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Taxation of foreign earnings and income: how to calculate and declare?

We are frequently called upon by our clients to calculate the individual income tax on gains and losses on financial assets abroad (shares, bonds, fund shares) and the respective income (dividends and interests). Unfortunately, the rules to evaluate foreign earnings and income are very different from those used for Brazilian sources, and quite unfavorable. In many ways, Brazilian law discourages tax residents in Brazil from acquiring financial assets abroad directly.

The purpose of this text is to describe how the gains and incomes from offshore assets are calculated by the individual and what their taxation is. We have already had the opportunity in this text to describe how foreign currency assets should be reported to the Federal Revenue Service (RFB) through the income tax statement (DIRPF) and to the Central Bank through the Brazilian Capital Declaration Abroad (CBE).This text goes a step further, describing how the alterations in the taxpayer’s equity position should be reported in the DIRPF and CBE.

Difference between foreign currency earnings and incomes: general rule.

Brazilian tax legislation, as regards the gains and income related to offshore assets held in foreign currency by individuals, is very unclear and very similar to the rules applicable to assets located in Brazil. For a first approach, we can summarize the general rule as follows:

Types of income earned abroadTax treatmentObservations
Disposals of assets or rights acquired, in any capacity, in foreign currency.Capital gainProgressive rate of 15% -22.5% (except in succession mortis cause and donation, where it is 15%)Same exemptions or reductions of assets located in Brazil.Different rules for acquisition originated from incomes originally earned in BRL  or in foreign currency.Determined transaction by transaction.Does not allow loss compensation
liquidations or redemptions of financial investments acquired, in any capacity, in foreign currency
foreign currency disposals held in cash.Capital gainProgressive rate of 15% -22.5%Exemption from sale of up to USD 5,000 / year Determined transaction by transaction.Does not allow loss compensation
result of offshore rural activityRural activityprogressive rates up to 27.5%calculated annually, separately from the results of rural activity in Braziladmits compensation for losses abroad
other income received from sources located abroadPayment bookletprogressive rates up to 27.5%monthly payment, depending on the month of receipt, and annually at DIRPF

In addition to the fact that there are four different tax treatments for gains and incomes earned abroad, the calculation needs to consider the conversion of amounts in foreign currency to BRL. And the four tax treatments apply five different conversion methods. This type of complexity makes it very difficult for individuals to faithfully observe the brazilian tax legislation.

To make the understanding easier, each of the items above will be treated separately, with a primary focus on financial assets abroad. For this reason, the results of rural activity abroad will not be developed in this text.

Capital gains in foreign currency

In our text on how to declare assets abroad, we state that, as a rule, assets abroad must be reported by historical acquisition cost.There we do not detail how to do it, which is important for the calculation of capital gains in foreign currency, and it applies to assets and financial applications(stocks, bonds, investment funds shares as well as to real estate and other assets and rights.

How to determine the acquisition cost

The procedures were regulated by Normative Instruction SRF no. 118/2000. With effect from 01.01.2000, the legislation orders the acquisition cost of assets abroad to be classified according to the origin of the income used to acquire them.There are three possible situations, with their consequences summarized in the spreadsheet below:

Origin of the resources used to acquire the asset abroadAcquisition cost, for income tax calculation purposesExample
Earned in BRL
Convert into BRL at the currency sale quote, disclosed by the Central Bank, for the respective acquisition date.Taxpayer received the paycheck in Brazil in BRL and sent the money abroad, acquiring the asset.
Earned part in BRL and part in Foreign CurrencyEach part is converted according to the rules above, proportionally to the acquisition cost in foreign currencyTaxpayer sent resources from Brazil abroad to invest in financial investments (part originated from incomes earned in BRL) and the interest from that investment was reinvested (part originated from incomes earned in foreign currency).
Earned in foreign currencyConvert from foreign currency to USD by the respective acquisition dateTaxpayer received in foreign currency remuneration for services provided abroad and used its value to acquire the asset.

How the tax amount is calculated

To facilitate the understanding, we have listed the rules for determine  the IRPF calculation base for one of the three hypotheses above:

1) Assets acquired with income originally earned in BRL: to determine the calculation basis, the values of the sale and the acquisition cost are converted into BRL and then the tax due is calculated.

  • The value of the original investment expressed in foreign currency (for example, in sterling pounds) must be converted to USD (sales parity) and then to BRL at the fixed dollar rate, for sale, by the Central Bank of Brazil, for the investment date;
  • When there is a sale, liquidation or redemption, the amount received must be converted to US dollars (purchase parity) and then to reais at the fixed dollar rate, for purchase, by the Central Bank of Brazil, for the date of receipt;
  • If the value of the investment is sold, liquidated or partially redeemed, the weighted average cost is calculated in proportion to the portion of the investment made;
  • the positive difference between the amount of the receipt and the proportional cost will be the capital gain in foreign currency, taxable at the rate of 15% -22.5% currently (except in succession causa mortis and donation, where it is 15%).

