- 1.What are the most common types of private equity transactions in your jurisdiction?
Currently, the main private equity transactions in the Brazilian market involve the acquisition by private equity funds of common or preferred shares in closely held companies, made either as cash-out or cash-in transactions, or a combination of both. Investments in expansion stage companies are more common than early stage financing.
Despite the predominance of investments in private companies, private investments in public equity ‘PIPE’ are becoming more common. Transactions involving leverage raise, such as leveraged buyout (LBO) and bridge loans, are not typical. This appears to be by virtue, on one hand, of the absence of a leverage and indebtedness culture, and, on the other hand, of the high interest rates charged by commercial banks. Nevertheless, LBO transactions are becoming more frequent, especially for private equity funds with access to international credit.
- 2.What types of investors are most active in the private equity market of your jurisdiction?
Pension Funds remains the most active type of investor, representing 22 per cent of the total committed capital existing in the country. The reasons for this predominance are the huge amount of capital they hold, in addition to the viability of applying part of this capital in long-term investments. The National Monetary Council Resolution that addresses the investments of the pension funds allows them to apply the maximum of 20 per cent of their capital in PE/VC structured funds. There is also a tax-related benefit established by Law No. 11312/06, which enables the payment of the tax rate levied on the investors’ capital gains only at the time of the amortisation of quotas or upon liquidation of such funds.
Notwithstanding that, the diversification of the investor’s base is increasing. For instance, parent organisations represent 16 per cent of the total committed capital; GPs 11 per cent; banks 10 per cent; family offices 9 per cent; investment funds 7 per cent; trusts and endowments 7 per cent; and fund of funds 6 per cent.
Investors are highly concentrated in Brazil, the US and Europe. Brazilian investors represents 60.5 per cent of the total committed capital, while the US investors represents approximately 25.6 per cent and EU investors account for 8.8 per cent. (Data obtained from FGVcepe - Overview of the Brazilian PE/VC industry - April 2010).
- 3.What historically have been the main target industries and what trends were noticeable throughout 2010? What trends do you expect to see in the next 18 months?
The PE/VC industry in Brazil operates in a broad range of sectors of the economy. Nevertheless, IT and electronics are historically the leading sector when it comes to the perception of PE/VC investments.
In 2010, PE/VC investments in Brazil were distributed as follows: 19.5 per cent on the IT and electronics industries; 9.7 per cent on energy and oil; 9.4 per cent on civil construction; 6.1 per cent on communications; 5.1 per cent on retail; 4.5 per cent on agribusiness; 3.8 per cent on food and beverages; 3.8 per cent on transportation and logistics services; 3.6 per cent on the pharmaceuticals, medical and aesthetics industries; 3.2 per cent on financial services; 2.7 per cent on the biotechnology and infrastructure industries; 2.3 per cent on education; 2 per cent on entertainment and tourism; 1.6 per cent on real estate; 1.3 per cent on metallurgy, mechanic and electric material industries; 1.1 per cent on extractive industries and 0.5 per cent on chemical industries. The other 13.5 per cent of the investments were performed on other industries and services or on unidentified sectors.
The future scenario for the Brazilian economy (which includes the forthcoming FIFA World Cup in 2014, the Olympic Games in 2016 and the recent discovery of several petroleum reserves) generates the expectation of a significant increase in investments on the energy, oil and gas, transportation and logistics services, infrastructure, entertainment and tourism, metallurgy, mechanic and electric material industries. (Data obtained from FGVcepe - Overview of the Brazilian PE/VC industry - April 2010).
- 4.Please describe the main features, size and activity levels of local private equity funds. Are there any regulatory or market restrictions or incentives to the development of such funds? Have any begun to participate significantly in transactions out of their local jurisdiction?
Private equity funds in Brazil are usually structured as Fund for Investment in Equity Participation (FIP) and as Fund for Investment in Emerging Companies (FMIEE). FIPs are commonly used to perform investments in expansion stage companies while FMIEEs are often used for early stage financing. This difference is mostly given to the fact that the regulation on FMIEEs establishes a limitation on the size of the target company, restricting the investment only to companies that fit the following criteria:
- an annual net revenue equal or inferior to 150 million reais:
- not controlled by a group with a consolidated net worth over 300 million reais.
