The new taxation of closed-end funds: Sofia’s choice – 11/20/2023 – What tax is this

Referencing the book and the film of the same name, “Sophie’s Choice” has become an expression used to describe situations in which it is necessary to make a difficult choice, under pressure, between two equally undesirable scenarios. This expression well illustrates the investors’ dilemma in the face of the possible approval of bill 4173/23, which intends to change the taxation of investment funds. This article aims to point out some of the options and the respective consequences arising from the aforementioned PL.

In summary, the PL changes the taxation of investments in closed-end funds, which, as a rule, will have their income taxed periodically, in May and November of each year. In other words, the PL extends the come-share system to closed-end funds, currently applicable only to open-ended funds, which anticipates the taxation of income, regardless of the distribution to the shareholder.

Furthermore, income accumulated until 12/31/2023 must be taxed from 2024 onwards. In other words, income accumulated in the portfolio of a closed-end fund which, under current rules, would be taxed only upon the redemption, amortization or sale of shares, will suffer the incidence of income tax, at a rate of 15%, on 05/31/2024. There is already talk in the market about potential unconstitutionalities, both because it taxes income that has not yet been made available to the shareholder, and because it retroacts to reach income determined before the PL was even approved, violating tax non-retroactivity.

Apparently aware of these questions, the PL itself offers an option: early collection, in 2023, of the tax on this accumulated income, at a reduced rate (8%, in the current wording of the PL).

Here is “Sophie’s choice”: the taxpayer will be able to choose between taxing the “stock” of income in December 2023, to guarantee the use of a reduced rate, renouncing any discussion about its validity; or, refusing this anticipation, challenge the taxation in court in May 2024, running the risk of, in the case of an unfavorable decision, losing the benefit of the reduced rate and having to tax the stock of income at a rate of 15%. In other words, the choice that arises is: accept immediate payment of the tax, even at a less burdensome rate, or undertake an uncertain legal discussion, with the risk of applying a higher rate in the future.

And even if there is a choice for early taxation, it is necessary to pay extra attention. After all, the PL approved by the Chamber of Deputies provides that this choice must be made by November 30th. However, the Federal Senate has not yet completed the analysis of the PL. Without changes to this deadline, there is little time to evaluate the pros and cons of each decision. Furthermore, the PL provides for the loss of the benefit of the reduced rate in the case of underpayment. In other words, even opting for anticipation, there is a risk that the tax authorities will question the tax calculation and apply the 15% rate in the future.

Relativizing the usual dynamics of “Sophie’s choice”, there may be a third alternative, depending on the investor’s specific situation: restructuring involving the incorporation, spin-off or transformation of the fund.

This is because, if certain requirements described in the PL are met, these operations, if carried out in 2023, will not involve taxation of the income appropriated in the fund’s portfolio. If it is possible to change the classification of the investment fund, this movement could completely eliminate the application of the quota allowance.

For example, a multi-market investment fund will probably be subject to the share price as early as 2024. Depending on the assets in your portfolio, it may be interesting, still in 2023, to transform it into a type of fund not subject to the share price (for example: FII, FIAGRO, FIA or FIP, as long as it is classified as an investment entity). From 2024 onwards, however, the transformation of a fund with quotas into a fund without quotas will be subject to different rules, and there may be taxation simply because of a change in the taxation regime.

The PL imposes many “Sophie’s choices” on investors, administrators and investment fund managers: immediate disbursement, uncertain dispute or even restructuring. There are many variables to consider before defining a strategy. And, amid all this, there are insecurities: will the PL really be approved this year? Is there still room for any changes to your predictions? Is it possible for the National Congress to adjust the deadline for opting for early taxation?

Unfortunately, the way taxation is being viewed in Brazil does not allow us to wait for these points to be defined. From now on, it is necessary to carry out an in-depth assessment of the scenarios that will likely arise if the PL is approved. Only in this way — with caution and preparation — will it be possible to navigate among the many choices that will have to be made.

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