BACCF – Brazilian-American Chamber of Commerce of Florida

BRAZILIAN MARKET:

M&A AND TAX UPDATES

Speakers: José Augusto Figueira / Mona Clayton / Wade Angus / Bruno Xavier / Rafael Vianello March 20th, 2015

Mergers and Acquisitions in Brazil - 2014

Despite international market skepticism, M&A activity in Brazil remains strong. 879 transactions were recorded in 2014, a record since PwC started this research in 2002. •

Brazil has maintained robust levels of M&A activity over the last five years.

•

One supporting factor for the high M&A volumes is an observed return to deal multiples more in-line with global norms. While certain industries and growth businesses continue to command premium EBITDA multiples, the greater market understands that the "price to do business in Brazil" has been reset. Average of 803 announced transactions per year Average of 646 announced transactions per year 879 799

Average of 384 announced transactions per year

722 645

644

2008

2009

752

771

2011

2012

812

573 395

415

389

2004

2005

337

2002

2003

2006

2007

2010

2013

2014

Jan-Dec Source: PwC analysis

Note: Excludes those not disclosed in press and agreements

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Mergers and Acquisitions in Brazil - 2014

Transactions up to $100 million, remain the most numerous, accounting for 64% of all announced deals

National investors continue to be the lead players in Brazilian transactions

Domestic vs. International deal participation

Announced Deals Profile Deals

Domestic

Foreigners 404 405 397 411

395 390 Mega market (More than US$ 1 bi)

22

332 323

232 Middle market (US$ 101 mm to US$999 mm)

190 180 173

76

101

239

155

168

128 117

337

280

269 169 182

Small and middle market ( bellow US$ 100 mm)

427

185 147

83

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Source: PwC analysis

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Mergers and Acquisitions in Brazil - 2014

M&A activity continues to span a wide range of sectors and continues to consolidate the market. IT led the market with 141 announced transactions in 2014 141

Deals by Sector - 2014 83

IT

Auxiliary Services

78

Banking

69

Retail

• In 2014, private equity firms were present (entry and exit of capital) in 36% of announced transactions.

36%

59

Mining

58

Public Services

50

Food

41

38

Oil and Gas

Real Estate Services

•

Capital for growth and sectors consolidation are key drivers

•

But still room for significant growth ….only 0.9% of Brazilian GDP and pension funds still entering the market

deals by

Financial Investors in 2014 Source: PwC analysis

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Mergers and Acquisitions in Brazil - 2014

• Historically, US outbound deals in Latin America represented approximately 11% of the total announced deals, of which over 40% involved Brazil • Brazilian total transaction value rose 16% to $84.2 billion last year, representing 44% of all Latin America transactions (Bloomberg) • Private equity transactions in Brazil nearly doubled to $14.1 billion (Bloomberg) - Important role of local private equity firms and investment banks in M&A transactions • IPO market remains weak and less active than in 2014 • Most transactions are cash transactions with deferred payments to align interests of local management (retention plans, earn-out provisions)

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Brazil - Key Pitfalls

•

Brazilian anti-corruption law effective in 2014

•

Tax system is highly regulated and complex resulting in significant tax issues arising in M&A transactions

•

Extensive social security laws and labor regulations govern employeremployee relations

•

Post-closing and risks of successor liability

•

Heavy Government involvement in many sectors of the Brazilian economy Tax and Labor contingencies

Regulatory approvals

Main Risks

*Environmental contingencies

•

Corruption and Compliance

Timing for approvals and disclosure of the transaction - Pre-merger review by CADE regarding antitrust - Additional regulatory approvals apply to a number of industries and sectors 6

Brazil – Outlook for 2015

•

Weaker local currency makes Brazil cheaper and more appealing for overseas acquirers

•

Multiples and assets prices are down: “buy low, sell high” investment decision

•

Adverse financial impacts on Brazilian groups triggering: - More focus on compliance and anti-corruption policies - Potential corporate restructurings and spin-offs - Increase in asset-sale transactions

•

Increase in M&A involving financially distressed companies

•

Hot sectors for investments are agribusiness, retail, consumer goods and services, education, healthcare, infrastructure (e.g. telecom, logistics/transportation, oil and gas)

7

Brazil – Outlook for 2015

• Consolidation of certain industries (i.e. telecom industry): Likely consolidation involving carriers Oi, Telefonica, Claro and TIM in 2015 •

Long-term financing alternatives are limited and remain an issue

• Ongoing concessions program in airport, railway, waterway, and ports will provide further opportunities for foreign investors, as well as Brazilian players and JVs with foreign and domestic partners

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Brazil legislative update & planning opportunities Agenda Key aspects of Brazilian tax system Brazil legislative update Selected planning opportunities

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Key aspects of Brazilian tax system

The most complex system

• Most complex system according to World Bank/PwC* • Over 250 thousand new rules since Constitution (1988) • Over 700 legislative changes from Jan. to Sept. 14

Tax litigation is part of companies´ lives

• New rules are often considered illegal or unconstitutional, which triggers endless disputes • Settlements are not allowed by tax law

Complexity + high burden = large liabilities

• Advanced control mechanisms • High penalties • Industry required to pay taxes on behalf of customers

High impact on competition

• Tax evasion and unilateral tax incentives highly interfere in companies´ competitiveness • Taxes heavily influence key business decisions

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Privileged and Confidential

Key aspects of Brazilian tax system

•

•

Headline tax rate: 34% -

25% income tax

-

9% social contribution tax

Income tax mechanisms: -

General income tax: gross income less applicable deductions.

