Everyone who has followed events in Brazil over the years has heard year after year that the country was on the verge of emerging as an international economic powerhouse. While it took awhile for Brazil to finally emerge, it is certainly the case today that it has arrived, and U.S. manufacturers looking for new markets can no longer have serious aspirations in Latin America without having a Brazil strategy. Why is Brazil so important to U.S. businesses looking for markets for their products? Look at its current standing in the world:
- Depending upon which statistics you look at, Brazil is either the fifth, sixth or seventh largest economy in the world;
- Brazil is the largest economy in Latin America;
- Brazil is the fifth largest country in the world by area;
- Brazil has the fifth largest population in the world with approximately 198 million people;
- As a member of the free trade area known as the Mercado Comum do Sul (which translates to Market of the South and is commonly known as Mercosur), whose members, in addition to Brazil, include Argentina, Paraguay and Uruguay, Brazil provides low or no duty access for goods originating in the member countries to a total market of 240 million people;
- During the administration of its former President, Lula da Silva, and thus far during that of its current President, Dilma Rousseff, Brazil has enjoyed political stability;
- With growth in 2010 at 7% and projected growth for 2011 at between 4 and 5%, Brazil is experiencing phenomenal growth, especially when compared to other developed and developing countries;
- Brazil’s growing middle class has Reais to spend and is traveling to the U.S. and other countries to take advantage of its new purchasing power;
- With the discovery of its huge offshore oil deposits, it is rich with oil, and is becoming self-sufficient in oil production.
While Brazil has great potential, however, entry into the market can be difficult. High import tariffs, a complicated tax regime and a strict labor code are just a few of the hurdles that foreign businesses must overcome in order to succeed in Brazil. This article focuses on U.S. manufacturers who want to sell products in Brazil and discusses the legal aspects of doing business in Brazil, either by importing products into the country, or by forming a subsidiary in Brazil and manufacturing products locally, as well as some of the issues which arise when choosing either of these options.
Importing Products into Brazil.
For many manufacturers, the first step towards establishing a presence in a foreign market is made by importing products into the country. This is done either by selling directly to a customer identified in the country, or by selling through a distributor, who resells the products. While importing may work well in most markets, it is a difficult prospect in Brazil due to Brazil’s high tariffs and taxes.
The United States and Brazil are not currently parties to a bilateral free trade agreement or a double taxation treaty. As a result, importers from the U.S. bear the full burden of the tariffs and taxes on imports. Tariffs in Brazil range from 0 to 35%, with the average tariff being 7% (down from 14% in 2009). Tariffs are charged on the CIF value of the imported goods (i.e. cost, insurance and freight). The bound rate that Brazil can levy on imports under World Trade Organization (WTO) rules is 31.4%. Since tariffs can be changed by the government at any time, importers are subject to risk and uncertainty.
Apart from the tariff rates, importers must also pay a succession of cascading taxes on imported goods. These taxes include the 25% Merchant Marine Renewal Tax for goods shipped by sea (AFRMM), the 0 to 20% Industrial Products Tax (IPI), the 0 to 20% Merchandise and Services Circulation Tax (ICMS) charged by the particular state in Brazil into which the goods are imported (the average rate is 18%), the 1.65% Contribution to the Social Integration Program and Civil Service Asset Formation Program (PIS/PASEP), and the 7.6% Contribution to Social Security Financing (COFINS).
After adding tariffs and taxes together on some goods, the result can be a 100% increase in the cost of the imported product. Furthermore, there are non-tariff barriers that importers must address. Before importing products into Brazil, importers must register with the Brazilian Foreign Trade Secretariat (SECEX) and be registered with the Registry of Importers. Finally, importers must determine whether an import license is required in order to import a particular product. In the event a license is required, depending upon the product, obtaining the license could take up to a year. Importers must do an import analysis on their products before choosing to import into Brazil. If the products compete with existing products manufactured in Brazil, unless the imported product has improved or unique features or superior quality, the product may be uncompetitive after adding on tariffs, taxes and the cost of registering and obtaining an import license. If the product is unique, has competitive advantages that outweigh its imported cost, or are not subject to higher tariffs, importation may be a viable option. If importation is not practical, manufactures can avoid the import tariffs, registration and licensing costs by establishing a subsidiary in Brazil.
Establishing a Subsidiary in Brazil.
If importation is not an option, manufacturers might consider forming a Brazilian subsidiary and manufacturing their products in Brazil. Brazil allows 100% foreign ownership of Brazilian entities. Although there are several choices of entities in Brazil, the most common entities include: (i) the limitada (or limited liability company) -- a hybrid between a corporation and a partnership -- and (ii) the sociedade anônima or S/A, which is similar to a C corporation in the U.S. The characteristics of each entity are as follows:
Characteristics of a Sociedade Anônima:
- Limited Liability (i.e. owners liability is limited to the amount of their investment).
- Minimum of two shareholders. Need not be Brazilian citizens or residents.
- May be private or public.
- Must register with the Commercial Registry and publish in the Official Gazette and in another widely circulated newspaper in the city where the entity is incorporated.
- At least 10% of the initial paid in capital must be deposited with a commercial bank and paid up at the company’s formation. In the case of foreign investment, the shareholders must register with the Brazilian Central Bank, obtain a password from the Central Bank and register the capital before capitalizing the company.
- Managed by officers, but may also have a board of directors.
- Officers must reside in Brazil. Board members are not required to do so, but must grant a power of attorney to someone in Brazil to receive service of process.
- Company’s financial statements and minutes of shareholder’s meetings must be published.
- Must set aside 5% of annual profits as a legal reserve.
- Time and cost: 2 to 3 months. $5,000.
