M. J. Alves e Burle

By M.J. Alves e Burle Advocacy Brasil in partnership with Rogerio Peres, Lawyer and Professor at Institute Insper

On March 30, 2020, the Brazilian Government issued the Provisional Measure n. 930/2020 providing new rules to tax financial institutions on the profits arising from the variation of currency exchange in foreign subsidiary investments. This measure reduces the costs of hedge operations by eliminating the overhedge’s distortion.

This framework influences in different ways financial institutions with and without hedge operations. While for the companies that did not adopt an exchange hedge it represents an additional taxation, on the other hand, for investment with hedge guarantees, it represents a reduction of operational costs.

Before this change, only the exchange variation in hedge operations was taxed, while the profits related to the investment itself was exempt. This lead to a mismatch between the assets and the liabilities related to a foreign investment, which obliged the financial institution to contract an additional protection (overhedge) to compensate the amount deducted of the profits in the hedge operations.

The opportunity introduced by the new rule is to suppress the overhedge operation by taxing jointly the exchange variation of investments abroad and hedging operations. It is intended that these two “exchange positions” compensate each other and can neutralize the effects of exchange rate variations on the financial institution’s equity with investments in foreign subsidiaries.

Even while the new framework is being assessed by Congress, the rules provided are already into force, but not yet enforceable as a gradual transition between the two models was established. According to the provisional measure, the previous rules will remain valid for 2020, 50% of the exchange variation gain arising from the investment will be taxed in 2021 and just in 2022, the new rule will be fully implemented.

This new framework can still be changed or fully rejected by Congress before any of the rules are enforceable. The Congressmen are assessing the information to decide on the convenience to enlarge, restrict or maintain the framework as suggested. It is important to keep tracking this matter within the Congress. It might also be possible to suppress the overhedge’s distortion for non financial industry which could reduce its hedge costs or minimize the tax assimetry for the institutions that did not adopt hedge for its offshore investments.