According to Brazilian law, the dividends distributed to the shareholders are exempt from income taxes. As a consequence, M&A transactions in Brazil are commonly negotiated by the involved parties under the condition that the existing profits are distributed to the original shareholders previously to such transactions.
The comprehension of Brazilian law as regards the distribution of partial dividends is essential for the negotiation of M&A transactions in Brazil, especially considering the legal restrictions imposed thereto.
The distribution of partial dividend by corporations is regulated by Section 204 of Brazilian Corporations Law, being such dividend classified either as interim (intermediário) or intercalary (intercalar).
The interim dividend corresponds to the amount of the profits ascertained in the previous corporate years and distributed to the shareholders. Such profits were contained in the financial statements related to the last years, already approved by the shareholders in specific Annual Shareholders' Meetings and, for some reason, were retained as accrued profits or as profits reserve.
According to Section 204, paragraph 2 of Brazilian Corporations Law, "the bylaws may authorize the administrative bodies to declare an interim dividend from the accrued profits or profit reserves existing in the last annual or semi-annual balance sheet".
Therefore, the interim dividend may only be distributed under the following conditions: (i) the profits shall be contained in the last annual or semi-annual financial statements and approved in the previous Annual Shareholders' Meeting; (ii) the amount to be distributed shall be limited to the accrued profits or to the profits reserve; (iii) the company's bylaws must authorize the distribution (which will be further ratified by the shareholders); and (iv) the decision on the distribution of dividends must be taken by the administrative bodies of the company (Board of Directors or Officers, as the case may be). Once verified such conditions, the interim dividends may be distributed to the shareholders.
On the other hand, the distribution of intercalary dividend may imply severe restriction to a M&A transaction. Such dividends corresponds to the distribution of the profits ascertained in the financial statements related to the corporate year currently in force and is regulated by the main paragraph and the paragraph 1 of Section 204 of Brazilian Corporations Law, which sets forth the following:
Section 204. A corporation, which prepares a balance sheet every half year by virtue of any legal or statutory provision, may by resolution of the administrative bodies, if so authorized in its bylaws, declare a dividend from the profit ascertained in such balance sheet.
Paragraph 1. Whenever, in accordance with statutory provisions, a corporation may prepare a balance sheet and distribute a dividend at shorter periods, the total dividend paid in each half year of any fiscal year may not exceed the amount of the capital reserves described in paragraph 1 of article 182.
The literal analysis of the above provisions suggests that the intercalary dividend can only be distributed by corporations as regards the profits ascertained in two kinds of financial statements: (i) semi-annual financial statements; or (ii) financial statements comprising shorter periods, but limited to the total amount of the capital reserves, which is the reserve composed by the amounts corresponding to the premium paid by the shareholders on the subscription of newly issued shares and from the sale of founder shares and subscription warrants.
In both cases, the intercalary dividend may only be distributed under the following conditions: (i) the company's bylaws must authorize the distribution (which will be further ratified by the shareholders); and (ii) the decision on the distribution of dividends must be taken by the administrative bodies of the company (Board of Directors or Officers, as the case may be).
The restriction on the distribution of profits related to periods shorter than six months, i.e., the limitation by the value of the capital reserve, is justified by the necessity of protecting the company and the creditors, since the supporting financial statements are not considered mature enough to reflect the reality of the company regarding its capacity of distributing dividends at the end of the corporate year.
Under the same rationale, the main paragraph of the referred Section 204 allows the distribution of profits ascertained in semi-annual balance sheet of the company regardless of the company's capital reserve, since the semi-annual balance sheet is considered mature enough to support such a distribution of dividends.
At this point, however, an interesting question arises: what happens if, for example, the shareholders intend to distribute company's dividends in October, just before the sale of their equity ownership to a third party? In other words, if Section 204 of Brazilian Corporations Law refers specifically to the distribution of semi-annual dividends, is it possible for the company to distribute dividends based on the profits ascertained in a period higher than six months but lower than a full year?
In order to answer such questions it is necessary to better understand the main paragraph of Section 204 of Brazilian Corporations Law. Following the rationale explained above, one of the possible interpretations to such provision is that the reference to the semi-annual balance sheet indicates a minimum period (six months) provided by Law for the preparation of the balance sheet to serve as the basis for the distribution of periodical dividends.
Such interpretation is in accordance with the legal intention of protecting the company and the creditors against the distribution of partial dividends whenever the company appears that will not have enough profits for such distribution.
Despite such plausible understanding, the distribution of intercalary dividends related to the profits ascertained in balance sheets related to periods higher than six months may be questioned by the other parties involved in a M&A transaction. In order to avoid further discussions and to mitigate any risks of misinterpretation of Section 204 of Brazilian Corporations Law, it is preferable to take some precautions, such as (i) immediately after the decision of the Board of Directors on the referred distribution of intercalary dividends, it is also recommended to have a Shareholders Meeting ratifying (unanimously, if possible) such decision; or (ii) set forth the distribution of the intercalary dividends in the relevant documents of the transaction (Share Subscription Agreement, Share Purchase and Sale Agreement and/or Shareholders' Agreement).
An alternative to the distribution of partial dividends that may be discussed on a M&A transaction is the payment of the profits' amount as part of the purchase price, leaving the existing profits for the distribution of dividends to the future shareholders of the company in the subsequent year.
Such alternative, however, must be carefully considered. On the sell-side, the purchase price may be taxed if there is a capital gain on the sale of the corporate interests. On the buy-side, the company may not perform as expected as from the date of the purchase of its shares and, therefore, the totality or part of the negotiated dividends may not be available for a future distribution at the end of the year.
Therefore, when negotiating a M&A transaction, it is essential for the parties to carefully consider all corporate and tax issues that impact on the definition of the purchase price. Among such issues, we highlight the relevant discussions on the distribution of the existing profits as partial dividends.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.