Published by WorldTrade Executive, a part of Thomson Reuters

LATIN AMERICAN
Law & Business Report
Volume 18, Number 3 March 2010

HIGHLIGHTS
Report Card: Year-End Venture Equity Report Released

ConTenTS
Changes to Lease Rules in Brazil. By Ana Beatriz Nunes Barbosa (Denis Borges Barbosa Advogados)......................................................p. 9 Cross-retaliation with Respect to Intellectual Property Rights: Provisional Measure No. 482 of February 10, 2010 - A Step Forward in the Cotton Case Between Brazil and US at WTO. By Andr Zonaro Giacchetta, Ren Guilherme S. Medrado and Mrcio Junqueira Leite (Pinheiro Neto Advogados)............................................p. 9 Brazilian CFC Rules: Background and Status After Eagle II Case. By Leonardo Freitas de Moraes e Castro (L.O. Baptista Advogados)...................p. 12 Brazil Releases Exchange Controls. By Walter Stuber and Adriana Maria Gdel Stuber (Walter Stuber Consultoria Jurdica).........................p. 16 CVM Latest Rules and Their Impact On International Investors. By Mariana Noronha Muniz (Miguel Neto Advogados Associados).......p. 18 United States and Chile Sign Income Tax Treaty. By Neal A. Gordon and Craig E. Barrere (Morgan Lewis and Bockius LLP)..................................p. 19 Chile - New Cabinet Members; Deficit Concerns. By Walter Molano (BCP Securities, LLC)........p. 20

Brazil

The just published 2009 Year-End Report of Venture Equity in Latin America finds that despite a protracted drop in capital levels as the result of the economic crisis, Latin American venture and private equity has been very resilient in 2009. There has been a marked rise in the sheer number of deals, funds and exits. Page 3

Pending US FTAs with Colombia and Panama Not a Priority for the US in 2010

The date, the US Administration has not provided any signal that it intends to move for Congressional approval for pending U.S. FTAs with Colombia or Panama. Page 7

Coping with Mexicos Thin Cap Rules

In an exclusive interview, Fred Barrett of PricwaterhouseCoopers discusses Mexicos thin cap rule and other problem areas for deducting interest such as back-to-back loans. Page 21

Perus Stabilization Agreements Have Stimulated Foreign Investment and the Economy

Chile

Stabilization Agreements in Peru have been an important factor in stimulating foreign investment in the country. A Stabilization Agreement freezes specific legal regimes for a specific investment and for a specific period of time. Page 26

Chile and US Sign Income Tax Treaty

Chile and the US have signed an income tax treaty, which now must be ratified. It is the first treaty between these countries and only the second bilateral income tax treaty between the US and a South American country (the other being Venezuela). This development coincides with Chiles recent acceptance into OECD. Page 19

Navigating Mexicos Thin Cap and Related Foreign Party Finance Rules: An Exclusive Interview with Fred J. Barrett, PricewaterhouseCoopers Mexico. Conducted by Gary Brown and Scott Studebaker......................................................p. 21 Mexico's Supreme Court Ruling on Flat Tax Law. By Jorge Narvez-Hasfura (Baker & McKenzie, S.C.)......................................................................p. 25

Mexico

Contents Continued on Page 2

Contents, Continued from Page 1

Regional Peru

Report Card: 2009 Venture Equity Year-End Report Released.............................................................................p. 3 Changes in the Political Landscape. By Sidney Weintraub (Center for Strategic and International Studies. By Walter Molano (BCP Securities, LLC).........................................p. 5 Pending United States FTAs with Colombia, Panama Not a Priority for United States in 2010. By James Shea (White & Case)..............................................................p. 7

Economy, Foreign Investment Thriving Under Stabilization Agreements. By Luis Sotelo (DLA Piper)..........p. 26

Are Your Companys Investments Abroad Adequately Protected? By Oscar M. Garibaldi and Miguel Lpez Forastier (Covington and Burling LLP)................p. 29

Venezuela; Regional

Copyright 2010 by Thomson Reuters. Reproduction or photocopying even for personal or internal useis prohibited without the publisher's prior written consent. Multiple copy discounts are available.

