Regional Reorganization: Be Aware of Tax Issues

Excerpt from Practical Latin American Tax Strategies
published by WorldTrade Executive, Inc.

By John A. Salerno and Julian R. Vasquez (PricewaterhouseCoopers LLP)

Multinationals considering the reorganization of their group legal entity or operational structures in Latin America need to be cognizant of the potential income tax implications related to the sale or transfer of shares or other equity interests in their affiliates.

While most companies are keenly aware of the tax implications relating to the sale of a direct or indirect subsidiary to a third party, many do not realize that an intra-group transfer of shares in connection with, for example, the formation of a regional holding company structure or post-deal integration planning, may also trigger tax in certain Latin American countries. Absent tax treaty protection the tax cost of the transfer of shares can be quite high.

In some cases the relevant taxable “transfer” is not so evident, and may occur, for example, as a result of the liquidation of a nonresident shareholder of a Latin American company.
Domestic law or tax treaty-based strategies often exist to minimize or eliminate the local country income tax burden on capital gains. Thus, particularly in the case of transactions with related parties, slight modifications of a transactional structure may, in certain cases, yield a more favorable tax result.

This article, which appears in full in the May 2008 Practical Latin American Tax Strategies summarizes the income tax treatment of the transfer of privately-held and publicly-traded shares in ten Latin American jurisdictions, and highlights some tax strategies. A portion of the article relating to Brazil follows:

Brazil

Private Companies

Gains recognized in connection with the sale or transfer of shares of a Brazilian privately-held company by one nonresident to another are generally subject to capital gains tax at a 15% rate. This rate is increased to 25% to the extent that the seller (or transferor) is located in a tax haven jurisdiction.

The gain is subject to Brazilian tax even when both seller/transferor and buyer/transferee are nonresidents of Brazil. Unlike Argentina, Brazilian law imposes the obligation to pay the Brazilian capital gains tax on the buyer's (or transferee's) representative domiciled in Brazil (note that foreign shareholders of Brazilian companies are required to have a Brazilian-domiciled representative, in addition to being registered before the local Revenue Service).

Capital gains generally correspond to the positive difference between (i) the amount for which the shares are sold/transferred (i.e., the selling price), and (ii) the amount at which those shares are registered in the name of the seller (transferor) with the Brazilian Central Bank. In the case of the sale/transfer of shares that were previously acquired from other parties, there may be grounds to sustain that the acquisition price should be used in lieu of the amount registered with the Brazilian Central Bank as foreign capital.

Tax treaties generally do not provide relief from income taxes imposed on capital gains recognized by nonresidents (except for the Brazil-Japan treaty, which exempts capital gains from Brazilian tax). Certain tax planning, however, may be available to mitigate taxes on capital gains.

Publicly-Traded Companies
Capital gains recognized by foreign investors in connection with the sale of Brazilian publicly-traded shares are subject to Brazilian tax at a 0% or 15% rate as follows:.

- 0% when the foreign investor is not located in a tax haven jurisdiction and the investment was originally made in accordance with Resolution 2689 (which provides for special foreign investment accounts that may only be used by the foreign investor in the acquisition of certain regulated investments, such as the shares of Brazilian companies listed with the Brazilian SEC).

- 15% in all other cases.

Other Taxes

No other Brazilian taxes should apply on the transfer of shares/interests in local entities.

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Mexico Enacts Important Commercial Litigation Reform

Excerpt from Latin American Law & Business Report
published by WorldTrade Executive, Inc.

By Oliver J. Armas, Luis Enrique Graham and Salvador Fonseca
(Chadbourne & Parke LLP)

A new system of "preventive" appeals, contained in the recently enacted reforms to the Mexican Code of Commerce, is designed to substantially reduce the complexities that currently tend to complicate commercial proceedings in Mexico.

The current system of appeals in commercial proceedings in Mexico is rather complicated. There are, for instance, intermediate and final appeals; the type of appeal depends on whether the challenge is directed against a resolution issued by the judge during the proceedings (intermediate appeal) or against the final resolution on the merits of the case (final appeal).

Currently, when filing an intermediate appeal, parties have to put forward all of their arguments and allegations before the court of appeals, even though there is the possibility that the issues discussed in the intermediate appeal will become moot once a resolution on the merits is rendered by the court of first instance. The reforms intend to remedy that.

The reforms, which will become effective July 16, 2008, primarily concern the appeals process. A new system of “preventive” appeals aims at substantially reducing the complexities that currently tend to complicate commercial proceedings in Mexico. The reforms also include new rules regarding documentary evidence and testimony from fact and expert witnesses; grant more time (15 instead of 9 business days) to file an answer, and harmonize default rules.

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Mexico's Dictamen Fiscal Is Similar to New Fin 48 in the US

Excerpt from Practical Mexican Tax Strategies
Published by WorldTrade Executive, Inc.