The funds size varies accordingly to its purpose and the manager’s reputation. The Brazilian Securities Commission (CVM), which is responsible for regulating the PE/VC funds, does not establish a parameters for the fund’s size, although funds with committed capital of less than 10 million reais are unusual. It shall be highlighted that the minimum capital for a fund to operate must be set forth in its own statute, as well as the timeline for the subscription and payment of its quotas.
The managers of the PE/VC funds are, in their great majority, independent (79 per cent) and non-public companies. The runner-ups are organisations linked to financial institutions (12 per cent) and, to a lesser extent, those linked to the government (2 per cent) and to industrial groups (4 per cent).
The maturation of private equity investments is bringing increasing sophistication to the private equity funds. Group deals are becoming more popular, including deals between foreign and Brazilian private equity funds.
- 5.Are there any private equity funds listed in your jurisdiction? Are there any special regulations or requirements applicable to the listing and public offering of securities by such funds or any reform initiatives that are under discussion?
ICVM No. 400 (29 December 2003) regulates the procedures for public offering of securities. The requirements for public distribution of quotas of the PE/VC funds are in no way different from those concerning companies’ shares, also applying the requirements of hiring an intermediating financial institution and preparing an offering memorandum. However, under the terms of ICVM No. 476 (16 January 2003), the public offerings of quotas of closed-end investment funds distributed with restricted efforts have a more simplified distribution procedure. The restricted efforts distribution is the one directed for a maximum of 50 qualified investors, being only a maximum of 20 investors allowed to acquire the securities, and the minimum amount to be subscribed by each investor is of 1 million reais.
On February 2011, CVM has placed for discussion a draft of an instruction that addresses the rules for trading quotas of closed-end investment funds. The main goal is to clarify that the quotas can only be negotiated on regulated markets:
- when distributed through public offering;
- when distributed through the restricted efforts distribution proceeding;
- when already listed on regulated markets; or if they are previously submitted for registration for negotiation, with the preparation of a prospectus.
- 6.What are the main issues in connection with the liability of fund managers?
The PE/VC funds are commonly structured according to ICVMs No. 391 and No. 209. These instructions establish a series of responsibilities for the managers, which are basically derived from the fault or negligence in managing the fund (prudent investor standards). The rules concerning the liability of fund managers have not yet been subject matter of analysis by Brazilian courts and there is no development or manifestation in the sense of applying parameters such as the ex-ante versus ex-post analysis or the business judgment rule.
- 7.What are the main remuneration schemes for fund managers and have there been any recent shifts observable in the market? Are there any limitations or reforms under discussion regarding the same?
The managing institution charges a management fee on a yearly basis, which varies from 1 to 3 per cent of the committed capital, or of the equity held by the fund (fixed fee). There is also a performance fee (success fee), which is variable and is calculated on a pre-established percentage (normally 20 per cent) over the obtained earnings basis. The regulations that are applicable to PE/VC do not impose any limitation for the establishment of the management and performance fees usually charged by the managers.
- 8.Please describe any legal considerations of particular importance in your jurisdiction in connection with executing leveraged buyouts and similar strategies.
Leveraged acquisitions are seldom used in Brazil due to the high interest rates for securing financing.
- 9.What are the main organisational forms used in your jurisdiction to channel private equity investments? Has there been any change over time in the types of organisational forms used? What are the main formation requirements?
