The tax on credit and exchange transactions, insurance and securities (Imposto sobre Operações de Crédito, Câmbio e Seguro, ou relativas a Títulos ou Valores Mobiliários - IOF) in Brazil is assessed on the amount of bank loans and similar transactions, on the amount of foreign currency purchased or sold, on insurance premiums and the price of securities purchased or sold. The applicable tax rate may vary from zero to 25% and depends on the kind of the operation. The IOF is a regulatory tax and the rates are decreased or increased by the Brazilian government whenever the authorities decide to foster or reduce the inflow of foreign currency funds into the country.

Interest rates in Brazil are higher than those practiced in the international market and this difference represents an opportunity of making additional gains that attracts foreign investors. Therefore, the IOF rate affects the effective cost and reduces the profitability of the transaction.

At this moment the Brazilian government wants to reduce the entry of foreign currency funds for short term investments, which is considered speculative capital, and it is not desired by the country. The Brazilian Finance Minister, Guido Mantega, claims that "international currency war" had broken out and he argues that the increase of the IOF rate is an important measure to defend the value of the Brazilian currency (Real) in this war.

In this month of October of 2010, the Brazilian government increased twice the IOF rate levied on exchange transactions related to the inflow of funds for foreign capital investments in the Brazilian market, comprising investments in fixed income instruments, such as debentures and other private debt instruments (títulos de dívida privada), and investment funds, including multimarket funds (fundos multimercado), stock funds (fundos de ações) and private equity funds (fundos de investimento em participações - FIPs). Prior to October 5, 2010, the liquidation of such exchange transactions was subject to the IOF at the rate of 2%.

The first increase was made by means of Decree No. 7,323, of October 4, 2010, which came into force on the following day (October 5), when it was published in the Official Gazette of the Union (Diário Oficial da União - DOU). As a result, the transaction the rate has been increased from 2% to 4%.

Immediately after, this increase was deemed to be insufficient and few days later, as of October 19, 2010, by means of Decree No. 7,330, of October 18, 2010 (published in the DOU of October 19, 2010), the applicable rate was increased again from 4% to 6%. At the same time, the IOF rate on exchange transactions for foreign capital investments related to the constitution of margins of guarantee (either initial or additional) required by the stock, commodities and futures exchanges was increased from 0.38% to 6%.

The IOF rate on foreign capital investments in the Brazilian capital market, comprising variable income instruments, such as securities traded on the stock exchange or assets traded on the commodities and futures exchange, in the form regulated by the Brazilian Monetary Council (Conselho Monetário Nacional - CMN), remains unchanged and continues to be 2%. Transactions with derivatives which result in predetermined income are considered fixed income and are taxed at the rate of 6%.

Currently, there is no IOF on exchange transactions related to the outflow of funds (remittances abroad) related to foreign capital investments in the Brazilian financial and capital markets, because the applicable rate is zero.

To eliminate "creative solutions" aimed to avoid the 6% IOF rate and close loopholes, the CMN Resolution No. 3,914, of October 20, 2010, expressly prohibits the financial institutions and other entities authorized to operate by the Central Bank of Brazil (Banco Central do Brasil - Bacen) to lease, exchange or lend instruments, securities or other financial assets to non-resident investors with the purpose to enable those investors to perform transactions in the derivatives market, without paying the IOF. As an exception, transactions contracted before October 21, 2010 (date of publication of CMN Resolution 3,914 in the DOU) may be maintained up to their maturity date, or, in case undetermined term transactions, up to December 31, 2010, will not be subject to IOF, but such transactions cannot be postponed nor renewed.

Furthermore, for the same reasoning, CMN Resolution No. 3,915, also of October 20, 2010, establishes that any domestic migrations of funds in Brazilian currency (Real) made by non-resident investors destined to the constitution of margins of guarantee required by the stock, commodities or future exchanges, are subject to simultaneous exchange transactions, pursuant to the provisions of CMN Resolution No. 3,912, of October 7, 2010, and consequently, are subject to the 6% IOF rate.

On October 6, 2010, in an extraordinary meeting, the Board of Bacen authorized to double the term of exchange transactions for future liquidation that the Secretariat of the National Treasury has to purchase foreign currency (United States Dollars) in the market in order to pay the External Federal Public Debt, increasing the number of days from 750 days (two years) to 1,500 days (four years). These purchases comprise interbank, arbitrage and financial transactions and the matter is regulated by Bacen Circular No. 3,507, of October 6, 2010. This is another measure to control the depreciation of the United States Dollar.

The Brazilian government is determined to avoid the overvaluation of the Real and eventually might have some success in achieving this purpose, depending on the effective result of the aggregate measures taken so far. According to the analysts, however, it is very likely that the Brazilian currency, in the same line of the vast majority of currencies of other emerging countries, continues to be affected by the global movement of the weakening of the United States Dollar. The most promising flows for the next year, in the case of Brazil, are those of direct foreign investments and foreign capital investments in securities traded on the stock exchange, which will not be affected by such measures. The attempt to contain the overvaluation of the national currency is not a exclusivity of Brazil and follows several other intervening measures announced by many countries during the last weeks, such as Japan, Korea and Taiwan, which tried to deal with the constant depreciation of the United States Dollar vis-à-vis their national currencies.

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