At the beginning of December, the Brazilian government has loosened the capital constraint measures adopted throughout 2012 to prevent the appreciation of the real (Brazilian local currency). The changes will reduce the burden of withholding tax and financial transaction tax on pre-export financings with a tenor of between 1 and 5 years, making these financings considerably more attractive than has been the case in 2012. Overall the changes will likely encourage foreign currency financing of Brazilian borrowers.
1. Background and rationale
Although officially local currency freely fluctuates in Brazil, the Brazilian government adopted a pro-active policy to control the appreciation of the real throughout 2012 by limiting investment into Brazil.
This was achieved mostly through tax measures in connection with financing, direct investment and derivatives transactions, as well as interventions by the Brazilian Central Bank (Bacen).
As a result pre-export finance which is one of the major routes for remitting funds into Brazil has been subject to various regulatory changes throughout 2012.
Before March 2012 foreign financial institutions were allowed to grant export financings to Brazilian exporters, for an unlimited term, benefiting from a 0% rate of withholding tax over interest and a 0% rate of financial operations tax (Imposto sobre operações financeiras or IOF). This placed pre-export financing at an advantage when compared to other overseas financing structures which attracted a 15% withholding tax rate.
However, on 1 March 2012, by means of Circular 3580/12, Bacen set the following parameters in connection with pre-export financings:
- limited the term of pre-export financings to 360 days; and
- allowed transactions between importer and exporters only, undermining pre-export finance arrangements, backed by banks essentially permitting corporate credit.
In June 2012, after much pressure from Brazilian exporters, through the issuance of Circular 3604/2012, Bacen once again allowed third parties to provide financing under pre-export arrangements.
Between June 2012 and December 2012 a number of structures, including local project debenture issuances, were proposed to avoid onshore funds and avoid the withholding tax exposure.
2. What has changed?
After the stabilisation of the real and its slight depreciation in December, Bacen acceded to the exporters arguments, namely that they could not benefit from the debt capital market to raise funds through the issuance of local debentures, due to cost and operation constraints. Bacen adopted two main measures:
- the extension of the duration of pre-export or advance payment transactions, allowing loans to be as long as five years (instead of 360 days); and
- changes to the tax on foreign-currency inflows - financial operations tax (Imposto sobre operações financeiras or IOF) by the Brazilian Finance Ministry, allowing the exemption of IOF payments in loans with tenor exceeding 360 days.
The measures were implemented on 4 and 5 December 2012, respectively when Bacen issued (i) Circular 3617/2012 that extended the maximum term for advance payment transactions; and (ii) Decree 7853/2012, that imposed a 6% tax rate to any foreign currency loans contracted as of 5 December 2012 with an average maturity term of 360 days (the taxable average maturity period before the decree was two years).
3. Applicable taxes to pre-export financings in Brazil
Financial operations tax (Imposto sobre operações financeiras or IOF) may be imposed by the Federal government at rates varying from 0% to 25%. In light of the current regulation, pre-export loans with a term of more than one year are exempt from IOF. Transactions with shorter terms are levied at a 6% rate.
Generally, cross-border payments of interest are subject to a withholding tax at a rate of 15% in Brazil, pursuant to Law 9481/97.
Although from a tax legislation standpoint pre-export financing arrangements, regardless the term, currently enjoy an exemption of withholding tax, the proper channel for remittance of funds by the Brazilian Central Bank allows only transactions with maturity limited to 1800 days to benefit from such exemption. As a consequence any transactions with maturity in excess of the 1800 days have withholding tax levied at a rate of 15%.
4. Next Steps
Although the current regulation is not as favourable to exporters as it was before March 2012, the changes have granted Brazilian exporters access to foreign resources. For some exporters, the access to foreign resources is now adequate to the production cycles of their respective products. Notwithstanding exporters of commodities with cycles that exceed the 1800-day threshold will still need to consider alternative structures so as to benefit from tax optimal structures allowing the necessary capital inflow.