Brazilian Tax Reform: Changes to the taxation of wealth held by individuals through offshore vehicles

The Brazilian Federal Government announced on 25 June 2021 the second phase of its proposed Tax Reform focusing on Income Tax. PL 2.337/2021 (hereinafter, the “Project-Law”) is intended to be effective on 1 January 2022.?

In addition to providing for the taxation of dividends, the elimination of interest on equity and changes in the taxation of investments, in this article I concentrate on the project’s intention to introduce anti-deferral rules for wealth held by Brazilian individual taxpayers through offshore entities and other vehicles incorporated abroad.

Anti-deferral rules for offshore vehicles

As previously provided for in Provisional Measure 627, of 11 November 2013 – finally never converted into law – Articles 6 and 7 of the Project-Law seek now to institute the so-called “Automatic Taxation Regime” of profits accrued by vehicles (i) located in Low Tax Jurisdictions (such as the Cayman Islands or British Virgin Islands) or benefiting from Preferential Tax Regimes (such as the US LLCs) and (ii) controlled by Brazilian-resident individuals. Please note the Project-Law seems to also capture vehicles with no legal personality such as foreign funds abroad and offshore trusts/foundations under the Automatic Taxation Regime.

Automatic taxation means that, differently from what is observed today, profits obtained by the offshore vehicle would be subject to taxation in Brazil in the calendar-year of the balance sheet on which they are ascertained, according to progressive rates of up to 27.5%, regardless of whether any distribution is effectively made to the Brazilian shareholder.

There are many doubts as to how this rule would apply since in several of the jurisdictions considered as Low Tax Jurisdictions there is no legal provision for the mandatory collection of periodic balance sheets. In addition, a mere redomiciliation of the foreign entity to a jurisdiction not listed as a Low Tax Jurisdiction (e.g. Luxembourg) would potentially be sufficient to avoid the effects of the intended Automatic Taxation Regime.

For purposes of application of the Automatic Taxation Regime, it will be considered that legal entities or other vehicles (with no legal personality) are “controlled” by a Brazilian taxpayer when the latter (alone or together with relatives, consanguineous or related, up to the third degree and/or with the spouse or partner), directly or indirectly:

• is the holder of rights that ensure, on a permanent basis, preponderance in corporate resolutions and the power to elect the majority of Directors; and/or
• has more than 50% interest in the share capital or equivalent and/or in the right to receive its profits or receive its assets in the event of liquidation.

Despite the great discussion that should take place in the Brazilian Congress, and the possibility that some points of the Project-Law may change prior to its approval, in relation to the Automatic Taxation Regime care has already been taken to define in the Project-Law that only the profits earned from 2022 onwards would be subject to this new Regime (the Project-Law expressly says that “profits will be considered available to the controlling individual residing in Brazil on the calendar-year of the balance sheet in which they were ascertained”). Also it would seem the Regime will apply to any income, irrespective of whether is active or passive or whether the offshore vehicle has economic substance or not. It is also important to note that upon actual receipt of dividends, the positive forex exchange variation, if any, would be subject to tax as a capital gain.

If the Project-Law is approved in its current form many Brazilian tax-resident high net worth individuals will need to re-assess their wealth structuring strategies. Many of those investing through offshore vehicles will most certainly need to review these in order to preserve and ensure the tax efficiency of those structures.

Offshore vehicles may subscribe international life assurance

In this context, Managers and Directors of these investment vehicles should start considering strategies to remain relevant and efficient for their Brazilian-resident shareholders. A venue they should consider is having the offshore vehicle investing the wealth currently under it into a Luxembourg unit-linked life assurance policy which, if properly structured and substantiated, will remain a robust, fully compliant and tax-efficient long term wealth planning solution?providing:

• Full Income Tax deferral on all income generated under the life contract. For as long as the offshore entity does not surrender the life policy no income is generated at the level of the vehicle.
• Efficient and flexible succession planning capabilities.
• Portability of the contract in case the circumstances would change in the future and possibility to design cross-border solutions in case family members are spread across different countries.
• Possibility to keep certain influence on how the portfolio linked to the life contract is managed.
• Access to international assets and institutional investments, including private equity, hedge funds alternative investments, etc.
• Wealth protection under Luxembourg policyholder protection rules, one of the strongest asset protection mechanisms provided for by a country rated Triple AAA.
• No taxation on payments made from the life policy to Brazilian-resident beneficiaries upon termination of the contract.

As already stated above, the Project-Law will now be discussed in the Brazilian Congress. We will therefore need to follow up on any changes the Project-Law may suffer prior to its approval, including the possibility of changes in the proposed Automatic Taxation Regime (as it currently stands and I have herein described) or even its removal as it already happened in 2013 when the Provisional Measure 627 was proposed.

Written by Pablo Peci?a