Taxation Of Investment Funds: The New Intended Regime

The Brazilian government again intends to change the taxation of investments in certain Brazilian funds, especially FIPs and closed-end funds, effective January 1st, 2019.

Similar changes had already been attempted via Provisional Measure (“PM”) No. 806, of October 30, 2017, which was not timely converted into law by Congress and thus expired. Now President Michel Temer has submitted a new bill to Congress (Bill No. 10,638/2018) with similar contents.

Closed-end funds, which currently are taxed only upon amortization or liquidation, would be subject to biannual Withholding Income Tax (“WHT”) collection, with past-accumulated gains being taxed at once, which may be challenged on Constitutional grounds.

Closed-end funds in general

Currently, the biannual WHT levied according to the “come-cotas” method1 applies only to open-end funds, with a few exceptions2. As from May 31, 2019, it would also be applicable to closed-end funds, i.e. those whose shares are not redeemable. Accumulate gains accrued until May 31, 2019, which are currently taxed only upon liquidation or amortization, would be taxed at once on that date.

The biannually collected WHT would be complemented upon distribution or redemption in case the WHT rate then applicable is higher.

The bill makes it clearer that this “come-cotas” would follow the usual rates of 15% for long-term funds and 20% for short-term funds3.

Extension of “come-cotas” taxation to closed-end funds had been announced by the Government as a means to help balance the federal budget. It however may be challenged in courts on constitutional grounds: income tax can only be imposed on income that is accessible to the investor, which does not occur in the case of closed-end funds before the fund is liquidated or amortized.

According to the bill, the following closed-end funds would remain free from “come-cotas” taxation:

Funds established solely for non-Brazilian resident investors; Real Estate Investment Funds (FII); Receivables Investment Funds (FIDC) and funds-of-funds (FoF) specialized in FIDC shares (FIC-FIDC); Stock Investment Funds (FIA) and FoF specialized in FIA shares (FIC-FIA); Private Equity Funds (FIP) and FoF specialized in FIP shares (FIC-FIP); Infrastructure FIPs (FIP-IE) and FIPs for Intensive Economic Production on Research, Development, and Innovation (FIP-PD&I); and Other closed-end funds which, on the date of publication of the new law, expressly provide in their regulations for their...