The most used alternatives to provide Brazilian subsidiaries with funds are the capital contribution and the foreign currency loans. After incorporation, and during its pre operational phase, subsidiaries of multinational companies in Brazil are treated as a center of costs and need working capital to develop their activities.
Return on investments and profitability may take longer than predicted and, especially when the companies run out on cash, there must be different solutions for the payment of intercompany liabilities. This short article aims to give the readers an overview of the procedures that may be adopted when the payment of an intercompany loan is not possible. Procedures described herein may apply to overdue intercompany loans and for those that are in the verge of becoming overdue.
“Loan is due and no payment was made by the subsidiary. What can be done now?” The first alternative for debts that cannot be paid to the creditor outside Brazil (when due) is the postponement of the debt. Parties must mutually agree and define a new payment term for the loan. Such new payment term will trigger the execution of an amendment to the original loan agreement. Accordingly, the original registration of the financial transaction (“ROF”) must be amended to reflect the new term, with the Information System of Central Bank (“SISBACEN”).
An Ordinance from the Brazilian Monetary Council sets forth that postponements carried out after April, 2011, to be effective, must be made through the execution of simultaneous foreign exchange transactions / agreements. That is, the postponement, for registration purposes, requires the Brazilian company to execute two foreign exchange contracts: the first, in which the payment of the current loan will be simulated and simultaneously the second, reflecting the incoming funds for the postponed loan. IOF tax will apply in the postponement, at a rate of 6% (over the total amount of the foreign exchange contract) if new loan is made with a term shorter than 180 days. This 180-day period may change from time to time according to the decision of the Brazilian Monetary Council.
Conversion of Debt into Equity
The conversion of the debt (loan) into equity may also be an alternative for the non-payment of the loan. In this case, Brazilian Central Bank ruling requires the creditor to irrevocably and unconditionally agree with the conversion, what may be carried out by a simple statement. From the corporate perspective, the conversion consists in a capital increase of the debtor, in an amount in reais equal to the (loan) debt in foreign currency. Creditor will subscribe such amount of shares, in an amendment to articles of debtor, and will pay-in such shares with credits it holds against the debtor, arising from the loan.
Conversions made after April, 2011, to be effective, must also be made through the execution of simultaneous foreign exchange transactions / agreements. Debtor will be required to execute two foreign exchange contracts: the first, in which the payment of the current loan (along with interests – if applicable) will be simulated and simultaneously the second, reflecting the incoming funds for the capital increase. Conversion will enable the foreign investor (Creditor) to have the foreign investment registration with the SISBACEN. No IOF tax is levied in the execution of foreign exchange contracts of the conversion. Accordingly, the term of payment of the loan (debt) must be observed: if conversion is carried out before the due date, IOF tax may apply at a rate of 6%. This analysis should be made in a case by case basis. Interests if converted, will be subject to 15% withholding tax.
“I will participate in a public tender and must write off all my balance sheet liabilities. What would happen if a debt of my Brazilian subsidiary is forgiven?” Debt forgiveness is used when the Parties may not any longer have the intercompany liability in the balance sheet. Sometimes, when participating in public tenders, companies are required to present certain indebtedness index and the liability represented by a loan, may cause the disqualification to participate in the tender. The debt forgiveness produces immediate effects, enabling the debtor to write off the balance sheet liability.
The disadvantage comes from a tax standpoint: Brazilian Revenue Office treats the debt forgiveness as an asset increase and therefore, it is subject to taxation of PIS, COFINS, Income Tax and Social Security (roughly 40% of forgiven debt). For that reason, foreign investors have been, up to the years, strongly discouraged to forgive debts. If, for any reason, the debt is forgiven, the corresponding ROF must be cancelled, and the creditor must execute a related statement for such purpose.
Debt Assumption / Corporate Reorganization
The debt assumption may be an alternative among companies (subsidiaries) of the same economic group, in Brazil. It may also serve as an alternative for the debt’s set off among Brazilian companies. Investor ‘A’ grants a loan to ‘B’, its Brazilian subsidiary and ‘B’ has not cash for the payment of the loan, when due. ‘B’, by its turn, has credits against ‘C’, which is a company of the same economic group of ‘A’ and ‘B’. ‘C’ may assume the debt ‘B’ has with ‘A’, offsetting the debts it owes to ‘B’. In such example, ‘A’ must expressly consent with the debt assumption and ‘C’ will, as a result of the debt assumption, pay ‘A’ any outstanding amounts after the set off.
Corporate reorganizations, such as mergers, may also trigger a similar effect of the debt assumption. Using the same example mentioned above, if ‘B’ is merged into and by ‘C’, ‘C’, as the resulting company, will succeed ‘B’ for all of its liabilities with ‘A’. In any of the cases, proper documentation must be drafted to support the debt assumption or the legal succession, and the corresponding ROF must be amended with the SISBACEN.
Some of the alternatives presented herein may also apply for service agreements, as well as for other debt instruments, such as imports carried out by the Brazilian companies. Depending on the case, other alternatives may apply.
André Garbuglio was an associate at Pacheco Neto Sanden Teisseire Law Firm.