Debates and discussions about Tax Reform, as well as other changes to national tax legislation, for the most different sectors of the economy, are being reported daily in the press.

The Venture Capital (“VC”) ecosystem and M&A transactions may also be affected by possible changes, so it is necessary to be aware and prepared for what is to come.

Aline Bauermeister presents some points that players should pay attention to for future deals.

1. Possible VAT taxation on corporate holdings, keeping in mind that the tax rate should range between 20.03% and 30.7%. Typically, in countries that adopt VAT, transactions involving corporate holdings do not usually incur VAT taxation. However, in the proposed Tax Reform that is currently under discussion, this exemption from taxation is not clear, as VAT will be imposed on goods and services.

2. Costs incurred in M&A and VC transactions may generate VAT credits. It is natural that in M&A processes and VC fundraising rounds, the involved parties incur costs for service providers, and VAT credits can be calculated on such costs to offset their own VAT liabilities. The rules regarding the utilization of these credits will need to be assessed for the optimal allocation of costs in such transactions.

3. Acqui-hire operations may also be impacted by the Tax Reform due to the introduction of VAT. As VAT is expected to apply to services, depending on the type of post-M&A or post-VC operation contracts, VAT may apply and affect the previously agreed-upon values. This also applies to the portion related to earnout, depending on how it was established in the contract.

4. Operations involving SaaS or digital assets, which are often a significant part of VC transactions, also need to prepare for the new tax changes. In line with OECD guidelines, the Brazilian legislative body has mobilized and proposed amendments to tax legislation specifically for transactions involving such assets.

5. Due diligence and contingency quantification processes will also need a more thorough examination, as the asset or target company may be affected by the Tax Reform, which could influence cash flow projections and, consequently, valuation.

6. Individuals residing in Brazil (such as many founders) who hold shares in offshore funds, investments in cryptocurrencies, digital wallets, mutual funds (and/or “safes”) with non-resident debtors, derivatives, and other foreign financial assets, as well as those holding corporate stakes abroad in Private Investment Companies (“PICs”), should pay attention to the proposals related to PL 4.173/23, which is currently running under urgent consideration. The tax rate can go up to 22.5%.

7. The PL 4.173/23 has incorporated the provisions of MP 1.184/23, which deals with the taxation of investment funds in Brazil. Thus, exclusive fund shareholders may be subject to taxation through the “come-cotas” system twice a year with rates ranging from 15% to 20%, starting from January 1, 2024, provided that the law is published this year. A reduced tax rate of 6% on accumulated earnings in such funds will also be granted if the taxpayer chooses to anticipate the taxation. There has been much discussion about this anticipation, but the fact is that it will be necessary to assess the specific case, as a reduced rate does not necessarily mean an “advantage” in all legal aspects involved.
8. Investment vehicles (CVCs) that invest through FIPs also need to pay attention to the rules of PL 4.173/23 regarding the concept of Investment Entities and the requirement for professional and independent management for the FIP to be classified as an “Investment Entity” rather than a “Patrimonial FIP.” In essence, an FIP is only entitled to the taxation system provided for investment funds when classified as Investment Entities, and despite tax legislation following CVM (Brazilian Securities and Exchange Commission) rules, this tax concept, if approved, will require an analysis of current structures from both a regulatory (CVM) and tax perspective, in light of the new rules.
9. The PL 4.173/23 has incorporated the provisions of MP 1.184/23, which deals with the taxation of investment funds in Brazil. As a result, exclusive fund investors may be subject to “come-cotas” taxation twice a year, with rates between 15% to 20%, starting from January 1, 2024, provided that the law is published this year. A reduced rate of 6% on accumulated earnings in such funds will also be granted if the taxpayer chooses to anticipate the taxation. Much discussion has revolved around this anticipation, but the fact is that it will be necessary to evaluate the specific case, as a reduced rate does not necessarily imply an advantage in all legal aspects involved.
10. CVCs (Closed-End Funds) that invest through FIPs (Private Equity Funds) also need to pay attention to the rules of PL 4.173/23 regarding the concept of Investment Entities and the requirement for professional and independent management for the FIP to be categorized as an “Investment Entity” rather than a “Patrimonial FIP.” In simple terms, an FIP is only entitled to the tax treatment given to investment funds when categorized as Investment Entities, and although tax legislation follows the CVM (Brazil’s Securities and Exchange Commission) rules, this tax concept, if approved, will require an analysis of current structures from both a regulatory (CVM) and tax perspective in light of the new rules.