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The mistaken taxation of FIIs
By Ana Carolina Monguilod | April 6, 2021
If compared to other fund structures, such as multimarket funds, for example, in the FII there is an additional taxation
Real Estate Investment Funds (FII) have become popular among Brazilians. An important funding vehicle for the real estate sector, they have become an alternative for both institutional and retail investors.
Created almost 30 years ago by Law n. 8,668, of June 25, 1993 (FII Law), the real estate funds offer their shareholders a return taxed by Income Tax at a rate of 20%, with obligatory distributions of 95% of the profits, calculated on a half-yearly basis.
There is also the possibility for individuals who invest in the funds to have their income exempt, at source and in the individual's annual adjustment declaration, as long as: (i) the FII has its quotas admitted for trading on the stock exchange or organized over-the-counter market; (ii) the FII has at least 50 quota holders; and (iii) the individual quota holder holds quotas that represent less than 10% of the total quotas and whose quotas entitle him/her to receive income lower than 10% of the total income earned by the fund.
The same law that created this FII exemption also benefited the remuneration produced by mortgage bills (LH), real estate receivables certificates (CRI), and real estate credit bills (LCI).
Regarding the taxation of FII, although their portfolios are exempt from income tax in relation to income and capital gains in general (art. 16 of the FII Law), it was instituted the taxation, by withholding income tax, of their income and net gains from fixed income or variable income financial investments (art. 16-A of the FII Law).
Realizing that it makes no sense to exempt securities related to the real estate market when held by individuals and tax them in the position of the FII, the legislator removed the levy of withholding income tax on investments made by FII in CRI, LCI, LH, and in the FII itself (art. 16-A, §1 of the FII Law).
Thus, once the legal requirements are met (in our opinion, not necessarily all of those applicable to individuals), the income distributed by FIIs to other FIIs will not be subject to withholding income tax, which would otherwise be 20% (according to article 17 of the FII Law).
This treatment seems obvious to us from a finalistic point of view in order to avoid double taxation, since the FII that hold shares of other FII are, in turn, held by individuals or legal entities, which will be subject to some taxation regime as final investors.
The Brazilian Federal Revenue Service (RFB), however, has expressed the understanding that capital gains earned on the disposal, by a FII, of shares in other FIIs are subject to a 20% income tax rate, according to the same rules applicable to capital gains or net gains earned on variable income transactions (COSIT Consultation Solution No. 181/2014).
Summarizing enough the understanding of the Tax Authorities, it would be mainly based on the fact that the taxation in question was ruled out only in relation to the withholding income tax. As a consequence, in the view of the Tax Authorities, gains subject to a system other than withholding tax would be taxable (art. 16-A, §1 of the FII Law).
In other words, in layman's terms, from an investor's point of view, his funds invested in an FII that holds shares of other FIIs will incur additional taxation, since the results of the earnings of the FII's portfolio will be taxed in addition to the taxation suffered by its shareholder.
If compared to other fund structures, such as multimarket funds, for example, in the FII there is the creation of additional taxation. And, if we think of a structure with several funds, one investing in the other, which is common in countries with a developed market, we would be creating several additional taxes, even before the result of the gain reaches the final investor.
We believe that the RFB was mistaken in its understanding and should consider reviewing it.
The provision that extended to FIIs the exemption previously given to individual investors was concerned only with with withholding income tax, because FIIs can only be taxed by withholding income tax on their net income and gains from fixed income or variable income financial investments.
The FII portfolio was kept absolutely exempt, exclusively admitting the taxation at source of its financial income. Thus, by excluding the withholding income tax potentially levied on FII, CRI, LCI and Mortgage Bills, it was guaranteed that such assets, if and when held by FIIs, would be exempt.
There is an article in the FII Law (art. 18) that determines that the capital gains and income earned from the sale or redemption of FII shares, by any beneficiary, including exempt companies, are subject to income tax at a rate of 20%.
It should, however, be interpreted in harmony with the other provisions of the same Law, prevailing the more specific one, which ensures the exemption of the FII portfolio with the possibility of taxation of the FII financial investments only in relation to withholding income tax.
It is understandable that the RFB may not be satisfied with some exemptions and special treatments granted by the legislature. In this case, as in so many others, many of the exemptions and special treatments are intended to support the (encouraged) growth of a particular sector of the economy important to the country.
We know that FIIs have been attacked in aggressive inspections, as we will explore in a future article.
For now and specifically on the above topic, the message we would like to register is that the RFB needs to put into practice its mission ("Exercise tax and customs administration with fiscal justice and respect for the citizen, for the benefit of society") and its values ("Respect for the citizen, integrity, loyalty to the institution, legality, professionalism, and transparency") instead of adopting a purely collection-oriented stance and, to this end, using interpretations that are visibly not in line with the will of the legislature.
The change of rules must be done through ordinary channels, and it is up to Congress to limit benefits that are clearly laid out in the tax legislation.
The Revenue's understanding, although not so recent (2014), has now been challenged in the Judiciary, raising hopes that our courts will take a correct position.
A mistaken position burdens not only the FIIs, but the entire Brazilian society, particularly investors and, ultimately, the real estate market, which is a major driver of the economy and labor contractor.
Ana Carolina Monguilod is a partner of the tax practice area of i2a advogados, a professor at Insper, Director of ABDF (Brazilian Association of Financial Law), representative of IFA (International Fiscal Association) in Brazil, co-chair of WIN (Women of IFA Network) in Brazil, Member of the Editorial Board of the PJT (Projeto de Jurisprudência Tributária) quarterly magazine, Member of the Editorial Board of the PJT (Projeto Jurisprudência Tributária) Quarterly Magazine, a partnership between ABDF and GDT (Grupo de Debates Tributário), LLM in International Tax Law from the University of Leiden (Holland), post-graduated in Tax Law from Cogeae-PUC/SP, Coordinator of GEP (Grupo de Estudos de Políticas Tributárias) at FGV Projetos, lecturer and speaker at various events and courses.
See the full article on InfoMoney's website: The mistaken taxation of FIIs.
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