Brazilian Congress complex. Photo: Marcello Casal Jr/Agência Brasil

Tax reform can make the Brazilian innovation ecosystem take a step back

Organizations fear the flight of professionals, excessive taxation of investors, and obstacles to IPOs as a reflection of the project under discussion in the country's lower house of Congress

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The triple helix model of innovation is known as a set of interactions between regulatory environment (government), incentives for research and knowledge (the academy), and a culture of entrepreneurship (industry). As such, the reform of the complex and bloated Brazilian tax system should be celebrated by the innovation ecosystem.

On the contrary, according to LABS‘ sources, the reform — which is being introduced piece by piece by Jair Bolsonaro‘s administration – could be a disaster for startups. The proposal currently under discussion in Brazil‘s lower house of Congress (PL 2337/2021) is the second phase of this reform, focused on income. It reintroduces a 20% dividend withholding tax and establishes rules that can make it harder for startups to hire top-of-class professionals, raise capital from foreign investors, and hinder plans for IPOs in the US.

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Amid the outcry of companies and entities against the bill is Dínamo, a think tank that advocates for the startup ecosystem in Brazil. Dínamo’s CEO, Rodrigo Afonso, believes PL 2337/2021 does not take the particularities of startups into account and can destroy advances made with the Legal Framework for Startups.

“It is a project that has very short-term benefits for the government and does not look at a [long-term] project for the country, at where we want to go in terms of the tax structure and the connections with other tax changes that need to be made,” says Afonso.

The risk of brain and startups drain

Afonso points out that the current government proposal may impact corporate structures and pose obstacles for angel and foreign investment. In this scenario, assets and rights transferred to shareholders during corporate reorganizations would be considered at market value — with 20% taxes (even before capital gains or losses).

READ ALSO: Brazilian startups raised $484.4 million in July: Distrito

Rodrigo Afonso, CEO of Dínamo: tax reform can destroy recent advances. Photo: Dínamo/Courtesy

To Dínamo’s CEO, the idea will increase the tax burden and risk for foreign investors. On the other hand, the Brazilian Ministry of Economy states that the new tax bill prevents abusive reorganizations and corporate tax evasion.

Another controversial point in the proposal is related to the startups’ abilities to hire and retain world-class employees: equity-based plans and profit-sharing payments. If approved, the reform changes the rules for both compensations granted to partners and directors, explained the Undersecretary of Taxation and Litigation at the Ministry of Economy, Sandro de Vargas Serpa, to the news agency of Brazil’s lower house of Congress.

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On the other hand, stated Serpa, “companies can keep their bonuses for results to employees. But deduction on income taxes will not be allowed for partners and directors. The tax system is fairer, as partners and directors have other forms of compensation from companies.”

A sad ending for the “perfect storm”

“Our challenges are the regulatory environment and talented professionals. And we are very close to a blackout because there’s too much demand for STEM positions and so little offer of human resources,” states the founder of the edtech Sirius Education and president of Brazilian startups association (Abstartups), Felipe Matos. He warns of the risk of an “exodus of workers” from innovation segments in-country, aggravated by the fact that some of them are already working in a work-from-home regime.

With more than 20 years of know-how in building startups, Matos believes that the Brazilian ecosystem is experiencing a perfect storm, despite regulatory issues. “We have a few recent advances with the Legal Framework of Startups; still, [we are] far short of what is needed. If Congress approves the tax reform as it is now, it will discourage growth,” says Matos.

Organizations fear the flight of professionals, excessive taxation of investors and obstacles to IPOs as a reflection of the project under discussion in the lower house of Congress
Felipe Matos, CEO and co-founder of the Brazilian edtech Sirius Education and president of Abstartups. Photo: Sirius/Courtesy.

According to Abstartups’ president, Brazil‘s ecosystem is booming thanks to the digitization accelerated by the pandemic, the low-interest rates that lead investors to seek higher returns on less conservative assets, in addition to the appreciation of the dollar, which makes Brazilian companies “cheaper” for foreign investors. All this added to the high degree of maturity of the country’s business community.

According to sources heard by LABS, there is a concern that startups migrate to avoid Brazilian bureaucracies. The U.S. state of Delaware has become a frequent destination for tech entrepreneurs due to its tax breaks and more founders-friendly legislation.

One of Delaware’s stimuli is the possibility of founders selling most of their startup’s shares without giving up decision-making power over the business. Thus, companies can open holdings in the U.S. to receive investments and become partners in the Brazilian subsidiary.

“We are not against a reform that changes the tax aspect of Brazil, which is really unequal. We are not fighting to avoid paying taxes. We are talking about creating mechanisms to maintain venture capital”

Rodrigo Afonso, CEO of Dínamo.

The tax reform does not simplify

For the tax lawyer and partner at Baptista Luz Advogados, Ivana Marcon, the main flaw in the proposal (which is still subject to change) is that it does not simplify Brazilian’s tax system. “The [biggest] obstacle is undoubtedly the lack of simplification of our system. We have too many laws and obligations to be fulfilled. There is difficulty in attracting investment for innovation companies, for example. The reform should come to simplify this system,” evaluates Marcon.

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While companies assess the possible consequences of the proposal, there is a feeling that the project may change unexpectedly in the coming weeks.

“It’s surreal. For us, this project is being accelerated without a discussion with society, with the entities involved. This could make us approve a law that affects a series of sectors that were not thought of in the first place,” criticizes Rodrigo Afonso from Dínamo.

Invited to comment on the topic at the Brazilian Senate last Friday, the Minister of Economy, Paulo Guedes, said he prefers not to carry out reforms rather than opting for one that makes the current system worse. According to Guedes, “there are a lot of people warning that it’s getting worse, but they are [also] the ones who will start paying taxes.”