PL 4173 and the New Taxation of Offshore Companies

The Draft Law 4173 (PL 4173), whose text came from a recent provisional measure, demonstrates the application of Income Tax on Trusts and Controlled Companies abroad. Let’s delve into this scenario in more detail.

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Author: Leonardo Almeida Lacerda de Melo

Offshore Companies

The use of offshore companies by Brazilian residents is quite common, both for internationalized companies and for Brazilians who have reached a certain level of wealth that requires specific planning for asset management, succession, and tax matters.

One significant advantage of this approach is the absence of direct taxation on offshore companies, as the Brazilian tax system is limited to taxing companies operating within the national territory.

However, in August of this year, the Draft Law 4173 was presented, which establishes the taxation of profits earned by offshore companies controlled by Brazilians, as well as assets and rights held in Trusts. Its original text came from the Provisional Measure 1172, recently sanctioned without the articles regarding offshore taxation. This matter, still relatively unexplored due to its recent nature, will take effect starting in 2024, and the PL itself will need to be analyzed by the National Congress. Let’s delve into these issues in more detail.

The Taxation Scenario Before PL 4173

The taxation of companies controlled abroad is a complex and strategic issue for many Brazilian companies operating internationally. In today’s scenario, before the promulgation of PL 4173, these companies are still subject to a specific tax treatment aimed at preventing tax evasion and promoting transparency.

In this model, Brazilian companies with subsidiaries or controlled offshore are subject to differentiated taxation, based on the principle of territoriality. That is, profits and income obtained by offshore were taxed in the country where they were located and were not directly subject to taxation in Brazil.

This approach allows for tax benefits, such as a reduced tax burden on profits earned abroad. However, it also brings challenges, such as the need to keep track of the tax legislation in different countries and deal with the complexity of calculating and repatriating profits.

Naturally, when receiving profits from the offshore company, the individual, or legal entity resident in Brazil must declare these profits as dividends to the Brazilian tax authorities. This declaration has a different treatment compared to dividends received from Brazilian internal companies, as it involves income earned abroad. The taxation will vary depending on the individual or entity and the tax regime adopted.

Significant tax advantages can be observed in the case of offshore companies, where proper planning allows for using this tool for asset management. This can even enable the tax reduction of certain taxes, such as ITBI (Tax on the Transmission of Real Estate Property) and ITCMD (Tax on the Transmission of Causa Mortis and Donations), when creating holding companies abroad.

The absence of Brazilian taxation on offshore companies opens the path to using tax havens’ legislation for asset planning through Trusts with considerably favorable taxation. This is the current scenario before the implementation of PL 4173 as it is currently written.

What Changes with the New PL 4173

As previously mentioned, the Draft Law establishes the application of Income Tax directly on companies controlled in the country where they operate, as well as on Trusts used for asset planning.

However, the measure presents an ambiguous scenario when delving into technical aspects, as it risks generating double taxation on the same tax base, and it does not consider the various non-double taxation treaties that Brazil has with several countries worldwide.

Due to these issues, there is an expectation of a considerable change in the original text of the Draft Law in the National Congress if it is approved. Nevertheless, let us analyze the current scenario and the specific provisions of the new measure, with its scope and more specific matters.

New Taxation of Controlled Offshore

PL 4173 states in its chapter III the application of its tax rate on companies controlled abroad. This chapter presents the definition of Brazilian controlled companies, which are foreign companies with more than 50% of their quotas owned by Brazilian resident individuals or related parties, including companies owned by the resident. In other words, if the Brazilian resident or any company in which they are a shareholder owns more than half of an offshore company, this offshore will be subject to the PL’s tax rate.

Another requirement imposed by the Draft Law is that the controlled company must be located in a country with preferential tax treatment or have its own income less than 60%.

Regarding own income, it involves a slightly more technical analysis and requires closer attention from the reader. It essentially states certain sources of income of the company that are not considered own income, as they are passive incomes. If these passive incomes exceed 40% of the total income of the company, it must fall under PL 4173 and, therefore, be subject to taxation under the measure. Let us take a closer look.

Definition of Own Income and Its Impact on the Incidence of Controlled Companies in the New Law

The Draft Law defines Own Income as income acquired through the company’s own commercial activity, excluding income from the list in the same chapter regarding this form of taxation:

• a) royalties;
• b) interest;
• c) dividends;
• d) equity interests;
• e) rents;
• f) capital gains, except in the sale of equity interests or permanent assets acquired more than two years ago;
• g) financial investments; and
• h) financial intermediation.

In other words, a company that derives more than 40% of its income from the sources listed above and is considered a controlled company according to the PL will be taxed accordingly.

It’s important to note the provision of royalties in the list provided by the Draft Law as income derived from activities other than the company’s own commercial activity. This provision requires attention, as many software companies offer their products through royalty retribution, which will likely result in the incidence of the PL’s tax on these companies.

There are also provisions for other exceptions related to the concept of Own Income. This happens, for instance, in the specific scenario where a Brazilian controlled offshore is an authorized Financial Institution. In this case, interest, financial investments, and financial intermediation will be considered Own Income and excluded from the list provided for this specific type of offshore company.

As demonstrated, the scenario requires tax planning regarding both corporate matters and profits of companies controlled abroad to avoid higher taxation on their income. However, this issue may also affect Brazilians who currently reside abroad and own companies in their country of residence. Let us see more about it.

How the New Law Affects Brazilian Residents Abroad and the Importance of Definitive Exit Declaration

The new law requires particular caution regarding Brazilian residents abroad. This applies specifically to Brazilians who leave the country without making the proper, Definitive Exit Declaration (more information in our post). When a Brazilian living abroad fails to submit the Definitive Exit Declaration, they continue to be considered a resident in Brazil for tax purposes and must continue to declare Income Tax in Brazil as required by law.

The issue arises when a Brazilian who did not file the declaration opens a company in their current country of residence. For the purposes of PL 4173, this company is considered a controlled offshore and may be subject to taxation at the rate provided in the PL. This matter demands caution from the Brazilian regarding their tax regularization in order to prevent unnecessary tax burdens on their assets.

The Importance of Specialized Assistance

The PL 4173 brings considerable changes concerning tax planning involving offshore companies. The new tax could impose a heavy burden on the entrepreneur if proper planning is not in place.

For this reason, the assistance of specialized professionals such as those at Koetz Advocacia in international tax planning is essential to prevent the incidence of this and other taxes related to these offshore companies. As well as to provide the best approach for internationalizing their business and developing their asset planning. As mentioned before, several changes regarding the PL’s text may still occur, requiring close monitoring of all assets held abroad.