Brazilian Monetary Council approves new rules on concept of ‘Investment Entities’ for tax purposes
Resolution regulates new tax exemption requirements applicable to non-resident investors in Brazilian Private Equity Funds and closes loopholes concerning taxation of investment funds for Brazilian investors
On December 21, 2023, the Brazilian Monetary Council (CMN) held a meeting to approve CMN Resolution No. 5,111. The resolution provides a new definition of the term ‘Investment Entities’ that distinguishes Brazilian Private Equity Funds (FIPs) exempt from paying tax from FIPs subject to a 15% withholding tax on distributions. This development comes in the wake of the elimination of previous requirements in October 2023 (including the so-called ‘40% test’ and tax-specific portfolio requirements) as a result of Law No. 14,711/2023 (please click here for more information on those changes).
The release of CMN Resolution No. 5,111 concludes the process of regulating this tax exemption, as it provides the necessary guidance for reviewing current investment structures and structuring new funds. As a result, the legal certainty surrounding the tax treatments applicable to such structures has been substantially improved.
The resolution provides objective criteria for classifying a fund as an investment entity. For example, aspects of this classification may include traditional private equity structures, local professional management, and structures for raising foreign capital (including via pension funds and foreign sovereign wealth funds). This provides greater legal certainty and allows for identifying the tax treatment each structure should be subject to – an important element of the different strategies commonly used in the asset management arena.
Based on the concepts provided for in Law No. 14,574/2023 and inspired by provisions in CVM Rule No. 579/2016, the resolution outlines examples of funds that should be considered ‘non-investment entities’. This includes cases where an individual holding the majority of a fund’s quotas makes decisions on the composition of the fund’s portfolio, is an officer of the portfolio companies, or has controlled such companies in the five years preceding the investment in the fund.
On the other hand, CMN Resolution No. 5,111 also lists situations that do not disqualify the fund as an investment entity. This includes the existence of governance bodies, shareholders’ agreements, and minority investments made in the fund by the manager or individuals within the management structure conducted in line with investor interests (i.e., investments that give them ‘skin in the game’).
The resolution also provides additional detail in regard to a concept in Law No. 14,574/23 that permits a fund’s professional management structure to be established offshore. In this regard, the resolution lists different types of foreign investors with discretionary management structures, such as partnerships, investment funds, sovereign wealth funds, pension funds, endowments, government agencies, multilaterals, and development agencies.
The ‘investment entity’ definition provided in CMN Resolution No. 5,111 is also relevant for investors residing in Brazil, as it differentiates certain funds that stand to benefit from a withholding tax deferral from those subject to semi-annual taxation. Furthermore, it regulates certain aspects of the new rules applicable to investment funds in general in Brazil from 2024.