Published: January 01, 2000
Brazil, along with Russia, India and China, is part of the BRIC quartet of leading emerging market countries that is increasingly driving global growth. While Brazil has not matched the stellar expansion of China and India, its economic progress over the past decade is steady, impressive and ongoing: 2.9% growth is anticipated this year. [1] Moreover, Brazil’s resilience during the financial crisis confirmed the extent to which the country, now the world’s seventh largest economy, has advanced. Brazil’s growth has been driven by a number of factors including historically high commodity prices. However, a large part of the country’s success is attributable to its economic and financial reforms, which have produced healthy public finances — Brazil currently has one of the lowest fiscal deficits in the G20 and sizeable FX reserves. Private sector balance sheets are also in good shape. Meanwhile, efforts to create a deeper and more sophisticated capital market have been successful and have helped to broaden companies’ access to finance.
Brazil’s emergence as a leading global country — typified by its hosting of the 2014 World Cup and the 2016 Olympics — is prompting increased interest among multinational companies. Brazil’s expanding middle class, large and growing domestic market (the eighth largest in the world) and vast untapped natural resources make it an attractive investment destination: Brazil is the fourth largest recipient of foreign investment globally. Importantly, government policies and regulatory frameworks are supportive of international investment.
For multinationals expanding into Brazil at present, many aspects of the country’s financial system will be pleasingly less complicated than a few years back: The country is renowned for having one of the most modern and automated financial systems in the world. Its payment system, for example, offers quick and secured funds availability, with payments and settlement online in real time or the next day.
Brazil has two options for domestic payments in BRL. For low-value payments below BRL 999.99 (approximately $500), Documento de Credito (DOC) credit transfers are used. The ordering account is debited when the payment is initiated and funds are available at the beneficiary account on the following business day. For high-value payments of more than BRL1,000, Transferencia Electronica Disponivel (TED) electronic funds transfers are usually used (although there are no specific limit amounts on TEDs). Credit is available to the beneficiary’s account on the same day soon after the transfer is initiated by the payer.
One unique aspect of Brazil’s financial system is the Boleto, an automated collections and reconciliation instrument. A Boleto is similar to an invoice, but has a barcode that allows the electronic reconcilement of the payment with the outstanding client receivable. Boletos are issued by a bank on behalf of a corporate customer and represent a debt to be paid by the buyer of goods or services provided by that corporate. The ordering account, or buyer, is debited when payment is initiated and funds are available for the beneficiary (the selling corporate) on the following day. A Boleto can be mailed to the payee by the bank via the post office and can be paid electronically and/or at any bank branch until the expiration date. After the due date, a Boleto can only be paid in a branch of the bank that issued it. Electronic Boleto presentment is starting to be used in the market.
As the BRL is not a fully convertible currency, and is highly regulated by the Central Bank of Brazil, cross-border transactions are necessarily more complex than local payments. Every foreign currency transaction in Brazil — both for financial institutions and corporates — must comply with Central Bank rules. FX transactions must be registered and must have supporting documentation to prove the cross-border payment is legal.
Supporting documentation requirements (and taxes) vary for different types of cross-border payments. (Some examples are transactions related to Exports, Imports, Payments for Services, Capital Injection, Cross-border loans, etc.) Consequently, it is recommended that corporates consult their currency sales specialist so that documentation requirements can be discussed in advance of a transaction and a smooth execution can be achieved.
As a foreign currency transaction, all foreign capital investments must be registered with the Central Bank of Brazil. Registration is required, regardless of whether investment is in the form of foreign direct investment, a foreign loan or a portfolio investment. Registration is usually performed by a law office and is done using a module called the Electronic Declaratory Registration (RDE) on the Central Bank of Brazil’s system. Registration provides an open channel so that the funds brought into Brazil can be remitted back to the foreign investor or creditor in the future.
Another important consideration for international corporates is Brazil’s FX spot transaction tax — known as Tax on Financial Operations (IOF) — which has different rates and rules depending on the nature of the FX transaction. Again, companies should seek advice from their currency sales specialist.[[[PAGE]]]
To operate effectively, multinationals need to understand the nuances of Brazil’s FX markets and the hedging strategies that are possible. Brazil has a sophisticated and dynamic FX market, with standard settlement of two days for spot and average daily volume of USD3 billion.
