Brazil: Capital Investments In Brazil-Exchange Rules

Until a recent past most of foreign investors that made direct capital investments in Brazil were automatically protected against exchange losses, as the Brazilian Central Bank used to issue a foreign capital certificate guaranteeing that the amounts of the original US dollars invested could be repatriated tax free as long as there was no deterioration of the company’s net worth.

This is no longer so.

Due to many changes that have occurred in the tax and exchange control regulations such a guarantee no longer exists.

This is so for the following reasons:

As of Setember 4, 2000 the Brazilian Central Bank has changed the way foreign investors register their investments in Brazil.

From now on there will be no need to request central bank approvals for the foreign investment made in Brazil. At the same time no more foreign capital certificates will be issued.

According with the system now in force, the registration is for information only and must be done through the internet in a specific site that central bank has made available to the companies.

The system is known as RDE-IE (which stands for declaratory eletronic registration-foreign investments).

Indeed the system now in force has made the registration much faster and less bureaucratic as no approvals from central bank are necessary.

In order to operate the system the company has to provide some financial ( balance sheet, etc) and statistical information the first time the new system is used, and maintain these information up to date, all made through internet.

However, it is important to point out that the system is prepared in accordance with current regulations, which determine that the foreign investor in Brazil is subject to the same rules as locals, for capital gain computation purposes.

For local investors, capital gain is computed by the difference of Reais (Brazilian currency) invested and Reais received when the investment is realized.

Thus ,according with the rules in force, the tax impact would be as follows:

A foreign investor decides to invest US$ 1,000,000 as capital investment in a Brazilian company and that amount represents R$2,000,000 at the date of the investment.

Shortly after, a devaluation of the Brazilian currency occurs (let’s say 50% devaluation) Now u$ 1,000,000 would be equivalent of R$ 3,000,000 ).

If the foreign investor wants to repatriate it back there will be a 15% capital gain tax on the additional R$ 1,000,000 caused by the devaluation

Most of the investors are not aware of this aspect of Brazilian regulations and although there still exist some grey areas (for example, in some tax jurisdictions the tax authorities still inform taxpayers that the old tax ruling 550 ( Portaria 550/94) is still in force for the computation of the capital gain which is not the case.

Tax ruling 550 was revoked by law 9.249/95, which introduced new mechanisms for computing capital gains for residents and non-residents.

Thus, it became very important that industries that need to make large amounts of capital investment in Brazil ( oil&gas, telecommunications, etc) should analyze if those investments should not be made as debt ( loans ) investment rather than equity.

This is so for many reasons:

So far brazil tax rules does not have debt /equity nor thin capitalization provisions.

Also foreign loans are still protected against exchange variation according to a specific tax provision.

However one should take in consideration that interest payments are subject to a Brazilian 15% withholding income tax. Dividends however are not subject to any withholding tax.

However if it is convenient, it is even possible to make interest free loans to the Brazilian subsidiary. In this case however the foreign parent company country rules must be analyzed as there may be some imputed interest income (which is the case of the US tax rules, for example).

Another change in the Brazilian environment is that foreign loans are no longer subject to any type of restrictions.

In the past foreign loans were subject to term restrictions and in most cases prepayment of the principal could not be made.

All those restrictions are gone. The only tax aspect that still must be observed is that if the foreign loan is made for 90 days or less there will be a financial transaction tax (IOF) of 5% on the principal amount.

However loans for 91 days and up are totally free regarding repayments etc.

A question that always comes up is regarding interest rates.

Although there are no written guidelines issued by the authorities, Central Bank’s position is that interests should follow market rates. If they are far above market rates the central bank will notify the Brazilian IRS that will most likely audit the Brazilian subsidiary and eventually disallow the deduction of the amounts that exceeds market rates.

Another aspect regarding exchange controls that most foreign investors have curiosity is to know whether it is possible and legal for a Brazilian company to maintain a foreign bank account in a foreign country.

The answer is yes.

In the past few years, Brazil has been is easing up its foreign exchange restrictions and as long as the central bank regulations on the subject are followed there is no problem for a Brazilian company to maintain a foreign bank account in a foreign country.

For the oil & gas and energy industry that possibility exists even in Brazil.

Under certain very specific conditions an oil & gas/electric energy company is able to maintain a US dollar bank account in a Brazilian bank.

In conclusion much has happened in brazil in the past few years in the exchange controls rules. Some changes may have important tax consequences some not but it is important that foreign investors became aware of these changes and make sure that the best strategy is in place to protect its investments in Brazil.