Dividends versus Interests on Net Equity: origin and tax regime

Shareholders often ask about the differences between dividends and interests on net equity (JCP), mainly with respect to their respective concepts and payment causes.

Lucia Regina Pereira Moioli

For most shareholders, perhaps there is no doubt that dividends are, roughly, the amount paid by one company to its shareholders, as a general rule, such payment is proportional to: (a) the number of shares held by each shareholder; and (b) the distribution of profits in accordance with the financial results. The JCPs, in turn, are indeed some sort of compensation over the capital employed by the shareholders in the company, independently from possible distribution of dividends, which may occur upon achievement of profits in accordance with the financial results, in way that, they may be mistaken, most of time, as being the dividend itself.

In the past, it was possible to restate the balance sheets according to the inflation, which allowed legal entities to consider, in their financial statements, the inflation effects when the company used capital of third-party investors[1], creating an overstated inflation (taxable revenue), and when the company used its own equity capital[2], creating understated inflation (deferred revenue).

Such mechanism has been revoked by Law No. 9245/95, and with that, the companies are only allowed to deduct the inflation effects on equity capital as financial expense, calculated in accordance with the Long Term Interest Rate (“TJLP”). It means that the equity capital, when used in profitable transactions, shall be updated by the TJLP, and the company shall not need capital of third-party investors to fund itself.

 

The JCP is set forth by Law No. 9245/95, as per the following:

“Article 9. The legal entity may deduct, for purposes of calculating the real profit, the interests paid or credited to each owner, quotaholder or shareholder, as interests on net equity, limited to the variation, on pro rata basis, of the Long Term Interest Rate” (emphasis added)

 

The most reliable jurists do not agree with the nature of the JCP: (i) some believe that the JCP are a financial and operational expense; and (ii) others believe that the JCP are means to distribute the profits dressed as distributed dividends or capitalized profits.

From a market perspective, unlike dividends, the compensation by means of JCP is not mandatory, which is why some companies decide not to make such payments. However, for several reasons, there is no doubt that the companies cannot fund themselves using only capital of third-party investors, considering, for instance: (a) that the more capital of third-party investors, the greater are the risks involved in the business; and (b) that sometimes, the company cannot find satisfactory sources of capital of third-party investors.

Therefore, JCPs are commonly used as means to compensate the shareholders, when they decide not to redeem, within a certain time, the investment made in the company, so that said shareholders can receive a reasonable return in the future as payment of interests on capital employed.

Another advantage of the JCP is that the amounts paid as JCP may be deducted from the payments due by the company as compulsory dividends (Article 9, Paragraph Seventh, of Law No. 9245/95) in order to pay less tax, because the JCP are recorded as expenses and, therefore, they reduce the applicable taxes calculation basis. This is another reason why many companies, in some situations, prefer to distribute JCP instead of dividends[3].

Accordingly, the Brazilian Securities Exchange Commission (“CVM”), by means of Instruction CVM No. 683, which has revoked Resolution No. 207, has determined that:

“The interests paid or credited as compensation on net equity can only be attributed to compulsory dividends (Law No. 9249, of December 26, 1995, Article 9, Paragraph Seventh), provided for in article 202 of Law No. 6404, of December 15, 1976, based on the net value calculated upon withholding income tax.” (emphasis added)

According to Brazilian corporate legislation, there is no limit to the JCP amount to be paid to the shareholder. The only limitation existing is tax-related, with respect to deduction of the expense due to such compensation (corporate income tax – “IRPJ” – and social security contribution on net profit – “CSLL”). In practice, corporations commonly use JCP as means to compensate their shareholders. However, JCP are not so often used by limited liability companies, even though not prohibited by law.

Moreover, with respect to tax legislation, there is a significant difference between JCP and dividends, since (i) shareholders who receive dividends are exempt from income tax, once dividends derive from net profit, and the company’s income tax has already levied on said amount; and (b) JCP are subject to withholding income tax, as mentioned before. Accordingly, the differences between dividends and JCP lie on their origin and tax regime, which are:

jcp

dividends

 

 

Therefore, opting for JCP represents a relevant measure to companies that intend to compensate their shareholders upon a tax benefit similar to what they manage to get when funding themselves through capital of third-party investors. Moreover, by comparing the tax levied and availability of resources to shareholders, it is possible to identify that using JCP to compensate shareholders can be more profitable than distributing dividends.

Lastly, considering that tax laws change very often, before any tax and/or corporate planning, we would advise the reader to get legal advice for updated guidance on the matter and for analysis on the applicability to the specific case.

[1] Capital of third parties: represent funds from third parties used to acquire assets. It is a long-term capital obtained by means of loans from third parties to the Company. It corresponds to the Company’s actual or current liabilities.

[2] Own equity capital: funds from the entity’s quotaholders or shareholders or derived from its social transactions. It is the sum of the corporate capital, its variations, the profits and reserves. In other words, it came from the entity’s own economic activities, such as profits, capital and profits reserves.

[3] The Lojas Americanas, on October 4, 2016, in a meeting of the board of executive officers, approved the distribution of 30 million (equivalent to BRL30,000,000.00) as interest on net equity considering the intermediary balance sheet drafted on September 30, 2016. The owners of ordinary and preferential shares shall be entitled to it on October 5, in the end of the day. The distribution shall occur on April 14, 2017, and shall have the gross amount of BRL0.0212 per share.

Por Lucia Regina Pereira Moioli Garbuglio and Carolina Ferlin