Originally published in the June 2 edition of World Tax Daily (Copyrights Tax Analysts)
The Brazilian government is considering reinstating the financial transactions tax (IOF) on foreign investments in Brazilian fixed-income bonds, according to recent Brazilian media reports.
The government has begun informal talks on restoring the IOF in an attempt to minimize the adverse effects of the large inflows of foreign capital into the country that made the Brazilian currency appreciate almost 10 percent vis-à-vis the U.S. dollar in May alone.
The government would most likely restore the 1.5 percent IOF on foreign investments in fixed-income bonds, which was reduced to zero in October 2008 in response to the international financial crisis. The government is specifically focusing on foreign investors in public bonds that pay, on average, 10.25 percent interest per year. The 1.5 percent IOF would then reach almost 15 percent of the income expected from investments in those bonds.
However, critics say restoring the IOF for bond investments by foreigners would do little to relieve the depreciation of the U.S. dollar as compared with the Brazilian real. In May alone, foreigners invested $811 million in Brazilian public bonds, significantly less than the $3 billion to $4 billion invested monthly in early 2008. Critics argue that most of the U.S. dollar appreciation is a consequence of direct (productive) foreign investments in Brazil rather than speculative capital aiming to profit from local high interest rates.
In October 2008, Brazilian companies had difficulty obtaining financing from international markets, which is usually less expensive than local financing. They then turned to local banks, and the inflow of foreign funds was drastically reduced to such a level that the U.S. dollar appreciated almost 50 percent between August and October 2008.
As international financial markets stabilized in recent months and became more accessible to Brazilian companies, they decided to replace expensive local financing with cheaper money raised abroad, which increased capital inflows into Brazil and depreciated the U.S. dollar exchange rate.
The government is not yet considering raising the IOF on other forms of international capital coming into Brazil. But if the U.S. dollar depreciates beyond BRL 2.00, other measures — such as other IOF rate increases —might be taken to try to stall the appreciation of Brazilian currency, which harms local exporters.
David Roberto R. Soares da Silva