Brazil is a nation rapidly on the rise. In 2010, the country’s economy grew 7.5%, making it the seventh-largest in the world, according to the World Bank. In 2011, Brazil’s GDP is expected to grow 4.5%, slower than last year but still a healthy pace. And growth over the next few years also is projected to be robust as the country gears up to host two blockbuster events—the 2014 World Cup and the 2016 Olympic Games—that require huge investments in urban infrastructure, such as airports and public transportation.

With its large, expanding domestic market (the fifth most populous in the world, with a substantial middle class), wealth of natural resources and stable democracy, Brazil is a thriving destination for foreign investors. According to the United Nations Conference on Trade and Development, Brazil ranked fifth among all countries in foreign direct investment inflows in 2010, rising from 15th the year before.

In recent years, reported The Economist. “Brazil has been transformed from ‘country of tomorrow’ to ‘once-in-a-lifetime opportunity.’”

Despite these bright prospects, however, Brazil remains a complicated place to do business for foreign-based companies. Challenges include a highly complex and expensive tax and labor environment, burdensome bureaucracy, costly credit, lingering corruption and deep social imbalances. On the World Bank’s Doing Business Index. Brazil ranks 127th among 183 countries in the ease of doing business, which it defines as having a regulatory environment that is conducive to the startup and operation of a local company.

To gain insight into emerging opportunities, the JofA asked two top accountants with direct experience in Brazil to provide their perspectives about the country’s business and accounting environment. Sharing their views were Eduardo Pestarino, regional executive for The Americas at Crowe Horwath International; and José Bendoraytes, managing partner of Horwath Bendoraytes Aizenman & Cia. a member firm of Crowe Horwath International in Brazil. Their answers are presented jointly.

LEGAL / REGULATORY

JofA: What are the available forms of organization for a U.S. investor to do business in Brazil?

Pestarino/Bendoraytes: A foreign company can apply to open branches in Brazil by submitting an application to the Brazilian government. There are several formalities that have to be fulfilled, including the filing of documentation with the National Department of Registry of Commerce (DNRC). The process of registering a new business can be lengthy, since it involves as many as 15 different procedures. Foreign companies must appoint a representative (who does not need to be a native Brazilian but must be a resident in Brazil) to act on their behalf.

The two main types of business organizations in Brazil are the limited liability company (LTDA) and the corporation, known as “Sociedade Anónima” or “SA.”

The LTDA is the simplest, least expensive and most popular form of organization in Brazil. It is similar to U.S. limited liability companies, limited partnerships and closely held companies. At least two partners are required to form an LTDA.

The Brazilian corporation resembles a U.S. corporation. It also must have at least two shareholders, who are liable only to the extent of the stake they hold in the company.

A Brazilian corporation may be publicly held or closely held. A publicly held company must be registered at the Comissão de Valores Mobiliários (CVM, Brazil’s version of the SEC), along with the securities it issues, which may be traded on the stock exchange or on the over-the-counter market. The securities of a closely held company are not available to the general public.

At this point in time, Brazil only has around 1,000 public companies. Most of the country’s 6.2 million businesses are small and medium-size enterprises.

JofA: What do companies need to understand about protecting intellectual property in Brazil?

Pestarino/Bendoraytes: Since 1994, Brazil has been a signatory of the World Trade Organization’s Trade-Related Aspects of Intellectual Property Rights (TRIPS) agreement. TRIPS establishes a minimum protection standard to property rights and requires signatory countries to review and adapt national laws that meet that standard.

Over the years, Brazil has issued several property rights laws that assure protection to the holders of industrial property rights. These laws prevent others from producing, using or selling products or providing services that infringe patents, trademarks, industrial designs or secrets. These laws also protect the intellectual property rights relating to the development of new plant varieties, recognizing Brazil’s rich biodiversity and the high costs of research and development.

Software property rights also are protected for 50 years in Brazil, and authors—both domestic and foreign—have copy rights protected for 70 years.

While there are still areas of concern, particularly with respect to pirated audiovisual goods, pharmaceuticals and medical devices, much progress has been made in intellectual property protection.

JofA: How effective is Brazil’s legal system, and can companies get disputes resolved fairly and within a reasonable amount of time?

Pestarino/Bendoraytes: Brazil’s legal system is effective, and companies can expect fair resolutions of disputes. Although effective, the system is slow as a result of legal instruments used by the attorneys to delay judgment and final sentences and force unappealing decisions. For that reason, the majority of international contracts entered into in Brazil have a provision relating to arbitration procedures.

JofA: What are the key aspects of the local labor environment to consider?

