Tax Reform: 4 Suggestions delivered to the Ministry of Economy

On February 25th, I had the fortunate opportunity to meet with the Special Advisor to the Minister of Economy, Isaías Coelho, together with the following members of the Brazilian Federal Revenue Service: Fernando Mombelli, Undersecretary of Taxation and Litigation, Roni Peterson Bernardino de Brito, Advisor to the Undersecretariat of Taxation, and also Mariana SinicioGovernment Relations Consultant at Sinicio & Benatti. The purpose of the meeting was to present 4 suggestions to the Ministry of Economy on Tax Reform of the IRPF, in order to make the tax rules clearer and simpler, avoiding the contradictions that foreign investors in Brazil and Brazilian investors abroad currently have to deal with.

That's why, we present some of the various difficulties faced by who live abroad and invest in BrazilBrazilian citizens who live abroad and have handed over the Declaration of Final Departure from the Country (DSDP)or foreign investors who want to invest in Brazil. 

We argue that the lack of clarity in Brazilian rules hinders investments in the countryespecially because of the confusing guidelines on the correct fulfillment of tax and exchange obligations. We therefore suggest four solutions:

• Clearer rules for defining status tax of a person, either as a tax resident in Brazil or as a non-resident;
• Simpler rules for taxing income from financial investments abroad;
• Allow the creation of an optional income tax return for investors not resident in Brazil;
• Create a tax residency certificate in Brazil, to make it easier for Brazilians to obtain tax incentives abroad from foreign tax authorities.

In this text, I will briefly talk about the suggestions made, in order to go into them in greater depth later in specific texts for each of them.

1. Tax residency and "definitive intent" 

One of the main issues raised by us in the debate on Tax Reform refers to the tax concept of residenceby applying the notion of "definite mood" and its reference to the Civil Code. It is possible to see that even public bodies present confusing information, as in the guidelines offered by the Brazilian Government to the OECD within the scope of the exchange of information within the Common Reporting Standard (CRS)which are incomplete and don't even refer to the updated IRS regulations¹See SRF Normative Instruction 208/2002..

Furthermore, the New Foreign Exchange Law²Law no. 14.286/2021, art. 1.As a result, the Central Bank was allowed to set its own residency criteria for foreign exchange purposes, which until then should have been the same criteria used by the Internal Revenue Service. This is likely to hinder investment even more from 2023, when the New Foreign Exchange Law comes into force. From then on, we will have two authorities with different criteria for interpreting an individual's situation.

Because of this scenario, we proposed that a tax residence criterion be adopted that preserves the link with the concept of civil domicile that exists today, but with rules that harmonize it with the concept that should be followed by the Central Bank for exchange and statistical purposes.This is so that, as far as possible, the criteria adopted by the two authorities are the same within their respective competencies. 

What's more, we suggest that the law provides for specific rules for special cases, such as students, medical patients e professionals "on board" (such as crew members of ships, aircraft, oil rigs, space stations, etc.), as well as diplomats, military personnel and other public servants on mission, professionals linked to international organizations, cross-border workers, iindividuals with jobs that require high mobility e refugees, given the special characteristics of people's lives in each of these scenarios.

Another proposal was to provide a clear and less case-by-case definition of how the main and ancillary tax obligations will be fulfilled in the year of transition from being a tax resident in Brazil to being a non-resident, and vice versa. To this end, we suggest that all income tax returns have the same format, with a special situation formIf you have acquired or lost tax residency in Brazil during this period, please provide the corresponding dates.

A single declaration format would also make it easier to compliance in situations not foreseen by the current income tax return format, but still legally possible, such as when one of the members of a couple is a tax resident in Brazil and the other is not, because they work from abroad supporting their family in Brazil. 

2. Taxation of Financial Investments Abroad

We dealt with Income tax reform proposed in 2021 by the Government, in PL 2.337/2021. In its original formatThe bill brought considerable innovations in the taxation of financial investments, such as:

• reduction of tax rates to 15% (fifteen percent) in various situations;
• simplification of the calculation of the tax base, with quarterly calculations of net gains on the stock exchange and over-the-counter market, without distinguishing between normal operations and those of day-tradeand with annual rather than half-yearly fees;
• a transitional rule in which closed-end funds become subject to the quota-come tax, paying 10% instead of 15% on the stock of accumulated income if they spontaneously pay the tax within a pre-established period. 

These changes were approved by the Chamber and have remained so until now under discussion in the Federal Senate.

One point that Bill 2.337/2021 failed to address was the taxation of the same financial investments made abroad by tax residents in Brazil. The current rules³See SRF Normative Instruction 118/2000 and art. 16 of SRF Normative Instruction no. 208/2002. are extremely confusing, laborious and generally not complied with by taxpayers. 

In addition, the way the current rules operate is also excessively cumbersome. Financial transactions subject to foreign currency capital gain rules carried out directly by the individual must be reported one by one, rather than by period.

