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MP 1.137 reduces withholding tax on debt instruments and improves benefits applicable to FIP
To attract foreign capital, MP 1137 reduces withholding tax on debt instruments and improves benefits applicable to FIP
Provisional Measure No. 1137 (MP 1137), which establishes a zero rate of withholding income tax (IRRF) on income arising from private debt instruments that have foreign investors (non-residents) as beneficiaries, was published on 9/21/2022. In addition, relevant changes were made to the legislation of Equity Investment Funds (FIP).
Encouraging foreign investment in the financial and capital markets | zero IRRF rate
As of 1/1/2023, the IRRF rate on income deriving from investments specified below is reduced to zero:
- Securities subject to public offering issued by private corporations, except financial institutions, provided that they are registered in a registration system authorized by the Central Bank of Brazil (BC) or by the Brazilian Securities and Exchange Commission (CVM), within the scope of its powers;
- Quotas of Credit Rights Investment Funds (FIDC) whose investment policy is for the acquisition of credits originated or transferred by a legal entity, except financial institutions, and provided that they are admitted to trading in the organized market or are registered in a system authorized by BC or CVM, within the scope of their competencies;
- Financial Letters, as provided for in Article 37 of Law No. 12249/10; and
- Quotas of other investment funds (without defined classification and may be FIDC or other type of fund) that invest, exclusively and in any proportion, in: (a) assets or securities indicated above; (b) federal government bonds; or (c) committed transactions backed by federal government bonds or investment fund quotas investing in these government securities.
The benefit applies to foreign investors investing in the Brazilian financial and capital markets under the regulations of the National Monetary Council (CMN), currently CMN Resolution No. 4373 of September 29, 2014 (4373 Investors) and investment funds established abroad whose assets are formed by resources from sovereign savings of the country of origin (Sovereign Funds).
4373 Investors must also comply with the following requirements: (a) be domiciled outside a Favorable Taxed Jurisdiction (FTJ) (jurisdictions that do not impose tax on income or tax it at a rate lower than 20%, also called “tax havens”); (b) not be beneficiaries of a privileged tax regime; (c) not be considered a related party of the transferor or payor. Such requirements do not apply to Sovereign Funds, which may enjoy the IRRF zero rate even if they are domiciled in a FTJ.
Changes to the FIP Tax Regime
Articles 2nd and 4th of MP 1137 brought relevant changes to Law No. 11312/2006, which governs taxation of investments in FIP quotas, mainly related to the benefit of the zero IRRF rate for 4373 Investors.
2.1 Composition of the FIP portfolio
MP 1137 revokes the rule that requires the allocation of the FIP portfolio to a minimum of 67% of shares, subscription bonuses and convertible debentures issued by corporations, and the FIP must comply only with the rules of portfolio composition issued by CVM.
2.2 Foreign investment in FIP: changing the requirements to zero rate
One of the main changes promoted by MP 1137 is the repeal of the minimum capital dispersion requirement so far imposed for application of the IRRF zero rate on income paid to 4373 Investor quota holders, commonly called the “40% Test”, which would guarantee the benefit to 4373 Investors even if holding more than 40% of FIP shares.
In addition, in order to harmonize the rules of portfolio composition provided for by law and those issued by the CVM, and in line with the repeal of the minimum requirement of 67% mentioned above, MP 1137 also repeals the restriction on investment greater than 5% in debt securities (except for convertible debentures and government bonds) by the FIP.
As for the domicile requirement, the original wording of Law No. 11312/06 provides that the quotaholder cannot be resident or domiciled in FTJ. However, the original wording did not include privileged tax regimes.
MP 1137 includes the privileged tax regimes in the aforementioned domicile requirement, which can generate much controversy, considering that several investments in FIP are made by companies that theoretically enjoy privileged tax regimes such as Limited Liability Companies (LLCs) located in the USA. It is worth checking the list of privileged tax regimes provided for in Normative Instruction 1037/2010.
MP 1137 establishes that Sovereign Funds are beneficiaries of the zero IRRF rate when they invest in FIP, even if they are residents or domiciled in FTJ.
2.3 Equitable treatment of foreign investment in FIP, FIP-IE and FIP-PD&I
MP 1137 recognizes the application of the zero rate also for income paid to 4373 Investors who invest in Infrastructure Investment Funds (FIP-IE) and Investment Fund in Participation in Intensive Economic Production in Research, Development and Innovation (FIP-PD&I), as described in Law 11478 of 2007, correcting a historical distortion in the tax treatment applicable to investors of such funds.
- Validity and effectiveness
MP 1137 comes into effect with its publication, but with effects production from January 1, 2023 on. The National Congress has up to 120 days to convert MP 1137 into law, with possible changes. If its conversion into law does not occur, the National Congress must regulate the effects of the legal relations constituted in its validity.
