Around R$600bn in single-investor, closed-end vehicles are targeted by the government
Gustavo Schwartzmann — Foto: Gabriel Reis/Valor
Nearly R$600 billion in closed-end funds, both in single-investor vehicles and those aimed at few investors, are in the government’s sights to increase public revenues. If Finance Minister Fernando Haddad’s plan follows the script of previous legislatures, portfolios used by wealthy families for better tax efficiency will be subject to the periodic withholding of income tax, which is already levied on typical fixed-income, multimarket, and foreign exchange portfolios.
The dilemma, already observed in bills that did not move forward in Congress under former presidents Michel Temer and Jair Bolsonaro, is whether the collection of an additional tax will apply from 2024 on income obtained this year or whether the entire portfolio will pay retroactively. Without this condition, the measure would be of little relevance to the intentions of increasing budget revenues.
The return of the issue to the spotlight has spurred discussions among wealthy investors with lawyers and financial advisors about what should be done to face the government’s taxation. Family funds would no longer have one of their main advantages, tax deferral – with tax only charged on the annual amortization or liquidation. This is what drives compound returns over time. But they would retain attributes such as succession planning and the ability to offset losses and gains between asset classes, which is not possible with typical investment funds.
What has already changed since Bill 2,337, sent by former Economy Minister Paulo Guedes to the Chamber of Deputies in 2021, is that some groups have converted or split existing portfolios to separate the portion invested in equities, said tax lawyer Ana Cláudia Utumi, with Utumi Advogados.
This is because in funds that house these assets, whether open-end (which allows the purchase and sale of shares at any time) or closed-end (with restricted rules), the capital gain is taxed only on the withdrawal of funds, there is no incidence of income tax on investment because of how unpredictable equities are.
According to the rules of the Securities and Exchange Commission of Brazil (CVM), these portfolios must have at least 67% of the equity in stocks. “But in most families, an average mutual fund [with multiple asset classes] does not have that much risk in equities and continues to defer taxation,” said Ms. Utumi. “And the years 2021 and 2022 were not so rosy, portfolios faced losses.”
What she’s seeing in wealth managers’ interactions with clients is a recommendation to look at portfolios and assess what can be more easily liquidated to pay the tax. “There are a lot of funds with illiquid portfolios, and if the client doesn’t have the money, they may have to sell the assets overnight at low prices.”
Ms. Utumi takes for granted a bill including the taxation of the entire portfolio, otherwise the matter would lose appeal to the government. She recalled that when the mandatory withholding of income tax on investments was introduced in 1997, the government managed to tax income retroactively, despite challenges in court that did not succeed.
“There is no doubt that there will be taxation, both of closed-end, single-investor funds and offshore [funds]. The industry has been waiting for this for a long time,” said Bernardo Assumpção, CEO of Arton Advisors. For him, the provisional measure 1,171 sent to Congress in May – which provides for the taxation of capital gains and income of Brazilians abroad to compensate for the exemption of those earning up to two minimum wages – was very well written.
In the case of vehicles used by wealthy families in Brazil with assets of R$10 million and more, he added, Minister Haddad has been very vocal – even calling these structures “tax havens within Brazil” in an interview with GloboNews last week – and has promised to present a bill this month in parallel with the budget proposal.
Mr. Assumpção said there has never been so much willingness for such a debate at the beginning of a government. “Everyone is waiting for the size of the bite, whether it will be on the current stock or from now on, in Brazil or abroad. It will be the end of the eternal postponement of income tax in family funds. But there will be no demonstration in Faria Lima,” he said, citing the avenue where most financial firms are based in São Paulo. “We will have to live with it, the appetite for collection is there.”
With about 30 closed-end funds in its base, the executive said pension vehicles tend to fill this gap and are the most sought-after alternatives to organize the funds obtained in liquidity events. “They preserve all the tools of a single-investor fund with increasing flexibility to make investments.”
Every time the taxation of wealth management funds returns to the scene, investors are concerned, said Gustavo Schwartzmann, chief investment officer of Santander Private Banking’s asset manager. “But the universe that our business works on has characteristics that justify the product and that go beyond tax deferral,” he said.
Among these characteristics, he cites the offsetting of gains and losses within the same vehicle, the fact that it operates in the institutional market with access to lower spreads and brokerage fees, as well as the possibility of carrying out tax and succession planning. It is also a means of accessing the capacity of top-tier asset managers, who almost always have their funds closed. “Managed portfolios of tax-exempt securities is a line that is unaffected by this discussion, as are single-investor pension mandates,” said Mr. Schwartzmann.
In an environment that is not conducive to the growth of the population’s income and with few mergers and acquisitions to create wealth, supplementary pensions would not have much room to grow in the short term, said Marcelo Mello, CEO of life, pension and investments of SulAmérica. But the possibility of taxing closed-end family funds tends to bring an important new flow to the so-called VGBL plans.
“In previous debates, there was a lot of discussion with law firms specializing in succession, a lot of requests to simulate the change of product 555 [traditional funds] to pension, to leave the concept prepared in case the rule was passed. Now that the issue is back, those who have a single-investor fund tend to plan for it,” said Mr. Mello.
The transfer of funds would create a tax event because it is not possible to convert a closed-end fund to a pension one. A multimarket fund can be transformed into an equity portfolio by adapting the regulation and the minimum 67% exposure to the equity market, said Evandro Bertho, partner at Nau Capital.
“Some larger clients who are controlling shareholders of listed companies hold their shares within a fund. They could withdraw the part that is not stock, so it would fit. The smartest way to do it is to withdraw assets that offer advantages for individuals in terms of taxes, such as [real estate and agribusiness] credit bills or tax-exempt debentures,” said Mr. Bertho.
The executive recalled that in Mr. Guedes’ bill, the taxation of the whole fund was optional, with a special rate of 6%, lower than the 15% of mandatory withholding of income tax on investments. “Let’s say the text comes out similar. For those who already thought about a redemption, a fixed income portfolio for individuals would be a way out because of tax exemptions.”
With nearly 20 funds on the shelf, the recommendation within Nau has been to wait for the new bill to think about possible solutions. “There is not much to do now,” said Mr. Bertho.
He does not believe family funds, which allow different asset classes to talk to each other in terms of results, with compensation for losses, will cease existing. Those who had losses with Americanas debentures and gains with the sale of a certain stock as an individual, he said, would pay the tax on the capital gain.
Another advantage of single-investor funds is the succession, which allows the donation of shares in life with usufruct of political rights by the original owner of the wealth. It is also a way to have access to professional and consolidated portfolio management.
For Dennis Kac, chief investment officer at Brainvest, closed-end funds lose appeal with the mandatory withholding of income tax on investments. “Investors are asking and waiting for the rule and if it will really approve the measure,” he said. “There seems to be a greater alignment of Congress, the Senate, the chance is greater of approval compared to previous bills. The text of offshore taxation has already come more ready.”
There may not be time to vote on the provisional measure that taxes offshore vehicles, as Congress did not create a joint committee nor choose a rapporteur for the bill, which tends to lapse, said Ms. Utumi. She believes that the government will include the issue in the same bill of single-investor, closed-end funds.
*Por Adriana Cotias — São Paulo
Source: Valor International