Taxation of Business Angel’s Incomes
03/10/2017 - Estevão Gross
The Business Angel’s figure has been introduced in the Brazilian legal system by the Complementary Law No. 155/2016, which entered into force on January 1st 2017 in order to stimulate the start-up market and innovation activities established by means of microbusinesses (ME) and small companies (SMEs).
In summary, in accordance with this Complementary Law, the business angel is defined according to the following specificities:
He does not enter into the equity capital of the invested company (ME or SME);
Its contribution is formalized by means of a participation agreement within the invested company with a term of maximum 7 years, which should include the purposes of innovation and productive investments’ fostering;
It can be an individual, a legal entity or an investment fund;
It does not have the partner’s status nor the right to interfere in the company’s management;
It is not responsible for any debt of the company;
It is remunerated for its contributions, in accordance with the participation agreement’s terms, for a period of maximum five years;
At the end of each period, the business angel will be entitled to a remuneration corresponding to the distributed results, not exceeding 50% of the company's profits
The business angel may only exercise a redemption right after a period of at least 2 years of capital contribution, or a longer period as provided for in the participation agreement, which cannot exceed, in any event, the invested amount properly adjusted.
The business angel’s figure has been implemented to exclusively apply to the MEs and SMEs, even if, during the course of their activities, they can lose this status. The legislator’s logic regarding this type of investment was based on its temporary nature, on the absence of responsibility over the company’s activities and on the compensation linked to the profits of the latter.
Consequently, the legislator chose to protect the business angel from the investee’s liabilities, having, however, conditioned its periodic remuneration to the (random) business risk. In doing so, it created a hybrid legal figure, situated between the company and the loan.
In the tax environment, the Federal Revenue Service (“Receita Federal”) published a Normative Instruction No. 1,719 / 2017, stipulating, in summary, that the periodic withdrawals (based on the investee's profit), the gains realized on the contribution’s redemption and the gains realized on the contribution’s transfer, are assimilated to income arising from fixed-income financial investments. As a result, the corresponding amounts are subject to the withholding income tax (Imposto sobre a Renda Retido na Fonte – IRRF) according to the following rates:
22.5% in participation agreements with a term of up to 180 days;
20% in participation agreements with a term between 181 and 360 days;
17.5% in participation agreements with a term between 361 and 720 days;
15% in participation agreements with a term longer than 720 days.
Firstly, we highlight that a normative instruction should not define any tax treatment. Only the law, within the constitutional limits, can create a tax, by establishing tax rules for each social situation corresponding to this or that tax category.
Secondly, by assimilating the amounts received by the business angel to fixed-income financial investments, we understand that the Normative Instruction extrapolated the legislation, taking into consideration the unique and “sui generis” figure of the angel investment and the absence of legislative provision authorizing such assimilation.
Furthermore, we cannot ignore that an important part of this investment’s remuneration is based on the investee’s profits, presenting a (random) business risk, (including a loss or a profit lower than what was expected), which makes impossible the assimilation to fixed-income financial investments and / or to simple loans.
Lastly, by equating the angel investment to fixed-income financial investments, the Normative Instruction made this method less interesting that the direct participation in equity capital, identifying it to a profit-sharing loan, in total dissonance with the spirit of motivation and fostering created by Complementary Law No. 156/2016.
Because of this, in addition to being totally inappropriate for the purpose of creating the business angel’s status, we understand that there are elements allowing to discuss the tax treatment of the business angel fixed by the Normative Instruction No. 1,719 / 2017.
We remain available for any additional clarification on this matter.