The FII (Fundo de Investimento Imobiliário) is a vehicle for investments in the Brazilian real estate industry. A FII may hold in its portfolio an extensive variety of assets, including real property, mortgage and other real estate bonds, real estate companies' securities, as well as equity in other investment funds. With regard to certain classes of such assets, the FII, if properly structured, may provide relevant tax benefits, especially for investors who are natural persons.
The FII is a flow-through entity not subject to the usual income and revenue taxes applicable to Brazilian companies. At the investor's level the gains obtained with the investment in a FII may be subject to income tax in Brazil 1, which (as well as the applicable rate) will depend on (i) how the gains were obtained, (ii) whether the investor is a natural or legal entity, and (iii) where the investor is resident, domiciled or set up.
Gains arising from distribution of proceeds, as well as amortization or redemption 2 of quotas will be taxed as follows:
(1) natural persons, whether resident or domiciled in Brazil or abroad: are exempted from income tax, provided that (a) the FII quotas are traded exclusively in exchanges, (b) such quotas are held at least by 50 different investors, and (c) the investor that intends to benefit from the exemption neither holds more than 10% of the FII quotas nor is entitled to more than 10% of the FII's proceeds; and (2) legal entities and natural persons not exempted: are subject to income tax at a fixed rate of 20%, if the investor is resident, domiciled or set up in Brazil, and 15%, if the investor is resident, domiciled or set up abroad, of the proceeds distributed (in case of amortization or redemption, though, only the investor's net gain is taxed). Such tax, where applicable, will be levied at the moment the FII transfers profits to investors. The FII's administrative manager must withhold and pay on investors' behalf the amount due.
It is noteworthy that FIIs must transfer to investors at least 95% of their profits recognized in each semester on a cash-basis accounting system (in accordance with financial statements dated as of June 30 and December 31). Such a rule is targeted at avoiding that profits remain untaxed indefinitely.
Direct distribution of dividends by invested companies to the FIII's investors is exempted from income tax. On the other hand, direct payment of interests on net equity (juros sobre o capital próprio) by invested companies to the FII's investors is subject to withholding income tax at a fixed rate of 15%. Such rules apply to all investors, whether natural persons or legal entities, or resident, domiciled or set up in Brazil or abroad. Additionally, PIS and COFINS will be levied on direct payment of interest on net equity made to legal entities set up in Brazil.
FIIs' income and investors' gains arising from distribution of proceeds, as well as amortization or redemption of quotas are not subject to PIS and COFINS, which are generally levied on the income of real estate companies set up in Brazil (as a rule, natural persons and legal entities set up abroad are not subject to PIS and COFINS).
As to sales of quotas to third parties, gains will be taxed as follows: (1) if the investor is resident, domiciled or set up in Brazil, at a fixed rate of 20% of the investors' total net gain within the respective month of all transactions involving quotas of FIIs (however, if the investor is a natural person and the transaction does not occur in an exchange, the 20% rate will be calculated on the capital gain of each separate transaction); and (2) if the investor is resident, domiciled or set up abroad, whether a natural person or legal entity, transactions (a) executed in exchanges will be tax free, and (b) transactions carried out outside exchanges will be taxed at a fixed rate of 15% of the investors' total net gain with all transactions involving quotas of FIIs within the respective month. The income tax due in quota sales, where applicable, must be paid directly by the selling investor.
In any scenario, if the investor is resident or domiciled in Brazil and a natural person, the income tax withheld or paid is final and no additional amount is due to the Brazilian IRS. If the investor is a legal entity set up in Brazil, the realized gains, as well as the corresponding tax withheld and paid, will be taken into account for the calculation of the investor's total taxable profit, and additional payment of income tax may be necessary, along with social contribution on net profits, PIS and COFINS 3.
Additionally, FIIs' investors may also be subject to a financial transaction tax (IOF) under the categories "Securities" and "Money Exchange". However, the current rates applicable to transactions related to FIIs are zero.
Specific rules apply to investors domiciled outside Brazil in jurisdictions that do not impose any income tax or charge income tax at a rate lower than 20% (frequently referred to as tax havens) or that are organized under a business entity type considered to have a privileged tax regime 4. Such investors are subject to the same tax treatment applicable to individuals resident in Brazil in distribution of proceeds, as well as redemption, amortization and sale of quotas. Dividends paid to tax-haven domiciled and "privileged tax regime" foreign investors are – as usual – exempt from income tax. Interests paid on net equity for those investors, on the other hand, are subject to a 25% (rather than the normal 15%) withholding income tax.
Notwithstanding its flow-through entity status, gains obtained by the FII with investments in financial instruments other than mortgage and real estate bonds are subject to the same income tax regime generally applicable to financial investments in Brazil 5. However, such tax may be offset against the income tax due at the moment the FII transfer such gains to investors. Gains arising from investments in mortgage and real estate bonds are exempt from income tax.
The FII will lose its flow-through entity status if it invests in ventures where the developer, the constructor or other investor is also an investor of the FII who holds, either severely or jointly with related persons6, more than 25% of the FII quotas. In such case, the FII will be subject to the same tax regime applicable to Brazilian companies. The goal of such a rule is to discourage real estate companies from benefiting from tax advantages granted to FIIs in ventures where there is no or small investments from third parties.
Given all its peculiarities, the FII is not always the most suitable vehicle for private equity investments in the Brazilian real estate industry, although under certain circumstances it may offer material tax advantages if properly structured. Hence, before resorting to the FII it is important to carefully consider whether other investment vehicles would not be more tax-efficient.
1 This article deals only with taxation in Brazil. It does not address the foreign taxation of gains obtained by investors with their investments in a FII.
2 Which may only occur when the term of the fund expires or upon dissolution of the FII.
3 The additional tax due, if any, will depend on the tax regime adopted by the investor in Brazil.
4 Instrução 1,037/2010 of the Brazilian IRS lists the jurisdictions considered to be tax havens and the business entity types that are considered to have a privileged tax regime (for example, the Uruguaian Sociedades Anónimas Financieras de Inversión).
5 Unless such financial instruments are subject to a special tax regime, the applicable income tax will vary according to the time period elapsed between the investment date and the date of recognition of gains, as follows: (i) up to 180 days: 22.5%; (ii) from 181 up to 360 days: 20%; (iii) from 361 up to 720 days: 17.5%; and (iv) for more than 720 days: 15%.
6 For this purpose, a related investor means (i) with regard to a natural person, her/his close relatives (parents, children, grandparents, grandchildren and siblings), legal entities controlled by such investor or by any of his/her close relatives, and partners, directors or officers of a legal entity under the control of such investor or his/her close relatives; (ii) with regard to a legal entitiy, its controlling shareholder, controlled companies and affiliates.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.