-

Presumed profits method: statutorily-provided profit margin percentages (see example below).

•

Deductibility standards/restrictions: -

Ordinary and necessary deductions.

-

Royalties limited to 1% (trademarks) or 5% (technical assistance / other types of IP) of sales, irrespective of arm’s length amount.

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Key aspects of Brazilian tax system

•

Thin capitalization rules: 2-to-1 debt/equity ratio (with potential treaty relief in certain cases).

•

Income tax withholding on cross-border payments: -

15% for most payment types.

-

25% for payments to blacklisted tax havens.

•

Tax haven rules: Blacklist vs. gray list.

•

Significant indirect taxes on cross-border royalty / technical assistance payments: -

PIS/COFINS:9.25%

-

CIDE:

10%

-

ISS:

2-5% (varies by municipality)

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Brazil legislative and regulatory update

Recent developments – Overview •

Beginning in 2008, the Brazilian accounting rules changed with the goal of aligning Brazilian GAAP with IFRS.

•

The so-called “Transitory Tax Regime” (“RTT”) was introduced to guarantee tax neutrality in view of the new Brazilian GAAP rules.

•

Brazilian taxpayers and tax authorities were uncertain regarding the tax consequences of the new accounting environment.

•

In 2013, a Normative Instruction (“IN") was published by the Brazilian tax authorities to regulate the RTT. -

The IN provided for two different sets of books: one for accounting and another for tax purposes.

-

In addition, the IN provided rules regarding the tax treatment of differences arising from Brazilian tax and GAAP rules. 13

Brazil legislative and regulatory update

Recent developments – Overview (cont’d) -

Legal basis of the IN is questionable (note the potential impact on interest on net equity and dividend payments).

•

Provisional Measure (PM) 627/2013 and Law 12,973 -

Primary purpose was to revoke the RTT and regulate the tax implications arising in connection with the new Brazilian GAAP rules.

-

Intended to provide more certainty to taxpayers and tax administration.

-

General rule: PM is effective as from January 1, 2015.

-

Election: taxpayer may elect to adopt the new rules retroactively as from January 1, 2014.

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Brazil legislative and regulatory update

Goodwill amortization – Prior to Law 12,973 •

For Brazilian income tax purposes, goodwill was determined based on the positive difference between purchase price and the net book value of the company being acquired. -

Economic justification: (i) fair market value of Target’s assets higher then book value; (ii) future profitability; (iii) intangibles, going concern, other economic reasons.

•

Requirements for tax amortization: (i) both upstream and downstream mergers between Buyer and Target; and (ii) appraisal report. Amortization over a minimum of five years.

•

Tax controversy -

Eagerness of the tax authorities to challenge transactions involving related parties; exchange of shares and “vehicle companies.” 15

Brazil legislative and regulatory update

Goodwill amortization – Law 12,973 considerations •

Goodwill must follow accounting standards; that is, purchase price allocation (PPA).

•

Specific allocation order: -

First to the net fair market value of Target’s assets and liabilities (including intangibles).

-

Goodwill is defined as any residual amount not allocated to Target’s assets and liabilities, including identified IP.

•

Requirements for tax amortization: (i) both upstream and downstream mergers between Buyer and Target; (ii) appraisal report; and (iii) transaction be carried out among unrelated parties. Amortization over a minimum fiveyear period.

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Brazil legislative and regulatory update

Goodwill amortization – Law 12,973 considerations •

Goodwill must be supported by a PPA appraisal report prepared by an independent expert. The appraisal report must be filed with Brazilian tax authorities. -

As to acquisitions taking place on or before December 31 , 2014, merger must be completed by December 31, 2017 for goodwill to be subject to the rules applicable prior to the new law.

-

Negative goodwill: taxable over a minimum of five years at 1/60 per month.

•

Will the new legislation impact current litigation with the Brazilian IRS?

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Brazil legislative and regulatory update

•

Since 2006 Brazil has consistently finished last out of the 183 countries surveyed in relation to time spent on tax compliance.

