Treasury & FX in Brazil

A lively and informative discussion – many thanks to all participants for their input.

There was a clear consensus: Brazil is a country which works, and where most treasury problems can be managed, but it has many rules which are very complex, are difficult to understand, and keep changing. Participants expressed frustration with the amount of effort and uncertainty involved. This included a Brazilian national on the call…..

The bottom line: most treasury actions in Brazil involve making a trade-off: you can rarely find a solution which has no downside. Often, the main downside is additional admin and bureaucracy: this in known within the country as “Costo Brasil”.

FX transactions:

• All onshore FX transactions require substantial amounts of documentation to be transmitted to the bank. This makes it very difficult to do competitive bidding – you cannot be sure the documentation process will run smoothly with a bank other than your main cash management bank. But this means the main bank has no incentive to offer competitive rates.
• Spot FX for goods imports can be handled directly. FX for financial transactions has to be handled through a broker – this adds cost.

Currency hedging:

• Onshore hedging involves paying a financial transaction tax of up to 2%. Hedging offshore is possible, using NDFs. These escape the tax – but they can create accounting problems, and they do not protect the I&E or the cash position of the local entity.
• It can be expensive. Interest rates are currently low, but when they are high, hedging is often viewed as being too expensive. It is not unusual for companies to practice balance sheet hedging but not cash flow hedging.
• Given the historical volatility, long term currency hedges are difficult to obtain and tend to be expensive.
• Brazilian legislation requires all domestic transactions to be settled in the local currency. It is not unusual for sellers to protect themselves by indexing the BRL settlement amount to the exchange rate on the date of payment – this contractual arrangement satisfies the requirements for hedge accounting (though the hedges are usually offshore). One participant could not apply hedge accounting, as the BRL amount was fixed on the date of invoicing.
• One participant had found that the company’s banking covenants excluded unrealised hedging gains and losses from EBIDTA. This is not a Brazil specific issue, but it is something treasurers should beware of. In any case, it is not unusual for the gains or losses on hedges to appear in different lines of the I&E to the underlying revaluations – this always causes confusion.
• Dividends can be paid, and they do not attract withholding tax. But there must be sufficient retained earnings, and the penalties for excessive distribution are significant.
• Funding via intercompany loans is possible, but the loans must be registered with the central bank. Some participants have solved the currency hedging issue by denominating the intercompany loans in BRL – this means they can be hedged in the offshore market.
• The interest rate on intercompany loans can be freely negotiated, but it is subject to withholding tax and tax transfer pricing rules. Generally, these limit the tax deductibility to a margin of 3% to 5% above the central bank rate. This is evaluated retroactively, which can make it difficult to manage.
• Intercompany loans are further limited by thin cap rules: a maximum debt:equity ratio of 2:1, which is reduced to 0.3:1 if the lending entity is in a tax haven.
• Cash can also be repatriated by paying interest on the net equity invested in the local subsidiary – but this is subject to withholding tax, and is limited to distributable retained earnings.
• Withholding tax is 15%, but this is increased to 25% for tax havens. As is usual in Brazil, the list of tax havens changes regularly, but it does include, or has included, several popular locations for treasury centres, including Ireland, Hong Kong and Singapore.

This list is not exhaustive – no list for regulations in Brazil ever can be. And this is one of the frustrations: participants often believe they have understood all the rules, and then discover a new one. This is simply a cost of doing business in the country – it is important to spend time with the tax team to understand what is going on.

It is also important to understand and accept this cost of doing business: too many MNCs baulk at the high cost of compliance in Brazil compared to other countries and try to manage with a reduced staff. This can be a false economy. Above all, it is essential to have good local advisors.