Taxation of savings vehicles in Brazil and a proposal of a "top-up" income tax

de Carvalho Junior, Pedro Humberto Bruno Working Paper Taxation of savings vehicles in Brazil and a proposal of a "top-up" income tax Texto para Discussão, No. 3103 Provided in Cooperation with: Institute of Applied Economic Research (ipea), Brasília Suggested Citation: de Carvalho Junior, Pedro Humberto Bruno (2025) : Taxation of savings vehicles in Brazil and a proposal of a "top-up" income tax, Texto para Discussão, No. 3103, Instituto de Pesquisa Econômica Aplicada (IPEA), Brasília, https://doi.org/10.38116/td3103-eng This Version is available at: https://hdl.handle.net/10419/316165 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/2.5/br/ 3103 TAXATION OF SAVINGS VEHICLES IN BRAZIL AND A PROPOSAL OF A “TOP-UP” INCOME TAX PEDRO HUMBERTO BRUNO DE CARVALHO JUNIORPEDRO HUMBERTO BRUNO DE CARVALHO JUNIOR 3103 Brasilia, April 2025 TAXATION OF SAVINGS VEHICLES IN BRAZIL AND A PROPOSAL OF A “TOP-UP” INCOME TAX PEDRO HUMBERTO BRUNO DE CARVALHO JUNIOR1 1. Tenured Researcher at Department of Macroeconomic Studies and Policies of the Institute for Applied Economic Research (Dimac/Ipea). E-mail: [email protected]v.br. Discussion Paper A publication to disseminate the findings of research directly or indirectly conducted by the Institute for Applied Economic Research (Ipea). Due to their relevance, they provide information to specialists and encourage contributions. © Institute for Applied Economic Research – ipea 2025 C331 Carvalho Junior, Pedro Humberto Bruno de Taxation of savings vehicles in Brazil and a proposal of a “top-up” income tax / Pedro Humberto Bruno de Carvalho Junior. – Brasilia : Ipea, Abr. 2025. 47 p. : il. – (Discussion Paper ; n. 3103). Inclui referências bibliográficas. 1. Ganhos de Capital. 2. Imposto de Renda da Pessoa Física. 3. Concentração da Riqueza. 4. Aprendizado. 5. Imposto sobre Heranças. 6. Brasil. I. Instituto de Pesquisa Econômica Aplicada II. Título. CDD 336.24 Ficha catalográfica elaborada por Elisangela da Silva Gomes de Macedo CRB-1/1670 How to cite: CARVALHO JUNIOR, Pedro Humberto Bruno de. Taxation of savings vehicles in Brazil and a proposal of a “top-up” income tax. Brasília: Ipea, Abr., 2025. 47 p.: il. (Discussion Paper, n. 3103). DOI: http://dx.doi.org/10.38116/td3103-eng JEL: H24; H27; H29; H71; K34; K36. DOI: https://dx.doi.org/10.38116/td3103-eng Ipea publications are available for free download in PDF (all) and ePUB (books and periodicals). Access: https://www.ipea.gov.br/portal/publicacoes The opinions expressed in this publication are of exclusive responsibility of the authors, not necessarily expressing the official views of the Institute for Applied Economic Research and the Ministry of Planning and Budget. Reproduction of this text and the data contained within is allowed as long as the source is cited. Reproduction for commercial purposes is prohibited. Federal Government of Brazil Ministry of Planning and Budget Officer Simone Nassar Tebet A public foundation affiliated to the Ministry of Planning and Budget, Ipea provides technical and institutional support to government actions – enabling the formulation of numerous public policies and programs for Brazilian development – and makes research and studies conducted by its staff available to society. President LUCIANA MENDES SANTOS SERVO Director of Institutional Development FERNANDO GAIGER SILVEIRA Director of Studies and Policies of the State, Institutions and Democracy LUSENI MARIA CORDEIRO DE AQUINO Director of Macroeconomic Studies and Policies CLÁUDIO ROBERTO AMITRANO Director of Regional, Urban and Environmental Studies and Policies ARISTIDES MONTEIRO NETO Director of Sectoral Studies and Policies, of Innovation, Regulation and Infrastructure FERNANDA DE NEGRI Director of Social Studies and Policies RAFAEL GUERREIRO OSÓRIO Director of International Studies KEITI DA ROCHA GOMES Chief of Staff ALEXANDRE DOS SANTOS CUNHA General Coordinator of Press and Social Communication GISELE AMARAL DE SOUZA Ombudsman: https://www.ipea.gov.br/Ouvidoria URL: https://www.ipea.gov.br CONTENTS ABSTRACT SINOPSE 1 INTRODUCTION ........................................................................ 6 2 TAXATION OF SAVINGS VEHICLES IN BRAZIL .................. 7 2.1 Open-ended fixed-income funds and bonds ..............................7 2.2 Real estate ................................................................................. 10 2.3 Pension fund ............................................................................. 12 2.4 Private closed-end funds and offshore trusts......................... 13 2.5 Real estate and agricultural funds and bonds ....................... 15 2.6 Equity funds and shares ........................................................... 16 2.7 Private equity and venture capital funds ................................ 18 3 EFFECTIVE TAX RATES ON SAVINGS VEHICLES IN BRAZIL ...............................................................................19 3.1 Summarizing tax rules on savings vehicles in Brazil .............. 19 3.2 Calculating marginal ETR ......................................................... 22 3.3 Effective tax rates among some OECD countries ................... 28 4 REVENUES OUTCOMES OF THE TAX REFORMS ON FUNDS ..............................................................................29 5 PROPOSALS TO REDUCE REGRESSIVITY: A TOP-UP INCOME TAX .........................................................................32 5.1 Tax avoidance related to residence status ..................................32 5.2 Three approaches that can effectively tax wealthy Brazilians 33 5.3 Designing a TUIIT for Brazil ...................................................... 35 5.4 Needed changes on the current income tax ........................... 41 6 CONCLUSION ........................................................................42 REFERENCES ............................................................................ 45 ABSTRACT The study examines the shift in taxation of open-ended fixed-income funds in Brazil from a realization basis to an accrual basis (locally known as come-cotas), which was introduced in 1998 and more recently extended to include private closed-end funds and offshore trusts through the enactment of Law No. 14,754/2023. The study estimated the effective tax rates of various savings vehicles, including real estate, fixed-income funds and bonds, stocks, pension funds, real estate and agricultural funds, and venture capital funds, among others. It finds that individual investments in rental properties are subject to a higher effective tax rate compared to other investment vehicles, especially financial assets. Finally, the study proposes a 14% “top-up” Individual Income Tax aimed at reducing overall tax regressivity from income tax and social contributions for the top 2% of wealthiest taxpayers. This minimum tax would encompass all sources of income, including dividends, certain unrealized capital gains, and benefits currently exempt by legislation, potentially generating a maximum of R$ 145.6 billion in revenue. Keywords: capital gains; individual income tax; wealth concentration; inheritance tax; Brazil. SINOPSE O texto trata da mudança para tributação recorrente ou antecipada dos fundos abertos de renda fixa (sistema popularmente conhecido como come-cotas) introduzido em 1998, e mais recentemente perante os fundos pessoais fechados e as trusts localizadas no exterior através da Lei no 14.754/2023. Através de simulações, o trabalho comparou a tributação efetiva de diversos veículos de investimentos, como imóveis, fundos e letras de renda fixa, ações, fundos de pensão, fundos imobiliários e do agronegócio, fundos de participação, entre outros. Estimou-se uma alta tributação do investimento individual em imóveis para aluguel em detrimento de outros veículos de investimento, sobretudo investimentos financeiros. Por fim, o estudo faz uma proposta para reduzir a regressividade da tributação conjunta do imposto de renda e contribuições previdenciárias perante os 2% mais ricos, introduzindo uma tributação mínima de 14% sobre a renda total do contribuinte, incluindo dividendos, certos ganhos de capital não realizados e benefícios atualmente isentos pela legislação. Com isso, estimou-se um potencial máximo de R$ 145,6 bilhões em ganhos de receita. Palavras-chave: ganhos de capital; imposto de renda da pessoa física; concentração da riqueza; imposto sobre heranças; Brasil. 