Illegal Tax Assessments Against Private Equity Funds

Author:Ms Isabela Frascino and Pedro Raújo Chimelli
Profession:Levy & Salomao Advogados

After threatening to charge Withholding Income Tax (WHT) from local financial institutions acting as legal representatives of foreign investors if any Brazilian residents were identified as ultimate beneficial owners (UBO) of the foreign investments in local funds, the Brazilian Federal Revenue Service (RFB) has now begun to issue tax assessments against local Private Equity Funds (FIPs) that receive foreign investments from entities or other funds domiciled out of Brazil, without being able to prove who are the UBOs of these foreign entities.

In being unable to prove the inexistence of any Brazilian resident UBOs, local FIP administrators have started to receive tax assessment notices charging WHT at a punitive rate of 35% (applicable to payments made to unidentified beneficiaries) on income earned by non-resident quota-holders. This applies over a grossed-up basis deemed net of WHT, which increases the effective tax burden to 53.85%.

The tax assessments derive from a misinterpretation of the tax legislation, for there are no rules demanding from FIP administrators the knowledge and provision of detailed information and documents on UBOs of foreign investment structures. This obligation is imposed exclusively on the legal representative of the foreign investor.

Neither is it possible to deem as “payment to unidentified beneficiaries” the remittances made to foreign quota-holders who are known and perfectly identified, not only by the FIP administrators, but also by the RFB, as they must be registered with the National Registry of Legal Entities (Cadastro Nacional das Pessoas Jurídicas - CNPJ) prior to their investment in local FIPs.

Although the tax liability/responsibility belongs to the paying source (i.e. the FIP administrator), for the purpose of determining the proper taxation on the FIP's investments what matters is that the direct foreign investor - taxpayer of WHT and holder of FIP quotas - is not resident in Brazil.

Indeed, the legislation granting tax benefits to these investments requires only that the quota-holder be a foreign investor not resident in a tax haven jurisdiction (as defined by the Brazilian legislation). According to the regulations currently in force, it is sufficient that the administrator of the foreign resources informs the Brazilian paying source that the investment originates from a foreign jurisdiction not deemed as a tax haven in order to ensure the application of the more favorable taxation. Only the...

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