Pestarino/Bendoraytes: Brazil’s labor system is complex and costly. It is governed by the CLT (Consolidation of Brazilian Labor Laws), and its principles are grounded in the country’s federal constitution, which makes changes extremely difficult.

Compared to the United States, Brazilian labor law involves a high level of state intervention. For example, while American labor law allows employers and employees to set labor agreements and use private arbitration for disputes, Brazilian disputes always end up in a court of law.

It is not uncommon for Brazilian companies to have an extensive written contract with employees. Additional costs for workers, such as taxes, health insurance, meal and grocery stipends, transportation stipend, vacation pay and a “thirteenth salary” (an additional month’s pay every December) can add up to more than 70% of base pay. Laying off employees also can be expensive. An FGTS (Unemployment Compensation Fund)-opting employee unfairly dismissed is entitled to withdraw the total deposits made by the employer in his FGTS account, plus interest, monetary adjustment and a 50% fine figured on the total amount deposited. Collective employment conventions may provide for an additional indemnity.

JofA: Can you share some basics on Brazilian currency laws?

Pestarino/Bendoraytes: Brazil’s currency, the real, is nonconvertible, so it is not available for trade on the forex market and cannot be bought or sold outside Brazil.

The Banco Central do Brasil maintains close control of the Brazilian currency market through Sisbacen, the Central Bank’s information system. The system functions as a virtual environment where currency transactions and operations are officially authorized and conducted.

Import and export operations must follow specific rules with regard to currency transactions. They include preparing contracts, documenting transactions and getting approval from Sisbacen. Almost all types of currency operations can be handled through a commercial bank or by local exchange brokers.

JofA: How is Brazil’s transition to IFRS progressing? What are the key challenges and benefits?

Pestarino/Bendoraytes: In 2007, Law 11,638 was enacted, and Brazil fully committed to the IFRS convergence process under the direction of the CPC (Accounting Pronouncements Committee), an offshoot of the CFC (Federal Accounting Council), the main accounting authority in Brazil. The CPC has issued more than 40 pronouncements relating to convergence since that time.

In December 2010, the CFC instituted the standards issued by the CPC as mandatory for all types of organizations, including:

Large enterprises and listed companies, defined as any national or foreign company that has more than R$240 million (US$151 million) in assets or more than R$300 million (US$189 million) in revenues.

Regulated organizations, including banks, insurance companies and investment funds, which must also follow the rules issued by the CVM, the Central Bank and SUSEP (Superintendência de Seguros Privados, a division of the Ministry of Finance that regulates insurance).

Foreign-owned companies.

Training is the main challenge relating to IFRS implementation, because the adoption of principles-based standards requires a change of mindset and approach. For example, the previous Brazilian accounting system was designed to provide information to tax authorities, while IFRS is intended to serve investors. The IFRS rules also are less detailed and, as a result, generally require a higher level of professional judgment. Emphasis is given to the “substance” of transactions rather than simply the legal “form.”

The benefits in adopting IFRS in Brazil include reduced complexity, greater transparency, comparability and efficiency.

JofA: Could you provide an overview of Brazil’s tax compliance and reporting system?

Pestarino/Bendoraytes: The Brazilian Constitution attributes taxing powers to federal, state and municipal governments. Brazilian taxation may take the form of taxes, fees, betterment fees, other contributions and compulsory loans (see Exhibit 1 for a list of the main types of taxes in Brazil).

(Click here to open Exhibit 1 in a new window.)

The federal tax administration agency in Brazil is the Receita Federal do Brasil (RFB or Brazilian Revenue Service). The Brazilian Revenue Service is also in charge of inspection activities and the collection of social security contributions. States and municipalities also have their own tax administration agencies.

Corporate taxpayers are subject to corporate income tax (IRPJ) and social contribution on net profits (CSLL) tax, which finances social programs. In addition to IRPJ and CSLL, the federal government levies taxes on foreign trade (import and export taxes), a value-added tax on industrial production (IPI) and a tax on financial transactions (IOF).

The federal government also imposes social contributions on the gross income derived by resident legal entities (PIS and COFINS contributions). There is also a federal contribution imposed on crossborder payments of royalties and certain technical, administrative and scientific services (CIDE, or Contribution on Economic Activities).

In addition, state governments levy a value-added tax (ICMS) on the distribution of goods and services. The ICMS is payable at all stages of the chain of sales, from the manufacturer to the end consumer. Municipal governments also levy a tax on services (ISS) provided by a company, contractor or professional.

