Another day, another possible tax to add to our list… 💸
Brazilian startup founders with corporate structures abroad might face some additional taxation on their profits and dividends, through a law in the making known as MP 1171/23.
This provisional measure changes how income tax works for people that are residents of Brazil but have earnings from financial investments, companies, and trusts abroad.
MP 1171/23 has yet to be voted by both the Brazilian Deputy Chamber and the Brazilian Senate, but the provisional measure would be fully approved by mid-September.
Ok, whew, some room to breathe. 😮💨
Still, we all know that being prepared is always a good call in Latin America. 👀
So here's everything you need to know about the MP 1171/23 (so far): what is this provisional measure, and how will it affect founders and individual investors?
(Btw, the MP 1171/23 only talks about profits and dividends. Capital gains still follow their own regulation. Yay, one less thing to worry about!)
Before the MP 1171/23, profits and dividends from offshores only got taxed when they were effectively in the hands of the Brazilian founder or investor ("regime de caixa"). The tax bracket ranged from 0% to 27.5%, depending on the total amount. If the cash stayed offshore, there was no tax to be levied.
In that sense, the MP 1171/23 promotes an anti-deferral tax regime, like what we see in countries such as Chile, Colombia, Mexico, and the US. That means you pay taxes upfront, not when you move the money to Brazil.
This provisional measure adds a separate report you have to make on your income tax declaration as an individual (Declaração do Imposto sobre a Renda das Pessoas Físicas/DIRPF).
Starting from Jan 1st, 2024, the MP 1171/23 states you'd have to also declare the yields (e.g. profit and dividends) of the capital you've invested abroad.
These accrued yields (if you already have any) will then be taxed on Dec 31st of every year ("regime de competência"). The currency is converted according to the last day of the year's USD and BRL value.
After you've declared your IRPF, the yields/profits would be taxed as such:
The provision measure only applies from 2024 onward. That means yields and profits from 2023 and before aren’t taken into account.
Still, the MP will allow Brazilian residents to update the value of their older assets abroad to their market value on Dec 31st, 2022, or Dec 31st, 2023. There will be a 10% tax on the difference between this value and the value of the asset when it was acquired. This tax should be paid by Nov 30th, 2023 or May 31st, 2024, depending on the chosen date for the market value.
Let us give you an example: say you own assets currently valued at R$100,000, and you paid R$40,000 for them at the time of purchase. If you choose to update the value of your asset, you'll pay a 10% tax over the spread between these two values, which would amount to R$6,000.
But get this. When you go to report your IRPF in the following tax year, the updated value of R$100,000 will be the baseline to calculate your tax bracket, not your old R$40,000.
That means you'll have a higher tax basis (and, therefore, lower capital gains) whenever you are disposing of the assets in the future. That's a way of guaranteeing lower taxable capital gains if you're really considering liquidating your assets and having money in your hands in Brazil.
Let's see a practical example: you're finally selling the company for R$180,000. If you declared the updated value of R$100,000, you'd pay a capital gains tax applied on the R$80,000. If you do not do the update and your company was still worth R$40,000, you'd pay the 15% to 22.5% capital gains tax over R$140,000 instead.
And that's why paying the 10% tax now and updating your tax basis will entail a lower capital gain tax in the future. 🔮
Great question, voice in my head! 😉
Let's preface by stating the obvious: if you're still in the early stages, you won't have to worry about dividends any time soon. This will only ever be something to keep in mind when your company becomes profitable. 🤞
With that out of the way, let's say you're a Brazilian startup with an intermediary in the US and a holding company in the Cayman Islands – like the Cayman sandwich, you know.
Your company's cap table sits at the Cayman level, and that's where all founders and investors hold shares. If you're making money in Brazil but looking to distribute profits and dividends to shareholders, you'll first have to move that money from your local entity to the intermediary, and then to the holding company. From there, you'll be able to spread the love.
With that context in mind, MP 1171 has a few implications when it comes to profits and dividends.
