On June 16, 2014, the Brazilian Minister of Finance announced the tax benefits that will be adopted with the goal of opening a new source of fund raising for companies that normally do not have access to the local capital market, particularly the small and mid-size companies known as small caps, and also aimed to reconnect investors (individuals) to the stock market.

The package of measures includes the exemption of taxes on capital gains for trading of shares issued by small caps, the extension of the tax exemption for infrastructure debentures and the standardization of fixed income market indices investment funds (Exchange Traded Funds - ETFs). A new provisional measure (medida provisória) will be enacted by the Federal Government to regulate these matters.

The first measure is to extend to the capital gains for the purchase and sale of shares of small caps the same tax treatment given to infrastructure, real state and agribusiness securities and investment funds. In all these cases, the income tax rate has been reduced to zero. For other companies the applicable tax rate continues to be 15%. Therefore, this benefit (zero rate) only applies to small caps, which are defined as "companies with market value of less than R$ 700 million or which have gross revenue for the preceding financial year to the Initial Public Offering (IPO) of shares of less than R$ 500 million". This tax benefit applies until 2023 and includes transactions performed in the secondary market or involving individuals that invest either directly or through investment funds1.

In addition to this tax exemption, the small caps will have simpler rules for disclosure of information, which can be done through the internet.

Furthermore, two investment funds set up by the Brazilian Development Bank (Banco Nacional de Desenvolvimento Econômico e Social - BNDES) will facilitate these transactions. The first Fund will have R$ 1 billion to be used by BNDES Participações S.A. – BNDESpar to buy 20% of the shares of IPOs made by small caps. There is another Fund in the amount of R$ 250 million, whose resources will also be invested in these transactions.

The Ministry of Finance is creating a working group composed of members of the Federal Government, the Brazilian Stock Exchange (BM&FBovespa) and the Brazilian Securities and Exchange Commission (Comissão de Valores Mobiliários – CVM) destined to tax simplification. The members of this group will simplify the rules of payment of the income tax on shares and to foster investments and will have a period of 90 days to submit their proposals on this subject. Currently investors must collect taxes until the last day of the month following the transaction´s closing date and the rules are considered very complicated.

Another measure is the extension of incentives for infrastructure debentures until December 31, 2020. The tax benefit is income tax reduced at zero rate and applies to infrastructure projects with medium-term of four years. Previously, the tax benefit was scheduled to end in 2015 and the benefited sectors were limited to transportation, energy, urban mobility, among others. Now, infrastructure projects in the education, health, water and irrigation and environmental areas are also subject to the same benefit.

As an incentive to the creation of ETFs, which are electronic fixed income investment funds traded in the stock exchange, only this type of Fund will not be subject to the mechanism referred to as "eat-units" (come cotas), which is an advance of income tax payment due at each six months that reduces the number of units of the investor. This means that the income tax, which must be paid for all investment funds, in the case of the ETFs will only be due at the time of the redemption of their units, according to the average period of the Fund´s portfolio as follows: (i) if the term is up to 180 days (six months), the rate is 22.5%; (ii) if the term is between 181 days and 720 days (two years), the rate is 20%; and (iii) if the term is 721 days or more, the rate is 15%2.

These measures could bring great benefits to the small caps and to the Brazilian economy in the near future, but its impact will not be immediate.

1 This measure is especially welcome in periods of few businesses on the stock exchange like this year (2014). Although the Brazilian stock exchange is one of the most developed exchanges in the world, only eleven small caps managed to actually raise funds selling stocks until now. In Brazil, an IPO is usually only viable if the value involved is equal or above R$ 500 million. In other jurisdictions (United Kingdom, India and Hong Kong) it is possible to raise funds below R$ 10 million.

2 The terms and rates are the same for all investment funds.

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