6 DISCUSSION PAPER 3103 1 INTRODUCTION This study examines the recent changes in Brazil’s income tax legislation resulting from the enactment of Federal Law No. 14,754/2023 (Brasil, 2023b), which introduced accrual basis taxation for two types of funds primarily held by wealthy individuals: private closed-end funds and offshore trusts. Additionally, this study provides an overview of the taxation of other savings vehicles in Brazil, analyzes the revenue outcomes resulting from the new law, discusses income tax regressivity on the wealthiest citizens, and proposes measures to mitigate this issue. Many studies have indicated that the effective income tax rate on the top 0.1% of earners has remained approximately 2% for several years (Gobetti, 2024; Gobetti and Orair, 2016; Introíni et al., 2018), with the current exemption for dividend income cited as a primary factor contributing to this scenario. However, even with a possible reintroduction of dividend taxation in Brazil, it is expected that wealthy individuals will exploit other existing loopholes within the tax system. Thus, understanding the taxation of other savings vehicles is essential to formulate tax policies to effectively tax the top richest. Furthermore, this study analyzes not only the taxation of capital income and gains but also the applicable taxes on capital holding and their transfer through sale, donation, or inheritance across various savings vehicles. Since income tax exemptions and reductions are applied to each income category separately rather than considering the overall income of the taxpayer, the study highlights tax regressivity among the wealthiest individuals and proposes a “top-up” income tax that targets all sources of income, including those currently exempted for the richest individuals. The significance of this paper arises from the global trend of low capital taxation, which tends to favor wealthy individuals. These individuals often exploit loopholes in both local and international legislation to minimize their tax liabilities or engage in aggressive tax planning. Brazil’s 2023 reform concerning funds taxation aims to address one of the existing loopholes in the country’s tax framework. This study takes inspiration from various publications, including works by Hebous et al. (2024), OECD (2018; 2022a), and Zucman (2024). The study is structured into six sections, besides this introduction and conclusion. The second sections detail the current taxation framework across seven types of savings vehicles in Brazil: i) open-ended fixed-income funds and bonds; ii) real estate; iii) pension funds; iv) private closed-end funds and offshore trusts (those affected by Law No. 14,754/2023); v) real estate and agricultural funds and bonds; vi) equity funds and stocks; and vii) private equity and venture capital funds. Section three outlines the effective taxation levels associated with these seven savings vehicles, underscoring the significant burden imposed on rental real estate held by individuals, as previously demonstrated by OECD (2022a). Section four reviews Brazil’s capital gains tax revenues since 1998, highlighting the revenue implications 7 DISCUSSION PAPER DISCUSSION PAPER 3103 of Law 14,754/2023. Lastly, section five proposes a 14% “top-up” income tax for the top 2% wealthiest taxpayers to alleviate the disproportionate tax regressivity stemming from extensive capital income exemptions and existing loopholes in tax legislation. 2 TAXATION OF SAVINGS VEHICLES IN BRAZIL This section provides a historical overview and analyzes the tax rules of the seven savings vehicles in Brazil: i) open-ended fixed-income funds, and government or corporate bonds; ii) real estate; iii) pension funds; iv) private closed-end funds; v) incentivized funds and bonds for the real estate and agricultural sectors; vi) equity funds and stocks; and vii) incentivized private equity and venture capital funds. The analysis covers the existing taxes and their regulations that may apply at all stages of capital holding: acquisition, ownership, income appropriation, transmission via inheritance or donation, and disposal through sale. Additionally, this section distinguishes the rules applicable to residents and non-residents and provides a brief overview of the tax rules applied to certain savings vehicles among some OECD countries. 2.1 Open-ended fixed-income funds and bonds 2.1.1 Capital income and gains of residents In Brazil, the accrual-based taxation for open-ended fixed-income funds (fundos de renda fixa)1 held by residents was introduced in 1998 through Provisional Executive Order (Medida Provisória – MP) No. 1,636/1997.2 This change occurred during a financial crisis triggered by the Asian crisis, which put pressure on Brazil’s pegged exchange rate and caused the prime interest rate (taxa Selic) to rise to 45.9% in November 1997.3 MP No. 1,636/1997 established December 31, 1997, as the effective date for implementing accrual taxation, allowing income accrued before this date to continue being taxed upon realization. Additionally, the tax rate was raised from 15% to 20%, while the same law reduced the tax rate for equity funds (fundos de renda variável)4 from 15% to 10% to encourage investment in the domestic stock market. 1. In Brazil, fixed-income funds, which include more than 33% of fixed-income assets (such as government and corporate bonds, securities, certificates of deposit, and gold), are akin to money-market funds (fundos de renda fixa) and mutual funds (fundos multimercado). 2. This provisional executive order was annually renewed up to become definitive with the MP No. 2,189-49/2001. 3. Brazil’s annual prime rate (Tax Selic) increased from 19.0% to 45.9% in November 1997 due to effects of Asian crisis, decreased to 19.3% in July 1998, and increased again to 40.2% in September 1998 due to Russian crisis. 4 . They must be composed of at least 67% equities, shares, stocks, asset-backed securities, options, forwards, futures contracts, or other securities traded on the Brazilian Stock Exchange (Bovespa). 8 DISCUSSION PAPER 3103 During the financial crisis of the 1990s, upper-middle-class and wealthy individuals benefited from high interest rates on fixed-income funds, allowing them to accumulate wealth, which exacerbated inequality. Therefore, implementing accrual basis taxation on capital gains aimed to mitigate this trend (Hebous et al., 2024). The transition from realization to accrual basis for this common savings vehicle was popularly known as come-cotas (translated as “shares eater”). However, MP No. 1,636/1997 5 modified Law No. 9,532/1997 to exclude closed-ended funds from receiving the same tax treatment as open-ended funds, meaning the former continued to be taxed upon to realization. The subsequent RFB regulatory instructions (instrução normativa – IN) further clarified that private closed-ended funds would be taxed upon realization according to the standard capital gains schedule. Additionally, for tax residents, the income from offshore trusts was also subject to taxation upon its redemption in Brazil. In 2002, the Brazilian government launched a program to issue government bonds that individuals could hold directly, named as Tesouro Direto. These bonds are not subject to recurrent taxation under the come-cotas regime; instead, income tax is applied to accrued income upon early sale in the secondary market or at final maturity. Currently, the maturity of Tesouro Direto typically ranges from 3 to 30 years, some paying semestral interests and allowing to defer taxation. Therefore, direct investments in bonds have grown more significantly than those in fixed-income funds. Laws No. 10,892/2004 and No. 11,033/2004 modified the come-cotas framework, introducing biannual tax collection for fixed-income funds and establishing long-term rates for both fixed-income funds and fixed-income bonds. Long-term fixed-income funds held by residents have been taxed biannually at 15% under come-cotas, but higher rates apply for redemptions made within two years. 