We therefore suggest, in addition to a single form for reporting stock market investments made in Brazil and abroad, the following improvements to our tax system: 

• Currency conversionThe general rule is to use the exchange rate on the date of acquisition/disposal of the investment, although it is possible to use the exchange rate on the last working day of the calculation period for the sake of simplicity; 
• Cost of acquisition: The taxpayer can opt for the weighted average cost or the PEPS method (first-in-first-out, as is allowed in inventory accounting for IRPJ and CSLL purposes), as long as the adoption is consistent. 
• Qualification of interest and dividends: Interest and dividends received abroad can be unified at the same rate, 15%, whenever they refer to portfolio investments (i.e. without control or significant influence). This would reduce complexity, including for the situation of investment funds, which generally do not adopt the form of "pooling of resources constituted in the form of a condominium", preferred by Brazilian law, abroad. Alternatively, the income from investment funds abroad could be treated in the same way as fixed or variable income financial investments and subject to the same taxation, regardless of the classification adopted by the fund's jurisdiction of origin. In this case, it would be enough to confirm that the investment fund meets the criteria of the local jurisdiction in order to qualify as such.
• Compensation of foreign tax: It would be preferable to allow the tax paid abroad to be offset in all circumstances in which the foreign tax has the same or similar characteristics to Brazilian income tax, as is done, for example, in US legislation. It would be more efficient to make it clear that it is possible to offset the tax due abroad whenever it relates to foreign source income, even if it is paid after the Brazilian tax, making recognition of the offset conditional on proof of subsequent payment of the foreign tax; 

The idea is really to treat financial investment abroad in a similar way to the same financial investment made in Brazil, and in such a way as to minimize the possibility of double taxation.

3. Non-Resident Investor Declaration, optional

Currently, Brazilian legislation stipulates that non-residents do not have to file tax returns.
income tax after Declaration of Final Departure from the Country (DSDP)unless you go back to
assume the status of tax resident in Brazil.

Despite the beneficial intent, there are situations in which it is preferable to provide the non-resident investor with
submit a declaration involving only income and assets in Brazil. This exists in
countries like the United States and the Netherlands, for example.

We believe that a similar provision would be favorable for people who invest in real estate,
in relation to capital gains and rents, and also for small investors.

Currently, Brazilian law (dating back to the 1940s) requires the appointment of an attorney
resident in Brazil to pay the IRRF on rents. In practice, there is no
clear way of declaring this income, since the Dirf Manual does not establish the obligation
the attorney-in-fact from submitting the Dirf, even though he is responsible for paying the tax.

Most taxpayers today want to collect the tax spontaneously and in the name of
even if they live abroad. And most of these taxpayers file their returns
annual adjustment by mistake, believing he was complying with tax legislation.

The proposal is to maintain the current format of exclusive taxation at source, with the source
payer being the tax substitute, except when the non-resident investor submits a
income tax return stating the respective income.

4. Creation of a tax residence certificate, can be issued through e-CAC.

Currently, the Federal Revenue Service issues the "Certificate of Tax Residence in Brazil" to those who make use of an international agreement to avoid double taxation. The certificate was introduced by RFB Normative Instruction 1.226/2011.

This Normative Instruction says that it is used to provide information on the tax situation of an individual or legal entity, whether it is of interest to the Brazilian or foreign tax authority. However, the issuance of this certificate has been denied for simpler situations, in which the taxpayer needs to prove to the foreign tax authority that he was a tax resident in Brazil at an earlier date.

Furthermore, the status of resident or non-resident is not information available via e-CAC. In e-CAC you can only see the address entered as the tax domicile (which can be located in Brazil for non-residents or abroad for tax residents). Information on tax status is only disclosed in face-to-face service, with a detailed extract of the taxpayer's CPF registration status.

The proposal is to make the information available on e-CAC and allow the taxpayer to issue a "tax residency certificate" there, replicating the taxpayer's data that already exists in the Receita Federal database. The information can be issued by the system with validation of its veracity (as is already done for negative debt certificates) and, if the foreign tax authority still requires the signature of a civil servant, the certificate's information can be validated by a tax auditor via a digital service file.

Result of the discussion

The overall balance of the meeting was very positive, which I consider a small victory for our country and its taxpayers. We agreed to make possible suggestions for the text of a law or regulation of the existing law, to be evaluated by the Ministry of Economy and the Federal Revenue Service, which we should do topic by topic in the coming weeks.

I would like to emphasize that these suggestions are the result of my experience serving the many clients who read this content and are interested in our work. They are also the result of my concern about the way in which the Brazilian tax authorities currently operate, which falls short of the country's need for improvement.

On this blog you will always find relevant, up-to-date information on the subject and guidance on how to avoid problems with the tax authorities and other authorities. Feel free to tell us about your experience, share the content with other friends who need guidance and contact us by e-mail at contato@tersi.adv.br or via WhatsApp. Click here to send a message now.

Count me in!

References:

• 1
  See SRF Normative Instruction 208/2002.
• 2
  Law no. 14.286/2021, art. 1.
• 3
  See SRF Normative Instruction 118/2000 and art. 16 of SRF Normative Instruction no. 208/2002.