Brazil: Changes to the calculation basis and withholding tax for interest on net equity payments
On September 30 2015, the executive branch of the Brazilian Government released Provisional Measure 694/2015 (PM 694). Among other items, PM 694 amends the relevant legislation concerning the withholding tax applicable to payments of interest on net equity (INE) as well as introducing a further limitation in relation to the calculation base for such payments.
By way of background, INE is an alternative way of remunerating shareholders for investments made in Brazilian companies, calculated based on their net equity. INE is conditioned to the existence of profits and deductible up to an amount limited to the greater of:
50% of net income before corporate income tax (and after social contribution on net income) for the current year; or
50% of retained earnings and profit reserves.
Such payments of INE are determined based on the pro-rated calculation of the company's net equity accounts (with certain adjustments) multiplied by the long-term interest rate (TJLP). Before the introduction of PM 694, INE payments have generally been subject to a 15% rate of withholding tax, unless the recipients are located in a tax haven, in which case the withholding tax rate should generally be 25%.
Pursuant to PM 694, the calculation basis for INE payments should consider a pro-rated calculation of the company's net equity accounts multiplied by TJLP or 5% per year, whichever is lower. This limitation is potentially significant given the TJLP for September 2015 was 6.5% (increasing to 7% for October 2015 to December 2015). Further, the PM also increases the withholding tax rate to 18% (previously 15%). For foreign shareholders that cannot take advantage of the credit for the withholding tax, this increase could result in a further tax leakage. Treaty benefits should be considered.
It is important to emphasise that a provisional measure is a provisionary law, issued by the executive branch of the Brazilian Government, which has authority of law until it is acted upon by the Brazilian Congress within a prescribed 60-day period. If Congress does not act within this initial period, then it expires unless it is extended for an additional 60-days.
PM 694 entered into effect on the date of publication, however the changes outlined above should only take effect from January 1 2016.
It is important to note that amendments to provisional measures during the process of conversion into law are very common, therefore it will be important to monitor the developments of PM 694 during the conversion process.