The Real Estate M&A and Private Equity Review: Brazil
Overview of the market
Historically, Brazil's political environment has influenced, and continues to influence, the performance of the economy and the confidence of foreign investors in real estate deals in Brazil.
The 2018 Brazilian presidential elections marked the breakdown of the political dynamic, which had been in place since 2003. PT, the workers' party, led the ruling coalition from 2003 to 2016, during Mr Lula da Silva's (2003–2006 and 2007–2010) and Ms Rousseff's (2011–2014 and 2015–2016) administrations. Following the impeachment of Ms Rousseff, her former Vice-President, Mr Temer, formed an MDB-led government (2016–2018).
In January 2019, Mr Jair Bolsonaro took office, and since then has been facing some key reforms that are critical for Brazil to resume growth and sustain economic and social stability.
The first key challenge for Mr Bolsonaro's government was the implementation of reforms to the public pension system and fiscal policy. Although the social security system reform was duly approved in Congress at the end of 2019, the government is still facing difficulties with its fiscal policy reforms and, at this point, there is no certainty about when and how such reform will be approved.
Apart from other obstacles that Mr Bolsonaro is facing in his government's structure, Mr Paulo Guedes, the Finance and Economy Minister, is still being highlighted as a solid leader on the government team, suggesting a very market-oriented government.
Owing to all the measures implemented to avoid the spread of the covid-19 pandemic, at least at an earlier stage, a very severe impact was felt by almost all real estate sectors, which were particularly hit by the restrictions imposed by the government, such as compulsory closure and social distancing measures.
Such restrictions enacted by municipal and state authorities particularly affected the commercial leases, mostly the ones regarding the shopping centre and office sectors. In most cases, tenants have tried to negotiate with landlords some kind of suspension or discount (or both) on the rent and lease charges. Notwithstanding such negotiations, a considerable number of situations ended up in court.
Despite the covid-19 pandemic, since the beginning of 2021, the Brazilian real estate market has started to face a great recovery, mainly on the residential sector, due to the lower interest rates that have granted a large number of people access to real estate financing. The favourable conditions offered by the banks for the acquisition of properties have led to a considerable number of investments that have greatly reflected on the revival of the real estate market.
Although the control of the covid-19 pandemic effects is taking longer than expected, the real estate sector will certainly find alternative and creative ways to circumvent the obstacles imposed by such a pandemic and get the sector back on track.
The Brazilian legal system is based on the Roman-Germanic tradition, meaning that the core principles of law are always codified. The Brazilian tax system is extremely complex, and several layers of constitutional, federal, state and municipal laws and regulations unfold cumulatively; hence, a deep understanding of the tax implications for every project is critical to investment decision-making in Brazil. The courts usually take years to render a final and conclusive decision on how a law or regulation should be construed in specific circumstances, and the decision is often enforceable only in relation to the parties to the dispute. In other words, court rulings serve as a guide, but are rarely binding on all market players.
From a legal perspective, the key issues in acquiring real estate in Brazil are as follows:
- development of the most advantageous structure for a deal, taking into account such issues as liability and tax efficiency for investors;
- conveyance tax considerations;
- legal restrictions on the acquisition of Brazilian real property by foreigners;
- environmental and consumer law issues;
- the impact of specific laws related to real estate development and lease activities; and
- tax and labour issues at the operating company's level, which affect the company's results and, by extension, investor returns.
Real estate companies and firms
i Publicly traded REITs and REOCs – structure and role in the market
Publicly traded real estate investment trusts (REITs) existing and organised under Brazilian law do not exist in Brazil. Instead, FIIs and private equity funds (FIPs) are currently the two most popular and tax-efficient structures that investors use as vehicles for their real estate investments in Brazil.
Real estate operating companies (REOCs) are quite popular in Brazil. There is a plethora of REOCs of varying sizes and purposes in Brazil, most of them organised as closely held companies, although a few are publicly held companies traded on B3.2
REOCs are for-profit companies that pay standard corporate taxes in Brazil, as opposed to FIPs and FIIs, which are investment vehicles designed to receive and carry out investments under a more favourable tax treatment for the benefit of their investors.
FIPs usually invest directly in shares of a company (acting in the real estate business or in other markets), including closely held and publicly held REOCs. FIIs, however, usually invest directly in real estate assets by means of acquisition of a property itself or real estate-backed credits. Most Brazilian REOCs listed on a stock exchange and issuing real estate-backed securities must have adhered to senior corporate governance trading segments (almost all of them on B3's Novo Mercado).
