Law No. 14,130

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Posted: 03/30/2021

Law that creates investment funds for agribusiness is published with vetoes

As of today (03/30/2021), Law No. 14,130 was published in the Federal Register, creating Investment Funds for the Agricultural Sector (“Fiagro”). Fiagro will be organized as a special nature condominium, intended to invest funds in:

(a) rural properties;
(b) holdings in companies that explore activities that are part of the agro-industrial chain;
(c) in financial assets, negotiable instruments and/or securities issued by individuals and legal entities that are part of the agroindustrial chain;
(d) agribusiness credit rights and securitization securities issued, backed by agribusiness credit rights;
(e) real estate credit rights relating to rural properties and securitization securities issued, backed by such credit rights; and
(f) shares in investment funds that invest more than 50% (fifty percent) of their equity in the assets referred to in the items above.

As we have already had the opportunity to point out (see previous newsletter), the objective of the Law is to create new financial mechanisms for the agricultural sector in Brazil, making it less dependent on financing for the development of its activities and increased production and profitability.

In order to achieve this noble intention and to attract investors, the Congress had established some tax benefits for the investor, which were vetoed by the Presidency of the Republic as follows.

Taxation of the Fiagro Portfolio: the first veto refers to the non-taxation of investments made by Fiagro in certain assets, such as (i) Agricultural Deposit Certificate (“CDA”), (ii) Agribusiness Warrant (“WA”), (iii) Agribusiness Credit Rights Certificate (“CDCA”), (iv) Agribusiness Credit Bill (“LCA”); (v) Agribusiness Receivables Certificate (“CRA”); and Rural Product Card (“CPR”), in addition to the assets that can compose Fiagro’s portfolio.

As a rule, investments made by investment funds are exempt from taxation, as it levies at the investor level.

However, Law No. 14,130/2021, as approved, provided that the provisions of arts. 16 and 16-A of Law No. 8,668/1993 are applicable to Fiagro. Said articles provide that: (i) the income and capital gains earned by the FII are exempt from IOF and Income Tax; however (ii) income and net gains earned by the FII in fixed income or variable income investments are subject to income tax withheld, under the same rules applicable to legal entities subject to this form of taxation. This tax paid by the Fund is offset against the amount due in the distribution of income to the investor.

The application of these provisions, added to the veto of non-taxation at the fund level in applications such as CRA and CPR, creates undeniable legal uncertainty, as it is not express in the tax rule the non-taxation of these income when earned by Fiagro (which may give rise to disputes with the Federal Revenue of Brazil).

Taxation of income paid by Fiagro: the second of the relevant vetoes concerns the taxation of income earned by individuals who are investors of the fund.

The Bill approved by the Congress established that, as a rule, the income and capital gains earned and distributed to Fiagro’s investors are subject to assessment of income tax at the rate of 20% (twenty percent).

However, similarly to the tax treatment given to investors in Real Estate Investment Funds (“FII”), such income would be exempt if Fiagro’s shares were admitted to negotiation exclusively on the stock exchange or organized over-the-counter market, as long as the Fiagro has more than 50 (fifty) investors. The exemption is not applicable to any investor (individual) that holds 10% (ten percent) or more of the shares issued by the fund or whose shares give such investor the right to an income greater than 10% (ten percent) of the income earned by Fiagro.

This exemption rule was vetoed by the Presidency of the Republic. Thus, the income distributed by Fiagro will be taxed at the rate of 20% (twenty percent).

Such a rule may discourage the use of Fiagro, especially by individuals. This is so because article 3, items IV and V, of Law 11,033/2004 establishes Income Tax exemption on income earned by individuals with (i) Agricultural Deposit Certificate (“CDA”), (ii) Agribusiness Warrant (“WA ”), (Iii) Agribusiness Credit Rights Certificate (“CDCA ”), (iv) Agribusiness Credit Bill (“ LCA ”); (v) Agribusiness Receivables Certificate (“CRA”); and Rural Product Certificate (“CPR”).

Similarly, it is more advantageous for the investor to use an FII to invest in rural properties, aiming to avail themselves of the income tax exemption for the individual investor (if the legal requirements are met). Similarly, it would be more efficient to invest at a Private Equity Fund (“FIP”) that invests in companies that operate agro-industrial activities rather than through a Fiagro, as the latter is taxed at the rate of 15% (if the investor is resident in Brazil).

Such investments, if made via Fiagro, would be taxed at the rate of 20% when distributions are made by to its investors, thus making the use of this fund inefficient, compared to investments in agrarian securities or through the use of other types of investment funds.

Payment of Fiagro’s shares in assets: the third and last of the vetoes brought by the Presidency of the Republic concerns the deferral of capital gain in the event that Fiagro’s shares are subscribed by means of a contribution of real estate assets.

As a rule, the subscription of investment fund shares in general by contribution of assets or rights must be made at the fair market value of the asset or right transferred, thus requiring the payment of Income Tax by the investor on any capital gain assessed.

The Bill approved by the Congress provided that any gain earned by individuals or legal entities with the payment of Fiagro’s shares for real estate could be deferred until the sale of the shares or their redemption, in the event of liquidation of the fund, a rule that was vetoed by the Presidency of the Republic.

Analysis of vetoes by the National Congress: the vetoes of the Presidency of the Republic may be analyzed and rejected by an absolute majority of the House of Representatives and the Senate, that is, with 257 votes from representatives and 41 from senators. As a rule, the analysis by Congress must be done within 30 days from the veto message before the Legislative Secretariat of the State (which should take place until Thursday). If they are not analyzed within this period, voting on vetoes is automatically included in the voting agenda for the day.

In our view, the rejection of vetoes (especially on the taxation of Fiagro’s portfolios and the application of the exemption rule for individual investors) is of paramount importance for Fiagro to become a viable alternative for raising funds to finance the agricultural sector in Brazil.

Indeed, Fiagro (due to vetoes) does not prove to be an efficient alternative for investments in rural properties, as these could be exploited by FII with income tax exemption for individuals (provided that the requirements are met).

Similarly, equity in companies that exploit activities that are part of the agro-industrial chain is also not very efficient in Fiagro compared to FIP, in which income paid to residents in the country is taxed at a rate of 15% (with the possibility of applying a rate zero, in the case of non-resident investors).

Finally, it is more advantageous to invest directly in (i) Agricultural Deposit Certificates (“CDA”), (ii) Agricultural Warrants (“WA”), (iii) Agribusiness Credit Rights Certificates (“CDCA”), (iv) Agribusiness Letters of Credit (“LCA”); (v) Agribusiness Receivables Certificates (“CRA”); and Rural Product Notes (“CPR”), insofar as such bonds confer more favorable tax treatment to the investor compared to that applicable to Fiagro.