2) Assets acquired with income originally earned in BRL: to determine the calculation basis, the sale and acquisition cost values are converted to US dollars, the value of the capital gain from US dollars is converted into BRL and from there the tax due is calculated.

  • The value of the original investment expressed in foreign currency (for example, in sterling pounds) must be converted to USD (sales parity) and then to BRL at the fixed dollar rate, for sale, by the Central Bank of Brazil, for the investment date;
  • When there is a sale, liquidation or redemption, the amount received must be converted to US dollars (purchase parity) and then to reais at the fixed dollar rate, for purchase, by the Central Bank of Brazil, for the date of receipt;
  • If the value of the investment is sold, liquidated or partially redeemed, the weighted average cost is calculated in proportion to the portion of the investment made;
  • The positive difference between the amount of the receipt and the proportional cost will be the capital gain in foreign currency, taxable at the rate of 15% -22.5% currently (except in succession causa mortis and donation, where it is 15%).

3) Assets acquired with earnings originally partly in BRL, partly in foreign currency: the calculation basis is proportional to each of the origins, with the above rule applying to each one. Note that interest on financial investments in foreign currency available for withdrawal, even if they are not redeemed, are considered as zero cost capital gains by RFB, and its reinvestment is treated as originated from a income earned in foreign currency.

Consequence of the above classification

The practical consequence of classifying the asset in one of the categories above is the fact that the exchange rate variation between the US dollar and the Brazilian real is not considered in the income tax calculation basis when the origin of the acquisition is by a income earned in foreign currency. 

In a simple example, suppose that a stock was acquired for 1,000 US dollars when the price fixed by the Central Bank was 1: 1, and was sold for the same 1,000 dollars when the official price was 3: 1. If the income used to acquire this stock was originated in a foreign currency, the capital gain will be zero. That’s because, in US dollars, the difference between the sale price and the acquisition cost was zero 

If, however, the stock was acquired with incomes earned in BRL, the amounts above must be converted into BRL according to the official quote on each date. Thus, the acquisition cost was 1,000 BRL (1: 1 quote) and the sale value was 3,000 BRL (3: 1 quote). In this case, there was a taxable capital gain of 2,000 BRL (positive difference between 3,000 and 1,000).It is clear from this example that Brazilian taxation focused only on the exchange variation between the real and the US dollar during the period.

Why it is not easy to classify assets abroad according to the above rule

Distinguishing in which of the above categories the asset should be classified is, in practice, extremely difficult.The above classification was created by Normative Instruction SRF no. 118/2000, and not by the legal provision, article 24 of the Provisional Measure no. 2,158-35 / 2001. The law does not define how to classify correctly, leaving this task to the taxpayer.

Da forma como está, a legislação obriga o contribuinte a manter memória (i). do valor em reais na data da aquisição do ativo, (ii). foreign currency value on the date of acquisition of the asset and (iii). the origin of the resources used to acquire the asset.The IRS only clarified very specific situations, without a legal basis, which do not point to a clear rule:

  • the income produced by financial investments in foreign currency, even though derived from income originally earned in reais, will be considered income earned originally in foreign currency;
    • on the credited interest, if liable to be drawn by the beneficiary, the income tax is levied on the capital gain, considering its acquisition cost equal to zero;
  • in the event of a good, right or financial application transmitted by a tax resident in Brazil, in cases of succession, donation and dissolution of the conjugal company or of the stable union, the type of income originally earned by the donor or former spouse and used in the acquisition of the good or right or in the realization of the financial investment;
  • in the event that the transfer was made by a non-resident individual, the rules on financial investments and assets or rights acquired with income originally obtained in foreign currency will be applied.

It is worth noting that an important situation is still missing.Suppose that the proceeds from the sale of the stock in the previous example, in the amount of 1,000 US dollars, are used to acquire a US Treasury bond. In order to classify the origin of the resources used to acquire the security, is it important to know the origin of the resources used to acquire the share sold? The IRPF 2019 Questions and Answers Manual, Question 602, states that capital gains obtained on the sale of assets or rights abroad are considered income earned originally in foreign currency. But does this apply to all the proceeds from the sale used to acquire the security, or only to the part that was taxed as a gain? The fact is that not even the positions taken by the IRS on the subject are consistent. There are, for example, conflicting consultation solutions with each other regarding this point (Consultation Solution 6th RF No. 175/2010 and Consultation Solution 8th RF No. 115/2009).

What is possible to do

In view of the lack of clarity in tax legislation on the subject, the best position is to analyze the documentation on the origin of assets abroad. If the practical situation corresponds to one of those clarified by the IRS, there is a good justification for adopting the same procedure. Otherwise, it is necessary to check which classification is best supported by the available documentation.

The legislature, it seems, had the good intention of wanting to tax exchange variation only when there was an effective equity increase (assets purchased with funds from Brazil in reais being sold for a higher amount in reais),and non-nominal (originating in foreign currency). But the legislation made a rather artificial distinction to achieve its objective, and the IRS was unable to provide safe regulation.