6 Short-term fixed-income funds are taxed biannually at 20% under come-cotas and incur a higher rate of 22.5% if redeemed within six months. This long-term taxation on redemption is deductible from what was collected by come-cotas. Fixed-income bonds, such as Tesouro Direto and corporate bonds, are subject to the same long-term rates; however, they continue to be taxed upon sale in the secondary market or at their final maturity. Moreover, Law No. 11,033/2004 7 confirmed that other funds taxed on a realization basis would remain subject to this rule. This includes all funds not classified as open-ended fixed-income or mutual funds, encompassing private closed-end funds (fundos fechados), private pension funds, equity funds (fundos de investimento em ações – FIA), private equity 5. Item II, art. 6, MP No. 1,636/1997. 6. These increased rates are 22.5% for redemptions made within six months, 20% for those between six months and one year, and 17.5% for redemptions between one and two years. 7. Paragraph 3, art. 1, Federal Law No. 11,033/2004. 15 DISCUSSION PAPER DISCUSSION PAPER 3103 annual distributions (in Korea). According to these rules, these six countries likely apply the same tax treatment for both open-ended and closed-end funds. Ten countries (Austria, Czechia, Denmark, Germany, Latvia, the Netherlands, New Zealand, Portugal, Sweden, and Turkey) considered funds as opaque structures and applied a final withholding tax on accrued income. In contrast, eighteen countries taxed accrued income on funds only upon realization, either as interest, dividends, or capital gains, depending on the fund and the nature of the return. Capital gains tax on the sale of fund shares was imposed in all countries except Australia (which already taxes fund returns on an accrual basis), as well as in the Netherlands, New Zealand, and Portugal (which apply a final withholding tax on fund returns on an accrual basis). In contrast, Belgium and Colombia fully exempt funds from taxation on both accrued income and capital gains. Furthermore, no country imposes transaction taxes on investment funds. 2.5 Real estate and agricultural funds and bonds Real estate investment funds (FII) are closed-end funds with fixed or indeterminate shares that focus on the real estate sector. They were established by Law No. 8,668/1993 and are further regulated by Comissão de Valores Mobiliários (CVM) Instructions No. 472/2008 and No. 175/2022 (Annexure III). FIIs must invest in properties intended for rental, construction, or resale, as well as in shares of construction companies. They typically do not require a high minimum investment level and annual fees range from 1% to 2% of the invested capital. Foreign investors, even those residing in low-tax jurisdictions, are exempt from capital gains tax. By 2024, nearly 500 registered FIIs were traded on Bovespa, making them a popular savings vehicle among Brazilians, as they generally offer monthly tax-free dividends to individuals. Agricultural investment funds (Fiagro) have rules similar to those of FII. They were established by Law No. 14,130/2021, which incorporated Fiagros under Law No. 8,668/1993. Fiagros can be either open-ended or closed-ended funds linked to the agribusiness sector. They invest in various assets related to agribusiness, such as credit rights, rural properties, securities, and related shares. They offer tax-free dividends for individuals, and there is no predetermined time for redemption; however, shareholders can sell their shares on the secondary stock market, Bovespa. Foreign investors, including those residing in low-tax jurisdictions, are exempt from capital gains tax. By 2024, nearly hundred registered Fiagros were listed on Bovespa, making them a popular savings vehicle among Brazilians due to the absence of come-cotas and the regular distribution of tax-free dividends. 16 DISCUSSION PAPER 3103 In addition, real estate bonds such as certificates of real estate receivables (certificado de recebíveis imobiliários – CRI) and letters of credit for real estate (letra de crédito imobiliário – LCI) and agricultural bonds such as certificates of agricultural receivables (certificado de recebíveis do agronegócio – CRA) and agricultural credit letters (letra de crédito do agronegócio – LCA) are also sector-specific investments. LCIs are fixed-income securities issued by financial institutions to fund real estate companies, while CRIs are mortgage-backed securities issued by securitization firms. LCAs are fixed-income securities issued by financial institutions, backed by credit rights from the agricultural sector, whereas CRAs are specifically designed for agricultural financing. These bonds are considered more conservative investments, with returns typically slightly lower than the Selic interest rate; however, they are income tax exempt. 2.5.1 Capital income and gains Dividends regularly distributed by FIIs and Fiagros are tax-free for individual residents and nonresidents, even if they reside in low-tax jurisdictions. However, capital gains due to shares’ sale in the secondary market are taxed at 20%. FIIs are very low-taxed. At a corporate level, funds income (mostly property rents) and capital gains (due to resale of properties) are also tax exempted.11 While local property taxes and stamp duties still apply to properties owned by FIIs, they are generally low, stamp duties at 3% and an effective urban property tax rate of 0.4%. Fiagros also have slightly the same tax rules as FIIs at the corporate level, which income and capital gains are tax exempted. As a result, only capital gains from the resale of shares by shareholders in the secondary market are effectively taxed. 2.5.2 Capital transference by sale, donation or death Inheritance tax levied by state governments to FIIs, Fiagros, and real estate bonds and agricultural bonds have the same rules as other assets. 2.6 Equity funds and shares This section outlines the taxation of equity funds (FIA), and securities (stocks, shares, Brazilian Depositary Receipts – BDR) directly held by individuals and companies traded on Bovespa. FIAs are open-ended or closed-end funds with at least 67% of their capital comprised of securities, while fixed-income investments may represent up to 11. Art. 16, Law No. 8,668/1996. 17 DISCUSSION PAPER DISCUSSION PAPER 3103 33%. Although FIAs cannot distribute regular dividends, their shares can be redeemed (if they are open-ended funds) or traded on a secondary market. BDRs allow investors in Brazil to indirectly own shares of foreign companies without engaging with foreign brokerages. BDRs are issued by foreign companies through a Brazilian depository institution and can be traded on Bovespa. However, the tax rules for BDRs differ from those for Brazilian stocks and equity funds. 2.6.1 Capital income and gains Dividends received from direct ownership of shares and stocks are tax-free, while income from interest on net equity (juros sobre o capital próprio) is taxed at 15%. However, since 2015, accrued dividends on FIAs have been taxed at 15% upon realization, according to the interpretation of IN No. 1,585/2015 (Brasil, 2015). Prior to 2015, these accrued dividends on FIAs were exempt. Additionally, dividends from BDRs are considered offshore income and are taxed according to the standard progressive income tax schedule, which can go up to 27.5%. Capital gains of FIAs and stocks are taxed on realization at 15% for residents and 10% for nonresidents. However, capital gains from day-trade operations in the stock market are taxed at a rate of 20%, and small capital gains up to R$ 20,000 per year are exempt. Specific long-term equity funds held by nonresidents (not located in low-tax jurisdictions)12 are capital gains exempted under certain conditions. They must have 100% of their shares held by nonresidents, and their capital must comprise at least 85% of stocks, equities or other related securities. 