As part of the measures for improving the state budget, the Brazilian Government has enacted the Provisional Measure 694 (“MP 694/15”) on September 30, 2015.
Among other provisions, MP 694/15 brought significant changes to (i) the deductibility rules applicable to the Interest on Net Equity (“INE”) and to (ii) the applicability of the Withholding Income Tax (“WHT”) over such payments.
Below you may find more details regarding the INE mechanism and the changes introduced by the Brazilian Government.
According to the Brazilian law, in addition to dividends, Brazilian subsidiaries may also pay INE to their shareholders.
From a Brazilian tax perspective, such remuneration mechanism has a hybrid nature, as it is a remuneration to shareholders (similar to dividends) but it is treated as a financial expense for tax purposes, thereby deductible for corporate income tax purposes.
In general terms, INE is calculated by applying the daily pro rata variation of the government’s Long-term Interest Rate (“TJLP”) on the adjusted net equity of the Brazilian entity, considering all equity variations occurred during the year.
Up to now, INE was generally subject to 15% WHT on the date of payment or credit to the beneficiary. Such tax shall be considered as: (i) advance of the amount of corporate income taxes due at the level of the company; or (ii) definitive taxation, in the event that the beneficiary is an individual or a non-resident.
News Rules Introduced by the Brazilian Government
However, as mentioned above, MP 694/15 brought significant changes to the INE mechanism, as follows:
- Increase of the WHT rate from 15% to 18%; and
- Limitation of INE payment by applying on the adjusted net equity of the Brazilian entity (i) the daily pro rata variation of the TJLP (which has been set at 7% for the fourth trimester of 2015) or (ii) a fixed rate of 5%, whichever is the lower.
Such changes will enter into force as of January 1st, 2016, assuming MP 694/15 is approved and converted into Law still in 2015. In fact, the National Congress has 120 days after its publication (i.e., initially to 60 days, which may be extended for an additional 60-day period) to approve, amend, or reject such Provisional Measure. Assuming the Provisional Measure is approved (and converted into Law) only as of January 2016, it is our understanding that it should produce effects only in January 2017.