Other aspects of capital gains in foreign currency

For assets and rights located in Brazil, tax legislation allows taxation for capital gain (real estate, movable assets, equity interests and financial assets acquired outside the stock market, in general) or by net gain (financial assets acquired on the stock exchange or over-the-counter market, as a rule).In the second hypothesis, losses can offset gains, reducing the calculation basis.Although there are restrictions on this compensation, the fact is that there is no equivalent standard for the acquisition of financial assets abroad. For this reason, the legislation on capital gains in foreign currency is particularly unfavorable to investments in financial assets abroad. In addition to the impossibility of offsetting losses, transactions must be reported in the DIRPF transaction by transaction. This is the opposite of what happens for financial assets held on the stock exchange in Brazil, for which net gains are grouped month by month.On the other hand, the IRS informs that the IRPF exemption on the sale of small value goods, applicable in Brazil up to the limit of R$ 20 thousand / month (for stocks quoted on the stock exchange) or R$ 35 thousand / month (other assets and rights) also applies to assets abroad.

The maximum limit of R$ 35 thousand / month is applied to assets abroad in all cases, even for shares on the stock exchange abroad (IRPF Questions and Answers Manual 2019, Question 633).

Foreign Currency held in cash

The hypothesis of capital gains on foreign currency held in kind is quite marginal in practice. This is the gain earned on foreign currency purchase and sale operations, as in the case of the person who buys euros to obtain speculative gains from exchange rate variations or only to spend on travel abroad.

The applicable legislation orders the difference in reais between the sale price and the respective acquisition cost to be taxed as a capital gain. The conversion of values into reais takes into account the average monthly price of the dollar, for sale, published by the RFB.This is a very different rule from that applicable to other capital gains in foreign currency. To control the acquisition cost, each foreign currency (euro, dollar, yen) must be calculated separately at their weighted average cost. For this specific hypothesis, capital gain is exempt if the total of foreign currency disposals held in cash during the calendar year is equal to or less than US $ 5,000. In compensation, the exemption for the sale of goods of small value for up to R$ 35 thousand / month does not apply. The control of these transactions is complex and impractical, as the RFB maintains the understanding that it is alienation of foreign currency held in cash, including the expense of the currency for payment of travel expenses, either in cash or represented by traveler’s checks (Manual Questions and IRPF Answers 2019, Question 604). Meeting the control required by the RFB would mean knowing, during a trip abroad that started in one month and ended in the following month, how much was spent each month to calculate the exact value of the IRPF.

Other income from sources located abroad

Income from sources abroad is subject to mandatory monthly payment (payment booklet) regardless of where they were earned or where the resources are kept. Once again, it does not matter whether the funds were repatriated to Brazil or not, it is enough that the income is available to the taxpayer. 

To determine the value of income from sources abroad in reais, the amount in foreign currency (for example, sterling) must be converted into US dollars at the purchase parity between the two currencies on the date of receipt. Thus, assuming that the income is received on October 1, 2019, the purchase parity between the foreign currency and the US dollar of the same day should be used. Thus, for each income received during the month of October 2019, there will be a different parity for the conversion of foreign currency into US dollars.

In the next step, the amount in US dollars must be converted into reais at the purchase price informed by the Central Bank for the last business day of the first half of the month prior to receipt. For an income received on October 1st, you should look for the quote for September 15th. As September 15, 2019 was not a working day, you should look for the 13th to find the last working day of the first fortnight, and so on. By this method, all income received in October 2019 will be converted from US dollars to reais at the quotation on the same date (September 13, 2019).Foreign earnings are added to other earnings subject to the same regime in Brazil (such as self-employment, rents and other earnings), and can benefit from the same deductions (alimony, dependents and social security contributions due in Brazil). From the sum of income and use of deductions, the value of the monthly IRPF due is calculated, at progressive rates of up to 27.5%.

In the RFB’s view, these rules also apply to profits and dividends received by the taxpayer of a company domiciled abroad, whether those credited to a bank account held abroad or remitted directly to Brazil (Questions and Answers IRPF 2019, Question 124). For this reason, a stock quoted on a stock exchange abroad will have its income (dividends) taxed by the payment booklet and its sale taxed as a capital gain in foreign currency. The interest on a financial investment abroad will be treated by the capital gains rule (both principal and interest).

Comments on reflexes of asset movements at CBE

It is worth remembering that the assets and rights abroad owned by a tax resident in Brazil must be reported to the Central Bank through the declaration of Brazilian capital abroad (CBE). In this regard, the comments in our post on “How to declare assets abroad” are valid.

Regarding the subject of this text, CBE contains some fields regarding the income related to the assets owned by the declarant on the base date (usually December 31). For some assets, such as shares and investment fund shares, information is requested on dividends or income distributed to the declarant during the period. Transactions in the purchase and sale of assets abroad do not need to be reported.

In this blog you will always find relevant and updated information on the subject, in addition to guiding you 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 get in touch with us via email contato@tersi.adv.br or via WhatsApp. Click here to send a message now.

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Vinicius Tersi é advogado, especialista em Direito Tributário Internacional.

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