13 Capital gains from BDRs are treated the same as those from Brazilian equities and are taxed at 15% (or 20% for day-trade transactions). However, there is no relief for low-value capital gains. 2.6.2 Capital transference by sale, donation or death Inheritance tax levied by state governments on FIAs, stocks, BDRs and other related vehicles have the same rules as other assets. 2.6.3 Taxation of shares among OECD countries According to the OECD (2018, p. 30), as of July 2016, dividends from equities were taxed under either a flat-rate capital income tax or a broadly comprehensive income tax. The 12. The countries considered low-tax jurisdictions are those in the 1st article of the RFB IN No. 1,037/2010, available at: http://normas.receita.fazenda.gov.br/sijut2consulta/link.action?idAto=16002 (in Portuguese). 13. RFB IN No. 1,585/2015, art. 91, 6th par., II. 18 DISCUSSION PAPER 3103 latter model was applied in Australia, Canada, Chile, Finland, France, Hungary, Ireland, Japan, Korea, Luxembourg, Mexico, New Zealand, Norway, Spain, Switzerland, the United Kingdom, and the United States. Only Estonia exempted dividends. Capital gains on equities were taxed upon realization in 31 out of 36 countries, while being exempted in Belgium, Colombia, the Netherlands, New Zealand, and Turkey. There was no taxation on unrealized capital gains from shares. Additionally, stamp duties on share purchases or sales were applicable in Belgium, Ireland, Italy, and Greece. 2.7 Private equity and venture capital funds Private Equity Investment Funds (FIP) are incentivized closed-end funds. At least 67% of their capital must be allocated to sector-related equities, equity funds, debentures, securities, notes, and other assets traded on the stock exchange, while foreign investments are capped at a maximum of 33%. These funds are fixed-term and are divided into several categories, some of which offer significant tax benefits, as follows. 1) Closed-end equity funds for startups (FMA or FIA – Mercado de Acesso). 2) Small companies (FIP – Capital Semente), with an annual turnover of less than R$ 20 million. 3) Emerging companies (FIP – Empresas Emergentes), with an annual turnover of less than R$ 400 million. 4) Infrastructure or research and development – fundos de participação em investimento em infraestrutura (FIP-IE) and fundos de participação em investimento em produção econômica intensiva em pesquisa, desenvolvimento e inovação (FIP-PD&I) –, which are related to companies or projects in energy, transport, water supply, sanitation, irrigation or highly intensive research and development and innovation. 5) Multi-strategy (FIP – Multiestratégia) that is not tied to a specific sector. 6) The FIP-IE and FIP-PD&I were established in 2007 and 2011, respectively, and are exempt from taxes on dividends and capital gains. These funds must have at least five shareholders, and at least 90% of their assets must consist of shares, debentures, and other securities issued by corporations involved in developing new infrastructure projects in Brazil. They are part of Brazil’s sectoral policies aimed at attracting private investments, particularly in the sectors specified in Law No. 11,478/2007, which includes energy, transport, water supply, sanitation, and irrigation. Law No. 12,431/2011 further broadened the scope of 19 DISCUSSION PAPER DISCUSSION PAPER 3103 incentivized FIPs to encompass highly intensive research, development, and innovation sectors (FIP-PD&I). As of 2022, there were approximately 100 registered FIP-IEs, most related to energy projects. 2.7.1 Capital income and gains All FIPs are tax-free for nonresidents, even if located in low-tax jurisdictions. Specifically, FIP-IE and FIP-PD&I have tax-free dividends and capital gains for individuals resident in Brazil, 14 even with their share redemption in the secondary market. Capital gains of FIP-IE and FIP-P&D held by Brazilian companies and all other FIPs held by residents are taxed at 15% on realization. 2.7.2 Capital transference by sale, donation or death Inheritance tax levied by state governments on FIPs have the same rules as other assets. 3 EFFECTIVE TAX RATES ON SAVINGS VEHICLES IN BRAZIL This section estimates the marginal effective tax rates (ETR) on income generated and on total capital value for eleven types of savings vehicles in Brazil: owner-occupied houses, rental properties held by individuals, rental properties held by companies, real estate funds (FII), fixed-income funds, fixed-income bonds, stocks, private pension funds, equity funds (FIA), agricultural funds (Fiagro), and exclusive fixed-income funds for non-residents. The section aims to compare the ETR differences among these saving vehicles, demonstrating that taxes are far neutral and that create significant disparities in taxation across investments. It further seeks to confirm that rented real estate is more heavily taxed in Brazil, consistent with the findings of the OECD (2018). 3.1 Summarizing tax rules on savings vehicles in Brazil Table 1 summarizing the taxation rules according to four tax events: capital purchase, holding, income appropriation, appreciation (capital gains) and transference by death or donation of the cited savings vehicles. 14. IN No. 1,585/2015, art. 33, par. 1st: “the gains from the sale of shares of referred investment funds will be taxed at: I – 0% rate if obtained by an individual in transactions carried out on or off the stock exchange”. 20 DISCUSSION PAPER 3103 TABLE 1 Taxation of different savings vehicles in Brazil (2024) Savings vehicle Income Capital gains Purchase Inheritance or donation Holding REAL ESTATE • Rents received by individuals are under the standard progressive income tax (up to 27,5%). Imputed rents for owner-occupied are disregarded, and mortgage interests are not deductible for individual income tax. • Rents received by real estate companies enjoy lower rates (6-11%). • Taxpayers who own a single property valued at up to R$ 440,000 (approximately US$ 80,000 as of September 2024) are exempt. • Progressive schedule from 15% to 22.5%, prevailing 15%. Taxation can be deferred if an individual buys another residence within 6 months. • Capital gains tax is based on a cash method; however, expenses such as mortgage interest, renovations, and some taxes and fees can be used to adjust the property value. • Since 1996, inflation has not adjusted to the acquisition value. • 2-3% Stamp Duty (ITBI), based on market value. • Notary fees are about 1% of purchase value. • Inheritances and donations have been taxed by state governments at rates capped at 8% since 1992. • From 2024, tax rates must be progressive while the Federal Senate maintains competence to set the top rate. From 2024, Inheritance Tax includes estates or decedents located overseas. • The exempted threshold is reduced and varies among states, averaging US$ 10,000. Low-valued private residences are also exempted by the states. • There is no “step-up in basis” on death. Heirs can opt to pay capital gains tax on the transference or defer payment until the gains’ realization. • Urban Property Tax (IPTU) • Rural Property Tax (ITR) • Federal Marine Property Tax for Coastal Properties • No wealth tax. EQUITIES FUNDS AND STOCKS • Equity Funds (FIA) • Exchange Traded Funds (ETF) • Asset-backed securities (FIDC) • Over-the-Counter securities (OTC) • Brazilian Depositary Receipts (BDRs) • Dividends of stocks/shares directly held by residents and non-residents are exempted. • Dividends from BDRs are taxed according to the standard (progressive) income tax schedule (up to 27.5%). • Interest on Net Equity: 15%. • CG are taxed on realization at 15% for residents and 10% for nonresidents. It is a final withholding rate, not adjustable by the progressive income tax schedule. • Redemptions of equity funds' shares: 15% for residents and 10% for nonresidents. • Capital gains on financial assets up to R$ 20,000 per year are exempt, except for BDRs. • No stamp duties, fees may be applied. • No wealth tax. REAL ESTATE & AGRICULTURAL FUNDS AND BONDS • Real estate funds (FII) • Agricultural funds (Fiagro) • Real Estate bonds (CRI & LCI) • Agricultural bonds (CRA & LCA) • Regular dividends of FII and FIAGRO are exempted. • Income related