Originally published in the May 13 edition of World Tax Daily (Copyrights Tax Analysts)
Because of the interest rate reduction in domestic markets, Brazil’s executive branch is considering reducing the maximum withholding tax on financial investments from 22.5 percent to 15 percent.
The government’s decision is likely to come within the next few weeks as the executive branch considers issuing a provisional measure to reduce the withholding tax.
The government is not considering the tax reduction as a move to promote investment in Brazilian markets or to please taxpayers. Rather, it is motivated by the decades-old law guaranteeing a 6 percent annual interest rate for any savings account held in the country.
Historically, savings accounts have been the only viable investment opportunity available to small individual investors. Without sufficient funds to invest in financial markets benefiting from higher interest rates, small investors and poor families deposit their savings in savings accounts. The government does not tax interest earned by these accounts, while banks are required to invest the savings accounts’ balances in housing projects.
Over the years, Brazil’s high interest rates have made savings accounts (and their 6 percent annual interest rate) a less profitable and less attractive investment option usually reserved for the poor.
Amid the international financial crisis and with inflation under control, the government thinks that the main interest rate in the country (SELIC) must be reduced even further (from the current 10.25 percent annual rate). But a drastic reduction of SELIC could have a huge impact on the financial sector if investors leave investment funds and bonds and migrate to the tax-free savings accounts.
For example, assume an investment fund that pays annual interest of 12 percent is subject to a 22.5 percent withholding tax and charges an annual management fee of 4 percent of the fund’s assets. For a $10,000 investment, the taxpayer would earn gross interest of $1,200. But the net income would be significantly lower after the withholding tax (22.5 percent of $1,200, or $270) and the management fee (4 percent of the fund’s assets after tax ($10,930), or $437). In the end, out of the $1,200 gross interest, the investor would receive only $493, or 4.93 percent of the original investment. In this scenario, there is no doubt that savings accounts become a better investment opportunity.
Alternatives would be to tax savings accounts or eliminate the legal guarantee of 6 percent interest on savings accounts. However, such an alternative could have an adverse political effect going into the 2010 general elections because more than 90 percent of Brazil’s savings accounts have a balance smaller than BRL 5,000. Also, opposition parties have begun a campaign claiming that a leftist government plans to tax the savings of the poor or reduce its earnings just as savings accounts finally become a good investment.
The government’s only remaining alternative is to change the way financial investments are taxed. Currently, fixed-income investments are generally taxed according to the period money is invested at the following rates:
- up to 180 days: 22.5 percent;
- from 181 days up to 360 days: 20 percent;
- from 361 days up to 720 days: 17.5 percent; and
- from 721 days and up: 15 percent
Variable income investments are subject to a standard 15 percent withholding tax on nominal gain.
The government’s solution would be to reduce the tax rate for all investments to 15 percent. The government is also considering imposing withholding tax on savings accounts with large balances, such as those with balances greater than BRL 30,000. According to Brazil’s Central Bank, 98 percent of all savings accounts have balances smaller than BRL 30,000. Thus, the negative political impact of this move would be limited.
David Roberto R. Soares da Silva