Although FIIs and FIPs are the most popular vehicles for real estate investments in Brazil, recently Law No. 14,130, 29 March 2021 was enacted, creating a new type of investment fund – the agro-industrial production chain investment fund (Fiagro) – dedicated to investments in agribusiness, including in rural land.3 CVM it yet to regulate Fiagros, but such a type of vehicle may also turn out to be an important investment conduit for real estate investments in rural land in the near future.
ii Real estate PE firms – footprint and structure
A typical structural challenge that applies to every international private equity firm establishing an office and team in Brazil refers to the corporation type and compensation package to be adopted locally. The intricacies of the Brazilian tax system are such that it is very often preferable to set up a Brazilian company (as a subsidiary of a foreign-based parent company), which will be in charge of providing services, hiring the necessary staff and paying the monthly compensation and annual bonuses to personnel. The partners in these Brazilian companies are usually the most senior executives acting in Brazil, and operating expenses are charged to investment advisory service revenues.
If services are hired and paid for by a foreign-based related person, then transfer pricing rules apply. Another complex issue relates to the partner or employee status of the local team. Partners enjoy a more favourable taxation of profits and dividends as opposed to the high labour and social security costs of wage earners. For this reason, senior managers tend to make as many staff as possible into partners (non-employees), but from a legal perspective it is important to treat staffers with regard to their actual roles and responsibilities, the costs inherent to each being defrayed accordingly.
Another dilemma lies in the income that a Brazilian team will receive from a foreign-based parent company, whether as a monthly or annual compensation, or as a 'carry' upon realisation of divestiture gains. These aspects, and the corresponding solutions, should be considered on a case-by-case basis, in light of the tax and asset condition of each individual involved.
i Legal frameworks and deal structures
The most important laws are the Civil Code and the Brazilian Corporations Law. Extensive regulations from the Securities and Exchange Commission of Brazil (CVM) and from B3 also apply to publicly held companies adhering to specific corporate governance segments. CVM regulations also apply to investments made by FIPs and FIIs (as well as to Fiagros in the future). Transactions are generally structured via special purpose vehicles (SPVs) (as this gives more liquidity to real estate assets). A more detailed explanation follows on legal frameworks and deal structures for real estate transactions in Brazil.
There are a number of ways to invest in real estate in Brazil, such as direct investment in real estate, SPVs, FIIs and FIPs. Each alternative presents pros and cons depending on the purpose of the investment, funding structure, governance and tax impacts, among other criteria.
Direct investment in real estate
There are currently no restrictions on the direct acquisition of urban property in Brazil by a foreign individual or legal entity.4 The standard deal usually follows the steps below.
Initial agreement between seller and buyer
The parties execute a preliminary agreement, usually covering the following:
- the buyer's right to access certain documents regarding the property and the seller;
- the seller's obligation to make these documents available;
- specific due diligence rules and timelines;
- an exclusivity period; and
- sometimes even a down payment.
Typical non-binding documents executed at this stage are letters of intent or memoranda of understanding that encompass a limited number of rights and obligations of each party.
Purchase and sale commitment
One of the most typical conditional purchase agreements is the purchase and sale commitment (commitment) under which the parties agree that, once certain prerequisites are satisfied (e.g., full payment of the real estate price or satisfactory due diligence results), the buyer is required to acquire the property and the seller is required to sell it. This commitment is executed before the public deed of title is drawn up, and usually involves a down payment by the buyer.
Completion of deals
Once the terms and conditions of the commitment have been fulfilled or waived, the parties execute a public deed of title before a notary public, usually against full payment of the purchase price and of property transfer tax (ITBI, which varies from 2 to 5 per cent, depending on the location). Execution of this public deed of title involves notary costs calculated at the transaction value or assessed value, whichever is higher.
Registration of deeds
Under Brazilian law, title to real property is usually conveyed by means of a transfer deed, which is subsequently registered with the competent real estate registry office upon annotation in the corresponding property record. This registration is necessary to meet the formalities inherent in this type of document; disclosure of real property conveyancing must be arranged so that it is enforceable in relation to third parties. Acquisition of the real property is completed by transfer of title.
The most common ways for foreign investors to invest in the Brazilian real estate market are by forming a local legal entity (a joint-stock company or a limited liability company) to own real estate or develop real estate projects; and setting up a FIP, which, in its turn, will acquire the local legal entity owner of the real estate.
Brazilian law provides for several forms of business organisations, with the most widely adopted being the limited liability company and the joint-stock company. These two companies have some features in common and also share basically the same tax treatment, but limited liability companies are less bureaucratic and expensive than joint-stock companies.
Whatever the form adopted, these two companies have some features in common. First, as a general rule, there must be at least two partners (shareholders or members), which may be individuals or legal entities (and which do not have to be domiciled in Brazil). In principle, there are no minimum capital requirements for the organisation of such companies; the capital stock may be allocated between the parties at their own discretion.
When SPV equity holdings are sold, ITBI is not levied even if the SPV owns real property assets. However, ITBI will always be levied when real property is sold to a third party.
All REOCs are organised as joint-stock companies, and their shares are traded on B3 in the Novo Mercado trading segment. REOCs are subject to the Corporations Law, rules enacted by the CVM, their respective by-laws, and all governance rules, internal controls and corporate agendas set out in the Novo Mercado self-regulatory standards.