from Real Estate and Agricultural Bonds are exempted. • CG of FII and Fiagro are taxed at 20% on realization. INCENTIVIZED EQUITY FUNDS (FIP) • Infrastructure projects (FIP-IE) • R&D projects (FIP-PD&I) • Small companies and startups (FIA-Acesso) • Emergent companies (FIP-EE) • Exempted • Exempted for individuals 21 DISCUSSION PAPER DISCUSSION PAPER 3103 Savings vehicle Income Capital gains Purchase Inheritance or donation Holding FIXED-INCOME FUNDS & BONDS • Money market funds (renda fixa) • Mutual funds (multimercados) • Brazilian government bonds • Certificates of deposit (CDB) • Corporate bonds (fundo CP) • OTC swaps • Gold • Private loans • Options and forward contracts • Savings deposits (poupança) • Fixed-income funds for nonresidents • Interests accrued on fixed-income funds of residents are taxed biannually at rates of 15% or 20%, depending on whether they are from long-term or short-term funds. • Dividends accrued on Mutual Funds (funds with more than 33% of fixed-income assets) are also taxed biannually. • Income from bonds is only taxed when redeemed at the time of maturity at longterm rates. Interests from regular savings accounts (poupança) are exempted. • Income from exclusive long-term fixedincome funds for nonresidents are exempted if government bonds are more than 98% of capital. • CG on bonds is taxed together with Income Tax if redeemed before their maturity at long-term rates. Long-term CG rates for fixed-income assets range from 15% (for more than 2 years) to 22.5% (for less than six months). • The IOF is levied if redemption for funds and bonds occurs within less than 30 days. • No stamp duties. • No wealth tax. OFFSHORES ASSETS • Deposits • Money market funds • Mutual funds • Trusts • Rents • Insurance • Crypto assets • Others (except equity funds and stocks) • Since 2024, rents, dividends and interests, accrued on trusts, among other offshore assets will be taxed at 15%, regardless their redemption to Brazil. Tax base also includes other companies indirectly controlled by trusts. • Dividends from holding offshore stocks are exempted. • Accrued dividends from offshore equity funds are taxed only upon realization at 15%. • From 2024, capital gains will be taxed on an accrual basis at 15%, which includes the appreciation of cryptocurrency and dividends on mutual funds. • Exchange rate gains are taxed only upon realization. Taxpayers have the option to update their offshore capital value up to Dec 2023 at a reduced rate of 8%. • CG from offshore equity and equity funds will continue to be taxed only upon realization at 15%. • No Stamp Duties in Brazil. • Since 2024, assets and donors (including changes in the shares of offshore trusts) have been subject to the Inheritance Tax. • Since 2024, distributions from trusts involving the settlor or beneficiaries will also be subject to the Inheritance Tax. • No wealth tax. LIFE INSURANCE • Exempted on life insurance payout • CG tax of 15% is levied on the redemption of redeemable life insurances. • Tax on Financial Operations (IOF) at 0.38% on premiums • Exempted PRIVATE PENSIONS • Income is taxed only upon redemption. • Beneficiaries can choose between the standard progressive individual income tax (up to 27.5%) or long-term tax rates (generally the most favorable regime) that vary based on the redemption period (ranging from 35% for redemptions made in less than 2 years to 10% for those held for more than 10 years). • Contributions are deductible from income tax up to 12% of total income. • Exempted • No IOF • Pensions and benefits from closed-end pension funds are exempted. Some states tax open-ended pension funds. • The National Congress is discussing the exemption of income accrued from funds held for more than five years to prevent tax planning strategies. Sources: Brasil (2015; 2023b) and other Brazil’s tax legislation. Author’s elaboration. 22 DISCUSSION PAPER 3103 3.2 Calculating marginal ETR Table 2 was prepared to compare the ETR over five years for an investment of R$ 1 million across different savings vehicles, as follows. 1) Owner-occupied property. 2) Direct investment in rental properties by individuals. 3) Rental properties indirectly held by individuals through companies. 4) Rental properties indirectly held by individuals through real estate funds (FII). 5) Fixed-income funds. 6) Fixed-income bonds. 7) Stocks. 8) Pension Funds. 9) Equity funds (FIA). 10) Agricultural funds (Fiagro). 11) Exclusive funds for nonresidents. Considering the market situation as of October 2024, the table reflects the present values based on the following assumptions. 1) Present values will be adjustable using an average prime rate of 9% and an inflation rate of 4%, resulting in a net rate of return of 5%. 2) Annual rental income is equivalent to 7% of the property’s market value, yielding a net return of 3%. 3) Property taxes and rent contracts in Brazil are adjusted for inflation and property taxes are paid by tenants. Therefore, only owner-occupied properties effectively pay property taxes. 23 DISCUSSION PAPER DISCUSSION PAPER 3103 4) A stamp duty of 3% and notary fees of 1% apply to real estate purchase, while annual property tax and urban fees, 15 equivalent to 0.4% of the property’s market value are applied. 5) A marginal income tax rate of 27.5% applies to rental income for individuals, while real estate companies are subject to an effective rate of 12%. 6) Fixed-income assets and pension funds (net) yield 5% per year, whereas FIIs, Fia - gros, shares and equity funds (net) yield 8%. FIIs, Fiagros and stocks have tax-free dividends while accrued dividends on equity funds are taxed at 15% upon realization. In addition, capital gains tax is levied at 15% on the nominal difference between the purchase value and the sale value, but in the case of FIIs and Fiagros, the rate is 20%. 7) The taxpayer will have an annual income equivalent to 1,800% of the average salary (R$ 600,000 per year, adjusted by inflation) and will deduct 12% of their total income for contributions to pension fund. Accrued income from pension funds is taxed at 20% if withdrawn within five years of investment and at 10% if withdrawn after ten years.16 8) An inheritance tax of 4%, along with notary fees of 1%, is applicable after death as established in the State of São Paulo. According to legislation, the inheritance tax base is the total capital value including the accrued income for fixed-income and equity funds, while it is the asset’s market value for real estate, FIIs, stocks, and Fiagro. 9) It is assumed that after five and ten years, real estate, FII, Fiagro and stocks will experience nominal appreciation of 33.8% and 79.1%, respectively, reflecting an inflation rate of 4% alongside an average annual GDP growth of 2%. It is important to note that, according to capital gains tax rules, asset values are not adjusted for inflation or interest. 15. Urban fees are those charged together with urban property tax by municipalities and generally comprises garbage collection fee or public cleaning fee. 16. In the case of pension funds, the initial investment is reduced to allow for a maximum deduction of 12% of individual income. For example, for a 10-year investment, the initial investment will be R$ 470,074 instead of R$ 1,000,000, as with other investments. This adjustment will not affect the comparisons among different savings vehicles. 