Key Tax Considerations in

Acquiring Assets and Investing in Brazil

1. How to structure your investment or  acquisition in Brazil

2. How and when to use infrastructure investment funds, private equity funds and real estate funds

3. How to assess contingent tax liabilities in an acquisition of a Brazilian company

Breakfast Seminar organized by theBrazilian-American Chamber of Commerce

New York City, September 25, 2008

Maria Isabel Tostes da Costa Bueno

Tax Contingencies of Companies in Brazil

General Overview on Taxation in Brazil

• Brazil is a civil law country

• The legal system is based on codified laws and its corresponding enforcement

• Our Federal Constitution was enacted in 1988, and so far has been amended 56 times

• The taxing entities are the Federal Union, the States, the Federal District and the Municipalities

General Overview on Taxation in Brazil

• The Federal Constitution sets forth the general principles that must be observed in taxation

• The Brazilian Tax Code applies to all taxing entities

• As a rule, taxes are created by laws emanated from the legislative branch within each of the taxing entities, which shall exercise its taxing powers within the established constitutional boundaries

General Overview on Taxation Constitutional Principles

• Main Constitutional Principles for Tax Purposes

• The rule of law• Taxes are imposed by laws. Limited use of Provisional

Measures (relevance and urgency)

• Principle of legality• The taxable event has to be fully described in the law

• Principle of anteriority• Legal provisions creating or increasing taxation will be

effective only 90 days after the date of publication.

General Overview on Taxation Statute of Limitations

• Tax assessment

• 5 years from the taxable event for taxes and contributions

• Refunds or Offsetting

• 5 years from the undue or overpayment

• Generally, an administrative procedure is required so that tax authorities confirm the existence of the credit in favor of the taxpayer

General Overview on TaxationConsequences of Failure To Comply

• Civil and Criminal Penalties

• Civil Penalties (monetary Only)

• Fines applied on: underpayment of estimated tax, failure to file return, failure to pay tax, negligence, understatement of tax, valuation misstatement

• Criminal (monetary & prison)

• Tax evasion, fraud/false statements

• Payment of the tax extinguishes criminal punishment

• Interest and penalties

• Start time for accrual: due date for tax payment

General Overview on TaxationJudicial Tax litigation

• The Judiciary is divided into sections according to their competence/authority

• Regarding tax litigation, disputes involving federal taxes will be decided by the Federal Courts, while disputes involving state and municipal taxes will be judged by the State Courts

• The highest bodies of the Judiciary are the Supreme Court (constitutional matters), and the Superior Court (infra-constitutional matters)

General Overview on TaxationJudicial Tax Litigation

• After the Federal Constitution was enacted in 1988, a new tax system was created. Under judicial proceedings, already existing and new legislation started to be confronted with constitutional principles and provisions.

• The Brazilian Courts issued decisions that ensured that the constitutional principles had to be observed in the field of taxation, thus attributing certainty to these judicial decisions

• The judicial discussions regarding taxes are extremely sophisticated

• i.g. the impossibility of a previous unconstitutional law become “constitutionalized” by a subsequent constitutional amendment

General Overview on Taxation Judicial Tax Litigation

• Both taxpayers and tax authorities may start a judicial dispute

• Where proposed by taxpayers:

• To dispute a certain tax obligation

• To obtain a refund or to offset a tax credit

• To cancel an unfavorable administrative decision from the Administrative Court

• Where tax authorities begin the proceeding

• Tax foreclosure: presenting a warranty is mandatory

• Tax writ of prevention: in case of evidence of suspicious transfer of assets and properties

• The Administrative Courts also became a feasible alternative to discuss taxes with tax authorities

• Proposed by taxpayer• Refund (cash or offsetting)

• Began by tax authority• Tax Assessment Notice

• Taxpayers’ accounting entries and tax books have to be audited

• Reduction of penalty• Until the first defense is presented: 50% (cash

payment)• After the first decision: 30% (cash payment)

General Overview on TaxationAdministrative Tax Litigation

• Structure of the Federal Administrative Court• First Level

• Composed exclusively by tax authorities• Second Level

• Composed by representatives of tax authorities and taxpayers (8 judges)

• There is a Special Court that will harmonize different decisions from the Court’s several chambers

General Overview on TaxationAdministrative Tax Litigation

Tax Litigation Contingency How to Assess?