Another way for foreign investors to invest in the Brazilian real estate market is through an FII structure. According to Law No. 8,668 of 1993, further regulated by CVM Ruling No. 472 of 2008, FIIs are closed-end funds organised as unincorporated entities (condominiums), consisting of an unpersonified pool of assets (as opposed to non-Brazilian funds organised as partnerships or corporate entities), with no legal personality, through which joint ownership of real estate assets and securities is exercised.
Investments are permitted in the following:
- real properties and rights;
- equity of real estate companies;
- special purpose entities engaging in real estate business;
- other investment funds (FIPs, FIIs, FIDCs (i.e., receivables securitisation funds that must allocate over 50 per cent of their net worth in receivables (including those credit rights attached to underlying real estate businesses or assets)) that have an investment policy comprising activities permitted to FIIs; and
- real estate receivables certificates and other real estate backed instruments.
Investment funds do not have legal personality, but even so are still required to obtain a corporate taxpayer number (CNPJ).
FIIs are administered by legal entities accredited by the CVM and hold fiduciary ownership of the portfolio assets. These entities, the administrators, are also liable for payment of taxes by FIIs as and when due.
According to CVM Ruling No. 578 of 2016, as amended, a FIP must be organised as a closed-end condominium, also consisting of an unpersonified pool of assets, administered and represented by administrators registered with the CVM.
The FIP form can be especially attractive to private equity investors seeking lower individual exposure to risks through the gathering of funds by an investor pool and asset diversification. A FIP can also supply its owners with a platform for the centralised professional management of investees with the requisite market and financial skills that would otherwise not be available to investors acting individually or through subsidiaries.
Despite being an unpersonified entity, the FIP is also required by tax regulations to obtain a CNPJ and to book transactions in its own name and on its own behalf, as if it were an incorporated legal entity. Even so, the corporate tax enrolment of FIPs does not affect their unincorporated status and is required primarily for tax filings and reporting purposes.
An FIP can acquire shares (stock) of joint-stock companies, quotas of limited liability companies, convertible and non-convertible debentures, subscription warrants and other securities, either convertible into or exchangeable for shares issued by publicly or privately held corporations, the management of which must be actively monitored by the FIP. At least 90 per cent of the FIP's net equity must be allocated to such permitted investments. The remaining portion of the portfolio can consist of liquid fixed-income instruments (e.g., Brazilian treasury bonds) and other financial assets, mainly for cash management purposes.
Investments by an FIP in either closely or publicly held corporations are not subject to minimum revenue or net-worth requirements. Similarly, no mandatory concentration or diversification requirements would apply to the allocation of the FIP's portfolio in equity investments, unless otherwise stipulated in its by-laws, and except for investment by the FIP into non-convertible debentures, which is generally limited to 33 per cent of the subscribed capital of the FIP.
On 20 September 2019, the Economic Freedom Law5 was enacted in Brazil. Such Law, among other matters, expressly inserted in the Brazilian Civil Code general provisions dealing with investment funds, which should also be applicable to FIIs and FIPs. Between such provisions, the Economic Freedom Law established:
- the possibility of limiting the liability of quotaholders and an investment fund's service providers;
- rules regarding the possibility of the segregation of assets within investment funds in accordance with each class of quotas issued by the fund; and
- regulations regarding the liquidation of investment funds.
CVM has released a public hearing with a draft of its proposed ruling, regulating the new provisions inserted in the Brazilian Civil Code by the Economic Freedom Law, and market participants have sent their comments and suggestions to the proposed ruling until 15 April 2021. CVM is currently analysing the suggestions and comments received from the market and is soon expected to issue a ruling regulating such provisions.
On 21 March 2021, Law No. 14,130 was enacted, altering Law No. 8,668 of 1993, that created a new type of investment fund, the Fiagro, which is organised as a special condominium, consisting of an unpersonified pool of assets. Fiagros may be organised as closed-end condominiums, not permitting the redemption of its quotas at any time by investors, or as open-end condominiums, permitting the redemption of its quotas upon request of the investor.
In accordance with the referred Law, Fiagros may invest in the following:
- rural land;
- companies that perform activities in the agro-industrial production chain;
- financial assets, credit instruments and securities issued by individuals or legal entities that are part of the agro-industrial production chain, as per regulations;
- agribusiness credit rights and securitisation instruments backed by agribusiness credit rights, including certificates of agribusiness receivables and quotas of receivables investment funds or non-standardised receivable investment funds that invest more than 50 per cent of their net worth in such credit rights;
- real estate credit rights related to rural land and securitisation instruments backed by such credit rights, including certificates of agribusiness receivables and quotas of receivables investment funds or non-standardised receivable investment funds that invest more than 50 per cent of their net worth in such credit rights; and
- quotas of investment funds that invest more than 50 percent of their net worth in the assets referred above.
