Brazil Takes Aim at Investment Funds for the Wealthy

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By Ed Taylor

As part of its efforts to reduce a massive projected 2018 fiscal deficit, Brazil’s government is going after large fortunes hidden in closed investment funds.

These funds, also called exclusive funds, are opened by individuals and to date have only paid taxes when profits are redeemed, or at the time of annual amortizations. The government believes the closed funds are used by Brazil’s wealthiest families to invest large sums, often stemming from the sale of family assets.

The government took aim at these investments on Nov. 1 by issuing Provisional Measure 806, which establishes a taxation structure for the closed funds that closely mirrors that of Brazil’s open funds. Starting next year, closed funds will begin to pay a semester capital gains tax ranging from 15 percent to 22.5 percent, with the higher rate paid on investments of under 180 days and the lower rate charged on investments in excess of 720 days. Investments in open funds actually pay less: a rate of 20 percent for short-term investments.

“This places the holders of quotas in closed funds in a situation that is potentially more onerous than investors in open funds,” said attorney Flavio Mifano, a partner in the law firm Mattos Filho, in a Nov. 27 email to Bloomberg Tax.

About $125 billion is estimated to be invested in the closed funds, though no one knows the exact amount, according to Fernando Gelman, a partner in the investment firm Brainvest. Government officials have said they are expecting the new taxation to bring in $2 billion a year in tax, but market analysts and attorneys say the total could be much greater.

Brazil’s 2018 deficit is projected to be about $50 billion.

Sell Assets

“A lot of people are going to have to sell assets to pay the tax,” Gelman said via email Nov. 27.

In general, investments in the closed and exclusive funds are made for set periods of 10, 20 or 30 years. By avoiding taxation until the funds mature, investors have been able to significantly reduce their tax payments compared with investors in open funds.

But these gains will suffer a serious reversal May 31, 2018, when all of the capital gains of these funds accumulated as of Jan. 2 which have not been redeemed will be taxed at the rate of 15 percent. After this, the profits of the funds will be taxed twice a year in May and November, at the new rates.

Loud and Clear

The government is sending a clear message that it will no longer tolerate certain wealth management strategies, said Guilherme Cooke an attorney at he law firm Velloza Advogados.

“This affects only and exclusively the top of the pyramid, the wealth management industry, the funds whose strategy was to defer taxation,” he said via email Nov. 27.

The new taxation could spell the end for many of the affected funds.

“This will be an important loss of revenue for the wealth management industry,” Gottlieb Lindenbojm, chief executive of Wright Capital, a wealth management firm, predicted in a Nov. 27 email.

Delayed Vote?

Attorneys also expect a strong reaction from Brazil’s most powerful families.

Congress must approve the measure before the end of the year because it creates new taxation, or else it will be invalidated. Attorneys expect the wealthy to try to use their influence to delay a vote until the decree loses its validity. According to Cooke, there is little time left for congress to act. The legislature will enter into recess on Dec. 22.

Attorneys also believe that parts of the decree can be questioned judicially, including the fact that it permits the taxation of past investments.

“The constitution does not permit retroactive taxes,” said attorney Giancarlo Matarazzo of the firm Pinheiro Neto. He added that this amounts to changing the rules in the middle of the game.

To contact the reporter on this story: Ed Taylor in Rio de Janeiro at correspondents@bloomberglaw.com

To contact the editor responsible for this story: Penny Sukhraj at psukhraj@bloombergtax.com

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