24 DISCUSSION PAPER 3103 TABLE 2 ETR on accrued income and capital for an investment of R$ 1,000,000 over five years, considering purchase, holding, income, inherited and realization, market conditions for 2024, 5% net rate of return, present values Stage Year Real estate Financial assets Primary1Rented individual2 Rented company2 FII and Fiagro2,3 Fixed income funds4 Fixed income bonds Stocks2,3 Pensions fund5 Equity fund2 Nonresidents6 Purchase Stamp duties Y0 40,000 40,000 40,000 – – – – – – – Holding Property tax Urban fees Y0 4,000 – – – – – – – – – Y1 3,810 – – – – – – – – – Y2 3,628 – – – – – – – – – Y3 3,455 – – – – – – – – – Y4 3,291 – – – – – – – – – Income Income Tax Y0 – 7,857 3,429 – 7,143 – – -18,857 – – Y1 – 7,483 3,265 – 7,091 – – -17,959 – – Y2 – 7,127 3,110 – 7,041 – – -17,104 – – Y3 – 6,787 2,962 – 6,991 – – -16,290 – – Y4 – 6,464 2,821 – 6,941 – – -15,514 – – Inheritance Inheritance tax7Y4 41,941 41,941 41,941 41,941 38,592 40,000 41,941 – 46,050 – Disposal Capital gains8Y4 33,460 33,460 33,460 44,613 – 32,471 33,460 43,295 48,252 – 31 DISCUSSION PAPER DISCUSSION PAPER 3103 Figure 4 shows the revenues from various sources of capital gains from 2004 to 2024, including fixed-income open-ended funds, direct holding of fixed-income bonds, other funds and investments, swap operations, interest on net equity, income derived from Law No. 14,754/2023 and other sources (for example, capital gains tax on real estate, equity funds and stocks). Figure 4 indicates that income from fixed-income assets accounted for approximately 75% of total capital gains tax revenues between 2004 and 2012. This percentage decreased to 65% between 2012 and 2023 and further reduced to 60% in 2024 due to the rise of revenues from other sources. Indeed, revenues generated due to Law No. 14,754/2023, amounted to R$ 20.7 billion, representing 23% of total capital gains tax revenues collected from January to November 2024. FIGURE 4 Capital gains tax revenues per source of income1 45 45 45 39 34 35 34 35 34 26 31 34 35 35 30 32 21 25 35 30 22 30 32 31 35 39 38 42 41 45 38 36 32 34 33 30 29 27 26 34 39 323 37 0 20 40 60 80 100 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 Fixed-income funds Interest on net equity Fixed-income bonds Law No. 14,754/2023 Swap operations Others (real estate, shares, etc) Source: Brasil (2024). Author’s elaboration. Note: 1 Total = 100. Obs.: 1. Capital gains derived from offshore trusts, closed-end funds and the update of offshore assets, according to Law No. 14,754/2023. 2. For 2024, values are from January to November In 2024, the collection of R$ 20.7 billion derived by Law No. 14,754/2023 is divided into R$ 13 billion from private closed-end funds and R$ 7.7 billion from the update of offshore assets. 32 DISCUSSION PAPER 3103 5 PROPOSALS TO REDUCE REGRESSIVITY: A TOP-UP INCOME TAX 5.1 Tax avoidance related to residence status The enactment of Law No. 14,754/2023 was a way to close some existing loopholes in Brazil’s tax system. Dividends have been tax-free since 1993, which is the main reason for income tax regressivity (Gobetti, 2024). From 1998 to 2023, very wealthy individuals could create private closed-end funds or offshore trusts to manage their capital with taxation only on realization. Less wealthy individuals biannually pay come-cotas on open-ended fixed income or mutual funds. The Law brought a new way to tax the capital of wealthy individuals in the same way as general citizens. However, Brazilian legislation still has loopholes that enable wealthy individuals to avoid the accrual taxation on their capital. As shown by section 2, the pensions funds are taxed only on realization under long-term tax rates, with a reduced rate of 10% if the redemption occurs for more than 10 years. Real Estate Funds (FII) and Agricultural Funds (Fiagro) are dividend-free funds that may have a higher dividend yield than fixed income and, despite the risks, investments can be flowed to them due to the Law No. 14,754/2023. Equity Funds (FIA) do not provide recurrent dividends, but their accrued dividends are totally taxed on realization, which may be an alternative for private closed-end funds. However, the better strategy to avoid taxes and continue investing in Brazil is to change country of residence. If it is not classified as a “low-tax jurisdiction” according to the list of countries in RFB IN No. 1,037/2010 (Brasil, 2010), the investor can benefit from complete tax exemption on exclusive foreign investors’ equity funds (which must consist of at least 85% in stocks and other securities) or fixed-income funds (which must contain at least 98% in government bonds). This study highlights six countries that are not considered tax havens by Brazilian legislation but do provide large tax incentives for new residents: Switzerland, Portugal, Uruguay, Spain, Italy, and Greece. Switzerland provides a lump-sum tax agreement (Forfait Fiscal) available to expatriates and high-net-worth individuals who are not Swiss citizens or do not have a permanent residence. Instead of taxing expatriate’s actual worldwide income and assets, the lump-sum tax amount is based on their living expenses and standard of living in Switzerland. Portugal introduced the Non-Habitual Resident Regime – NHR (Regime Especial para Residentes não Habituais) in 2009, which was enhanced in 2020. The applicant must not have been a tax resident in Portugal in the five years prior to their application and must stay a minimum of 183 days in the year or have a permanent home in the country. Specifically, expatriates’ capital income and gains are tax exempted. 33 DISCUSSION PAPER DISCUSSION PAPER 3103 Uruguay also has a special tax regime for new residents: individuals who become tax residents after residing in another country may be exempt from income tax on foreign-source income for the first three years of residency in Uruguay. In Spain, the Royal Decree No. 687/2005, called Beckham Law (footballer David Beckham became one of the first foreigners who applied), provides several incentives for wealthy individuals who decide to become a Spanish resident if they did not reside in the country in the five years prior to their application. They must have an employment under a contract or a relevant investment (Golden Visa Program). Spanish-sourced income is taxed at 24%, but foreign income is exempted. In 2017, Italy introduced a “lump-sum tax” on foreign-sourced income for new residents. Prior to 2023, this value was 100,000 euros but was increased to 200,000 euros in 2024. Greece has a similar policy: in 2022, the “Non-Domiciled Tax Regime” was created with a 100,000 euros lump-sum tax on foreign-sourced income. In addition, Paraguay, which is a country that borders Brazil and residence of many Brazilian nationals, does not provide a specific incentive for new residents, but its income tax rate is only 10%. Conclusively, it can be noted that providing residence incentives is a growing global trend after the pandemics, especially in European countries that can offer high quality of life for their residents. Wealthy Brazilian nationals can reside in these countries, manage companies and investments remotely and enjoy tax-free capital income derived from Brazil. Therefore, Brazil must have more strict rules of residency status. For example, cataloguing countries that provide such incentives and adding them in RFB IN No. 1,037/2010 (Brasil, 2010). They will be considered as residents of a “low-tax jurisdiction” for personal income tax rules. 5.2 Three approaches that can effectively tax wealthy Brazilians This study has demonstrated that capital income is highly undertaxed compared to labor income. This section explores three proposals to effectively tax wealthy individuals whose capital income is the main component of their total income and, therefore bear a low effective tax rate. The first two proposals can be considered more classical, while the third is more contemporary, based on studies of OECD (2020) and Zucmann (2024). The first proposal is to implement a tax on dividends, which are currently exempt in Brazil. This could be designed as a 15% final withholding tax, similar to that applied to other savings vehicles discussed on section 2. Alternatively, as argued by Gobetti (2024), dividends could be incorporated into a comprehensive income tax framework, allowing 34 DISCUSSION PAPER 3103 for a partial deduction of the corporate income tax paid at the firm level, including those under favorable presumptive regimes, 17 thereby enhancing horizontal progressivity. However, focusing solely on dividend taxation overlooks existing loopholes related to exempted or unrealized capital gains, as well as the low taxation of inheritances and donations, which are significant sources of income for the wealthiest individuals. Additionally, there are various exemptions, caps, and allowances that can benefit them, including exemptions for income derived from stock bonuses and fringe benefits