Publisher: Gary A. Brown, Esq. Contributing Editor: Scott Studebaker Development Editor: Mary Anne Cleary Production Editor: Heather Martel Marketing: Jon Martel

Latin ameriCan Law and Business rePort (ISSN 1065-7428) is published monthly by WorldTrade Executive, a part of Thomson Reuters, 2250 Main St., Suite 100, P.O. Box 761. Concord, MA 01742 USA. Tel: (978)287-0301 Fax: (978) 287-0302 Internet Home Page: http://www.wtexecutive.com

ADVISORY BOARD
Frederick R. Anderson McKenna Long & Aldridge LLP Patricia Lopez Aufranc Marval, O'Farrell & Mairal (Buenos Aires) Ariel Bentata Ruden, McClosky, Smith, Schuster & Russell, P.A. Nicolas Borda B. Borda y Quintana, S.C. Abogados (Mexico City) Stuart S. Dye Holland & Knight LLP Maria Fernanda Farall Jones Day Thomas Benes Felsberg Felsberg e Associados, Advogados (So Paulo) Georges Charles Fischer Fischer & Forster (So Paulo) Isabel C. Franco Demarest e Almeida (New York and So Paulo) Sergio J. Galvis Sullivan & Cromwell Larry Manning Jones Day William Hinman Simpson Thacher & Bartlett LLP Salvador J. Juncadella Morgan, Lewis & Bockius LLP Hugo Cuesta Leao Cuesta Campos y Asociados (Guadalajara) Timothy J. McCarthy Hughes, Hubbard & Reed Thomas P. McDermott TPM Associates Antonio Mendes Pinheiro Neto-Advogados (So Paulo) John H. Morton formerly Hale and Dorr Edmundo Nejm Linklaters & Alliance (So Paulo) Uriel Federico OFarrell Estudio OFarrell Abogados (Buenos Aires) Juan Francisco Pardini Pardini & Asociados (Panama City) Reinaldo Pascual Kilpatrick Stockton LLP Robert J. Radway Vector International Marc M. Rossell Chadbourne & Parke LLP Keith S. Rosenn University of Miami School of Law Eduardo Salomo Levy & Salomo (So Paulo) Cristin Shea Eyzaguirre & Ca. (Chile) M. Stuart Sutherland Troutman Sanders LLP Miguel A. Valdes Machado & Associates, LLC (So Paulo) Carl Valenstein Thelen Reid & Priest LLP Juliana L.B. Viegas Trench, Rossi e Watanabe (So Paulo) Laurence P. Wiener Negri & Teijeiro Abogados (Buenos Aires)

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Report Card: 2009 Venture Equity Year-End Report Released

The 2009 Year-End Report of Venture Equity in Latin America, which has just been published, finds that despite a protracted drop in capital levels as the result of last years economic crisis, Latin American venture and private equity has proven to be very resilient in 2009. When looking at the sheer number of deals, funds and exits that took place in the region over the course of 2009, it is interesting to see that there has been a marked rise in activity, originating not only from foreign direct investors but local ones as well. For more information, or to order the Year-End Report published by Venture Equity Latin America, a sister publication to LALBR, go to http://www.wtexec.com/velaye.html Deals activity, for instance, grew from 34 transactions seen and recorded in 2008 to 67 transactions in 2009, demonstrating a 97% growth rate. As for funds, 25 closings were recorded in 2008, while 2009 boasted 40, illustrating again a remarkable rate of improvement (60%) in a twelve-month period. Exit activity, which was considered completely closed in Brazil as of a year ago and was predicted at that time to be delayed in 2009,1 actually showed positive 60% growth over the last year. Sixteen exits were transacted, not only in Brazil where the bulk of activity took place, but also in Colombia, Mexico, Peru and Uruguay. Moreover, a side-by-side comparison of investment activity between June and December of 2009, as compared to the previous six months, strongly suggests that activity is on the up. Even within the last six months of the year, deals activity more than doubled, rising from 29 transactions totaling $1.307 billion to 67 transactions totaling $2.840 billion by year-end. In other words, the third and fourth quarters of the year brought about a 117% increase in capital levels within a six-month period. Fundraising activity also grew considerably in the latter half of 2009: 19 fund closings totaling $2.327 billion in June rose to 40 fund closings totaling $5.034 billion in December. This capital growth translates into a 116% rate of improvement. Lastly - and similarly - exit activity grew by 40% in the last six months of 2009. Seven transactions totaling $2.600 billion increased to sixteen transactions totaling $3.643 billion. But these are not the only angles at which one can see signs of encouragement. Despite lower overall capital levels in 2009, there has been more investment activity in almost every country and/or region of Latin America this past year than a year earlier. Argentina, Brazil, Mexico, the Andean region, and Central America all saw increased levels of venture and private equity investment in 2009. So, it appears that limited partners are not losing interest in Latin America, but rather, they are simply re-pricing the risks on investment and re-strategizing for the future. What is also happening these days is that local inves3 tors, particularly those who have been least humbled by the global economic downturn, are also getting in on the game. As Michael Fitzgerald, Chairman of the Latin America Practice Group of Milbank, Tweed, Hadley & McCloy LLP explained, for the first time in the history of the two economies, the U.S.s and Latin Americas tables have turned.2 Within the last few months, there has been an explosion in the amount of access that Latin American companies have to U.S. capital, Fitzgerald said. Interestingly, the market had been completely closed up to mid-2009, when changes began taking place rapidly. The explosion Fitzgerald points to might also account for the explosive growth in activity that took place in Latin America in the latter half of 2009.

