Brazilian IOF reduced to 2%

As an attempt to stop the increasing appreciation of the Brazilian Real against the USD and other foreign currencies, the Brazilian Government had increased (to a 6% rate) and afterwards reduced (to a 2 % rate) the IOF levied on foreign investments made via private equity funds.

Back in October 2009, the Brazilian Government increased from 0.38% to 2% the IOF levied on exchange transactions related to all foreign investments made through the Brazilian Stock Market (BOVESPA) and via foreign investments in the Brazilian capital markets in general.

For most private equity players doing business in Brazil, this IOF did represent an additional burden as it affected not only the investments in the BOVESPA, but also the foreign investments made via the Brazilian most common Brazilian private equity instrument - the Investment Participation Fund (also known as FIP).  Indeed, FIP structures are viewed as investments in the Brazilian capital markets (registered and regulated by the Brazilian SEC - CVM) and, therefore, subject to such IOF.

In October 2010, due to concerns over the exchange market, the Government decided to increase (firstly in October 4, 2010) to 4% the IOF levied on exchange transactions related to investments in the Brazilian financial market and also to investments in the Brazilian capital market (including the FIP), with the exception of the investments made through the BOVESPA.

Two weeks later (on October 19, 2010), as the Brazilian Real continued to appreciate, the Government increased again, to a surprising 6% rate, the IOF levied on exchange transactions related to foreign investments made in the local financial and capital markets (including FIP) and investments made by foreign investors in the Brazilian Commodities and Future Market (BM&F) in order to maintain their minimum reserve.

This 6% taxation becomes a significant threat to the FIP’s short/mid-term projected profit margins, i.e., an important increase in the already high costs of permanent investment in Brazil.  For this reason, after a great deal of lobbying from PE players and investors, the Brazilian Government decided, in the end of 2010 (actually, on December 30), to reduce the IOF tax on foreign investments made through the FIPs to the old 2% rate.

Now the foreign investments made via a FIP (and through other sort of private and venture capital funds – the Emerging Companies’ Investment Funds or FIEE) are subject to the IOF taxation at a 2% rate¹. The IOF is triggered by the exchange transaction made in order to translate the amount to be invested in the FIP, denominated in foreign currency, into Brazilian Reais.  The IOF is not charged on the exchange transaction required to the return of the FIP investments or on the payment of the income derived from it.

By Fábio Dantas, M&A Tax Senior Manager

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1 Foreign investments in fixed income funds and other financial instruments (not FIP, FIEE and investments made in the Brazilian Stock and Exchange Market), as well as investments made by foreign investors in the Brazilian Commodities and Future Market (BM&F) in order to maintain their minimum reserve, continue subject to the IOF at a 6% rate.