Making the acquisition make sense

Brazil is the world’s fifth-largest country by area, with 8.5 million sq. km (3.2 million sq. miles) of territory, and its mineral and precious metal deposits are extensive. The country produces substantial amounts of gold and coal, and is the world’s second-largest producer of iron ore. Other important products include tin, quartz crystal, gems, and industrial-grade diamonds.

However, until a constitutional amendment in 1995, Brazilian mining was closed to foreign companies. Constitutional Amendment No. 6/95 was part of a process of change and opening-up for the Brazilian economy. This change revoked a provision that excluded foreign companies from activities such as mining by defining a “Brazilian company” as one whose equity-holders are Brazilian.

Now companies registered under Brazilian law and that have their administrative headquarters in the country are considered Brazilian, regardless of whether control is in Brazilian or foreign hands.

This simple but far-reaching change permitted any “Brazilian company” (irrespective of equity owners’ nationality) to participate in some sectors that previously were entirely in government hands, or subject to constitutional restrictions.

The current mining regime dates from the 1960s; as in many countries, it is based on concessions or authorizations under a Mineral Code. The concession, which is directed to facilitating industrial development of a deposit from extracting to processing the mineral, is granted through an ordinance of the executive secretary of the Ministry of Mines and Energy.

This is the “traditional” doorway to enter the Brazilian mining industry, and with the large number of greenfield opportunities available, it remains a common route. But other paths can be preferable, for various reasons, including tax-planning considerations. And the opening of the industry to foreign companies has accelerated this trend, by introducing players who are accustomed to using financial and tax strategies to enhance commercial value.

Acquisition and integration of an existing mining operation can be attractive, for both commercial and administrative reasons. The transaction may improve the abilities of both acquirer and target companies to share equipment, consolidate or fully utilize space or human resources, or acquire technology, know-how or revenues, among many other advantages.

It is also worthwhile to look closely at tax advantages, and detailed tax planning can add considerable value in many cases. Although the acquisition or integration may be attractive on a commercial basis, unexpected tax costs are potential “rocks under the water.”

Tax planning should not, however, be the reason for an acquisition. In fact, Brazilian federal tax authorities may contest tax benefits arising from a corporate restructuring exclusively focused on tax savings. The taxman also understands that it is necessary to have a commercial reason for company integration.

Mining is most prominent in Minas Gerais state, and so Brazilian acquisitions often relate to operations in that state. Accordingly, this article explains two kinds of tax pools connected with mining companies’ acquisitions in Minas Gerais. (Minas Gerais is the example chosen to make this description concrete for a reader, but most aspects are applicable to other Brazilian states. For example, income tax and other federal taxes are subject to the the same regulations throughout Brazil, and guidelines for ICMS (value-added tax) are under a federal law, which is implemented by the states within a narrow range of permitted modifications.)

Some examples of tax issues that can arise are:

— State ICMS credits on sales and services; and

— Accumulated federal fiscal losses for purposes of income tax and the related tax known as “social contribution on profits.”

ICMS is a value-added tax implemented under state legislation. This legislation provides that most acquisitions, including those of fixed assets used in the production cycle, generate ICMS credits. On the final delivery of goods for consumption, ICMS applies to the whole invoice value, and the ICMS “debit” generated will be recorded in the taxpayer’s ICMS books.

At the end of the ICMS fiscal period (normally one month), the taxpayer offsets ICMS credits against ICMS debits. If the result is a debit, it is remitted to the State Revenue Authority. If the result is a credit, no remittance is due and the credit carries over the next month.

It is common for mining companies to accumulate ICMS credits on their books. This can result from exports (which are ICMS-exempt), or because purchases are loaded to the front-end of a mining project that may not proceed when, or as, expected. ICMS credits from purchases that lead to exports, and from purchases that never generate revenue, are maintained.

Other transactions also increase ICMS credits on your books, for example ICMS deferred delivery. Specific examples include:

— interstate delivery of iron ore from the extractor to a pellet fabrication plant in another state; and

— delivery of pellets that are to be further processed, but ultimately exported (see ICMS Rule – Decree No. 43,080/2002, Article 225 and 227, Part 1, Annex IX).

Even if the ICMS credit is deferred until delivery of the subsequent or final product, ICMS credits may be maintained.

Mining companies with accumulated state ICMS credits have the alternative of using these credits against other ICMS debits arising from operations. Or they may transfer the credits to other ICMS taxpayers.

For example, commercial or industrial companies may transfer state ICMS credits arising from exports after Nov. 1, 1996, to another taxpayer also in Minas Gerais.

Industrial companies may also transfer accumulated ICMS credits from their installation or expansion phases to other companies (their subsidiaries) if the ICMS represents payment of capital for quotas or stocks acquisition. The transferee and the subsidiary company may use the ICMS credits to acquire raw material and fixed assets, and to collect ICMS on import of goods, as set forth in Article 1, Annex VIII, Decree No. 43,080/2002 and Resolution No. 3,228/2002.

As a result, before acquiring an ICMS credit or a company that has such credits, it is always necessary to determine the origin of ICMS credits.

Also if the company acquired is a mining company with industrial activities and the buyer is not an industrial company, it likely is advisable to transfer the target’s ICMS credits to another company in the same state before acquisition of the target.

The purchaser company may gain access to ICMS credits of the acquired company that exist on the date of the integration.

Income tax pools

Loss pools for purposes of income tax and social contributions on profits must be analyzed from a different angle. An important factor is that the purchaser may not use fiscal losses of the acquired company existing at the time of the acquisition, as set forth in Articles 513 and 514 of Decree No. 3,000/99.

On the other hand, a company with fiscal losses may be integrated organizationally and legally into another organization, still retaining its legal existence. In that case, the continuing company would be generally entitled to use the fiscal losses, if the reorganization meets some commercial purpose.

Even this brief discussion shows that a detailed review of the type and source of tax benefits is necessary to achieve expected tax efficiencies from a merger or acquisition.

And one of the key objectives is to define, prove and defend a commercial purpose.

— Roberto Carneiro is a managing partner of Carneiro e Sesana, a Rio de Janeiro law firm associated with Macleod Dixon. Glenn Faass is Macleod Dixon’s managing partner in Latin America.