By the end of 2019, the Brazilian Internal Revenue Service (IRS) issued an interpretative rule (Interpretative Rule no. 5/2019) clarifying that the ‘jurisdiction of origin of foreign investments’ in Brazilian financial and capital markets should take the jurisdiction where the direct investor in Brazil is resident or domiciled into consideration, rather than the jurisdiction of indirect investors or the jurisdiction of the ultimate beneficial owners (UBO).
The discussion is relevant because Brazilian tax laws grant particular income tax benefits (tax exemptions and reduced tax rates) for any foreign investor that invests in Brazilian financial and capital markets, in accordance with applicable regulations that rule against residents of jurisdictions blacklisted as tax havens by the Brazilian IRS.
While such tax benefits were enacted decades ago, no material doubts were raised in regard to the issue until the tax ID regulation was amended in mid-2016 to require foreign investors (along with domestic taxpayers) to disclose their corporate/investment chain until reaching their respective UBO, if any.
An UBO for this purpose is an individual with some level of voting rights that would allow control or significant influence over the foreign investor (any individual holding direct or indirect stake of 25% or more is deemed to be an UBO).
Even though such amendments in the tax ID regulation has not changed any of the tax laws that grants the tax benefits for foreign investors, increasing concerns started to be raised for investment structures composed of multi-jurisdictional layers and multi-jurisdictional indirect ultimate investors.
What would be the consequence, in a given investment structure, if the foreign investor discloses a Brazilian resident individual (or an individual residing in a blacklisted jurisdiction) as its UBO? What if certain indirect investors in the upper tiers of the investment chain, holding less material indirect stakes, could be residents of a blacklisted jurisdiction or even in Brazil? Would those factors be relevant in determining the applicable tax treatment for those cases?
As an example, a foreign investor in Brazil could take the form of an international investment fund incorporated in a non-blacklisted jurisdiction, such as the United States, the United Kingdom or Luxembourg among others, to raise funds in the international market. Investors of such international investment funds could invest in that fund directly or indirectly through their particular structures, and would generally include large institutional investors (such as pension plans, endowments and sovereign governments), listed pulverised vehicles, family offices of high net-worth individuals and funds of funds with global/macro investment strategies.
Looking further, it is worth discussing what could be the investor base of this last category: the fund of funds. Evidently, it could also be formed by those same categories of investors (eg. institutional investors, listed vehicles, family offices and other funds of funds), and so forth. It might as well be the case that some Brazilian based fund, with a global/macro investment strategy allocated a fraction of its portfolio in one of those international fund of funds, that by turn invested a portion of its portfolio in the international fund that, by its turn, invested a portion of its portfolio in Brazilian assets.
Assuming full compliance with applicable regulations, should any of those factors matter to determine the Brazilian income tax treatment on income and gains earned by the foreign investor, in connection with the investments made in Brazilian financial and capital markets?
They do not matter in accordance with the best interpretation of the relevant Brazilian tax laws, and the clarification provided by the interpretative rule issued by the Brazilian IRS, that is binding for the whole tax administration.
However, it is important to note that the interpretative rule recognised that the jurisdiction of origin of the investment is the one of the direct investor investing in Brazil but carved-out the cases of sham and fraudulent transactions.
Because experience in tax disputes in Brazil shows that there could be some level of dispute as to the characterisation of sham and fraudulent transactions, some questions could remain unanswered and disputes could arise in the future in connection with the matter.
Evidently the carve-out for sham and fraudulent transactions could be applicable, for instance, to a foreign investment vehicle that is wholly owned by a Brazilian resident individual hiding behind the structure, and that has not properly reported such investment in its income tax returns or has not complied with applicable foreign exchange regulations. Yet, there may be other cases where the applicable regulations were fully complied with, the indirect investment was properly reported in the correspondent income tax return, and where the Brazilian resident individual has not incurred in any misconduct and has not committed fraud or sham of any sort.
Even if some of the questions remain not entirely clarified, the interpretative rule is a positive development for the discussion, given that it avoids diverging interpretations among the tax inspectors and brings more certainty to the tax treatment of foreign investment in the Brazilian financial and capital markets.
Flavio Mifano
T: + 55 11 3147 7842
E: flavio.mifano@mattosfilho.com.br
