Income tax reform in Brazil: interest on extinguishment of equity


In September 2021, the Brazilian House of Representatives approved the Income Tax Reform Bill (Projeto de Lei ‘PL’ n ° 2.337 / 2021) under discussion in the Brazilian Parliament. This is not a final version, as it still depends on Senate approval and ratification or presidential veto to come into effect.

It should be noted that the dividend tax rate has been set at 15% (currently the Brazilian system only taxes income as profits, at the corporate level; the participation exemption is in effect, in generally since 1996), but the legislative proposal includes many other different changes in the Brazilian income tax system (personal income tax and corporate tax).

The aim of this article is to analyze one of these other changes: the extinction of the so-called “interest on equity” (IOE) tax system. This article provides a brief overview of the origins of this tax category, as well as the implications its extinction could have on national and international taxation, impacting corporate tax strategies that may need to be reassessed.

The OIE payment rules and its history

The tax regime of the OIE appeared in the Brazilian legal system through Law No. 9.249 / 1995 (a federal law) as an alternative to the remuneration of capital in relation to dividends; it is therefore a sort of “distribution of benefits”.

In short, it granted the possibility to companies operating under the Lucro Real tax regime (taxation of real profits, on the basis of accounting books) to pay interest on the equity of the companies at a given rate (TJLP). This payment is deductible from the corporate tax base, taxable profit (taxed in full at the rate of 34%), on the one hand, but this payment is subject to withholding at the rate of 15%, considered as a tax on the beneficiary of the interest (the shareholder).

This possibility has allowed a better return on the capital invested in Brazilian companies and induces the capitalization of companies by its shareholders. In other words, such a regime induced the financing of companies by equity instead of shareholders instead of debit from third parties. It is out of the question that this financial instrument was created to encourage the expansion of business activity by increasing equity, rather than debt.

The strategy then consisted of aligning the opportunity cost with that of the company’s other creditors. In other words, the tool has a very simple objective: to discourage companies from seeking resources in the financial market, which can rely on the capital of their owners. This could improve the financial health of Brazilian companies. In addition, the objective of neutrality vis-à-vis the source of funding is another hallmark of this regime, since interest in Brazil is generally taxed at 15% at source.

IOE qualification on TNT

From a legal point of view, this instrument has a hybrid character, since the OIE holds both rights and obligations typical of own funds and third party capital. This point alone already brings a multitude of complexities to the treatments accorded by national tax law, but the difficulty is even greater in the international scenario, including its qualification for the purposes of interpretation and application of tax treaties. double taxation (DTC) signed by Brazil.

It should be noted that TNTs use a schedule structure. They divide the items of income into categories, according to an autonomous qualification, in order to distribute the taxing rights among the contracting states. For this reason, they do not take a general and comprehensive consideration of the result. And then the question arises: in which category does IOE belong?

In a preliminary analysis, two possibilities arise for qualifying IOE taking into account the income categories adopted in the OECD model for tax treaties:

  • Interest, provided for in article 11 of the Model, if typical aspects of third party capital are taken into account; Where
  • Dividends, provided for in Article 10 of the Model, if typical aspects of equity prevail.

The difference in categorization leads to the application of different rules for the taxation of this type of income in international transactions: either by mechanisms adopted by the State of residence to avoid double taxation, or by the form of taxation by Source state.

It is important to mention that, contrary to what is adopted in the current model of the OECD, Brazil, in general, uses in its DTAs, for the definitions of dividends and interest, discount clauses integrating into domestic law. . In other words, for the construction of the two concepts, it must be observed that the income should be treated by the treaty in the same way as it was under the tax legislation of the State where the company which received it. payroll is a tax resident.

However, in some cases, the OIE may be qualified in one or the other category depending on the wording adopted in the relevant TNT. Although, after the publication of Law No. 9 249/1995, Brazil adopted an explicit provision in its treaties to qualify the JCP as an interest.

It was done by means of protocols concerning almost all of the TNTs signed thereafter. The only exceptions were the protocols annexed to the DTAs with Finland and Uruguay. It is important to mention that this type of protocol was not annexed to the treaties signed before the publication of the law n ° 9,249 / 1995.

extinction of the OIE

While this qualifying discussion is relevant in determining the tax rules applicable to IOE’s cross-border outbound payment from Brazilian companies, it represents some sort of tax advantage in most cases. For this reason, this form of return on capital has become very common in national and international business structures.

The extinction of the possibility of paying IOE in Brazil provided for in the tax reform under debate, if confirmed, would require the reassessment of general tax strategies regarding the distribution of income of Brazilian companies in many cases. For this reason, we highlight this possible modification of the law which will have a significant impact on the business practices related to Brazil.

Paulo Victor Vieira da Rocha

Partner, VRBF Advogados

Marina da Silva Fernandes

Partner, VRBF Avocats

Murilo Jakuk Ferreira Lopes

Partner, VRBF Avocats

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