given to company directors or executives, as well as income tax deductions for pension funds and uncapped medical allowances. Wealthy individuals are more likely to engage in tax planning strategies that exploit these legislative loopholes. The second proposal is a more traditional approach: a net wealth tax. This could be implemented more easily since Brazil’s Constitution already includes a provision (art. 153, VII) for a Tax on Large Fortunes (IGF). However, it has never been implemented despite two voting sessions in the National Congress, held in 2000 and 2008. Considering experiences of European countries that currently have or have previously implemented wealth taxes, it appears that wealth taxes require minimal exemptions and a relatively broad taxpayer base to yield significant revenue outcomes. Their main challenges involve the capital valuation and the lack of liquidity of certain assets. The tax would likely rely on self-declared values, purchase prices, or book values, which can often be outdated. Additionally, owner-occupied residences and family businesses may encounter liquidity and valuation difficulties and consequently have been historically exempted from wealth tax. The third proposal is inspired by some elements and mechanisms of the OECD model for the minimum corporate income tax, the Pilar 2 (OECD, 2020), the report by Zucman (2024) defending a minimum tax on the world’s billionaires, the proposal by Hebous et al. (2024) for taxing unrealized capital gains, and the study by Gobetti (2024) on individual income tax reform in Brazil. This study main proposal consists of a Top-Up Individual Income Tax (TUIIT) on wealthy taxpayers’ total income, without applying any exemption, exclusion or reduction. TUIIT would be implemented through the following steps. 17. According to Gobetti (2024), although Brazil has a standard corporate income tax rate of 34%, 99% of registered companies operate under presumptive tax regimes with effective rates ranging from 6% to 14% of total turnover. He estimates that 70% of distributed dividends come from companies subject to these presumptive tax regimes. 35 DISCUSSION PAPER DISCUSSION PAPER 3103 1) An analysis would be conducted of the effective individual income tax rates with mandatory social contributions across different income strata, using data from income tax declarations. 2) The highest effective tax rate among all strata would be identified as the “top-up” rate, with its corresponding income level serving as the tax threshold. 3) Consequently, all upper-income strata that are currently subjected to lower effective taxation would have their income tax liabilities “topped-up” by the new tax. 5.3 Designing a TUIIT for Brazil Unlike other articles that analyze income tax regressivity in Brazil using income tax declaration databases (Gobetti, 2024; Gobetti and Orair, 2016; Introíni et al., 2018), this study introduces an innovative approach by including mandatory social contributions as part of the effective taxation on income, given that both Brazil’s government and the OECD (2022b) classify social contributions as a tax. In Brazil, social contributions are mandatory for everyone; however, they are only partially linked to the benefits received and resemble a tax more than a “contribution” to a private fund. Additionally, this study considers income derived from inheritances and donations received within a year as part of taxpayers’ total income. It will be assumed that state governments effectively taxed 2% of inheritances and donations, and consequently 98% of their reported values will be included in the analysis. Figure 5 illustrates the effective tax rate of taxpayers’ gross income (including inheritances and donations) in 2022, including income tax alone as well as combined with mandatory social contributions. The figure indicates that the top effective tax rate (without social contributions) is equal to 10%, and it is reached within the income percentiles P91 to P94. This rate slightly decreases to 9.3% in percentiles P97 to P98, and then falls more sharply, dropping to only 3.5% among the top 1%. 36 DISCUSSION PAPER 3103 FIGURE 5 Effective tax rate on taxpayers’ total income1 between income strata (P20-P100) with and without social contributions (2022) (In %) 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 Income tax Income tax and social contributions P20-21 P21-22 P22-23 P23-24 P24-25 P25-26 P26-27 P27-28 P28-29 P29-30 P30-31 P31-32 P32-33 P33-34 P34-35 P35-36 P36-37 P37-38 P38-39 P39-40 P40-41 P41-42 P42-43 P43-44 P44-45 P45-46 P46-47 P47-48 P48-49 P49-50 P50-51 P51-52 P52-53 P53-54 P54-55 P55-56 P56-57 P57-58 P58-59 P59-60 P60-61 P61-62 P62-63 P63-64 P64-65 P65-66 P66-67 P67-68 P68-69 P69-70 P70-71 P71-72 P72-73 P73-74 P74-75 P75-76 P76-77 P77-78 P78-79 P79-80 P80-81 P81-82 P82-83 P83-84 P84-85 P85-86 P86-87 P87-88 P88-89 P89-90 P90-91 P91-92 P92-93 P93-94 P94-95 P95-96 P96-97 P97-98 P98-99 P99-100 Source: Brasil (2023a). Author’s elaboration. Note: 1 Total income includes inheritances and donations. The study establishes an effective taxation on inheritances and donations of 2%, considering the 4% statutory rate in state of São Paulo, but it can vary from 2% to 8% among states. Regarding the combined taxation from income tax and mandatory social contributions,18 the highest effective tax rate is equal to 14% and it is observed within the income percentiles P86 to P95, beginning at a monthly income level of R$ 14,343 (P86). This rate slightly decreases to 12.6% between percentiles P97 to P98, declines to 9.9% from P98 to P99 and then falls more sharply, dropping to only 3.9% among the top 1%.19 The reason for this decrease is that exempt capital income is much more prevalent among the wealthiest individuals, in contrast to labor income, which is subject to both income tax and capped social contributions. Based on the 2022 income tax database (Brasil, 2023a), the proposed TUIIT rate would be set at 14% for the top 2% richest taxpayers. Figure 6 presents a scenario reflecting this proposal. 18. For private workers, the monthly cap for public pensions (INSS) is R$ 7,786, with a maximum deductible contribution of R$ 877, or 11%. For public workers, the cap is R$ 44,008, with a top deductible contribution of R$ 7,205, or 16%. 19. The effective tax rate (including social contributions) among the top 0.1% and 0.01% richest was 2.2% and 1.4%, respectively. 37 DISCUSSION PAPER DISCUSSION PAPER 3103 FIGURE 6 Effective taxation with and without a 14% TUIIT on the wealthiest 2% taxpayers (In %) 13.8 14.2 14.0 14.0 13.8 13.5 13.3 12.6 9.9 8.1 7.6 7.2 6.7 6.2 5.7 5.1 4.4 3.7 2.2 0 2 4 6 8 10 12 14 P90-91 P91-92 P92-93 P93-94 P94-95 P95-96 P96-97 P97-P98 P98-P99 P99-99.1 P99.1-99.2 P99.2-99.3 P99.3-99.4 P99.4-99.5 P99.5-99.6 P99.6-99.7 P99.7-99.8 P99.8-99.9 P99.9-100.0 Income tax and social contributions with a TUIIT of 14% Income tax and social contributions Source: Brasil (2023a). Author’s elaboration. 5.3.1 Who are the top 2% richest taxpayers? According to the official database of income tax declarations for 2022 (Brasil, 2023a), the top 2% richest taxpayers consist of 768,355 individuals with gross monthly income (including received inheritance and donations) higher than R$ 52,504, taxable income above R$ 28,534 and net wealth exceeding R$ 2.14 million.20 However, there is a limitation regarding wealth values in the database, as they may be outdated, often reflecting only the purchase price. This discrepancy highlights the significant gap between gross and taxable income, which tends to widen as total income increases, primarily due to the exemption on dividends. For instance, the top 0.5% richest taxpayers report a total income greater than R$ 121,058 and a taxable income exceeding R$ 50,680 (42% of total income). Table 4 presents the average total income and net wealth values among the top 10% richest taxpayers, while table 5 details the sources of income, including labor and pensions, dividends and interest on net equity, taxable fixed-income, taxable capital gains, inheritances, and other sources. 