Companies rush to complete M&A deals in Brazil ahead of uncertainty about tax break after 2009

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Companies are rushing to conclude M&A deals in Brazil this year, while a tax break which allows companies to deduct 34% of the premium paid in an acquisition is still guaranteed, specialized lawyers told mergermarket.

Along with the recent devaluation of the Brazilian real, which made acquisitions cheaper for foreign bidders, tax deductions are currently one of the great attractions for acquisition deals in Brazil, said Paulo Sigaud, partner at law firm Felsberg & Associados.

This sort of tax incentive exists only in a few countries, and the Brazilian regulation attracts great interest from investors in international forums, said Marcio Calvet Neves, M&A specialist at Veirano Advogados.

Created in 1997 by former president Fernando Henrique Cardoso to help attract bidders for the Brazilian privatization program through law 9,532, the tax break on acquisition premiums has apparently been regarded by the federal tax authority, Secretaria da Receita Federal (SRF), as fertile ground for overly creative tax planning, said the lawyers.

In recent years, SRF has improved its oversight of the economic fundamentals presented by companies for the premiums paid in acquisitions, the lawyers explained. “The number of SRF notifications in deals tripled in 2008 compared to 2007,” said Neves. In fact, some ownership restructurings and acquisitions proved to be motivated only by the tax benefits they would generate, said the lawyers. “But many premiums were defensible, and companies have found an adequate forum to discuss such notifications at the Ministry of Finance´s Taxpayers´ Council, which is analyzing case by case,” said Neves.

Given SRF´s perceived resistance to the benefit, its future is recurrently believed to be uncertain, said the lawyers. In late 2007, many expected law 11.638, which adapted Brazilian accounting standards to International Financial Reporting Standards (IFRS), would change the rules for the calculation of the premium and its taxation, possibly extinguishing the tax benefit after 2008, they explained.

The doubts were clarified in December 2008, when Provisory Measure (MP) 449 created the transitory tax regime, Regime Tributario de Transicao (RTT), said Neves. Interpreted by an observer as a possible safeguard for government-owned bank Banco do Brasil´s acquisition of Nossa Caixa bank, the provisory measure affirmed that new accounting rules are neutral in terms of taxation up to the end of this year. Though it has not yet been voted into law, this aspect of the regulation is expected to be maintained, said Neves.

In fact, MP 449 states RTT will be in force until a new law disciplines the tax-related effects of the new accounting criteria, said Neves. Part of the market believes tax authorities tend to create these regulations, possibly extinguishing the benefit in 2010, once liquidity conditions have improved, the lawyers said.

SRF said through a spokesperson it cannot anticipate decisions about matters that are still to be discussed concerning the revision of tax regulations derived from the new legislation for public companies. “Up to now, oversight measures have been sufficient to mitigate companies´ tax planning,” said the spokesperson in response to an inquiry from this news service. “The current situation of international financial crisis, which may demand strengthening of companies, discourages any abrupt legislative changes,” the spokesperson added.

In the face of uncertainty, many clients are rushing to conclude pending deals and start their income tax deductions in 2009, said both lawyers. Though deductions have to be gradual, over a period of at least five years, deals concluded this year, while the RTT is in force, should be able to take full benefit of the tax break, said Sigaud. Though the termination of the benefit is a possibility, SRF could also continue to be satisfied with stricter oversight, said Neves.

For now, the tax benefit seems to be helping Brazil maintain its strong M&A activity despite the global slump, said Sigaud, who expects M&A volumes to possibly fall by more than half if the tax break is extinguished.

In the last six months, 70 deals worth USD 29bn were completed in Brazil with an additional 39 completed without disclosing valuations, according to Mergermarket´s deal database. The results compare to 97 deals worth USD 19.5bn during the same period one year ago, an increase of 49% by value.

During the same periods in the US, the value of completed deals fell 39% to USD 509.7bn. In other BRIC countries, completed M&A value fell 15% in India to USD 12.8bn, increased 11% in China to USD 49bn, and collapsed 72% to USD 16bn in Russia.

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