If you're only making money and operating out of your Brazilian subsidiary, you can exclude the profits and dividends coming from Brazil when calculating your taxable profit abroad. Only profits made outside of Brazil are subject to the foreign income tax.
If your foreign legal entity is paying corporate income tax in another country, you can deduct that amount from your Brazilian subsidiary's tax report, up to the tax payable ceiling of 15%.
These rules prevent double taxation on the profits generated by Brazilian subsidiaries held by controlled offshore entities, like startups incorporated overseas, but it's important to note that commonly used setups like a Cayman Islands holding or a Delaware LLC are exempt from corporate tax.
And when it's finally time to distribute profits to the offshore entity in order to pay dividends to shareholders, Brazilian tax resident individuals will be subject to an income tax rate of 27.5% when receiving their portion of the money, and the personal taxes paid on these profits cannot be credited against the tax on attributed income unless a double tax treaty applies.
The good news is that having to pay these taxes means you've made it big, so here's a positive outlook for you. Now that that's out of the way, let's get down to business.
What does "capital you've invested abroad" mean exactly? 🤨
Well, it can be further divided into three categories:
1) financial investments abroad;
2) profits and dividends from controlled entities abroad (a.k.a. offshores);
3) assets linked to trusts abroad.
The second category includes startup founders and investors and their holding companies abroad.
Buuuuut, and you can take another deep breath now, not all Brazilians will be subject to the MP 1171/23 even if it ends up being approved.
The MP 1171/23 rule applies only for:
1) Owners of the controlled entities. This means either having 50%+ ownership of shares or the power over corporate decisions, such as electing managers. If you have a minority stake on or no power over the offshore, you're in the clear.
2) Entities located in tax-advantaged countries or regions, such as Cayman and Delaware. No tax-advantage region, no new taxation for you.
3) Profits and dividends actually generated inside said entities. The foreign tax only applies to profits made outside of Brazil, so if you have a Brazilian company, all your operations are inside the country, and your foreign entities are not profitable, you'll only pay local corporate taxes for your subsidiary in Brazil. This means your foreign entities are off the hook.
4) Said entities in which over 20% of the earnings come from interest, rentals, royalties, or other financial investments. Still, pay attention to what type of money you do make under the offshore company. If it's something like what we just described, it's called "passive income" by the Brazilian Government and it can be taxed. That's in contrast to "active income," generated by economic activities like selling products and services.
Even if you fall under any of these criteria, you could still be eligible to pay less taxes. When calculating their yield, founders can deduct losses from the profits of their startup. Talk to your tax advisor to find out if and how you can qualify for these deductions.
Private investment companies (PICs) can be built both by founders or investors as individuals ("pessoa física"). But here's why the MP 1171/23 might have a bigger impact on investors rather than founders.
PICs formed with the objective of investing or passing money down generations generally have the objective of generating passive income, multiplying the money invested through the upside of each financial investment (yield). That's true even for angels that make startup investments.
In comparison, founder-created PICs generally hold a relatively small amount of cash, soon to be invested in the Brazilian operation.
If an investor surpasses the 20% passive income mark and meets the other criteria (such as having a majority stake), they'll have to pay the tax. And besides the yield of the money invested, management and performance fees can count as profit. Aaaand these are all generated in the PIC itself, not in a Brazilian operation. 😰
But just like founders, investors can also deduct losses from profits when calculating their yield.
Things are changing, but they're not as scary as you may have thought. While this provisional measure does affect startup founders, it is widely more impactful for investors.
Founders will keep having corporate structures like the Delaware Tostada and the Cayman Sandwich because their benefits go way beyond having an anti-deferral tax regime. It's about showing the best corporate governance to top investors, for example.
Until things become a little clearer, your trusted tax advisor will be able to help you navigate these murky waters with no trouble.
These changes are not yet permanent. If you would like to have your voice heard, let Brazilian National Congress know what you think of MP 1171.
(This article is constant being updated. See ya next time 😉)