PE and VC investments are conducted by means of a number of legal structures, among which, in Brazil, there is predominance of vehicles based on the regulation issued by the CVM. Among these, in first place we find the Fund for Investment in Equity Participation (FIP), which is regulated by ICVM No. 391. In second place, we find the Fund for Investment in Emerging Companies (FMIEE), regulated by ICVM No. 209. The taxes levied on gains earned by the funds that are regulated by CVM are usually less burdensome than those that are applicable to other investment structures, such as equity-holding partnerships or investment-holding companies. This mostly explains the predominance of these funds. However, there is no limitation for investments in PE and VC to be conducted through other structures, such as holdings companies, direct investment and corporate venture. The limited partnerships, a structure that is usually used in the US for investment in PE and VC, are not generally accepted in Brazil. However, many foreign vehicles that adopt this structure in their countries of origin conduct investments in PE and VC in Brazil. The following forms are the most usually used (by volume of committed capital):
- funds created under the CVM regulation: 39 per cent;
- limited partnership: 34 per cent;
- corporate venture: 1 per cent;
- holding company: 2 per cent;
- direct investment: 17 per cent; and
- others: 7 per cent.
In order to form a FIP or a FMIEE, the asset manager must register the statute of the investment fund with a public notary and register the placement of its quotas with the CVM. It is required that the CVM also authorise the fund’s operation, which is commonly done automatically when the basic documents of the investment fund are filed with the CVM by the asset manager.
The CVM’s authorisation for the public offering of the quotas is the only procedure that may take longer, usually within 30 to 60 days as from the filing of the documents requested as per CVM regulations.
- 10.What are the most important legal issues arising in the operation and governance of local companies in your jurisdiction?
Brazilian corporations must have executive officers who are resident in Brazil, must publish their financial statements annually and any amendments to the by-laws are contingent upon prior resolution in a shareholders’ meeting, with certain calling notice requirements if the totality of the shareholders are not present or of a specific quorum for certain matters, or both. The shareholders may be represented by attorneys-in-fact who have been appointed for less than one year, who must be either other shareholders of the company or attorneys in law, whereby for a publicly held company a financial institution may also be the attorney-in-fact. For public-held companies there is also a requirement of providing periodic information to the CVM, as defined in ICVM No. 480. Publicly held companies must necessarily have a board of directors, while closely held corporations may have it or not.
Further, private companies receiving FIP investments shall comply with the following corporate governance rules:
- prohibition to issue and trade ‘profit participation shares’;
- one year mandate for all members of the Board of Directors;
- disclosure of all contracts executed with related parties, shareholders agreements and share/securities option programs;
- election of an arbitral institution for resolving corporate conflicts;
- adherence to the Stock Exchange’s special levels of corporate governance in the event of an IPO; and
- annually audit of its financial statements.
- 11.Are there any issues to be considered in connection with the limitation of liability under the laws of your jurisdiction?
In corporations, the liability is limited to the issuance value of the shares subscribed or acquired by the shareholders. However, there are cases which may cause the disregard of the corporate veil, in a way to make the shareholders liable with all of their personal equity. In Brazilian legislation, disregard of the corporate veil is mainly supported by article 50 of the Brazilian Civil Code and by article 28 of the Consumer Protection Code, and is usually applied by the courts in classic cases of abuse of the corporate veil (characterised by confusion of patrimony or deviation of purpose), right abuse, fraud practice and practice of illegal acts or violation of the by-laws or articles of association. So far, for the PE/VC funds, due to the non-existence of leading cases, there is some uncertainty as to the liability of the quotaholders, given the legal omission concerning the limits of the liability of such funds for problems and debts contracted by the companies that make up their portfolio.
- 12.What are the most common minority protection rights, whether granted by operation of law or contractual agreement ? Are there any special issues to be considered under the laws of your jurisdiction?
