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The Brazilian government’s latest increase in tax on Financial Transactions (IOF) could affects transfer pricing audit several transactions in the financial and capital markets, including investments in fixed income, investment funds and derivatives transactions.Brazil raised taxes on foreign inflows for the second time in a month this October to halt the appreciations of the local currency and protect exports from what local officials have termed as a “global currency war”.While this increase will boost Brazil’s economy, the change will adversely affect the US.

In a international expansion of an emerging market, investors needed to know about the risks involved in investing in their market segment of choice. The decree (Decree 7,330/10) issued on October 18, 2010further raised the IOF tax to six percent, barely a week after the government first increased the rate from two percent to four percent. Inbound investment in several kinds of financial transactions in Brazil will be impacted. Investors will need to structure their investments differently if they want to minimize their IOF costs. Investors may also look for different forms of investment as they want to minimize the impact of the IOF on their transactions.

The IOF is levied on foreign exchange transactions related to the foreign investment in fixed income transactions, investment funds, including Private Equity Funds (FIP), and the attendance of initial or additional margin requirements in connection with futures transactions carried out within the Brazilian Stock, Commodities and Future Exchange. The new rate is effective from October 19, 2010.
There are exceptions to the IOF rate increase and the below will continue to have a two percent IOF rate:

1. Investments in variable income investments traded on the Brazilian capital markets; and
2. Acquisition of stock or stocks subscriptions in public offerings registered with the Brazilian Securities and Exchange Commission (CVM), or where registration is not mandatory under the CVM regulations, if the issuing companies are still registered with the CVM.

The subsequent repatriation of a foreign investor’s initial investment (i.e. the exchange of Brazilian currency into foreign currency) remains exempt from the IOF.
IOF on the below foreign investments remain unchanged:

1. Foreign exchange transactions related to direct investment in Brazilian companies remains subject to a rate of 0.38 percent on the inflow and outflow of cash (e.g., capital increase, capital gains and dividend payments); and
2. Foreign exchange transactions related to international loans which are subject to a zero rate on the inflow and outflow of cash, continues.

Although the IOF tax obviously affects domestic and foreign investors differently, it does maintain a level playing field among foreign investors. The recent developments in the IOF tax should be seen as part of a natural evolution of an emerging market. For those foreign investors who are positioning themselves to profit from this development, the real impact will be in the operations functions supporting the trading, allowing for new competitive advantage to be grasped by those providers able to master the service delivery of these new aspects. Incomplete knowledge about foreign markets can be a real impediment to your company’s international expansion plans. Employing the help of a partner can your organization scale all difficulties and ensure success in your endeavors in any international business expansion