Brazil circles the wagons around local economy, extends IOF tax on foreign loans out to five-year maturities.
Brazil’s extension last week of the 6 percent financial operations tax (IOF) on foreign loans and bonds, from those maturing within three years to all maturing within five years not only was an attempt to weaken the country’s currency but also an attempt to protect the local industrial economy as a whole.
“The industrial sector has seen stunted growth,” said a banker in São Paulo of the financial operations tax or IOF extension. “The labor market is suffering, there is bad infrastructure and high energy costs. So [Brazil] has figured out one way to protect industry is by using the exchange rate.”
After first increasing the tenor on foreign loans that are not subject to the 6 percent IOF tax from two to three years on March 1, 2012, Brazil decided again to increase the tenor on March 12 to five years. It is hoped that a more punitive extension will temper the inflow of speculative “hot money” and keep the BRL competitive (in the 1.70-1.85 range according to some market watchers). “The IOF has been the most important tool to protect [Brazil] from the inflows,” the banker said.
This means that foreign loans into Brazil – including the most common form of corporate funding of local subsidiaries, intercompany loans – will need to be five years or longer in tenor or subject to the 6 percent IOF tax on the notional amount.
Coupled with the thin-cap rules and the 15 percent withholding tax on interest payments to the parent, intercompany funding thus looks less attractive. At the same time, withholding tax on dividends has been reduced to zero (as of Jan. 2011), making equity investments relatively more attractive.
The IOF remains a constant irritant for companies operating in Brazil and this latest move just exacerbates the existing challenges, i.e., in the areas of efficient use of cash, funding mechanisms and risk mitigation, including FX hedging.