One can say that the most common right for protection of minority shareholders is the tag-along provision. The Corporations Law (Law No. 6404/76) provides, in its article 254-A, that the sale of control of a publicly held company is contingent upon the conduction, by the acquirer, of a public offering of acquisition of shares with voting rights owned by the minority shareholders. Our legislation also assures, in the tag along provision, the right for the minority shareholders of receiving a price equivalent to at least 80 per cent of the amount paid per share included in the controlling block. Another relevant protection for the minorities in the Brazilian legal environment is the pre-emptive right, also provided by the Corporations Law. The pre-emptive right consists in an essential right that enables the shareholder to maintain the same percentage of participation in the company’s capital stock in an event of a capital raise. Hence, the shareholders have a pre-emptive right for the subscription of the new issued shares, so they can assure to hold the same percentage of participation held prior to the capital increase. In addition to these legally assured rights, the parties may establish contractually other rights for the minority shareholders, being common in shareholders agreements executed for PE/VC investments to use protective rights, such as right of first refusal in the sales of shares, tag-along, drag along, pre-emptive rights, right to appoint members of management, veto powers, anti-dilution provisions, exit rights and dispute resolution mechanisms. All these rights are enforceable not only by the Brazilian courts, but also by the companies, who have the legal prerogative of refusing the registration of transactions in the corporate books if they are not accomplished according to the shareholders agreement duly filed with the company.
- 13.What are the main exit strategies used by private equity investors in your jurisdiction? Are there any limitations to the enforceability of exit arrangements? Have you seen a shift away from or towards certain exit strategies over the past year?
The divestment alternatives are: initial public offering (IPO), trade sale, buyback, sale to another investor (secondary sale) and liquidation (write-off). In Brazil, from January 2005 to June 2008 (pre-crisis), the exits by means of sale in the stock market, encompassing public offerings of shares and secondary transactions, represented 54 per cent of the total divestments conducted. This preponderance can be explained by the scenario of economic stability experienced by the country in the mentioned period, coupled with the reduction of interest rates, factors that led Brazil to be highlighted as an alternative for long-term investments. The trade sales were the means used for 22 per cent of the divestment transactions, followed closely by buybacks, which were the alternative chosen for 19 per cent of the total exits. Write-offs represented only 5 per cent of the cases.
Obviously, the global financial crisis changed this scenario. In despite of the effects of the crisis not having been as serious in Brazil as they were in other countries, the market conditions caused going-public transactions to become rare, which can lead to an increase of divestments by means of trade sales. According to the KPMG’s survey (September 2009), in 2008 and 2009 only nine companies went public.
- 14.What are the key legal issues to be considered when appointing or replacing directors and officers?
Directors and officers are subject to the same rules of liability in Brazil. Both must conduct their activities using a standard of care of the prudent man. The business judgment rule, although provided in legislation since 1976 (article 159, paragraph 6, Corporations Law), has not yet been applied by Brazilian courts. It is common to require that administrative officers deliver their shares as guarantee of their management and the use of D&O insurance is growing.
Executive officers must be domiciled in Brazil. Such rule is not applicable to the directors, although they must appoint a legal representative in Brazil to receive summons.
- 15.Please describe the most significant issues commonly considered under the laws of your jurisdiction in connection with purchase and shareholders’ agreements.
The Brazilian Corporations Law provides in its article 118 for the shareholders agreement. Its legal nature is of an agreement that is subject to the common rules of validity of any legal transaction and its subject matter is the exercise of the rights that derive from ownership of shares. There is a classification concerning the subject matter of the agreement, which is restricted to the covenants relative to the exercise of voting rights and the negotiability of the shares. The company does not have the obligation of observing any covenant that addresses themes that are not typified; however, the covenant may be valid between the parties. Obviously, the agreement cannot have as part of its subject matter any illegal act. The typified themes, namely the exercise of voting rights and the negotiability of the shares, are also those with most practical interest, which is why the Law of 1976 was oriented in this direction. The legality of an agreement that disciplines the exercise of voting rights is uncontested. However, one must stress that the figure of the voting trust does not exist in Brazil. The agreements cannot grant to other parties any voting rights, which is indispensable for the proper operation of a company; however, the agreements may mention how the vote will be exercised. The agreement will not be effective when its content goes against social interest, or when there is a conflict concerning the construal of the sense of a covenanted vote.
Concerning the purchase agreements, there are no special rules related to their validity besides the ones established for any other agreements.