20. Most bills in the National Congress regarding the Tax on Large Fortunes propose a threshold of R$ 50 million, which is significantly higher than the reported wealth of the 98th income percentile. 38 DISCUSSION PAPER 3103 TABLE 4 Gross income and net wealth values among the top 10% richest taxpayers (2022) Strata Average value (R$) Share on total value (%) Taxpayers Monthly gross income Effective tax rate Net wealth Strata Taxpayers Total income Total net wealth P90 – 95 1,920,838 22,732 14.0% 675,667 Top 10% 3,841,676 51.5 58.5 P95 – 98 1,152,503 37,202 13.1% 1,363,306 Top 5% 1,920,838 40.6 49.8 P98 – 99 384,168 60,745 9.9% 2,648,139 Top 2% 768,335 29.8 39.1 P99 – 99.5 192,084 93,960 7.2% 4,190,221 Top 1% 384,167 23.9 32.2 P99.5 – 99.9 153,667 195,498 4.7% 9,834,036 Top 0.5% 192,083 19.4 26.8 P99.9 – 99.99 34,575 752,523 3.0% 38,813,268 Top 0.1% 38,416 11.9 16.5 P99.99 – 100 3,841 5,542,811 1.4% 285,815,548 Top 0.01% 3,841 5.3 7.4 Source: Brasil (2023a). Author’s elaboration. According to table 4, in 2022, the top 2% richest taxpayers accounted for 29.8% of total income and 39.1% of total net wealth. In contrast, the top 0.1%, those with approximately monthly gross income exceeding R$ 384,501 and net wealth over R$ 17.55 million, held 11.9% of total income and 16.5% of total net wealth. Regarding income composition, table 5 indicates that labor remains the primary source of income up to the top 2% earners. Beyond that threshold, the share of labor income begins to decline, while exempt dividends significantly increase, reaching 50.7% among the top 0.1% richest taxpayers. In addition, other income sources, which include exempt capital gains, rents, and insurance payouts, comprised 15.7% of their total income. TABLE 5 Gross income composition among the taxpayers’ income strata (2022) (In %) Source P20 – 501P50 – 90 P90 – 98 Top 2% P98 – 99 P99 – 99.5 P99.5 – 99.9 Top 0.1% Labor and pensions 83.3 79.7 62.9 19.8 43.4 30.5 17.3 5.6 Rural business 0.6 1.7 2.7 6.1 3.9 5.3 7.8 6.4 Dividends, INE and bonus22.7 6.5 16.3 41.4 26.7 34.0 42.6 50.7 Taxable capital gains 0.0 0.1 0.7 5.6 1.6 2.4 3.9 9.8 39 DISCUSSION PAPER DISCUSSION PAPER 3103 Source P20 – 501P50 – 90 P90 – 98 Top 2% P98 – 99 P99 – 99.5 P99.5 – 99.9 Top 0.1% Fixed-Income 1.2 2.4 4.5 7.9 6.5 7.4 8.3 8.4 Inheritances and donations 2.5 2.2 2.5 3.4 3.2 3.7 3.8 3.2 Others19.6 7.4 10.4 15.8 14.7 16.6 16.2 15.7 Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Source: Brasil (2023a). Author’s elaboration. Notes: 1 The strata P0-20 was excluded because there are some outliers. 2 INE – Interest on Net Equity and Bonus – Incorporation of Capital Reserves and Stock Bonuses. 3 Among the top-richest, the most relevant sources of income reported as “others” by RFB database are “Exempted capital gains”, “Rents”, “Insurances”, and “Income from overseas”. This was verified by another RFB database, which does not provide the data divided into income strata. 5.3.2 A Top-up income tax: two mechanisms In the first approach, given that a direct top-up tax on individual income may be deemed unconstitutional in Brazil, the Tax on Large Fortunes (IGF), as provisioned by the Constitution, could be implemented with a high rate and a low wealth threshold – such as a tax rate of 3%21 applied to a threshold of R$ 2 million, but with a cap of 14% on total income. This would function as a TUIIT for high earners, following a similar framework proposed by Zucman (2024), but with a broader base since it would not be restricted to billionaires. Under this proposal, income tax, mandatory social contributions and inheritance tax22 effectively paid by taxpayers with at least R$ 2 million in net wealth would be deductible from their 3% IGF, which would be capped at 14% of their total income. This approach aims to equalize taxation across high-income strata. However, the implementation faces a political challenge due to its low wealth threshold. The top 2% richest taxpayers are those with reported net wealth exceeding R$ 2.14 million, which may be considered politically too low for a wealth tax threshold, even if adjustments to wealth valuation could raise this threshold. In addition, individuals with relatively higher income but lower reported wealth would benefit, which undermines horizontal equity. The second approach would be more straightforward: it involves amending indi - vidual income tax legislation to introduce an additional top-up tax rate of 14% on total 21. It is expected that cases in which 3% of taxpayers' wealth exceeds 14% of their total income will be very rare. 22. This may encourage states to effectively tax inheritances since exemptions or reduction would be compensate by a higher TUIIT. 40 DISCUSSION PAPER 3103 income that exceeds the threshold for the top 2% richest taxpayers, which was R$ 52,504 (or approximately R$ 50,000) in 2022. 23 This total income includes inheritances, certain currently exempted capital gains, and other exempt or deductible income. This proposal presents a challenge: if the threshold is set at R$ 50,000, some individuals with total income slightly below this amount may experience an effective tax rate significantly lower than 14%, which undermines horizontal equity. Therefore, this proposal would benefit from implementing a final withholding tax on dividends, which may be a significant source of income for some of the top 5% richest taxpayers. This would enhance horizontal equity, with a TUIIT serving as a residual tax applied to other currently exempt income of the top 2%, minimizing tax avoidance. The TUIIT rate would be applied to the tax schedule starting from the income level of R$ 50,000, as outlined in the proposed schedule shown in table 6. Indeed, preliminary calculations estimate that a 14% TUIIT has maximum potential of R$ 127.5 billion in revenues if a withholding tax on dividends was not implemented, representing 44.6% of the individual income tax levied in 2022. However, this is an initial estimate of its maximum potential, and a more detailed assessment, including possible exclusions and arbitrage opportunities, will be necessary. Nonetheless, the potential for arbitrage is smaller compared to dividend taxation alone, as the proposal encompasses all sources of income. Additionally, it is essential to establish an “exit tax” for wealthy taxpayers who choose to change their residence status, similar to the United States, where an exit tax applies to unrealized capital gains in the event of a taxpayer changing citizenship. TABLE 6 Proposed individual income tax schedule with a TUIIT Bracket (R$) Percentile Rate 0 – 2,259 0-9 Exempted 2,259 – 2,827 9-18 7,5% 2,827 – 3,751 18-35 15.0% 3,751 – 4,665 35-47 22.5% 4,665 – 50,000 47-98 27.5% Over 50,000 98-100 TUIIT 14.0% Author’s elaboration. 23. It is important to note that not everyone earning more than R$ 50,000 would be subject to TUIIT. For instance, some high-earning public servants are subject to a 16% rate on social contributions, which likely results in an effective income taxation that exceeds 14%. 47 DISCUSSION PAPER DISCUSSION PAPER 3103 OECD – ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT. Inheritance taxation in OECD countries. Paris: OECD Publishing, Mar. 2021. (OECD Tax Policy Studies, n. 28). Retrieved from: https://www.oecd.org/en/publications/inheritance-taxation-in-oecd-countries_e2879a7d-en.html. OECD – ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT. Housing taxation in OECD countries. Paris: OECD Publishing, 2022a. (OECD Tax Policy Studies, n. 29). Retrieved from: https://www.oecd.org/en/publications/housing-taxation-in-oecd-countries_03dfe007-en.html. OECD – ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT. Revenue statistics 2022: the impact of COVID-19 on OECD tax revenues – 1965-2021. Paris: OECD Publishing, 2022b. Retrieved from: https://www.oecd.org/en/publications/ revenue-statistics-2022_8a691b03-en.html. ZUCMAN, G. A blueprint for a coordinated minimum effective taxation standard for ultra-high-net-worth individuals. Paris: EU Tax Observatory, 25 June 2024. Retrieved from: https://www.taxobservatory.eu/publication/a-blueprint-for-a-coordinated-minimum-effective-taxation-standard-for-ultra-high-net-worth-individuals/. 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