Characteristics of a Limitada:
- Limited Liability (i.e. owners liability is limited to the amount of their investment).
- Minimum of two members. Need not be Brazilian citizens or residents.
- Register with the Commercial Registry and published in the Official Gazette and in another widely circulated newspaper in the city where the entity is formed.
- Paid in capital can be paid in over a period of one year. Note that for obtaining a permanent visa for expatriate managers, however, a minimum amount of $200,000 US must be fully paid in. In the case of foreign investment, the members must register with the Brazilian Central Bank, obtain a password from the Central Bank and register the capital before capitalizing the company.
- Managers must be residents of Brazil.
- Managed by one or more members. The Articles of Association must state the name of the managing member.
- The Limitada need not publish its accounts, amendments to its Articles of Association, or other corporate documents.
- Qualifies for check-the-box treatment to be treated as a partnership or disregarded entity for U.S. tax purposes.
- Time and cost: 2 to 3 months. $5,000.
Note that in the case of both the S/A and the Limitada, officers or managers must be residents of Brazil. Therefore, foreign companies will need to hire local management. It is important to note, however, that foreign directors can oversee local management and direct overall affairs of the company. Also, since management in Brazil are only authorized to act on behalf of the company by virtue of a power of attorney, the authority of management to act can be restricted by the terms of powers of attorney. In both the case of the S/A and the Limitada, it is most common for U.S. companies to form two domestic limited liability companies to act as the owners of the shares or the quotas of the Brazilian S/A or Limitada. In the case of the Limitada, the effect of using two domestic limited liability companies as the quotaholders of the Limitada is that profits and losses can be passed through to the parent company. Finally, it is very important to register the foreign capital invested in either the S/A or the Limitada by the U.S. owners with the Brazilian Central Bank. Failure to do so will prevent the subsidiary from being able to remit dividends and repatriate the registered capital to the foreign U.S. owners.
Once again, as in the case of import taxes, corporate taxes in Brazil are complicated. Brazil taxes companies on their worldwide income. The current corporate tax rate is 34%. There is also withholding on foreign investment of between 15% and 25%, although there is no tax on dividends to foreign owners. The topic of taxation could take up an entire article by itself, but suffice it to say that because of the complexity of corporate taxation, it is crucial to retain competent Brazilian tax advice.
While most companies moving to Brazil to manufacture their products will look to locate close to their optimum market in the country, many U.S. manufacturers are moving to the Manaus Free Trade Zone in Manaus, in the State of Amazonas. Manaus is the capital city of Amazonas and has a population of approximately 1.6 million people. It has access to raw materials and a strong work force. The Manaus Free Trade Zone offers qualifying foreign companies numerous state and federal business and tax incentives, including:
- a 75% tax reduction through 2013 (this incentive may be extended);
- an 88% reduction in import duty tax for raw, intermediary and secondary materials, and for the packaging of foreign products that are used during the manufacture of industrialized products in the Free Trade Zone intended for consumption elsewhere in Brazil (provided that the superintendency gives its approval);
- an exemption from import duty tax for products that are destined for internal consumption (including capital goods), and for those products that are listed in Interministerial Instruction 300/1996 destined for the Amazon region;
- reduction proportional to Brazilian raw material and workforce participation (for IT goods).
- excise tax exemption applies to eligible foreign goods traded within the Free Trade Zone, as well as to foreign goods used within the zone subject to certain restrictions. The excise tax exemption is also qualifying goods produced within the Free Trade Zone and to domestic goods entering the zone; and
- goods produced within the Free Trade Zone may be exempt from export taxes.
- eligible goods for consumption or industrialization or re-exportation by other Brazilian States to the free trade zone may be exempt from VAT;
- Amazonas grants a VAT credit equal to the amount payable at the point of origin for goods manufactured in other Brazilian States as these goods enter the Free Trade Zone; and
- VAT on eligible goods is refunded subject to certain conditions.
When looking for a location for a manufacturing facility, it is worth looking at the Manaus Free Trade Zone, but it is also worthwhile investigating whether other states and municipalities in Brazil are willing to offer incentives.
Another important consideration for companies establishing a subsidiary in Brazil is hiring employees. Employment practices in Brazil are very different from those in the U.S. Brazil has extensive legislation regulating the relationship between employers and employees. The basic legislation is contained in the Consolidação das Leis do Trabalho. Brazilian law requires employers to pay several mandatory benefits and related charges and to contribute to social security and the employees’ severance and pension plan system. While employers enjoy freedom of contract in most states in the U.S., allowing employers to terminate employers without cause and without incurring severance, Brazilian law does not allow employers to terminate employees without cause without paying what can be expensive statutory severance. Furthermore, it is not uncommon in many industries for Brazilian companies to wrongly characterize workers as independent contractors to avoid paying expensive social taxes and severance. While this is not uncommon, rules for characterizing who is an employee in Brazil are similar to the rules in the U.S. If a person provides services to one company, receives compensation from that company and the company directs when and where the services are provided, the person will need to be characterized as an employee. Failure to treat the person as an employee can result in the company being liable for unpaid social withholding taxes, penalties and interest as well as other civil and criminal fines. It is therefore important for U.S. owners to carefully monitor their subsidiary’s compliance with Brazilian employment laws.
Predictions are that Brazil will continue to show strong growth. Choosing the best option for accessing the market before attempting to do so can save U.S. manufacturers substantial time and money. For some, importing may be a viable and profitable option, for others, the only option for leveling the playing field with Brazilian manufacturers and avoiding high tariffs and import taxes may be to manufacture in the country. Doing business in Brazil is difficult compared to the U.S., but with proper planning and with knowledge of the legal and cultural landscape, doing business in Brazil can be highly profitable.