Generally, the same provisions applicable to FIIs under Law No. 8,668 of 1993 will also be applicable to Fiagros as per such Law. Nevertheless, CVM will still regulate Fiagros, so that the new provisions inserted in Law No. 8,668 of 1993 may effectively apply.
ii Acquisition agreement terms
Whatever the structure adopted to invest in real properties in Brazil, a prospective buyer should always undertake a complete and detailed due diligence on both the property and the seller. The due diligence scope and criteria have a direct bearing on the avoidance of future problems relating to the property or to the purchase and sale transaction.
The due diligence may verify the existence of open issues (debts, suits and claims) concerning the target property or the seller, which could label the deal as a fraudulent sale and eventually vitiate the transfer of legal title.
Furthermore, a buyer could use due diligence efforts as proof of its good faith in acquiring a property, which may help protect its ownership rights against third-party claims.
In addition to a complete review of the documents related to real property and its chain of title, a target property valuation is advisable. This valuation is useful for business purposes, and also helps establish a fair value for the target property (which is thus being negotiated on an arm's-length basis, without any harm to the seller's creditors or to prior owners).
On the basis of due diligence findings, the buyer may ask for additional pre-closing measures, such as:
- a more robust set of guarantees;
- supplemental representations and warranties;
- allocation of a portion of the purchase price to an escrow account for some additional time; and
- even a reduction in the purchase price.
Special attention should be paid to representations and warranties concerning specific real estate aspects (also addressing any existing burdens on the real properties concerned) with a resulting impact on indemnification rules and mechanisms. Further issues to be taken into account are the prerequisites possibly related to a spin-off involving non-target assets, notably in the event an SPV structure to handle operating real estate assets was not put in place at the time of the original investment and, therefore, an SPV sale does not represent the best choice of deal structure in a particular situation.
The buyer may also give up on a deal if due diligence findings point to any serious issue that renders the property unfeasible for the intended business. Comprehensive due diligence encompassing not only real estate aspects but also environmental, tax and administrative circumstances can give a full picture of the property, its seller and other sensitive issues (e.g., indigenous or landless settlements and expropriation cases), which makes the buyer better equipped to balance the risk of claims against the target property.
iii Hostile transactions
Hostile takeover transactions do not tend to occur in Brazil, particularly because most REOC by-laws contain non-negotiable provisions or poison pill clauses under which a tender offer must be made at prohibitive prices (thus making hostile takeovers practically unfeasible).
Notwithstanding the above, B3 issued, in 2016, procedures permitting and regulating public acquisition offerings of FIIs' quotas. Such procedures, in practice, make hostile takeover transactions involving FIIs possible. Nevertheless, since the issuance of such procedures by B3, there has been no relevant number of hostile takeover transactions of FIIs so far.
iv Financing considerations
Real estate transactions are typically financed by means of the investor's own capital or through bank loans secured by a security package. In addition to personal guarantees and guarantees tendered on company shares, the most common securities for real estate transactions in Brazil are mortgages and fiduciary liens.
Under Brazilian law, a mortgage is basically defined as a lien placed on a real estate or other immovable property by a debtor (or its designee) as security for a debt owed to its creditor. If the debt is unpaid as and when due, creditors may bring suit to sell the mortgaged property and use the proceeds to pay the debt.
A fiduciary lien is a type of security interest by which the debtor transfers to the creditor conditional title to a certain property, holding for itself only physical possession of the property. The debtor recovers full title to and indirect possession of the property when the secured obligations are fully satisfied. If the debtor defaults, the creditor may arrange for foreclosure via out-of-court proceedings, which are carried out directly by the real estate registry office where the fiduciary lien is registered.
v Tax considerations
Under current tax regulations, foreign exchange transactions involving currency inflows or outflows associated with investments are generally subject to tax on foreign exchange transactions (IOF/FX), which is a tax triggered by settlement of foreign exchange (forex) transactions carried out by local or non-resident investors.
Inbound forex transactions for the acquisition of land (or for setting up a local SPV to that end) are generally subject to IOF/FX tax at a rate of 0.38 per cent. This also applies to the repatriation of investments (upon a sale of assets or a capital reduction in Brazil). However, the distribution of profits (dividends and interest on net equity) is subject to IOF/FX tax at a zero rate.
In principle, the direct purchase of land by an SPV has no tax implications or risks other than those common to ordinary real estate negotiations. Generally speaking, an SPV must satisfy its obligations towards the seller as established in the corresponding purchase agreement, and also pay the ITBI tax at a rate varying from 2 to 6 per cent (depending on the municipality where the land is located).
Corporate income taxes
Upon a future sale of land, an SPV must pay corporate income taxes (IRPJ/CSL) on capital gains as well as on any positive results from fair value adjustments to the land price, but that are otherwise deferred for tax purposes. The tax rate varies depending on the IRPJ/CSL tax regime adopted by the SPV (mainly the actual profits taxation regime or the estimated profits taxation regime, and in certain more specific cases, also the special taxation regime).6
In Brazil, corporate taxation materialises in the form of corporate income tax (IRPJ) at a rate of 25 per cent,7 and a social contribution on net profits (CSL) at a rate of 9 per cent. With very few exceptions, these taxes are levied on the same tax base, which is why it is commonly said that the IRPJ and CSL taxes are levied at a combined rate of 34 per cent.