The FX derivatives market enables a wide array of strategies for hedging; the most common uses non-deliverable forward (NDF) contracts. Swaps and options are also widely available and decent liquidity can be found for tenors of up to five years. While FX spot transactions must be registered at the Central Bank of Brazil, derivatives transactions are registered at a clearing house. Other risk factors, such as interest rates, inflation and commodities can also be hedged and registered locally. The PTAX reference exchange rate for the US dollar — calculated and published by the Central Bank of Brazil — is the most used FX rate benchmark.
Corporate clients use different tools for trading FX spot and derivatives: Telephone is the most frequent, especially for more complex structures such as swaps and options. Multibank electronic trading platforms (such as Bloomberg’s RFQ) are mostly used for “plain vanilla” transactions, such as NDFs.
For the flow of funds in and out of Brazil, Central Bank of Brazil rules apply regarding documentation. Supporting documentation is required to generate an FX contract (which must be signed by all parties prior to execution) according to the Central Bank of Brazil standard. The taxes levied vary depending on the nature of the transaction, or whether it is an inflow or outflow of funds.
Central Bank of Brazil allows Brazilian entities to hold offshore accounts in hard currency. This mechanism is mostly used by corporate entities to receive export flows. The corporate entity can use export proceeds received into such accounts to pay for imports or other obligations. However, export proceeds received into the offshore account may not be used to make loans to related or third parties, or to pay third-party obligations.
Both BRL and foreign currencies are used for invoicing, with USD the most frequently used foreign currency.
BRL invoicing is mostly used for intercompany transactions, either related to commercial transactions (exports and imports). BRL invoicing offers easier currency risk management at a subsidiary level as risk is managed by the foreign entity. It is, therefore, most frequently used by subsidiaries with a small local operation. For subsidiaries with a large local structure, invoicing is normally denominated in a hard currency (such as USD or EUR), and currency risk management is performed by the local team.
One disadvantage of BRL invoicing is that, for foreign loans denominated in BRL, the equivalent swap rate in BRL translates into a higher nominal interest rate for the loan. This would generate a higher tax burden since withholding tax is levied on interest payments.
Processes and regulations related to hedging in Brazil are straightforward. All over-the-counter derivatives transactions must be registered at a local clearing house (with CETIP being the largest). Registration is done by the bank that is the counterparty on the derivative transaction. As the BRL is not a full deliverable currency, all derivatives trades done in Brazil are net settled in BRL. Consequently, there is only a single payment in BRL — from the entity that owes the settlement amount to the entity due to receive it. The PTAX is the most widely used fixing for USDBRL.
There is no specific limitation on the volumes and amounts of derivatives transactable by a corporate — it is entirely driven by the entity’s risk management policy and its bank’s suitability analysis (which should ensure that the amounts and tenors being transacted are in accordance with the corporate entity’s exposure).
In Brazil, over-the-counter derivatives are classified into NDFs, swaps and options. The type of derivative determines how it is registered at the clearing house and what tax is levied. It is important for companies to discuss with local tax advisors the specificities of each type of instrument, as well as other taxes that may apply to some types of derivatives transactions.
To trade derivatives onshore, local entities must first establish a relationship with a bank and complete “Know Your Customer” requirements according to Central Bank of Brazil rules — this is a straightforward process that should take no more than a few days. The only other documentation requirement is the local derivatives contract, called the Global Contract of Derivatives (CGD). This is in line with the ISDA Master Agreement, but has some adaptations for the local legal environment.
Many companies that enter the Brazilian market are concerned about their ability to lend money to their subsidiaries in the country. While there are no restrictions on making loans to Brazilian entities, there are three important considerations for multinationals: local Brazilian FX regulations, tax implications, and rules regarding transfer pricing and thin capitalization.
As noted earlier, foreign loans into Brazil must be registered with the Central Bank of Brazil in advance of the funds being brought into the country. This Registration of Financial Operations (RDE-ROF) translates the loan agreement into the Central Bank’s template. It is usually performed with the assistance of a legal office or an FX broker. Basic information related to the loan agreement is required, such as names of the lender and borrower, the loan amount, amortization schedule and interest rate.