- 16.Please describe the main issues related to dispute resolutions under purchase, shareholders’ and other principal private equity agreements. What are the most common dispute resolution mechanisms selected in these agreements?
Any divergences between the shareholders and the company, or between the controlling shareholders and the minority shareholders, as a general rule adopted by the PE/VC investments, are resolved by means of arbitration. The Brazilian Corporations Law provides for the use of arbitration as a form of solution of conflicts between shareholders, and the BOVESPA (São Paulo Stock Exchange) has created a specialised tribunal for solution of these divergences, the Market Arbitration Chamber (CAM), which is available for any interested party, shareholder, investor or company, even if concerning a closely held company.
- 17.What are the most common funding structures? Are there any significant issues commonly confronted in implementing such structures?
The most common form of funding in Brazil is still through capital increases, on account of the high interest rates charged for bank loans..
Hybrid options such as non convertible or convertible debentures have been used more often by PE/VC investors. Such hybrid options, however, may further represent a severe issue for the target company, since they tend to increase the company’s liabilities, lowering its net worth and also its liquidity indicators.
- 18.Is there a domestic financing market for private equity deals? Has there been a shift in the sources of funding over the past few years? Where do you expect to see financing come from in the next 18 months?
In June 2008, close to 57 per cent of the committed capital in PE and VC came from foreign investors. On the other hand, according to the data raised by Gvcepe - Private Equity and Venture Capital Research Center at Fundação Getúlio Vargas referring to 2009, approximately 50 per cent of the funds raised for the industry in that year came from domestic sources. As for domestic financiers, the pension funds play an important role, accounting for approximately 24 per cent of the comitted capital volume. The pension funds usually invest in PE/VC funds that are organised within the scope of CVM regulation, which partly explains the increase of the share of CVM regulated funds in the proportion of the total committed capital of the PE/VC industry.
Presently, we notice a trend towards diversification of the types of investors of the PE and VC funds, including governments and government-controlled companies, insurance companies, other investment funds, banks and family offices. Besides that, according to the local magazine Relações com Investidores, no. 142, April 2010, it is expected that the amount invested by pension funds and foreign investors in the Brazilian PE/VC industry triplicates until June/July 2011. This trend is confirmed by the announcement made by Advent International concerning the biggest fund ever created in order to invest in Latin America, which gathered 1.65 billion dollars, of which more than 50 per cent may be destined to Brazil. Also confirming such trend, Carlyle announced in July 19th 2010 its investment in Qualicorp, a health care industry related company, with a deal value of approximately U$1.2 billion. It is also important to highlight that ABVCAP announced that intends to establish an educational process towards the smaller Brazilian pension funds, in order try to maximise the number of these entities investing their money in the PE/VC industry.
- 19.What are the principal accounting considerations that arise in private equity transactions? Are there any contemplated or ongoing shifts in regulatory accounting standards in your jurisdiction?
Following the adaptation of the local accounting regulatory standards to the IFRS, new pronouncements have been and are being issued by our local accounting ruling body (Accounting Pronouncements Board - CPC).
- 20.Are there any disclosure, registration or licensing requirements affecting private equity funds investments currently in effect or under consideration by regulators?
Brazil does not have a consolidated legislation regarding PE/VC funds. As they are legally treated as a condominium, the only condition for forming a PE/VC fund is to register its statute with a Notary Public. However, PE/VC funds that offer their quotas to the public must comply with all the regulations set out by CVM. As CVM’s regulations are well known by the market and guarantee a certain level of legal certainty to the relations between investors and asset managers, most PE/VC funds are formed under the CVM’s rules and supervision, even when their quotas are only placed privately. In view of the above, it is safer to assume that, in all cases, PE/VC funds should be registered with the CVM and placements of their quotas should be treated as being publicly offered.
Thus, in order to form a PE/VC fund, the asset manager must register the statute of the investment fund with a Notary Public and register the placement of its quotas with the CVM. It is required that the CVM also authorize the PE/VC fund’s operation, which is commonly done automatically when the basic documents of the investment fund are filed with the CVM by the asset manager.
