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No withholding tax on qualifying bonds & Hybrid Financing Instruments

No withholding tax on qualifying bonds & Hybrid Financing Instruments
2 Apr 2012

Foreign companies investing into Brazil are often concerned with the withholding taxes levied. Most tax treaties with Brazil allow for Brazil to levy withholding tax on interest. Income derived from bonds (ie debentures) or securities publicly-issued by a Brazilian private company and acquired by foreign companies[1], can however be subject to a zero rate Brazilian withholding income tax ("WHT") from 1 January 2011. Taxand Brazil discusses the terms and conditions required to benefit from a zero rate WHT and how investors can use hybrid financing instruments to create a tax advantage.

To benefit from the zero rate WHT, the bonds or securities must, in general, present the following terms and conditions: (i) a pre-fixed interest rate, linked to a price index or reference rate (RR); (ii) average maturity term greater than 4 years; (iii) the issuer is not allowed to repurchase the paper within 2 years after issuance; (iv) the early settlement through redemption or prepayment is not allowed; (v) inexistence of resale commitment took on by the buyer; (vi) when stipulated, periodic income payments must observe a minimum break of 180 days between them; (viii) evidence of its negotiation in the regulated securities market; (vii) a procedure demonstrating the aim at allocating the funds in investment projects.

Besides, this the zero rate only applies to foreign beneficiaries that are not resident or domiciled in countries which do not tax income or tax it at the maximum rate lower than 20% ("Tax Favourable Jurisdiction")[2].

The Decree n. 7,632/2011 introducing some new regulations to the Decree n. 6,306/2007, which rules the Tax on Financial Transactions ("IOF"), also reduced to zero the rate of IOF/Exchange due on the foreign exchange transactions related to the inflow and outflow of proceeds in connection with the bonds and securities ruled by the aforementioned law.

The new rules will make it possible for multinationals to structure receivables on Brazilian companies and eliminate interest WHT. The Netherlands is, for example, not considered to be a Tax favourable jurisdiction and can therefore be used to efficiently leverage Brazilian companies.

The use of financing hybrid instruments from a Brazilian tax perspective

Although the legislation requires that bonds or securities must be publicly-traded; it is possible to have a public placement of debentures\ exclusively destined to some qualified investors[3]. Thus, it is possible to structure the issuance of debentures by a Brazilian company, to foreign entities.

From a Brazilian tax perspective and considering the above, it is possible to envisage an efficient structure using hybrid instrument among Brazilian and foreign entities, even though hybrid instruments are not ruled by Brazilian tax legislation.

A hybrid instrument is a financing form widely used in tax planning which provides a tax-deductible payment in the country where the company receiving the finance is located and does not correspond to a taxable income in the country that provides it. In other words, a hybrid instrument structure comprises a financing instrument which is considered "debt" in the jurisdiction of the company receiving the finance and paying "interests" and "equity" in the jurisdiction of the company remitting the funds and receiving the relevant remuneration.

In this context, the debentures issued by a Brazilian company and acquired by foreign companies may be used as a finance hybrid instrument since it shall be deemed a "debt" from a Brazilian tax perspective and might be considered "equity" from the tax perspective of the foreign company acquiring it, depending on the local legislation.

From a Brazilian tax perspective, apart from the zero rates of WHT and IOF/Exchanged mentioned, interests paid by a Brazilian company on account of issued debentures are usually considered debts (financial expenses) and deductible from the taxable basis of its corporate income tax, as long as it observes the normal requirements established by the Brazilian Income Tax legislation.

For such a hybrid instrument structure, though, it is important to verify the characteristics the debentures must have for the purpose of being considered "equity" from the perspective of the foreign acquirer company and that they do not jeopardise its "debt" nature from a Brazilian tax perspective.

Taxand's Take

Income from qualifying bonds or securities, ruled by Law n.12,431/2011, remitted to or credited in favour of foreign beneficiaries is subject to zero rate WHT and IOF/Exchange and is usually considered deductible from the taxable basis of Brazilian corporate income tax.

Although these bonds and securities must be publicly available, from a Brazilian regulatory perspective, a public placement of debentures destined to be qualified investors may enable the use of hybrid financing instruments between Brazilian and foreign entities.

The characteristics of the debentures must be observed in accordance with the mentioned legislation and general tax requirements in order to be considered "debt" and to guarantee the deductibility of the relevant interests.

Your Taxand contacts for further queries are:
Jose Otavio Haddad Fallopa
T. +55 11 2179 4542

Debora Bacellar de Almeida
T. +55 21 2114 7601

Marc Sanders
T. +31 61 136 7769

[1] Including quotas of investment funds exclusive for foreign investors that have at least 98% of its net worth applied in bonds or securities of Law 12,431/2011.
[2] The WHT levied on the interest income to beneficiaries located in Tax Favorable Jurisdictions remains 25%.

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Taxand's Take Author