Time spent to comply with tax obligations (in hours per year)

63

Switzerland

218

Germany

291

Chile Argentina

405

Bolivia

1025

Brazil 2600

0

1000

2000

3000

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Brazil legislative and regulatory update

Electronic filing reports and accounting records Public System for Digital Bookkeeping (“SPED”) SPED environment – in place since 2009

Digital Accounting Books (ECD) • Balance sheets • Ledger

New Legislation • sub-accounts

Digital Tax Books (EFD)

Cost of compliance

To ensure tax neutrality or allow deferral

• Tax books • Electronic invoices New Legislation • CIT electronic book (ECF) – Due 2015 • e-Social – Due April 2016 Online gathering of labor, social security and tax information related to the contracting of manpower (employees and contractors)

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Brazil legislative and regulatory update

CFC rules – Summary of primary changes •

New concepts and rules for CFC (controlled foreign companies) purposes were introduced by the new legislation.

Main aspects

Current rules

New Legislation

Triggering event •

Taxed in Brazil when profits are earned abroad regardless of distribution.

• Subsidiaries and branches: when profits are earned abroad regardless of distribution(*). • Affiliates: upon distribution.

Accounting losses

•

Controlled in foreign currency.

•

Consolidation

•

All investments • abroad consolidated in • the first tier.

To be controlled in Brazilian Reais. Consolidation no longer allowed (exception made until 2022 for consolidation in Brazil if some requirements are observed).

(*) Incentive was granted to some industries allowing an exemption of CFC profits

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Brazil legislative and regulatory update

2015 Tax increases • • •

IOF – loans – individuals PIS/COFINS and CIDE gas PIS/COFINS – import of goods (from 9.25% to 11.75%) in general

Medium and long term: most likely vehicles for tax burden increases • • •

PIS/COFINS on services Contractors organized as legal entities Dividends

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Brazil planning opportunities

Brazil IP common structure

US

Principal

Brazil OpCo 1 License agreement

Structure • Swiss Principal license economic use to Brazil Licensing of technology and other IP income tax withholding: • WHT 15% general domestic law rate. (25% for payments to tax havens) - PIS/COFINS: 9.25% combined rate (debatable). - CIDE: 10% - ISS: 2 to 5% (debatable) - IOF: 0.38% Deductibility limitations: • Fixed percentage s of net revenue (1% to 5%). • Not subject to transfer pricing regulations. • Subject to registration with the National Institute of Industrial Property (INPI) and Brazilian Central Bank (BACEN).

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Brazil planning opportunities

Brazil IP alternative structure

US

3

2 Principal

Sale US LLC IP Holder

Brazil OpCo 4 Merge

1

Steps • Swiss Principal forms US LLC or transfers to existing US LLC. • To use the Brazil market IP, Swiss Principal enters into an agreement with US LLC. Pursuant to the agreement, US LLC pays Swiss Principal for the use of the Brazil market IP based on the value of the IP rights attributed to Brazil. • Swiss Principal sells US LLC to Brazil OpCo. • US LLC merges upstream into Brazil OpCo. • Swiss Principal license economic use to Brazil

US LLC IP Holder

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Brazil planning opportunities

Center-led model – Manufacturing for local market sales Brazil

Parent

Overseas Brazil service fee Local manufacturers/ Distributors Purchase of inputs, raw materials, and/or finished products

Brazilian hub

Sale of manufactured goods Local customers

General considerations • Brazilian hub responsible for strategic decision-making or provides services (e.g., management, engineering or R&D services). • Substance in Brazilian hub required. • In-country tax rate differential: Full amount of service fee expense deductible for local manufacturer at 34% tax rate. • WHT-free repatriation of Brazilian hub’s after-tax income to its foreign parent. Key tax considerations • Brazilian hub adopts Presumed Profits Method (“PPM”) for calculating corporate income tax resulting an effective income tax of approximately 11%. Annual gross revenues earned in previous taxable year must not exceed R$78m (approx. US$31m)

Suppliers

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Dragagem - RDC – Lei n. 12.462/2011 Cenário Atual - Principais problemas enfrentados

BACCF – Brazilian-American Chamber of Commerce of Florida

RDC PARA DRAGAGEM  Procedimentos licitatórios e contratações conduzidas, regra geral, pela Secretaria Especial de Portos – SEP.

Thank you!!!

 Modalidade: Contratação Integrada.  Critério de Julgamento Técnica (30%) e Preço (70%).  Remuneração por desempenho (i.e. antecipação da entrega da obra?). José Augusto Figueira: [email protected] Mona Clayton:  Transição do regime “Lei [email protected] n. 8666/93” - mudança de cultura. Wade Angus: [email protected] Bruno Xavier: [email protected] CENÁRIO ATUAL – PRINCIPAIS PROBLEMAS ENFRENTADOS Rafael Vianello: [email protected]

 Exposição aos riscos inerentes a uma obra de dragagem (i.e. rochas, ambientais, paralisação).  Demora no procedimento de contratação de dragagem e início das obras (aproximadamente 8 meses).  Desequilíbrio concorrencial – profundidades diferentes nos diversos portos. Critério para a locação dos recursos da União? 25