CVM’s authorization for the public offering of the quotas is the only procedure which may take longer time, usually within thirty to sixty days as from the filling of the documents requested as per CVM regulations.
The CVM also imposes, by means of the normative instructions that regulate the PE/VC funds, obligations of disclosure by the manager of certain data concerning the funds. For this purpose, the managers have the obligation of disclosing any relevant fact concerning the fund to the quotaholders and to the CVM. One must stress that secret information of the companies that make up the portfolio of the fund, obtained by the manager under a confidentiality commitment, or on account of the functions performed by the manager in the invested company, are not encompassed in the concept of relevant fact. There are also obligations of publication of the financial statements of the funds, which must be submitted to audit by independent auditors at the end of each fiscal year. In this context, the manager must send to the CVM and to the quotaholders: quarterly, the information on the fund’s net equity and the quotas issued; six-monthly, the composition of the portfolio, the financial statements, the fees charged to the fund and the list of institutions that are responsible for providing services of custody of the securities of the portfolio; yearly, the financial statements for the fiscal year, the equity value of the quota and the fees charged to the fund (ICVM No. 391, article 32; ICVM No. 209, article 34). Also, the manager must send simultaneously to the CVM, any information related to the fund disclosed to the quotaholders or third parties. In addition, within a period of eight days counting from the respective resolution in a general meeting, the following acts related to the fund must be notified to the CVM:
- change in the regulations;
- substitution of the manager;
- consolidation;
- merger;
- spin-off;
- liquidation; and
- distribution of new quotas.
The resolutions related to the matters listed above will only be effective after acknowledgement of the definitive minutes of the meeting by the CVM (ICVM No. 391).
- 21.Please describe any restrictions, requirements or protections applicable to foreign investors in connection with private equity investments.
As determined by Brazilian legislation (Law No. 11371), all foreign capital invested in a legal entity in the country is subject to registration with the Central Bank. The Federal Constitution of 1988 provides, in article 172, that the ordinary legislation must discipline, based on the national interests, the investments of foreign capital in the country. In this regard, some strategic industrial sectors, such as media, mining, gas, petroleum and aviation cannot be controlled by foreign capital. Besides that, there is no specific restriction to foreign investors in connection with private equity investments.
It is important to highlight that the Brazilian government expressly reestablished the tax rate applicable over the internalization of foreign resources for purposes of investing in PE/VC funds to the original standard of 2 per cent;
- 22.Are there any government approvals required in connection with private equity investments in certain industries or any industry-specific regulatory schemes that can affect private equity investments? What are the main requirements to obtain such approvals? Have there been any observable trends recently in the posture of specific regulators or the regulatory environment generally in connection with the review or approval of such investments?
- 23.Please describe any antitrust approvals or other competition law requirements that may apply in connection with private equity investments.
Currrently, there are at least three substantial case laws regarding this subject in the Brazilian Antitrust Department, which are: (i) the investment made by the Fundo de Participações e Consolidação FMIEE in a company named Tecnologia em Sistemas de Legislação S.A.; (ii) the investment made by the Fundo de Investimento em Participações Caixa Modal Óleo e Gás in a company named Enesa Participações S.A., and; (iii) the indirect investment made by the BTG Pactual Economia Real Fundo de Investimento em Participações in a company named Rede Nordeste de Farmácias Ltda. In the analysis of such cases, the Brazilian Antitrust Department showed a tendency in considering private equity funds quotaholders and/or managers as ultimate parent entities in order to apply antitrust regulation and its respective thresholds for the investment transactions to be subjected to the antitrust authorities analysis, if and when: (i) the fund’s quotaholders have effective influence in the decision making process of the fund, and/or; (ii) the fund’s manager have effective influence in the decision making process of the invested company.
