In order to remunerate the invested capital, Brazilian companies are allowed to distribute earnings to their shareholders in the form of dividends or under the concept of interest on net equity (juros sobre o capital próprio – JCP). From an economic perspective, the JCP is equivalent to a dividend. Usually the JCP is a tax maximizing way to distribute earnings to the shareholders, as it is deductible for income tax purposes. This deduction is up to a certain limit established in the Brazilian applicable law.

The maximum amount accepted for tax purposes is calculated using the company´s net equity, excluding some reserves, based on the daily pro rata variation of the long-term interest rate (Taxa de Juros de Longo Prazo –TJLP). The TJLP is the official rate defined by the Central Bank of Brazil (Banco Central do Brasil – Bacen) and used as reference in long-term loans provided by the Brazilian Development Bank (Banco Nacional de Desenvolvimento Econômico e Social - BNDES) [1].

The JCP must be calculated by reference to the net equity accounts. Therefore, earnings cannot be distributed in the form of JCP, if the company: (i) does not have a significant amount of equity; or (ii) has a negative equity figure.

The amounts paid as JCP are deductible for corporate income tax (Imposto de Renda da Pessoa Jurídica – IRPJ) and social contribution on net profits (Contribuição Social sobre o Lucro Líquido – CSLL) purposes. This deduction is limited to the greater of (i) 50% of the net income (after deduction of the CSLL and before taking into account the JCP and the provision for the IRPJ), or (ii) 50% of retained earnings plus any earnings reserves as of the initial date of the period in respect of which the payment is made.

For purposes of income distribution, the JCP is treated similarly to dividends. The only significant difference is that the withholding tax (Imposto de Renda Retido na Fonte –IRRF) is due by non-exempt shareholders, resident or not in Brazil, upon receipt of such interest payment. The IRRF is collected by the Brazilian company on behalf of its shareholders when the distribution is implemented[2].

The applicable rate of the IRRF due in the case of the JCP used to be 15%, except when the shareholder is a non-resident (that is, he/she/it is not a Brazilian resident) and is resident and domiciled in a country or location classified as a favorable tax jurisdiction (Jurisdição de Tributação Favorecida – JTF). If this happens, the IRRF rate is increased to 25%. According to Brazilian tax legislation, in the case of payments of JCP, a shareholders´ country or location should be deemed a JTF whenever: (a) such country or location does not tax income; (b) such country or location taxes income at a rate lower than 20%; or (c) the laws of such country or location do not allow access to information related to shareholding composition, to the ownership of investments, or to the identification of beneficial owner of earnings that are attributed to non-residents. The Brazilian Revenue Service (Secretaria da Receita Federal – SRF) periodically issues an exhaustive list naming the countries or locations that are considered JFT.

The amounts shareholders receive as dividends or JCP are deducted from the mandatory dividend owed to shareholders. Law No. 6,404, of December 15, 1976 (the Brazilian Corporate Law – BCL) requires that the bylaws of a Brazilian company specify a minimum percentage of the available profits for the annual distribution of dividends, known as mandatory dividend, which must be paid to shareholders as either dividends or JCP. In the event that a mandatory dividend is not provided in the bylaws, the BCL establishes that the mandatory dividends shall not be less than 25% of the company´s net income.

The JCP was introduced by Law No. 92,249, of December 26, 1995 (Law 92,249/1995). Article 9 of Law 92,249/1995 establishes that a legal entity can deduct, for the purpose of calculating its actual profit (lucro real), the interest paid to the owner, partners or shareholders, by way of return on net equity, calculated on the net equity accounts and to the extent of the variation in the long-term interest rate (TJLP) calculated pro rata per day. 

Provisional Measure No. 694, of September 30, 2015 (MP 694/2015), which was published in the same day in the Official Gazette of the Union (Diário Oficial da União – DOU), amends the wording of article 9 of Law 92,249/1995, changing the current rules on IRRF on JCP due or payable, and those relating to the deduction of the corresponding expenses for calculation of IRPJ and CSLL.

With respect to the rule on IRRF, MP 694/2015 increases the applicable rate to the JCP from 15% to 18%. However, the rate which is due or payable to or by recipients domiciled in JTF remains 25%, because no reference is mentioned in MP 694/2015 about this subject.

Furthermore, the current deduction of JCP expenses, which is based on the application of the daily pro rata variation of the TJLP levied on the net equity accounts, will be replaced by the application of the lowest rate between the TJLP and 5% per year.

Therefore, MP 694/2015 would change the JCP computation, applicable to payments made to both Brazilian residents and non-residents, as follows: (i) the IRRF would be increased to 18%; and (ii) the TJLP would be limited to 5%.

MP 694/2015 is effective as from September 30, 2015 (date of its publication in the DOU) for 60 days, and it may be extended for an additional 60-day period, for a total of 120 days, on a request from the Brazilian Congress. If the Brazilian Congress approves MP 694/2015, the changes would be effective as of January 1st, 2016[3].

[1] According to Resolution No. 4,437, of  September 24,   2015, issued by the Brazilian Monetary Council (Conselho Monetário Nacional – CMN), the TJLP rate for the last quarter of 2015 (from October 1st to December 31st)  is 7% per year.

[2] No taxes are due by the shareholders in connection with the receipt of dividends, because the payment of the taxes on the profits has already been made by the Brazilian company, which distributes the net income.

[3] The Brazilian Congress has up to 120 days to approve or reject MP 694/2015. If the approval occurs any time after December 31, 2015, the effectiveness of the new rules with respect to the IRRF increase and to the deduction of the expense in the IRPJ calculation will be postponed to January 1st, 2017. The change on the CSLL tax basis, however, should be valid as of January 1st, 2016.

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.