Tax Law Highlights | Taxation of Offshore Assets - Law No. 14.754/23

1. Updates in evidence:
Law 14.754/2023 establishes new rules for the taxation of investments held by individuals abroad (including offshore companies and trusts) and instituted the "come-cotas" regime (advance payment of income tax, which occurs at six-month intervals) for certain closed-end investment funds set up in Brazil.

To explain more about the subject and clarify some important points, we have prepared material on the taxation regime for offshore companies.

Read below for a summary of this material and to download the complete content at the end.

2. Introduction:
In the investment structure usually adopted by Brazilians, companies could be set up abroad (offshore) which made financial investments, earning income and reapplying the funds. As taxation only took place when the funds were made available to the Brazilian partners, this structure allowed (Brazilian) taxation to be deferred until such time as the funds were made available to the Brazilian partner via a dividend distribution or capital reduction.

Law 14.754/23 sought to end the structure that allowed deferral of taxation on financial investments using offshore companies. Taxpayers must include in their individual income tax returns (DIRPF) income from offshore companies that meet the requirements of the law on December 31 (the last day of the calendar year).

This is why it is said that taxation is "automatic", because income tax is levied even if the profit has not been distributed to the shareholders via dividends. In international tax practice, the term Controlled Foreign Corporation Rules (CFC Rules) is used to desig

nate the tax policy which stipulates that income generated by foreign subsidiaries must be taxed by the country of residence of the parent company, even if it has not been distributed as dividends. For this reason, it can be said that Law 14.754/23 established the CFC Rules regime for individuals.

3. Tax landscape:
Brazil inaugurated the CFC Rules for foreign companies controlled by Brazilian legal entities in 2001 with the enactment of Provisional Measure No. 2.158-35/2001. This regime is full of legal controversies, some of which were decided in Direct Action of Unconstitutionality No. 2.588 and judged by the Federal Supreme Court (STF) in 2013, which ruled that the CFC Rules regime of Provisional Measure No. 2.158-35/2001 would be constitutional for controlled companies and unconstitutional for affiliated companies that were not based in tax havens.

Law No. 14.754/23 inaugurated the CFC Rules for individuals but with similarities and differences to the regime of Provisional Measure No. 2.158-35/2001 (which has already been analyzed by the Supreme Court). It is therefore important to analyze whether the grounds of the STF's decision in 2013 are equally applicable to the regime of Law 14.754/23 and, in relation to the differences, whether they are compatible with the Constitution.

4. Repercussions and changes:
Profits earned by offshore companies that fall under the situations provided for in Law 14.754/23 will be taxed by individuals on December 31 of each year from 2024 onwards. For didactic purposes and to simplify some exceptions, there are three groups of conditions that determine the "automatic" taxation, on December 31, of the profit earned during the year:

(i) being incorporated in a "tax haven";
(ii) being subject to a privileged tax regime; or
(iii) having an Active Income of less than 60%.

For offshore entities that fall into one of the three hypotheses described above, the accounting profit for the year (without considering the equity result) must be converted from USD to BRL and taxed on December 31 at a rate of 15%. There are some special rules for (i) partially offsetting the tax paid abroad (with a series of limitations and bureaucratic requirements) and (ii) offsetting losses of the controlled entity itself that are calculated from 2024 onwards.

For other offshores (i.e., those not subject to the "automatic" taxation regime), the general rule will continue to apply that taxation will only occur when the funds are actually made available to the shareholders, applying the rate in force at the time the funds are received. Optionally, the taxpayer can also apply the "automatic" taxation regime on December 31 of each year.

Profits earned before Law 14.754/23 came into force cannot be subject to "automatic" taxation, otherwise the tax law would have retroactive effects, which is prohibited by the Constitution. The law gives taxpayers the option of paying income on these profits in advance (which would only occur when they are distributed) at a reduced rate (8%) and without taxing the exchange rate variation.

5. What conclusions can we draw?
The "Automatic" Taxation Regime can lead to income tax being levied on "fictitious" or "virtual" income. This is because taxation takes place before the end of the investment on "temporary gains" that may not materialize. The compatibility of this taxation with the principle of income realization especially for highly volatile financial assets (i.e., crypto-assets and hedge funds) - tends to be the subject of analysis by the Brazilian judiciary in the coming years.

The "anticipation" of taxation on profits earned until 2023 proves to be advantageous for individuals who made investments abroad when the Brazilian Real was valued against other currencies. In addition to the reduced rate of 8% (the rate currently in force is 15%), the "anticipation" of taxation expressly excludes the exchange rate variation, which will be taxed if the taxpayer chooses to tax the profit earned up to 2023 when the amounts are effectively repatriated.

Law No. 14.754/23 does not allow taxpayers to offset losses recorded in one company against gains recorded by another company. Unlike the "automatic" taxation regime for profits from offshore companies controlled by legal entities (Law No. 12.973/14), the regime under Law No. 14.754/23 does not allow individuals to "offset" gains/losses recorded by several controlled companies within the same calendar year. The compatibility of this provision with the principle of the universality of income is likely to be the subject of analysis by the Brazilian judiciary in the coming years.

The Tax team is available to discuss these matters and practical aspects of international structures.