When any of the above mentioned conditions are verified, the investment shall be submitted to the approval of the antitrust authorities. In such cases, the thresholds are: (i) revenues superior of 400 million reais by any of the parties of the transaction (including by the fund manager and/or by the fund’s quotaholders) in the previous fiscal year; or (ii) post-transaction market share equal or superior to 20 per cent (also applicable to the combination of any of the parties involved, including each of the quotatholders themselves together with the invested company). The regulation requires 120 days for the approval of the transaction, but the usual timeframe may take a year or more.
- 24.Are there any anti-money laundering or other similar financial regulations that should be considered when structuring a private equity transaction or setting up a vehicle?
The Brazilian legislation, by means of a specific law, provides for procedures to be adopted by the financial and securities market players and also by the regulatory agencies concerning the avoidance of money laundering practices. Such law defines money laundering as a crime, subject to penalties which may vary from simple warnings to heavy fines and disqualification of fund managers and financial institutions.
PE/VC fund managers and other institutions subject to CVM’s regulation (such as securities distributors, securities dealers, and others), specifically, shall adopt procedures for assuring the identity of their clients and registering all the transactions in which they are involved, in order to allow the supervision of financial transactions and the communication of any suspicious transactions to the CVM. All the information on clients’ identities and their transactions shall be kept in order by the fund managers or other institutions regulated by the CVM for a 5 years period as from the completion of the transactions, or indefinitely, in case any investigations take place. The current regulation also establishes that institutions subject to CVM’s supervision shall develop and implement a guide for controlling procedures to assure faithful compliance with the terms of said regulation, and shall maintain, as well, a continuous training program for its employees on the procedures of control and prevention of money laundering.
- 25.Are there any exchange controls that typically affect how foreign private equity investments are structured in your jurisdiction?
Foreign investments in Brazil can be subdivided into portfolio investments, direct investments and loans. In summary, one must declare to the Central Bank the entry of all funds, using the module that corresponds to the type of investment, and in the relevant wake thereof, the portfolio investment must be declared via the RDE-Portfolio (Electronic Declaration Record-Portfolio), the loan via the RDE-ROF (Financial Transactions Registration) and the direct investments through the RDE-IED (Direct Foreign Investments). Registration of foreign capital that enters into Brazil is mandatory (article 3, Law No. 4131/62) and its lack may cause the application of sanctions by the competent authorities. Laws No. 4131 and No. 11371, National Monetary Council Resolutions No. 2883, No 3844 and No. 3447 and Central Bank Circulars No. 2997 and No 3491, establish the criteria for the application of penalty fines in the case of information provided incorrectly, incomplete or not within the relevant deadline, and also the value of such fines. The “traditional” investments in PE and VC presume participation of the investor in the capital stock of the company receiving the investments, in a way that the transaction is characterised as a direct foreign investment, as provided in Resolution No. 3844/10, Schedule I (which institutes and regulates the direct foreign investment - RDE), as follows: “Article 5. Shall be registered as direct foreign investment the equity held by the non resident investor in the capital stock of a receiving company, paid up or acquired under the terms of the current laws (...)”
REMITTANCE OF PROFITS ABROAD
In principle, there are no restrictions for distribution of profits and their consequent remittance abroad. Profits generated as from 1 January 1996 are exempt of withholding income tax and the remittances of profits must have their destination recorded in the RDE - IED Module.
REINVESTMENT OF PROFITS
If the foreign investor opts to reinvest the profits in Brazil, he or she may register it as foreign capital, in the same way as for the initial investment, thus avoiding the levy of income tax on capital gains upon repatriation.
REPATRIATION
Foreign capital registered with the Central Bank may be repatriated to its country of origin at any time, without need for prior authorization. The income tax regulation of 1999 establishes in its article 690, item II, that amounts in foreign currency, registered with the Central Bank of Brazil as investments or reinvestments that are returned to their country of origin, are not subject to withholding income tax. Repatriation of an amount that is greater than what is registered with the Central Bank will be considered to be capital gains and levied at source at a rate of 15 per cent.
- 26.What are the basic tax issues affecting private equity investments in your jurisdiction?
In relation to the main private equity vehicle used in Brazil (FIP) there is no taxation over its income or capital gains derived from its portfolio of investments.
