An important first step

The Brazilian legal system is based on civil law (Roman-Germanic system), where rules are arranged in a codified system, as opposed to the common law (Anglo-Saxon system), a system based mainly on case law. As such, the concept of the trust as it is known in common law did not exist in Brazilian legislation until very recently.

However, on 12 December 2023, the National Congress of Brazil (Congress) approved Bill No. 4,173/2023, which was then converted into Law No. 14,754/2023 (the Law). Consequently, the Brazilian tax system underwent a major overhaul, particularly with the latest changes introduced by the Law for:

• local investments in closed-end funds;
• financial portfolios held offshore directly through an individual bank account;
• controlled foreign company rules for Brazilian individual taxpayers regarding international controlled entities; and
• trust legislation.

It is important to note that, although the Law has revoked some provisions related to taxation rules for international investments and closed-end investment funds, it does not list any repeal for the trusts environment, given that the environment has never been properly regulated by the Brazilian legal system. Therefore, the rules established by such law represent innovations not only from a tax perspective relating to trusts but also from a reporting perspective to the Brazilian Internal Revenue Service (the IRS).

In this sense, the Law innovated as it established, for the first time in the Brazilian legal system, specific tax rules for trusts, including reporting obligations before the Brazilian IRS for both settlor and beneficiaries (in Brazil, the tax filings include not only income but also a list of assets and rights held locally and abroad), and tax consequences for each distribution of a trust fund for its beneficiaries.

The Law also established objective concepts for the main agents and contractual aspects of a trust, emphasising the roles of the trustee, settlor, beneficiaries, rules of distributions and letter of wishes.

Brazilian individual taxpayers previously interested in implementing such structures are now wondering what the changes promoted by the Law mean for the potential implementation of trusts. Further, what are the possible impacts on the future estate and succession planning of ultra-high-net-worth (UHNW) families in Brazil? This article intends to analyse these points.

Background

The Brazilian tax scenario for individual taxpayers has remained without significant change for many years. However, some game-changing events occurred during 2023. First, there was Provisional Measure No. 1,171/2023 (the Measure), which was published in May 2023 and proposed relevant changes to individual income tax and asset reporting in Brazil for foreign assets.

A few months later, Congress approved Bill No. 4,173/2023, which was converted into the Law. The Law, which entered into full force and effect on 1 January 2024, impacted all Brazilian tax residents who have portfolios abroad, receive earnings from foreign sources and/or hold assets and rights offshore. For the first time, trusts were properly covered by Brazilian legislation.

Although trusts have been part of discussions about international estate and succession planning for years, Brazilian legislation has neither regulated nor introduced trusts into its legal system.

As a result, Congress discussed several measures aimed at enabling the constitution of trusts within the country. Among the main measures are:

• Bill No. 4,758 of 2020, which established the concept of ‘fiduciary contracts’ that would operate with a structure similar to trusts abroad;^[1] and
• Complementary Bill No. 145 of 2022, which, in addition to introducing and regulating trusts, also established the taxation applicable to distributions of the trust fund for the purposes of both estate tax^[2] and income tax.^[3]

Despite the abovementioned measures, at the time of writing, trusts have not yet been duly regulated by local legislation to be implemented under the Brazilian legislation. On the other hand, the Law shows signs of future implementation by establishing taxation rules for offshore trust distributions and reporting to Brazilian tax authorities for both settlor and beneficiaries.

Building the concept of trusts in Brazil

As previously mentioned, the absence of regulatory legislation for trusts has, naturally, led to scattered and non-linear interpretations regarding the income from trusts located abroad before Brazilian tax authorities and courts.

In one of its first dealings with the subject, the IRS, when addressing the Special Regime of Foreign Exchange and Tax Regulation (Regime Especial de Regularização Cambial e Tributária, RERCT),^[4] through Normative Instruction No. 1,627/2016 (the Instruction), expressly established that beneficiaries of trusts were compelled to fill in a Brazilian tax amnesty return.^[5]

In 2020, the IRS issued the controversial Private Ruling COSIT No. 41/2020, in which a Brazilian taxpayer questioned whether distributions earned through a trust should be subject to the individual income tax or to the estate tax.

In its interpretation, the IRS confirmed that distributions from a trust to Brazilian-resident taxpayers must be taxed according to the individual income tax rules, considering that such amounts were interpreted as an increase in the taxpayer’s wealth. Therefore, the taxpayer should pay income tax under the voluntary monthly tax payment system (Carnê-Leão) with tax rates up to 27.5 per cent. It is important to note that this position was reinforced by the IRS, according to the understanding of Private Ruling DISIT/SRRF08 nº 8010/2023. In this sense, such interpretation may be summarised as below:

‘INCOME RECEIVED FROM A FOREIGN SOURCE.

The receipt of income from abroad by a resident in the country is a triggering event for the Income Tax and it is subject to monthly taxation through the application of the monthly progressive table (Carnê-Leão) and in the Annual Income Tax Return.’