By Steve Axler & Dinorah Gonzalez
(Halliburton)

One of the concerns resulting from the introduction of FIN 48 for many in-house tax practitioners, especially for US based multinational companies, is that the US Internal Revenue Service would now essentially have a road map to various tax positions taken by the taxpayer. However, the disclosure of tax positions to the tax authorities is not a new or unusual event in Mexico. In fact, for large taxpayers in Mexico this is an annual occurrence. known in Spanish as the Dictamen Fiscal.

Often simply referred to just as “the Dictamen”, this a tax audit of a Mexican legal entity or person that carries out business activities or any foreign residents with a permanent establishment in Mexico. The Dictamen Fiscal can only be performed by a registered and certified Mexican public accountant. Upon completion of the Dictamen, the accountant will issue a report which will be filed with the Mexican tax authorities (Servicio Administración Tributaria or “SAT”) stating whether, according to the applicable tax regulations and audit standards, the taxpayer has complied with its obligations. The public accountant is required to sign the Dictamen under penalty of perjury.

It cannot be emphasized enough the influence that a Mexican statutory auditor has regarding the tax positions taken by a taxpayer in Mexico. A trap for a new or unsophisticated investor in Mexico is to execute a reorganization or to take an uncertain tax position without first discussing this with the auditor. In the best circumstances, if the taxpayer has not discussed the transaction with the auditor before the Dictamen review begins, much time, effort, expense and stress will be incurred in getting the auditor comfortable with the transaction given the limited time frame the auditor has to understand the transaction and complete the Dictamen.

In the very worst scenario, the auditor may not agree with a position taken by the taxpayer and may not be willing to sign the Dictamen or will give a negative opinion. The taxpayer is then faced with the decision to unwind the transaction, find another auditor, or in the worst situation face a tax audit from the SAT. Consequently, the taxpayer will be in the difficult position to explain why there is a negative opinion or no Dictamen at all.

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Brazil PE Fund Raising Continues Despite Global Crisis

From 4/30/08 Venture Equity Latin America
Published by WorldTrade Executive, Inc.

Brazilian private equity and venture capital fund raising has continued strong in 2008, despite the global impact prompted by the US subprime crisis. For the year, Brazilian fundraising is expected to surpass the $4 billion raised in 2007. The continued interest in Brazil is a result of a series of factors, including economic stability, low inflation, a consumer credit spending boom resulting from lower unemployment and higher income levels, particularly among lower income groups. In April alone, local and international funds raised over $1 billion. Standard & Poor’s recent decision to raise Brazil to investment grade will also have an impact on fund raising, because it will allow a broader range of investors to back Brazilian funds.

AIG Raises Nearly $700 Million for Brazil Investments
The highlight of April’s fund-raising activities was the final close of AIG Capital Partners’ Brazil Special Situations Fund II, L.P. (“BSSF II”). The fund received commitments of $691.9 million, surpassing its initial fundraising target.

AIG has a superb track record of investments in Brazil and has been a leader in IPO exits. In February of 2003, AIG invested $26 million to acquire a 17% share of Brazilian low-cost, low-fare airline Gol. AIG sold its share for $220.6 million in share offerings in 2004 and 2005. In July of 2003, the fund also invested $11.6 million in Intelsat, which it later sold to Brazilian long-distance company Embratel. The fund also owns a share of Brazilian supermarket chain Sendas, which was sold to leading supermarket chain Pão de Acuçar.

Vision, Moore to Close $300 Million
Brazil Real Estate Fund
Vision, a Sao Paulo-based asset management firm, together with New York-based and Moore Capital, will hold a first close on a $300 million real estate private equity fund which will invest exclusively in Brazil. A second close on the fund is expected to occur within the next few months, according to Ken Wainer, one of Vision’s founding partners and the head of its real estate investment division.

The fund will focus on three areas, including brown-field office development, which entails the construction of new Class A, Leeds green seal certified office buildings on sites previously used for industrial or residential purposes.Vision will also be acquiring existing office buildings, which will then be retrofitted to improve infrastructure and then rented or sold. The fund will also invest in Brazil’s expanding affordable housing sector.

FAMA Holds First Close on R$250 Million Fund
São Paulo-based investment firm FAMA held the first close on its first private equity fund, the FAMA Private Equity I FIP. The final fund raising target is R$400 million, with fund raising activities taking place both in Brazil and abroad. Credit Suisse Hedging-Griffo is involved in the fund raising process.

Fama, which is best known for private investments in public shares (PIPE) investments, decided to enter the private equity market in an effort to capitalize on its experience managing companies, according to André Burger, a partner at FAMA who joined the firm after over a decade ago at Rio Grande do Sul-based fund manager CRP.

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Mexico Energy Reform

Excerpt from WorldTrade Executive's
North American Free Trade & Investment Report
By Jorge Jiménez (López Velarde, Heftye y Soria)

On April 8 Mexico’s President Felipe Calderón submitted to the Mexican Senate a long-expected set of bills for the so-called “energy reform.” After testing the waters with the public and the media for several weeks with a campaign promoting strategic alliances for deepwater exploration and production, the Government decided for a rather moderate reform for the Mexican petroleum industry.

