This week, IFN brings you an exclusive interview with Fábio Figueira, a partner at Brazillian law firm Veirano Advogados, during which we discussed Islamic finance opportunities in Brazil and the country's investment infrastructure.
1. What are the current trends in general investments and what are the opportunities for Islamic finance to spread in Brazil?
Since the Growth Acceleration Program (PAC) was launched in 2007, investments in the infrastructure sector in Brazil have significantly intensified, with a focus on housing, sanitation, transport and energy projects. Whereas several new projects and concessions on ports, airports and roads, as well as in the energy sector, have been granted and developing in the recent years, a large portion of such investments is yet to be done or even in need of further financing to move forward.
The opportunities for investments are not only found in projects to be developed, but also on ongoing finance to support the companies' cash flow. The electricity sector, for instance, in which project finance has dominated the financing transactions on the energy generation side, is now demanding heavy financing for its operational side as well. Due to the current hydrologic situation in Brazil and corresponding rise in energy prices, distribution companies alone have already contracted loans in excess of USD 6.5 billion in 2014, and are currently seeking additional funding to settle energy purchases of 2014. As prices and demand for energy continue to increase, it is expected that both additional investment and financing will be necessary in the upcoming years.
In this scenario, regular loan structures are being replaced for more complex transactions, involving various types of arrangements, from infrastructure bonds to equity deals. As sponsors in the infrastructure sector look for innovative and alternative solutions for their investments, we believe that the opportunities for Islamic investments in this sector will continue to rise. Of course, as discussed below, these alternatives should be carefully reviewed in order to ascertain that they would be Shariah compliant.
2. What are the preferred vehicles to invest in the country? Any local incentives?
Investments in Brazil made by foreign entities usually take
place by means of (i) the incorporation of a legal entity in Brazil
or (ii) the acquisition of the totality or part of the capital
stock of a legal entity already incorporated in Brazil. The most
common legal entities in Brazil are the corporation (sociedade
anônima or S.A.) and the limited liability company (sociedade
limitada or limitada).
A corporation has its capital stock divided into shares and it is governed, essentially, by the Brazilian Corporations Law and its by-laws (estatuto social). A limited liability company has its capital stock divided into quotas and it is governed, essentially, by the Brazilian Civil Code and its articles of association (contrato social).
The main difference to consider when electing for one or the other form of legal entity is what kind of organization is envisaged. Please note that only corporations are entitled to issue shares and other securities (and therefore raise funds) to be publicly traded in the stock exchange. The corporation is also chosen when investors want to set the governance of the entity with the execution of a shareholders' agreement. On the other hand, a limited liability company tends to be a more appropriate vehicle for structuring simpler foreign direct investments in Brazil as the management and other requirements are more flexible than for a corporation (despite the fact that the stockholders of a limited liability company may also execute a stockholders' agreement).
Please note that foreign companies may not operate branches in Brazil unless they submit a special request to the Ministry of Industry and Commerce and receive prior authorization through a Presidential decree. In practice, due to the bureaucratic difficulties in obtaining such authorization, few branches of foreign entities operate in Brazil.
The entering into of joint ventures may be an alternative for
foreign investors (which means the acquisition of part of an
already existing legal entity or the incorporation of a new entity
with a Brazilian partner). Usually, joint ventures take either the
form of a corporation or the form of a limited liability company.
Please note that, with a presence in Brazil through a participation
in a Brazilian legal entity, the foreign investor may indirectly
participate in, for example, a consortium agreement, which is
generally adopted for certain significant infrastructure projects
in Brazil. The consortium agreement is considered a
Furthermore, it is worth noticing that foreign investors may also invest in Brazil by means of the acquisition of quotas of investment funds incorporated in accordance with the Brazilian Securities and Exchange Commission (CVM). Brazil has a growing funds industry, focused in several different fields (real state, bonds, stocks, government bonds, among others).
From a tax perspective, on the day-to-day activities, the choice
between a corporation and a limited liability company does not make
that much of a difference. However, the option between one and the
other may be relevant for tax purposes if the foreign investor will
participate in a joint venture with a Brazilian partner and if the
agreed equity ownership does not correspond exactly to the amount
of cash that is contributed by each. While the corporation usually
provides more flexibility for non-taxable disproportionate
investments because of the possibility of issuing shares at a
premium without adverse tax consequences (and also the issuance of
ordinary shares and preferred shares with different values and
political rights), the limited liability company, on the other
hand, has greater flexibility in what regards disproportionate
distribution of profits.
In any case, dividends are not subject to any taxation in Brazil when distributed to shareholders or quotaholders.
Another fundamental issue is the treatment of capital gain. Brazilian local entities are subject to capital gains taxation at a 34% rate and individuals at a 15% rate, but non-residents are subject to specific rules. Basically, any gains derived from the sale of permanent investments are subject to a 15% withholding income tax (increased to 25% if seller is resident in a favorable tax jurisdiction).
In addition, in the case of portfolio investments there are special regimes and vehicles, such as the FIP (Participation Investment Fund) that under certain conditions will allow the non-resident to invest in Brazil with capital gains exemption. Non-residents will generally also not be subject to tax when investing directly in shares negotiated in the Brazilian stock exchange.
On the incentive side, there are various industry specific incentives (such as for IT and infrastructure projects), Federal regional tax incentives (for companies investing in the Northeastern and Northern Regions) and a great number of benefits for exporters, which is relevant for deciding on Brazil as a hub for the Latin American market.
Finally, it is also important to consider that the political system in Brazil has the country divided into 27 States and more than 5,000 municipalities. Taxes are charged by all three powers (Federal, State and Municipal). This gives rise to the possibility of negotiating special tax benefits with States and Municipalities (primarily VAT, service and real estate taxes) if the permanent investment has the potential to create local jobs and taxable revenue.
3. How do you see the developments of foreign Islamic investments? In which sector particularly? What is the support offered by local authorities?
As mentioned in our answers above, foreign Islamic investments can be made through different vehicles and the infrastructure sector is maybe the one foreign investors should pay attention to and tax incentives were also mentioned above. Brazil unfortunately still does not have specific regulations applicable to Shariah compliant transactions just like one may find in countries with a large muslim community. However, this fact, on the other hand, should not be seen as a barrier or an obstacle to investments in Brazil due to the comments we made above.
We should note that, as publicized last year (please see http://exame.abril.com.br/mercados/noticias/brasil-mira-oriente-medio-com-fundo-com-regras-do-isla), Banco do Brasil S.A., the main commercial bank controlled by the Federal Government, has announced its interest in starting operating in Shariah compliant transactions and it was mentioned that Banco do Brasil S.A. would be evaluating the possibility of launching an investment fund of Brazilian company which would be Shariah compliant.
Previously published in Islamic Finance News
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