Under the actual profits taxation regime, a company's taxable profit is determined as a result of its actual revenues less its tax-deductible expenses during a given calendar year. Broadly speaking, expenses are only admitted as tax-deductible when, besides being effectively paid by a company, they are deemed necessary (to the business of the company), usual (as to their type) and normal (as to their amount).
Under the estimated profits taxation regime, a company's taxable profit is determined as a fixed percentage of its gross revenues, regardless of any deductible expenses the company may have incurred during the calendar year. Percentage rates are set by law in accordance with the type of business that generated a given part of the company's revenues.
For revenues arising from property lease (as well as those arising from the assignment of rights in rem, for example, licensing of surface rights), the IRPJ/CSL tax base under the estimated profits taxation regime is calculated as 32 per cent of the gross revenues derived by a company from that specific activity; for revenues arising from a sale of properties, the IRPJ/CSL tax base is set at 8 per cent and 12 per cent, respectively, of the gross revenues arising from these property sales. Once the tax base is finally determined, IRPJ/CSL is then assessed at a combined rate of 34 per cent.
Social contributions on gross revenues
Social contributions on gross revenues (PIS/COFINS) are two social contributions that are jointly levied on the gross revenues earned by Brazilian companies. These contributions may be levied under a cumulative or non-cumulative system.
Under the cumulative system, a flat combined rate of 3.65 per cent (0.65 per cent for PIS and 3 per cent for COFINS) will be levied over the gross revenues of a company, this taxation being final (i.e., with no authorisation for a Brazilian company to take PIS/COFINS tax-deductible credits associated with its inputs). In turn, under the non-cumulative system, PIS/COFINS are levied at a combined rate of 9.25 per cent (1.65 per cent for PIS, and 7.6 per cent for COFINS). In this case, however, companies are authorised to ascertain and deduct tax credits calculated on some of the inputs, as defined by law, used in their activities of generating revenue that are also subject to PIS/COFINS, as well as on the depreciation of assets.
Companies that are subject to IRPJ/CSL taxation under the estimated profits taxation regime are subject to PIS/COFINS under the cumulative system at a flat and final 3.65 per cent combined rate. Conversely, companies subject to the IRPJ/CSL taxation under the actual profits taxation regime are subject to PIS/COFINS under the non-cumulative system at a 9.25 per cent rate.
Special tax regime
Provided certain requirements are met, among which that a homebuilding development project is irrevocably elected to be subject to a special real estate isolation regime, the corresponding SPV can alternatively elect to be taxed under the special tax regime (RET). Under the RET, a company's gross receipts out of the sale of real estate as well as interest derived from a seller's financing of such real estate sales are subject to a unified rate of 4 per cent, comprising 1.71 per cent COFINS (as defined above), 0.37 per cent PIS (as defined above), 1.26 per cent IRPJ and 0.66 per cent CSL.
Distribution of income
After-tax proceeds distributed by SPVs to foreign investors are exempt from withholding income tax (IRRF) (generally due on remittances at a 15 per cent rate), whereas remittances of interest on net equity are generally subject to IRRF at a rate of 15 per cent. Expenses related to such latter payments qualify as deductible from the IRPJ/CSL tax base if the SPV opts for the actual profits taxation regime.
Forex transactions for currency inflows or outflows related to FII investments are currently subject to IOF/FX at a rate of zero.
Under the prevailing regulations, the income and gains recognised by the portfolio of investment funds in general are not subject to corporate taxation (IRPJ/CSL and PIS/COFINS) or to IRRF.
Therefore, as a general rule, positive results posted by investment fund portfolios have tax implications for investors only, in the form of IRRF to be charged upon distributions to investors at rates varying in accordance with their legal qualification and country of residency.
Nonetheless, apart from this general rule, specifically in respect to FIIs, Article 16-A of Law No. 8,668 of 1993 establishes that gains derived from variable and fixed income investment in general (except for securities related to the real estate market, such as CRIs) are subject to IRPJ/CSL on the fund portfolio under the same rules as those applicable to legal entities in general.
Furthermore, Article 2 of Law No. 9,779/99 establishes that FIIs investing in a real estate undertaking whose developer, builder or partner holds, individually or together with a related person, more than 25 per cent of the fund shares are subject to the same taxation rules applicable to legal entities in general.
Distribution of profits or gains
Article 10, Sole Paragraph, of Law No. 8,668 of 1993 establishes that FIIs must distribute to their shareholders at least 95 per cent of profits recognised on a cash basis, once every six months (in June and December of each year).