The Brazilian tax system is complicated and time-consuming. The World Bank calculates that it takes a typical limited liability company that is domestically owned with 10 to 50 employees nearly 2,600 hours per year to comply with tax regulations in Brazil, compared to 187 hours in the U.S. And the average Brazilian company pays about 69% of its net profits to the government, compared to a total tax rate of 46.8% in the U.S. according to the World Bank.

JofA: Can you explain the difference between the “actual profit regime” versus the “presumed profit regime?”

Pestarino/Bendoraytes: Under the actual profit regime, companies calculate annually or quarterly their income tax liability on net profits for the taxable period, adjusted by additions and exclusions provided by tax law.

Certain companies are required to calculate their income tax liability under this regime, including those with total gross income in the previous year exceeding R$48 million (US$30.2 million); financial institutions, insurance companies and similar entities; and legal entities that derive profits, income or capital gains from abroad.

Corporate income tax (IRPJ) is due at the 15% rate on net profits. The portion of net profit that exceeds R$240,000 (US$151,000) per year is subject to an additional income tax of 10%. The social contribution on net profits (CSLL) is imposed at a 9% rate.

Companies that are not required to adopt the actual profit regime may calculate their tax liability under the presumed profit regime. This is a simplified tax method under which the company chooses to calculate its taxable base by applying a percentage of its total gross income earned during the quarter (presumed profit). The applicable percentage ranges from 1.6% for income from the sale of fuel and natural gas to 32% for income from the rendering of services, such as factoring and real estate rentals. Sales of goods are taxed at 8%. Income tax is imposed at the rate of 15% on the presumed profit, with additional taxes that include CSLL.

JofA: What is the rationale behind the transitional tax regime that was created in response to the implementation of IFRS?

Pestarino/Bendoraytes: Provisional measures established the RTT (Transitory Tax Regime) in 2009 in order to neutralize the impact of new IFRS accounting methods, given that pre-IFRS tax rules still apply in the country. Under the RTT regime, companies can calculate their main federal taxes on the basis of accounting rules in force until December 2007 (when the transition from the former Brazil GAAP to IFRS began). This approach will continue until a new tax law that considers the current Brazil GAAP effects is issued.

JofA: Are there financial and tax incentives available for foreign investment?

Pestarino/Bendoraytes: The Brazilian government encourages long-term investment through its tax system. Aside from tax and financial incentives granted at the federal level, state governments and municipalities also make grants available.

The most important incentives include:

JofA: Have there been any recent developments on the tax scene?

Pestarino/Bendoraytes: In August, President Dilma Rousseff announced a plan to provide R$25 billion (US$16 billion) in tax breaks over the next two years to protect manufacturers from a surge in imports from China fueled by the rising value of Brazil’s currency. The plan also eliminates a 20% payroll tax on four industries, including shoes and software. A portion of the tax cuts will be offset by an additional tax that these companies will pay on sales.

TRANSACTIONS

JofA: Are there restrictions on dividends and other fund flows out of Brazil?

Pestarino/Bendoraytes: There are no restrictions on remittances of dividends out of Brazil to shareholders domiciled abroad. Dividends paid out of profits are not subject to withholding tax or income tax.

Interest and royalties are subject to withholding tax—royalties at a 15% rate and interest at a rate of 15% to 25%. Remittances of royalties and fees through the official market to foreign licensors are generally limited to 1% to 5% of sales. The maximum amount deductible on the remittance is 5% of net receipts from the product manufactured or sold.

The remittances of profits must be registered at the RDE (Electronic Declaratory Registration). The foreign funds registered at the Central Bank of Brazil can be repatriated without previous authorization.

JofA: What does a company need to understand about transfer-pricing regulations in Brazil?

Pestarino/Bendoraytes: Brazil is not a member of the Organisation for Economic Co-operation and Development (OECD), but it has its own regulations on transfer pricing, including a convention to avoid double taxation. Brazil has no treaty to avoid double taxation with the U.S. Brazilian law considers that companies are related when they are under a common control, and transfer-pricing rules apply when one of the parties is located in a country that provides a privileged tax regime.

When products are imported by a Brazilian company, transfer-pricing rules verify whether the company is making excess payments to the foreign supplier. To that end, certain deductibility limits apply to payments made by the Brazilian company to its foreign supplier. Any amounts above such limit are added to the company’s taxable income.

As for exports, the Brazilian tax authorities check whether prices are not lower than those determined by comparability methods. The Brazilian company must report a minimum taxable income when selling goods and providing services to foreign-based related companies.

Calculation methods specified by the regulation on imports include:

PVL—Market sale price minus profit