Sugar and ethanol industry has been in the focus of the Brazilian M&A Market for a while. Both domestic and foreign companies have been frequently looking
at companies in this industry during such a consolidation process.
The sector’s taxation is quite peculiar in Brazil. There are several specific tax regimes applied mainly to VAT and taxes on revenues, such as tax suspensions, deferrals, presumed tax credits and special regimes, among others.
Besides the fact that the market is quite active, the due diligences performed during the last couple of years demonstrated that this economic sector, not that different from many others in Brazil, raises several concerns which enhance the importance of carrying out a review before making a binding offer or even before closing a transaction.
First of all, there are many family owned sugar and ethanol enterprises in Brazil. Some of them do not possess the corporate governance level required by world class companies. This means that despite the fact that those industries are in a very favorable environment with quite profitable forecasts, many companies still have significant downsides when it comes to tax, labor and social security compliance
In addition to the abovementioned, whenever looking at a sugar/ethanol company in Brazil, there are some aspects which must be analyzed carefully, such as:
Regarding the labor area, besides the potential hard work conditions for employees, there are some peculiarities in the sector which should be also observed. While the general rule states that social charges should be based on the payroll costs, the sugar/ethanol industry calculates and pays its charges based on the gross revenues, as these companies are considered agricultural industry. According to Brazilian legislation, companies which have both agricultural and industrial activities are considered as agricultural entities for social security purposes and, therefore, must calculate its social charges based on its gross revenues. In order to avoid the taxation based on the gross revenues some groups create two different entities, one industrial and another with a focus on agricultural/harvesting activity. This procedure may be questioned by the social security authorities if they understand that, in reality these entities are both part of the some agricultural industry and this structure reflects only a tax planning adopted to save social charges, but without proper business reasons.
Another important aspect which can trigger tax and labor risks to the buyer are the agricultural contracts. There are currently three types of contracts usually adopted by the sugar/ethanol companies and rural producers: the rural partnership; the rural lease and the sugarcane supply agreement. The Land Statute, however, was amended in 2007 by the Law 11,443 bringing new guidelines to the relationships between the parties referred above. As the industry is still adapting to these new guidelines, many rural agreements do not reflect current legislation triggering tax and labor risks for the companies, such as the characterization of these agreements as an operating lease agreement subject to the WHT taxation.
Such a complex tax, social security and labor environment combined with a historical weakness in internal controls and an inadequate corporate governance level requires a great deal of attention in transactions involving agribusiness in order to assure that the sugar/ethanol companies are prepared for the new requirements of the current economical, accounting and tax environment in Brazil.