The number generated during registration is noted in the FX contract. Registration provides an open channel to allow for future interest payments and principal repayments. Once the RDE-ROF is obtained, the corporate entity provides a simple copy of the loan agreement and the FX transaction is then ready to be executed.
For foreign loans to Brazilian entities, the IOF tax — which applies to all FX spot trades — has variable rates based on tenor. For foreign loans with an average tenor below or equal to 360 days, [2] a 6% IOF rate is levied on the notional amount of the loan, and is withheld from the BRL proceeds by the bank that executes the FX transaction. For foreign loans with an average tenor above 360 days, the IOF rate is zero — no tax is collected on the FX transaction. The threshold tenor (currently at 360 days) has been changed a number of times since its introduction, so it is important to check the prevailing rule at the time funds are brought into the country.
Foreign loans in Brazil are also subject to thin capitalization and transfer pricing rules. Thin capitalization rules allow deductibility of interest expenses up to a ratio of two times debt/net worth when the lender is based in a non-tax haven jurisdiction, and up to a ratio of 30% debt/net worth when the lender is based in a tax-haven jurisdiction. Transfer pricing rules limit tax deductibility at the subsidiary level for loans made from foreign-related entities to Brazilian companies to an interest cost defined by the local regulator. Both thin capitalization and transfer pricing rules are complex and should be discussed with a corporate’s local legal advisors.
For loans into Brazil denominated in a foreign currency, cross-currency swaps are most commonly used for hedging. Considerable liquidity is usually available for tenors up to five years. Other instruments that may be considered are NDFs and options. The same range of instruments is available for hedging equity contributions; the company’s risk management guidelines should determine hedging strategy. Corporate tax treatment of eventual losses on hedges should be addressed with local tax advisors, as there are specific rules for deductibility.[[[PAGE]]]
Repatriation of funds out of Brazil must comply with similar rules as for foreign loans into the country. All remittances — whether distribution of profits, dividends, capital reductions or interest on equity — require RDE-IED registration at the Central Bank of Brazil. RDE-IED registration establishes the link between a company making a foreign direct investment and the recipient company in Brazil. It is used for initial flows related to capital injections and for future flows when funds are remitted back to the parent entity. Tax rules and documentation vary according to the nature of the remittance.
For multinationals with excess cash in Brazil, payments of dividends and interest on capital are most frequently used to repatriate funds and minimize exposure to taxes or fees. Since dividends are taxed at balance sheet level, remittances by the local subsidiary are not subject to withholding tax. Payments of interest on capital generate a tax shield at balance sheet level. When the remittance is made, withholding tax (15% when the beneficiary is located in a non-tax haven jurisdiction) also applies. Both payments of dividends and interest on capital are not subject to the IOF tax when remittance takes place. A copy of the RDE-IED registration, a copy of the minutes approving the distribution of dividends or interest on capital, and a copy of the financials to which the payments refer, are required for the payment of dividends or interest on capital.
Other ways to repatriate cash from Brazil include capital reduction (subject to IOF FX tax of 0.38% and to withholding tax in case of capital gains) or a loan from the Brazilian entity to the offshore entity (for which the IOF credit applies at a rate of 0.38% flat plus 1.5% per annum in the first year).
With Brazil set to embark on its next phase of growth, it is certain to remain among the most favored destinations in Latin America for international investment for the foreseeable future. Corporates seeking to take advantage of the opportunities available in Brazil must recognize that, while many aspects of its financial and payment systems are advanced by global standards, there remain some challenges to doing business in the country.
In order to overcome challenges such as restrictions on the movement of foreign currencies, it is essential to work with a bank that combines global capabilities with local on-the-ground knowledge and expertise. That way, multinationals can achieve their objectives in Brazil and harness the opportunities available in what is expected to grow from the world’s seventh largest economy [3] to its fourth largest by 2050. [4]
Notes
[1] Bank of America Merrill Lynch forecast as of June 27th, 2013.
[2] As per the current tax legislation on April 19, 2013.
[3] Based on GDP in PPP terms, World Bank estimates contained World in 2050, PwC, January 2013, p2.
[4] Based on GDP in PPP terms, World in 2050, PwC, January 2013, p2.
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