• Due Diligence• In light of the fact that almost all Brazilian companies will

be involved in tax litigation, investors should thoroughly carry out a due diligence that covers all judicial and administrative ongoing discussions

• Supported by tax clearance certificates and by copies of the most relevant documents presented in the case/court records, if possible

• If not possible, the target company should provide information regarding the matter under dispute, the amounts involved and the current status of the lawsuit (need of a representation)

• It is possible to obtain, without the target company’s cooperation, information regarding judicial tax litigation (as the court records are public). Other information will have to be provided/disclosed by the target company

Tax Proceeding ContingencyHow to Assess ?

• Tax Proceeding

• What is not under litigation is also extremely relevant to be considered

• What has to be analyzed in order to uncover future contingency or even potential litigation?

• How taxes have been calculated• Any tax planning structure• Private letter rulings• Special regimes• Fiscal benefits

• The information regarding tax proceedings can only be obtained in case the target company cooperates and discloses the required data

Tax ContingenciesTendencies

• Key Interlocutors• It is fundamental that, since the beginning of the due

diligence, the scope of work is clearly defined, and also to identify who will be the “key interlocutors” in the company

• Experience shows that these measures assures more efficient work and precise information

• Recent Tendency• As fewer documents provided, a greater knowledge of

the main tax issues that affect the businesses and the jurisprudence tendencies will be needed

• Warranties• Due to this new tendency, there is a need to consider

adequate warranties to the investor, as escrow accounts, personal warranties, contractual provisions, etc.

Tax Liabilities and Succession

• Responsibility of the Company

• The company is liable for the taxes due

• The investors need to have good knowledge of the past and possible contingencies, even if these contingencies refer to periods prior to the acquisition/investment

• Contractual arrangements are only valid between the parties, not against tax authorities

• Exception

• Managers are only liable if there is a breach of contract or a breach of law

Tax Liabilities and Succession

• Structure

• The acquisition structure is essential to reduce the tax succession or protect direct responsibility

• Normally the structure does not avoid the tax succession

• The structure itself must not give rise to future liability

• The transfer of the goodwill implies a transfer of tax liability

• According to the prevailing jurisprudence, the transfer of the portfolio of clients already implies a transfer of the goodwill

• Alternatives to analyze in the structure

• Reorganization: spin-off

• Acquisition of a new company segregated from the target

• Rent of leasing of the structure for a certain period

• Debt convertible instruments

Major Tax Issues on the Investments in Brazil

Structuring the Investment

Andrea Bazzo Lauletta

Introduction

• Scope of the Tax Analysis• Discussion of the main tax issues currently in force,

related to investments to be made in Brazil by non Brazilian residents• Investments on operational Brazilian companies• Investments on financial and capital market

transactions• Although there are some specific tax issues for certain

economic sectors, there are issues that can be considered on a general basis• Tax issues on structuring• Tax issues on financing• Tax issues of the business• Tax issues on exit

Introduction

• General Tax Issues• Non Brazilian residents are subject to Income Tax in

Brazil (i) on any income paid by a Brazilian payer source and (ii) on any gain derived from disposal of assets located in Brazil• What are assets located in Brazil?