Under Article 17 of Law No. 8,668 of 1993, generally, the income and capital gains earned by an FII's local shareholders are subject to IRRF at a rate of 20 per cent. This IRRF is treated as a definitive taxation for individuals or as an advance payment of IRPJ/CSL due on the income by legal entities in general. A different tax treatment applies to foreign investors.
Finally, the income earned by individuals, who may be either tax residents in Brazil or abroad, from investments in FIIs is tax-exempt when:
- its shares are traded solely on a stock exchange or organised OTC securities market;
- it has at least 50 shareholders; and
- no shareholder holds 10 per cent or more of the FII shares, or is entitled to receive more than 10 per cent of the total income posted by the fund.
Other than the above, distributions of income and gains earned from FIIs by foreign investors are generally subject to IRRF tax at a 15 per cent rate (except for investors located in tax havens, in which case the applicable rate is 20 per cent). If those gains arise from the sale of FII shares on a stock exchange, they may be tax exempt (provided certain conditions are met, including that investors are not located in a tax-haven jurisdiction).
Forex transactions for the inflow or outflow of funds related to investments in FIPs are subject to IOF/FX tax at the current rate of zero per cent.
Tax neutrality at FIP level
FIPs are flow-through entities under Brazilian tax law and, as such, no earnings or gains from transactions carried out by the fund itself are taxed at portfolio level. In fact, because a FIP is formed as a closed-end condominium (not as a standard legal entity), the FIP enjoys some tax benefits such as not being subject to any taxes on its own transactions (i.e., IRPJ/CSL and PIS/COFINS).
In practical terms, this means that if the FIP sells stock or other securities of its portfolio companies at a gain, the fund itself is not subject to any taxation in Brazil, and the same goes for distributions made to the FIP by its investees.
Broadly speaking, the effect of such transactions for the FIP is that its shares appreciate at the same proportion of earnings or gains then received; only when the FIP makes distributions on its shares to investors will Brazilian taxes be imposed (or not, as the case may be), as further explained below.
Taxation on distributions made by the FIP to its shareholders
The tax treatment accorded to profit distributions made by an FIP depends on the legal nature and tax residence of the recipient investor. As a rule, distributions of proceeds from FIPs to local and foreign investors are subject to IRRF tax at a rate of 15 per cent.
Special tax regime for foreign investors
Under the current tax rules, Brazilian FIPs may distribute proceeds to foreign shareholders without paying IRRF, provided that certain requirements are met. In that specific regard, it is worth commenting on the precise conditions under which this special tax treatment can apply.
Article 3 of Law No. 11,312/2006 establishes that:
IRRF is levied at a zero rate on income earned from investments made in FIPs when paid, credited, delivered or remitted to an individual or collective beneficiary that is resident or domiciled abroad and acts in the Brazilian financial markets pursuant to the rules and conditions prescribed by the National Monetary Council, which are generally accepted to be those rules and conditions set out in Resolution No. 4,373 of 2014.
In addition, Article 3, Paragraph 1 of Law No. 11,312 of 2006 sets out that:
The tax benefit referred to above:
(i) is not granted to a shareholder that, individually or jointly with related parties, holds 40 per cent or more of the FIP shares, or when the FIP shares held by the shareholder, individually or jointly with related parties, assure him a right to receive more than 40 per cent of the total income earned by the FIP;
(ii) is not granted to a FIP whose portfolio, at any time, contains debt securities or other fixed-income financial instruments worth more than 5 per cent of the FIP's net equity, excluding Brazilian treasury bonds or share convertibles;
(iii) is not granted to those resident or domiciled in a country where income is either tax-exempt or taxed at a maximum rate of 20 per cent (tax havens).
In short, to qualify for IRRF tax at a rate of zero on FIP distributions, a non-resident investor must also be as follows:
- a '4,373 investor';
- hold less than 40 per cent of the fund, directly or indirectly; and
- not be domiciled in blacklisted tax-haven jurisdictions.
If any of the aforesaid requirements is not met, the income distributed by a FIP to foreign investors is subject to IRRF tax at a rate of 15 per cent.
The IRRF tax at a zero rate applies as well when a foreign investor sells its FIP shares on the secondary market at a profit. Hence, if all requirements above have been duly met, the capital gains from a sale of FIP shares by a qualifying non-resident investor should also qualify for IRRF taxation at a zero rate, as opposed to the general 15 per cent rate otherwise applicable to a non-qualifying investor.
Following the overruling, on 1 June 2021, of the presidential vetoes originally imposed on Law No. 14,130 of 2021, the tax regime attributable to Fiagro investments shall be similar in several aspects to that applicable to FII investments.
Forex transactions for currency inflows or outflows related to Fiagro investments shall also remain subject to IOF/FX at a rate of zero.
As a general rule, positive results posted by the Fiagro portfolios have tax implications for investors only, in the form of IRRF to be charged upon distributions to investors at rates varying in accordance with their legal qualification and country of residency.