In regard to withholding taxes, however, the FIPs shall withhold the income tax payable by its investors at a 15 per cent rate in the events of redemption or liquidation of the quotas of the fund along with the distribution of resources to such investors. However, the 15 per cent rate shall not be applicable if the fund does not meet the portfolio composition determined by the pertinent regulation edited by the CVM and/or does not keep at least 67 per cent of its portfolio formed by shares of closely/publicly held corporations, debentures convertible into shares and/or warrants issued by such corporations. In such cases, the income tax shall be withheld at a variable rate between 15-22.5 per cent, depending upon the duration of the investment. Notwithstanding that, no income withholding tax is applicable on the distribution of resources by the FIP to its foreign investors, as long as:
- such foreign investors do not hold 40 per cent or more of the quotas issued by the fund or the right of receiving 40 per cent or more of the income generated by the fund;
- the fund does not hold more than 5 per cent of its portfolio formed by debt instruments, except debentures convertible into shares; and
- the foreign investors are not resident or domiciled in countries which do not tax income or tax income at maximum rates lower than 20 per cent.
Concerning FIPs for investment in infrastructure projects, no income tax should be payable by individual investors selling their quotas within or outside a stock exchange environment or receiving income or gains distributed by the fund, provided that the fund, in the latter case, shall invest at least 85 per cent of its resources in debentures issued by specific purpose companies incorporated for executing infrastructure projects.
Besides that, ordinarily, foreign investors in Brazilian FIPs should not be subject to local taxation over resources distributed by the fund, provided that (i) such investors do not hold interest in the fund equal or higher than 40 per cent, (ii) the fund does not hold more than 5 per cent of its portfolio in debt instruments (except for debentures convertible into shares), (iii) the foreign investors are not resident or domiciled in countries which do not tax income or tax it at a maximum rate lower than 20 per cent.
The foreign investor shall be subject, however, to taxation over the conversion of any foreign currency into Reais by the time of execution of the corresponding exchange agreement, which will allow the internalization of the resources. The rate of such taxation is currently set at 2 per cent, but the government may lower or raise such rate at any moment, by decree, up to the rate of 25 per cent.
- 27.What impact are recent and projected macroeconomic trends in your jurisdiction and abroad and your government’s reaction to these trends having on private equity activity in your jurisdiction? When did you start to see an impact?
The main impact of macroeconomic trends in our jurisdiction over PE/VC transactions is the one derived from the inflation of prices, which, by its turn, is derived from the growth boom in 2010. Due to such inflation, investors are facing a sensitive raise in the valuation of the target companies.
In order to try to contain the increasing inflation, the government has been taking several measures, among which we may mention the raise of taxes (like the tax over financial transactions) and the raise of the benchmark Selic rate. However, none of these measures affect the PE/VC transactions themselves directly.
- 28.Please describe any other regulations applicable to private equity funds and private equity investments not discussed in your answers to the above questions.
- 29.Please describe any other recent trends observed in your jurisdiction affecting how private equity transactions are conducted or how these investments are structured.
The PE/VC industry in Brazil, after enjoying a phase of growth that began in 1995, has been consolidating itself and gaining more relevance in the country’s economy, with the support in investment of public and private institutions. With this movement, the regulatory systems have also advanced, as for example with the issuance of ICVM No. 391 to cover the lack of regulation for private equity investments, and with the current self-regulation code approved by Anbima and Abvcap.
- 30.Please describe any other relevant legal considerations or new developments related to private equity investments in your jurisdiction not discussed in your answers to the above questions.
A self-regulation was issued in 2010 with the purpose of providing more transparence for the funds and for the work carried out by the GPs. The code created levels of governance and established criteria that are more rigid for registration of PE/VC funds in Brazil, for the activity of the GPs and in relation to the LPs.It is expected that with the investment grade recently received by the country, foreign investment in the PE/VC will grow fast in the following years, especially if considered that the barriers imposed for foreign capital did not affect directly the long term foreign investments.
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