• The tax rates varies according to certain characteristics• Type of the investment and form of registration of

the investment before the Central Bank and Brazilian Securities Commission (CVM)

• Nature of the payments• Location of the non Brazilian resident

Type of Investments

• Financial and Capital Market Transactions• The investment must be registered before Central Bank

and CVM according to Resolution No. 2,689/00 (2,689 Investments and 2,689 Investors)

• Applicable to several transactions carried out on the Brazilian stock, future and commodities exchange and on the organized and non-organized over-the counter, as well as to certain registered transactions• Fixed and variable yield investments• Derivatives• Investments in Brazilian investments funds• Investments in listed companies

• Investments in Brazilian Companies• The investment must be registered before Central Bank

according to Law No. 4,131/62 (4,131 Investments and 4,131 Investor)

• Applicable to acquisition or subscription of equity in Brazilian companies, normally non listed companies

Investments in Brazilian Companies

Non listed companies

Listed companies

4,131 Investment

s

2,689 Investment

s

Investment funds

Location of the Investors

• Tax Treatment• Investors resident or domiciled in places considered by the

Brazilian legislation as a a low or nil tax jurisdiction (Tax Haven) are generally subject to higher rates of Income Tax and have no right to certain exemptions

• Discussion on the concept of Tax Haven• Country or place that does not impose income tax or

imposes at a maximum rate lower than 20%• Non-disclosure of information about the shareholding

composition and beneficiaries• New rules applicable as of January 1, 2009

• Law No. 11,727/08 introduced the concept of “privileged tax regime”

• In our view, the new rules apply only for transfer price (export and import transactions and loan agreements)

4,131 Investments

• 4,131 Investments• Applicable to sale of shares acquired as a 4,131

Investment• Listed and non listed companies• Sale on the stock exchange or not

• 15% of Income Tax• 25% for Tax Haven on sale on the stock exchange

• 0% of Income tax on dividends

Financial and Capital Market Transactions

• 2,689 Investments• Investors not located in Tax Haven

• Favorable tax treatment (Favorable Regime)• Exemptions and lower rates

• Investors based in a Tax Haven• Follows the rules and rates for Brazilian individuals,

which are higher than the Favorable Regime

Favorable Regime2,689 Investments

• Capital Gains• For purposes of the Favorable Regime, capital gains are

the gains assessed specifically on transactions carried out on the Brazilian stock, future and commodities exchange and organized OTC (Exchange Market)

• Exemption of Income Tax• Applicable to sale of listed companies in the Exchange

Market, which were acquired as a 2,689 Investment• Discussion of the migration from the 4,131 Investment

to a 2,689 Investment• Applicable to sale of shares of investment funds in the

Exchange Market

Favorable Regime2,689 Investments

• Income• For purposes of the Favorable Regime income is

specifically defined as any income received from the investments, including the capital gains assessed on transactions not carried out on the Exchange Market

• General rule• 15% of Income Tax

• Dividends• 0%

• Income on public bonds• 0% of Income Tax

• Income from swap, NDF and investment funds for listed shares

• 10% of Income Tax• Income from private equity investments funds

(FIP)• 0% of Income Tax under certain requirements

• Non Exchange Market Capital Gains• 15% of Income Tax• Discussions of the gains under IPO

FIP

• What is a FIP?• In Brazil, investment funds are not legal entities but

condominiums (no legal personality)

• Taxation of FIP

• Totally exempt of taxation at the FIP level

• Gains on any disposal of the investments in the Brazilian corporations are not taxable

• Income from the investments in the Brazilian corporations are not taxable

• Portfolio must be made up of shares or other securities that are convertible into or exchangeable for shares issued by any listed or closely-held corporations• FIP can not have limitadas

• Requirements for the Tax Benefit of 0% Rate• 2,689 Investor not located in Tax Haven• Each investor does not hold individually or together with

related persons, more than 40% of the sum of the shares (Shareholding Test) or receive more than 40% of the total income distributed by the fund (Economic Test)

• No debt securities of an amount equivalent to more than 5% of its net equity, except if such securities correspond to convertible debentures or subscription bonus

• Portfolio of at least 67% of shares of Brazilian corporations, debentures that are convertible into shares and subscription bonus

