding investment funds in Brazil, the existence of various tax regimes for different types of funds also brings complications and inconsistencies. Measures such as the introduction of automatic taxation on income and gains earned through closed-end investment funds are expected and should not take long to happen, following a previous attempt expressed through Provisional Measure No 806 of 2017. Similarly, there is an expectation that, in one way or another, investment funds abroad will be subject to similar rules as foreign-controlled companies regarding the taxation of their earnings and profits in Brazil.

Another measure that the federal government has been seeking for some time, and is the subject of promises of introduction in the coming months, is the reintroduction of taxation on dividends paid by Brazilian legal entities to their shareholders, whether they are tax residents in Brazil or abroad. Such taxation could also trigger conflicts and complexities regarding the potential double taxation of such dividends, which may or may not be resolved by the Brazilian network of double tax treaties. Although the latest promises suggest this reintroduction of income tax on dividends paid would be accompanied by a reduction in the tax burden on legal entities, this was not reflected in the last draft bill addressing the topic, which is why we cannot rule out the expectation of an increase in the total tax burden.

Regarding fiduciary structures, since 2016 there has been much academic discussion but only a few legal efforts to regulate foreign instruments or even create a Brazilian fiduciary instrument. We have also observed poorly advised and superficial judicial decisions and administrative manifestations that hinder the correct understanding of these instruments and undermine their legal certainty. Recent attempts to regulate trusts and foundations in a superficial and incomplete manner should not prosper, and we continue to expect that these instruments will be properly addressed by Brazilian legislation, which seems to be getting closer to happening.

Finally, the disparity between gift and inheritance tax rates, which is a state tax, creates inconsistencies and injustices that do not seem to make any sense. While some states, essentially due to financial needs, have already increased or are increasing their tax rates to the current legal limit of 8%, others maintain rates at lower levels but do not rule out changes in the future. Similarly, some states are proposing changes in the tax base in order to increase the value of assets for the purpose of taxation. These are measures that demonstrate the intention of state tax authorities to reform the existing rules, also attempting to reduce opportunities for estate and tax planning. As for the long-discussed but never introduced wealth tax, which may not have the appeal and popular acceptance that was imagined in recent years, the most likely probability seems to be that this idea will be replaced by a simple increase in rates or calculation basis of the gift and inheritance tax, including, eventually, an increase in the maximum legal rate and changes in federal legislation that redistribute the revenue collected from this tax among the federative entities.

The fact is that recent years have shown a growing interest from governments in introducing significant changes to the Brazilian tax legislation. These proposals, which are being discussed and are expected to be at least partially approved in the coming months, have the alleged justification of simplifying the system; however, in practice, we know that although simplification of the tax system is indeed a noble goal, the frequent revenue-driven eagerness of the Brazilian Tax Authorities does not allow us to believe that increased tax collection is not the main motivation behind these changes. It is also a fact that, with or without the expected changes, we will continue to work towards finding the most efficient structures and instruments for Brazilian families within the concept of tax justice.