Instead of opting between a liberalization of the market and the strengthening of Pemex as a national oil company, the proposed reform seeks to obtain the best of both worlds: it opens up certain midstream and downstream activities to private investment, and provides Pemex with the flexibility and the tools to boost its infrastructure projects dealing with exploration and production. The reform leaves the Constitutional principles of ownership of the hydrocarbons and the prohibition of granting concessions and executing risk contracts untouched, with which it increases the spread of support along the ideological spectrum in Mexico. However, the reform also proposes to allow Pemex to enter into “performance-based” contracts, something that to this date has not been possible.

The reform contains these features:

• Contractual flexibility for Pemex to contract services outside of the currently burdensome and in many cases impractical framework of the government procurement laws.

• Adjusting Pemex to international corporate governance standards, by incorporating independent directors to its Board and providing the Board true management autonomy, as opposed to the status quo where Pemex plans are determined by the Ministry of Finance quasi-exclusively on the basis of short-term tax collection maximization and revenue production considerations.

• Liberalization of the transportation, distribution and storage of liquids and petrochemicals, subjecting such activities to the jurisdiction of the Energy Regulatory Commission.

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Venture Equity in Mexico 2007; Projections 2008

By Venture Equity Latin America
Published by WorldTrade Executive, Inc.

Venture Equity Latin America's Year End Report for 2007 shows $717M invested in Mexico via 17 acquisitions in 2007. Areas attracting large investments in Mexico in 2007 included the transportation, finance services, and production sectors, where investments focused on steel production and chemical and industrial manufacturing. Of note was the increase in larger investments in Mexico during the second half of 2007, which provided a strong end to the year and continued growth from the prior year's activity. Investments in Mexico increased considerably from 2006 levels, rising from $388 million to $717 million.

Of the 17 investment deals over the course of 2007, Advent International and Nexxus Capital accounted for much of the activity and Nexxus' deals were focused on consumer financing and healthcare. Advent made three diverse investments in Mexico, two of which were for undisclosed amounts but one was for $317 million for Grupo Gayosso, Mexico's largest funeral services company and this was the largest disclosed amount for a Mexican deal in 2007.

Over the course of 2007, it became apparent that interest in Mexican transportation was once again on the rise in private equity circles. The interest was been spurred in part by the fact that Mexico- often overshadowed by developments in Brazil - now enjoys a decent economic state and a growing middle class. Although, this has not dispelled concerns about the future of Mexico's markets and doubts do remain. "We need an evolution in the market and the country," said Gómez Pimienta, president of the Mexico Fund, a $1 billion closed-end mutual fund based in Washington. "The lack of IPOs is leaving us with a limited menu." Looking ahead to investment activity in Mexico for 2008, the effects of the 2008 Mexican tax reform could be pivotal as the new rules are in effect from January 1, 2008. This is one area that will need to be monitored as 2008 progresses to see if the new tax rules negatively impact the size and number of investments from foreign investors, mainly investors from Canada and the United States.

The biggest change ushered in by the new tax reform regulations is the introduction of a 'flat tax' and this tax could influence investments in Mexico as it could mean greater tax burdens for some investors, while increasing the required amount of paperwork and record keeping time that other investors must devote to each deal so that they are in line with the new requirements. It is also to be seen over the span of 2008 whether this new tax will deter potential investors abroad from making investments in Mexico due to the additional financial and regulatory burdens imposed by this tax. Given the state of the US economy at the end of 2007 and the weakness of the dollar overseas, it is not clear yet if this new flat tax might create additional unwanted strain on US companies looking to invest in Mexico.

Two of the largest investment sectors to be impacted by this new tax could be the real estate sector and the mining and natural resources sector as these are main areas of investment for Canadian and US investors and multinationals during business in Mexico. For more details on Venture Equity in 2007 in Latin America, see the VELA Year-End Report,

Venture Equity Latin America’s 2007 Year-End Report Announced

Fund raising and private equity investment in Latin America set new records in 2007, according to the just released Venture Equity Latin America’s 2007 Year-End Report.

Fundraising for the region reached a total of $4.4 billion in 2007, showing the ongoing confidence that investors have in the region. The report documents deals of $7.4 billion, and exits worth $5.4 billion.

In many sectors including fuel production, real estate and energy, private equity investments were on the rise, but it was the fuel production and distribution sector, which dominated and had the biggest investments, mainly due to the global demand for fuel.

One growing trend in the region has been investments in sugar and ethanol and also the construction of ethanol mills. Much of this activity was in Brazil as sugar-cane based ethanol production and related projects had investment totals of around $1.435 billion.

In total Brazil had private equity investments of $5.1 billion in 2007 as compared to $1.3 billion in 2006.

Areas attracting large investments in Mexico during the year included the transportation, finance services and productions sectors, where investments focused on steel production and chemical and industrial manufacturing. Investments in Mexico increased from $388 million in 2006 to $717 million in 2007.

By the end of 2007, there had been 29 fund closings with much of the fundraising activities centered in Brazil, Argentina, Colombia and Mexico.

The report details which fund managers have successfully raised new capital and provides details on deals and exits. More