Nonetheless, apart from this general rule, specifically in respect to Fiagro, Article 16-A of Law No. 8,668 of 1993 establishes that gains derived from variable and fixed income investment in general (except for securities related to the agribusiness, such as Agricultural Deposit Certificate – CDA, Agricultural Warrant – WA, Agribusiness Credit Rights Certificate – CDCA, Agribusiness Credit Letter – LCA and Receivables Certificate of Agribusiness – CRA, as well as Rural Product Certificate – CPR) are subject to IRPJ/CSL on the fund portfolio under the same rules as those applicable to legal entities in general.
Tax Deferral on gains upon the incorporation of rural land into Fiagros
Under Article 20-E of Law No. 8,668 of 1993, legal entities and individuals, who contribute rural property into Fiagros at a gain, may elect to defer the taxation on such gains to the moment of eventual disposal of the Fiagro quotas, on a proportionate basis to the amount of quotas disposed of at each moment. The rural property being contributed to Fiagros must have been appraised by specialised professionals or companies, in accordance with regulations of the fund.
Distribution of profits or gains
Under Article 20-D of Law No. 8,668 of 1993, generally, the income and capital gains earned by Fiagro's local shareholders are subject to IRRF at a rate of 20 per cent. This IRRF is treated as a definitive taxation for individuals or as an advance payment of IRPJ/CSL due on the income by legal entities in general. A different tax treatment applies to foreign investors.
Finally, the income earned by individuals, who may be either tax residents in Brazil or abroad, from investments in Fiagro is tax exempt when:
- its shares are traded solely on a stock exchange or organised OTC securities market;
- it has at least 50 shareholders; and
- no shareholder holds 10 per cent or more of the Fiagro shares, or is entitled to receive more than 10 per cent of the total income posted by that fund.
Other than the above, distributions of income and gains earned from Fiagros by foreign investors are generally subject to IRRF tax at a 15 per cent rate (except for investors located in tax havens, in which case the applicable rate is 20 per cent). If those gains arise from the sale of Fiagro shares on a stock exchange, they may be tax-exempt (provided certain conditions are met, including that investors are not located in a tax-haven jurisdiction).
While Fiagro investments are yet to be regulated both by CVM and Brazilian tax authorities, it seems a promising new vehicle to foster investments in agribusiness while maintaining most of the tax advantages of FII investments, as well as adding some new interesting ones, such as the tax deferral on the gains on the contribution of rural property to Fiagros.
vi Cross-border complications and solutions
Brazilian law on real estate distinguishes between urban and rural properties. As previously mentioned, no restrictions apply to foreign investments in urban properties.
Nonetheless, the current rules on foreign investment in rural properties in Brazil8 impose some restrictions on the acquisition or lease of such properties by foreign individuals or entities, and also by Brazilian companies mostly held or controlled by foreigners. These restrictions include the need for prior approval from the Brazilian Institute of Agrarian Settlement and Reform, or from the National Congress, depending on the size of a rural property.
The rules extend to corporate transactions resulting in the direct or indirect transfer of rural properties, such as mergers and acquisitions or changes in corporate control, or if a Brazilian company becomes a foreign company. The acquisition or lease of rural properties by foreigners in contravention of the current rules may be voided.
Furthermore, Brazilian law also regulates the occupancy of properties located within the country's border zone (a 150 kilometre-wide strip along the division line of the national territory). Prior consent from the National Defence Council is required for possession, ownership, rural lease or creation of any other security interest involving real properties located within the border zone. This requirement is valid for foreign entities and for Brazilian entities held by foreigners (as majority or minority shareholders). The only and very recent exception is the tendering of in rem guarantees (i.e., mortgage and fiduciary lien) in favour of foreign creditors.
Currently, some alternative structures not covered by Law No. 5,079 of 1971 are being adopted by foreigners to sidestep current legal restrictions (see below).
Corporate real estate
As just mentioned, as a result of current restrictions on the acquisition and lease of rural properties by foreigners, some alternative structures are being adopted in the corporate real estate market. One structure currently used by foreign real estate investors is segregation of investments in an operating company (opco) and a real estate company (landco). In this structure, ownership of rural properties is held by the landco (the Brazilian company controlled by a local partner), whereas the opco is entrusted with operational activities (this company may be owned and controlled by a foreign investor). The landco and the opco execute one or more agreements by which possession and operation of the properties are transferred to the opco via contractual arrangements not restricted by Law No. 5,709 of 1971.
i Foreign investment in rural properties
A bill dealing with the restrictions on the acquisition or lease of rural properties by foreigners is currently under discussion by the Brazilian National Congress. Under the bill's much more relaxed policy, the acquisition of rural lands by Brazilian companies would be free of restrictions, regardless of the controlling shareholders involved (except in cases of control by foreign NGOs, foundations or sovereign funds). Notwithstanding that, the acquisition or lease of rural properties in the Amazon region or areas with a legal reserve equivalent to 80 per cent would have to be approved by the National Defence Council or they would not be allowed. The bill was approved by the Senate and is yet to be discussed further and approved by the National Congress, and then sanctioned by the President. During this process, amendments could be made and the whole bill could change (as has already happened in similar cases). Considering the current political scenario in Brazil, there are real chances that the discussions regarding the approval of such bill will take place during the time of Mr Bolsonaro's government.