When looking at the sheer number of deals, funds and exits that took place in the region over the course of 2009, it is interesting to see that there has been a marked rise in activity, originating not only from foreign direct investors but local ones as well.
Hottest Sectors, Biggest Deals in Latin America 2009 The most popular sectors for private and venture equity investment across Latin America in 2009 were: the financial services sector in first place, the housing/ education/consumer products sectors in second place, and the energy/healthcare sectors in third. Of course, these rankings vary by individual country, depending on the economic and political stability of the country in question. Brazil, for example, has been considered in many respects to be the frontrunner of the Latin American region for some time now, leading the pack not only in terms of infrastructure and political stability but also in terms of tax laws, domestic fundraising and accounting standards. In effect, most of the biggest deals of the year, which registered at $100 million or more, took place there: Brazilian infrastructure group Invepar invested $445 million in Metro de Rio in January. The investment was made in support of the development of Brazils subway system. Other known investors included Citigroup VC, Brazilian fund IIFIP and Brazilian pension fund Valia.
2009 Year-End Report, Continued on page 4

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2009 Year-End Report (from page 3)

Private equity firm Riverstone Holdings LLC bought out Pattern Energy Group LP from Babcock & Brown LP for $400 million in June. The investment was used to operate renewable energy and transmissions assets across Latin America. Brazils second largest private bank Bradesco acquired a 43.5% stake and partial control in dental insurance manager OdontoPrev in November. The deal was estimated to be worth around $380 million. South Africa-based Naspers acquired a 91% stake in price comparison website BuscaP for $342 million in October. U.S. private equity firm the Carlyle Group bought a nearly 64% controlling stake in Brazils largest tourism agency CVC Turismo for an estimated $250 million in December. So Paulo-based investment bank BTG Pactual committed approximately $174 million of its Brasil Energia Fund to ERSA, a Brazilian company dedicated to renewable energy, in November. Private equity firm Advent International acquired a 30% stake in CETIP, Latin Americas largest clearing house, for $170.6 million in April. A mere five months later, Advent floated its portfolio company via an IPO and raised $508 million.

The private equity unit of Capital International acquired a 15% stake in regionally-operating agribusiness El Tejar for $150 million in December. Fundraising, Exits More Equitable in 2009 While Brazil captured most of the biggest deals in 2009, fundraising activity told a different story. There was a fairly equitable spread in activity between Brazilian, Colombian and regional funds in 2009. Brazil did manage to chalk up $1,882 million in fundraising this past year, making it the relatively largest draw for investors and fund managers in 2009 (i.e. 30.65% of total activity). However, regional funds raised a collective $1,833.70 million (29.86%) in 2009, and Colombia racked up $1,711.75 million (27.87%), illustrating that other countries in Latin America are beginning to gain on Brazil in terms of attractiveness. As for other parts of the region, Mexico accumulated $408.20 million (6.65%) in fundraising and Peru, $302 million (4.92%). Fitzgerald shed light on why some of the Latin American underdogs are pulling a stronger draw of investors in 2009. Mexico, Fitzgerald argues, is one of the most promising Latin American countries thanks to its now investment-grade status; Peru and Chile both show promise because there is significant investment from Asia there, which creates export driven economic development.3 As for Colombia, while a free trade agreement with the U.S. has been concluded but not approved, the country

