Movement comes ahead of government measure to tax closed-end funds
08/30/2023
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Assets in these portfolios, usually intended for wealthy families, reached R$966.2 billion in July — Foto: Marcello Casal Jr./Agência Brasil
Single-investor funds and those reserved for just a few investors saw net outflows of R$71.4 billion this year through July, according to a study by Anbima, an association that represents the capital and investment market, requested by Valor. This is more than half of the nearly R$125 billion that left the sector in the same period. In 2022, a year in which the sector in general did not perform well, closed-end vehicles saw a net outflow of R$21.9 billion, for a total of R$113.2 billion in redemptions.
The assets in these portfolios, usually intended for wealthy families, reached R$966.2 billion in July, an increase of 10.6% compared to December 2022, due to the effect of asset appreciation. In total, the funds sector ended July at around R$8 trillion.
It is this part of the pockets of the super-rich that the government is eyeing in order to fatten its sources of revenue and cope with the increase in spending without jeopardizing the public accounts. According to the draft of provisional measure 1,184 sent to Congress, if the text is approved by the legislature as it stands, the “come-cotas” – the semi-annual tax levied on open-ended bond, multimarket, and currency funds – will be extended to other closed-ended vehicles that today pay tax only when they are liquidated or in annual amortizations. On the radar are equity funds, private-equity investment funds (FIP), and debt funds. Even real estate funds, Brazilians’ darlings, will have to meet certain requirements to escape the tax authorities.
The market is estimated to have around R$600 billion in closed-end and reserved funds for asset management – in the private banking segment, it was R$203.7 billion at the end of June, according to Anbima.
It’s not the first time that investors in the millionaire’s club have seen one of the main features of such funds, tax deferral – that is, postponing the payment of taxes for as long as possible, thereby increasing compound returns over time – threatened.
Even before the new tax proposal, there was talk of emptying family funds, accelerating the distribution of some of the money, or sending the money abroad, said André De Vita, a partner at Cascione Advogados. “Whoever did it, did it. Those who didn’t now have their funds tied up under the terms of the provisional measure. Obviously, those who moved before are more protected,” he said.
He sees reasons why the negative flows seen in private funds this year are the result of some early restructuring. “Many investors have dual citizenship, live abroad, and have the ability to move their funds abroad. There is a review of the portfolios with the managers to define the best composition.” For a mass that the government estimates at R$700 billion, Mr. De Vita believes that the withdrawals so far, which represent 10%, are not very representative.
In any case, the funds only pay tax if they generate income during the distribution and the redeemed share exceeds the acquisition value. “Since they have a profit and loss offset within the structure, it was possible to some extent to make an exclusive redemption without paying income tax. Some of the redemptions and write-offs may have been done as a result of this planning.” He points out, however, that withdrawals are generally allowed once a year in family portfolios, otherwise they lose the character of a closed-end fund and Brazil’s Federal Revenue understands that the vehicle is being used as a checking account.
The provisional measure brings new features, and some changes proposed by tax experts and asset managers to mitigate the effects of the new taxation will not work, said Felipe Marin, a partner at Velloza Advogados and a specialist in investment funds. One innovation introduced in the text is the concept of an “investment entity,” such as one that has professional discretionary management, and a “non-investment entity.”
Thus, an equity FIP would be subject to the “come-cotas” tax, unless it performs a periodic revaluation of the companies in which it invests. In that case, the tax would only be levied on the sale of assets in the portfolio or on the distribution of dividends that would have a positive impact on the fund’s quota.
“It is a much better scenario than what has been proposed [in previous bills]. People who use equity FIPs to manage family businesses don’t necessarily have to dismantle the funds; the vehicles can still be of interest for succession planning or as an asset protection measure,” said Mr. Marin.
Equity funds (FIAs) and exchange-traded funds (ETFs) would be treated similarly, separating those that are investment vehicles from those that are not. The fluctuation in stock prices would only be considered a gain or loss in the fund when sold, said Mr. Marin.
This distinction between investment and non-investment vehicles is an innovation for tax purposes, an attempt to separate some FIAs, FIPs, and ETFs from those that the government believes are used strictly for estate planning and better tax efficiency, said Érico Pillati, a partner at Cepeda Advogados. The provisional measure removes the definition of a single-investor, closed-end fund and adopts the new concept, in part by importing it from the Securities and Exchange Commission of Brazil (CVM) rule for private-equity investment funds.
“If it’s a fund that actually has a manager with discretionary power and meets the requirements that the National Monetary Council has yet to define, there is no withholding of income tax, and it’s taxed at 15% on redemption or amortization,” said Mr. Pillati. “If it doesn’t qualify [as an investment company], it will withhold income tax, including the equity fund.” This early tax levy only exists today for open-ended bond, multi-market, and currency funds. “The market will begin to reverberate the rule, but without a doubt it has a character of interpretation as to what is or is not a fund subject to the income tax.”
As expected, the government plans to tax the stock of income in the provisional measure, something that raises some sensitive points and could lead to discussions in the courts, said Mr. Pillati. The semi-annual tax on an open-end fund eats up a chunk of what would be charged on redemptions. But in a closed-end vehicle, there is no concept of redemption – either annual amortization or liquidation of the structure at maturity. But some of these portfolios have illiquid investments. The draft legislation states that the shareholder would eventually have to contribute funds for the manager to pay the tax. “Logically, some funds have existed for 20 years and have never had their income taxed, there has been no taxable event except amortizations, and now they are surprised by an unforeseen tax.”
Perhaps to dilute this type of complaint, the government proposes a tax rate of 15% from May 2024 in a single payment or in up to 24 installments adjusted by the Selic, the Central Bank’s key interest rate. An alternative would be to adhere to the “discount,” with a 10% tax in two stages: payment in four installments due from December 2023 to March 2024 for the appreciation of quotas calculated until June of this year, and a new tranche taking into account the gains between July and December, with a single payment in May 2024.
Mr. Marin of Velloza also points out that the merger, spin-off, incorporation, and transformation of funds will become taxable events from 2024. This is a sensitive point, according to Evandro Bertho, founding partner of Nau Capital, but until the end of the year, investors can still transform their structures without triggering this trigger.
A classic example, he said, is a client who has a closed-end multimarket fund with an equity allocation. They can increase their equity exposure to 67% and reclassify as an FIA, free of the mandatory payment of income tax, as long as they have professional management. “There is a window to reorganize what is possible. From 2024, there will be a change.”
Among the most tax-efficient alternatives are private pension funds, tax-exempt debenture funds, and portfolios with other tax-exempt securities.
*Por Adriana Cotias — São Paulo
Source: Valor International