Regarding Brazilian estate tax, charged on a state (not federal) level, the IRS has opted to not manifest this as the tax is assessed by the state authorities, raising concerns about a possible double taxation issue between federal income tax and estate tax.

In 2022, however, the São Paulo State Treasury Department published a response to Tax Consultation No. 25,343/2022, in which it defined the assessment of tax on gifts and inheritance (ITCMD) on the transfer of funds from a trust set up abroad to its beneficiaries, analysing a situation similar to that presented in Private Ruling COSIT No. 41/2020. This understanding has been duly clarified in the response’s summary, as follows:

‘ITCMD – Donation – Trust constituted abroad – Beneficiary resident in the State of São Paulo.

I.  The ITCMD is levied on the transfer of any asset or right resulting from a donation.

II.  Except in the event that the establishment of the trust instrumentalises any payment due to the beneficiary, the beneficiary becomes the holder of the right over the trust at the time of its appointment, free of charge and out of liberality, thus perfecting the donation.

III.  The ITCMD on the donation of rights made by a donor domiciled abroad to a donee resident in this state must be paid to the State of São Paulo.’

Further, in 2022, the Brazilian Supreme Federal Court decided in Extraordinary Appeal nº 851,108/SP that it was impossible for Brazilian states to charge ITCMD on transfers of assets held abroad by tax residents in Brazil.

However, this decision lost its effect with the introduction of Constitutional Amendment No. 132/2023, also known as the first step in the reform of the Brazilian tax system. The new constitutional wording made it possible for states to collect ITCMD on non-onerous transfers of assets located abroad. The new text so determined:

‘Art. 16. Until a complementary law regulates the provisions of art. 155, § 1º, III, of the Federal Constitution, the tax levied in the cases referred to in the provision will compete:

I -  in relation to real estate and respective rights, to the State in which the property is located, or to the Federal District;

II -  if the donor is domiciled or resides abroad:

a)  to the State where the donee is domiciled or to the Federal District;

b)  if the donee is domiciled or resides abroad, to the State in which the property is located or to the Federal District;

III -  in relation to the deceased’s assets, even if located abroad, to the State where he was domiciled, or, if domiciled or resident abroad, where the successor or legatee is domiciled, or to the Federal District.’

In this regard, the taxation scenario became relatively onerous, considering the possibility of the application of the maximum Brazilian income tax rate (27.5 per cent) in addition to the ITCMD on donations and transfers upon death (rates ranging from 2 to 8 per cent, depending on the state).

The Law and possible consequences

Important measures relating to the taxation of trusts in Brazil were implemented as the Law was introduced.

Transparency of trusts and distributions

The assets and rights held by trusts will be considered part of the personal assets of the settlor and will only be transferred to its beneficiaries in distributions made by trusts (which will be qualified as succession or donation, depending on the event).

An important point is that, in the case of irrevocable trusts, the related assets and rights can be transferred if the settlors definitively renounce their right to the assets held by the trust. As of 2024, the settlor must report the assets and rights subject to a trust on their Brazilian income tax return.

Taxation of income and capital gains

Income and capital gains will be taxed by the person considered the holder at the time of the income tax assessment. As shown above, the qualification as the holder of the assets depends essentially on the assets being made available to the beneficiaries or in the event of the settlor’s death.

The tax rate on income within the structure was established in direct connection with the rules for the asset holder, making it possible to apply the new tax rules for entities controlled abroad (15 per cent income tax annually or 15 per cent on the effective availability of assets)^[6] or for international investments made directly by the individuals. ^[7]

Trustee’s responsibility

Of the various responsibilities of the trustee, its obligation to provide the financial resources and crucial information to collect the income tax is of great importance. The Law provides that the trust deed and/or the letter of wishes be amended within 180 days of 13 December 2023 in order to include a provision that obliges the trustee to comply with the provisions of the Law.

In view of the recent changes, Brazilian legislation subtly indicates a greater openness to the reception of trusts in the country’s legal system.

Conclusion

Despite the fact that the concept of the trust, as it is known in common law, was not expressly foreseen by Brazilian law until recently, the Law puts an end to a long legal debate connected with the reporting and tax treatment of trusts. On one hand, the new rules establish that the property of assets and rights held in the trust shall be treated as the settlor’s property (with corresponding reporting to the IRS). On the other hand, the beneficiary will be vested only when a distribution occurs or in case of death or irrevocable abdication by the settlor (with consequent reporting to the IRS).

In terms of tax impact, whenever there is a change of ownership, the Brazilian estate and gift tax will be applicable. In other words, it will be taxed as an inheritance if it results from the settlor’s death or could be considered a gift if it occurred during the lifetime of the settlor. The income tax rate was set at 15 per cent, according to the structure used to hold assets.

Although it was an excellent start in terms of introducing basic trust concepts and guidelines in a Brazilian legal scenario, a measure aimed at regulating trusts is still needed to clarify more detailed concepts and controversial points that are not yet adapted to the Brazilian standards. Once this stage has been completed, it is expected that trusts will gradually become more important and more common in the estate and succession planning of UHNW families in Brazil.