Another legal trend refers to the compulsory identification of beneficial owners of foreign investment schemes for obtaining a CNPJ in Brazil, thus enabling the Brazilian authorities to identify the ultimate (direct or indirect) holders of equity interests in REOCs, SPVs, FIIs and FIPs. This requirement is difficult to implement when a foreign investment structure does not allow for identification of its beneficial owner.
In that regard, tax authorities have been issuing tax notices of late, which are yet subject to litigation, against fund administrators and custodian agents for their involvement in structures that should purportedly be viewed as non-compliant with the legal requirements mentioned above. In certain cases, the tax authorities argued that if the final beneficial owners could not be duly disclosed to the tax authorities, a 35 per cent withholding tax should apply on all distributions made by FIPs, for instance. Such allegation should not prevail following litigation in administrative and judicial courts, but a general recommendation is that investors provide detailed information on the ultimate beneficial owners of their respective investments.
The CVM is shortly to launch new rules lifting the bar on corporate government requirements for listed companies, and B3 has recently announced a package of adaptations and reforms to governance, compliance and disclosure rules applying to its most special trading segment, Novo Mercado.
iv Activism and voting
Minority shareholders have increasingly voiced their opinions on shareholders' meetings of Brazilian listed companies. New CVM rules are expected to address the possibility of distant and proxy voting, coupled with other mechanisms to spur active shareholder participation in decision-making.
1 Henry Sztutman and Jorge F Lopes, Jr are partners, Flávio Coelho de Almeida is a senior associate and Felipe Tucunduva van Heemstede is an associate at Pinheiro Neto Advogados.
2 Such as Aliansce (www.aliansce.com.br), Iguatemi (www.iguatemi.com.br), São Carlos (www.scsa.com.br), General Shopping (www.generalshopping.com.br), BR Malls (www.brmalls.com.br), Multiplan
(www.multiplan.com.br), BrasilBrokers (www.brasilbrokers.com.br), Rossi (www.rossiresidencial.com.br), MRV (www.mrv.com.br), Helbor (www.helbor.com.br), EZTEC (www.eztec.com.br), LPS (www.lopes.com.br), Even (www.even.com.br), Direcional (www.direcional.com.br), BR Properties (www.brpr.com.br), PDG Realty (www.pdg.com.br), Gafisa (www.gafisa.com.br), Sonae Sierra (www.sonaesierra.com.br), JHSF (www.jhsf.com.br), Cyrela (www.cyrela.com.br), Viver (www.viver.com.br), Beter (www.beter.com.br), LDI (www.grupoldi.com.br), CR2 (www.cr2.com.br), João Fortes (www.joaofortes.com.br), Trisul (www.trisul-sa.com.br). Please refer to the websites mentioned above to check the history, profile, strategy, competitive advantages, portfolio, governance and other corporate and investor-related matters of the most relevant REOCs currently doing business in the Brazilian market.
3 Note that the restrictions currently applicable to the acquisition or lease of rural properties by foreigners in Brazil, imposed by Law No. 5,709 of 1971 and Law No. 8,629 of 1993, as detailed below, should be observed on Fiagro investments.
4 As further explained below, there are currently restrictions on the acquisition and lease of rural properties by foreigners.
5 Law No. 13,874.
6 If a company has a considerable amount of tax-deductible expenses, it might want to be subject to IRPJ/CSL under the actual profits taxation regime, associated with the non-cumulative system for gross revenues (PIS/COFINS) taxation. By contrast, if a company does not have substantial tax-deductible expenses, it would probably be better off being subject to the estimated profits taxation regime, in which case the cumulative system for PIS/COFINS taxation also applies.
Roughly speaking, under the actual profits taxation regime, the net profits (determined in accordance with the tax regulations) derived by SPVs focusing on the real estate market and arising from the sale of properties or leases are subject to IRPJ/CSL at a rate of 34 per cent, and to PIS/COFINS at a rate of 9.25 per cent. Expenses incurred with PIS/COFINS payments are also deductible from the IRPJ/CSL tax base, thus resulting in an effective tax rate of 30.855 per cent. Under the estimated profits taxation regime, revenues from property sales are subject to a tax burden of 6.73 per cent for IRPJ/CSL/PIS/COFINS, whereas in cases subject to the special taxation regime, revenues from property sales are subject to a tax burden of 4 per cent for IRPJ/CSL/PIS/COFINS.
7 More precisely, the IRPJ rate is 15 per cent plus a 10 per cent surcharge, where the 15 per cent rate is levied on all of the tax base, whereas the 10 per cent surcharge is levied on the tax base in excess of 240,000 reais per annum.
8 Law No. 5,709 of 1971 and Law No. 8,629 of 1993.