FIP

FIP

• Example for Discussion

Shareholder 1 Shareholder 2

Shareholder 3

FIP

Holding

100% 100% 100%

33% 33%34%

FIP

• Example for Discussion

Shareholder 1 Shareholder 2

Shareholder 3

FIP

Holding

100% 80% 100%

33% 33%34%

HoldingHolding

20%

FIP

• Example for Discussion

Shareholder 1 Shareholder 2

Shareholder 3

FIP

Holding

100%

99%

100%

33% 33%34%

HoldingHolding

1%

General Types of Structure to Invest

Scenario 1

Investor

Operational Company

Limitada or SA

Investor

Holding

Operational Company

Limitada or SA

Scenario 2

Investor

FIP

Operational Company

Limitada or SA

Scenario 3

Taxation of the Operational Company

Comparison (real/presumed)

Real Presumed

taxable base tax due taxable base tax due

IRPJ (+) gross revenues(–) deductible expenses and costs(–) tax losses

15% +

additional rate of 10%

(+) percentage of gross revenues (i.e. 8% for sale of inventory and 32% for services and rent)(+) other revenues

15% +

additional rate of 10%

CSLL (+) gross revenues(–) deductible expenses(–) tax losses

9% (+) percentage of gross revenues (12% for sale of inventory and 32% for services and rent)(+) other revenues

9%

PIS/COFINS Total revenues. Possibility to offset tax credits related to some costs / expenses incurred in the business with PIS/COFINS due

9.25% Total revenues 3.65%

Taxation of the Operational Company

• Conclusions• The choice for the most efficient tax system will depend

on (i) the expected profitability of the business and (ii) the possibility of generating losses and registering PIS/COFINS credits

Flow of Dividends Taxation of Income Tax

Scenario 1

Investor

Operational Company

Limitada or SA

Dividends: 0%

Dividends: 0%

Dividends: 0%

Dividends: 0%

Dividends: 0% if the Requirements are met or (?)

Investor

Holding

Operational Company

Limitada or SA

Scenario 2

Investors

FIP

Operational Company

Limitada or SA

Scenario 3

Capital Gains Taxation of Income Tax – Non Tax

HavenScenario 1

Investor

Operational Company

Limitada or SABuyer

Buyer

• 4,131 Investment: 15%

Sale of the operational company

• 2,689 Investment

• Exchange Market: 0%

• Private sale and IPO: 15%

Capital Gains Taxation of Income Tax – Non Tax

HavenScenario 2

Investor

Operational Company

Limitada or SA

Buyer

Buyer

• 4,131 Investment: 15%

• 2,689 Investment

• Exchange Market: 0%

• Private sale and IPO: 15%

Holding

• Corporate taxation

• 34%

Sale of the Holding

Sale of the operational company

Capital Gains Taxation of Income Tax – Non Tax

HavenScenario 3

Investor

Operational Company

Limitada or SA

Buyer

Buyer

• 0% if the Requirements are met

• 0% if sale on the Exchange Market

• 15% if the Requirements are not metFIP

• No taxation

Sale or redemption of

FÌP

Sale of the operational company

FII

• What is a FII?• Another type of investment fund: real estate investment

fund• Taxation of FII

• No taxation of the portfolio• This tax treatment is applicable, provided that

the shareholders that own, itself or with related parties, more than 25% of the quotas are not partners, constructors or developers of the FII’s projects

• Taxation of the shareholders• Income Tax of 15% on periodical dividends

distribution (20% to Tax Haven)• Obligation to distribute dividends semi-annual

(based on the financial statements of June and December – cash basis)

FII

• Comparison with Operational Company• FII

• No taxation at the portfolio level and taxation of the dividends

• Operational company• Taxation at the company and no taxation of the

dividends

FIP-IE

• What is a FIP-IE?• Another type of investment fund: private equity

investment fund in infrastructure• i.e. energy, transportation, water treatment,

irrigation• Minimum of 10 shareholders, with no single

shareholder with more than 20%• Several regulatory requirements

• Taxation of FIP-IE• No taxation of the portfolio

• Taxation of the shareholders• Exemption of Income Tax for Brazilian residents for

investment held for more than 5 years• Income Tax of 15% for non Brazilian shareholders

• Discussion on the application of exemption for 2,689 Investor not located in Tax Haven