Latin American Investments 2005-2009: Year-on-Year Comparison by Country and Region

Regional 200 2009 9 Andean* 200 2008 8 200 2007 7 200 2006 6

Country or Region

Central America

Chile

2005 200 5
Mexico

Brazil

Argentina

$0.0

$1,000.0

$2,000.0

$3,000.0

$4,000.0

$5,000.0

$6,000.0

Private Fund Investments in Select Countries and Regions in Millions of U.S. $

LATIN AMERICAN LAW & BUSINESS REPORT

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regional
has warm relations with the U.S.,7 thanks to an amicable business environment and reliable monetary policy.4 Not surprisingly then, of the thirteen biggest funds registered at $100 million or more in 2009, six were regional, five were in Brazil, and two in Colombia including the biggest fund of the year: Vision Brazil Investments and Paladin Capital Groups joint commitment of $1 billion to the Vital Renewable Energy Company. Not only was there an abundance of fund closings in 2009 (40 funds at year-end, compared to 2008s 25), there was also a significantly increased number of exits. While ten exits were recorded at year-end 2008, sixteen were recorded at year-end 2009. The four biggest exits all took place in Brazil the largest being UBSs trade sale of Banco Pactual to BTG Investments for $2.5 billion in April but notwithstanding, there was still exit activity seen across the region as well. Thus, while one year ago, investors were advocating that firms should operate on a wait-and see basis to determine just how severely Latin America would be impacted by the financial crisis, now investors are waxing optimistic. Friederike Hofmann of the Swiss Investment Fund for Emerging Markets emphasized in a recent interview that as far as Latin Americas private equity landscape is concerned, more governmental commitment and more competition will be needed for growth, but once liquidity levels reach their pre-crisis levelseveral Latin American countries will offer the type of returns investors seek.5 o
1 Dimansecu, Katherine, In 2008, Much of Latin American Private Equity Activity Centered Around Brazil and the Andean Region, Venture Equity Latin America 2008 Year-End Report, p. 6. 2 Fitzgerald, Michael, Venture Capitalists Look South to Hot Latin American Market, Venture Equity Latin America, 1/15/10, Vol. IX, no. 1. 3 Fitzgerald, Michael, Venture Capitalists Look South to Hot Latin American Market, Venture Equity Latin America, 1/15/10, Vol. IX, no. 1. 4 Weil, Dan, Interview with Swiss Investment Fund for Emerging Markets, Venture Equity Latin America, 10/31/09, Vol. VIII, no. 17. 5 Weil, Dan, Interview with Swiss Investment Fund for Emerging Markets, Venture Equity Latin America, 10/31/09, Vol. VIII, no. 17.

Changes in the Political Landscape

By Walter Molano (BCP Securities, LLC) Latin America is enjoying one of the most prosperous periods of the past century. However, there are major political changes lurking close on the horizon. The strong personalities who dominated Colombia, Argentina and Venezuela for the last decade may be coming to an end. Draped with the veil of democracy, these leaders ran roughshod over their countries institutions. Their populist approaches appealed to the lowest common denominator, which was security in Colombia and income distribution in Argentina and Venezuela. However, they reached the limit of their power. In Colombia, the countrys judiciary finally reasserted its control over the countrys constitution. In Argentina, the opposition finally took control of the legislature, and in Venezuela, the collapse of the countrys infrastructure, due to years of neglect, will ultimately test the patience of the electorate. Therefore, big political changes are in store for these three countries. Yet, they are not the only ones with changes on the horizon. Chile, Brazil and Peru may also be in for political altercations. Chiles election of Sebastian Pinera was a good example of a free democratic process in Latin America. The process was a fair contest between two equally
Walter Molano (wmolano@msn.com) is head of research at BCP Securities, LLC in Greenwich, Connecticut, tel: 203629-2759.

prominent contenders. Moreover, there was not much difference in their platforms or proposals. It was basically the continuity of an economic model that worked so well for the past thirty-five years. However, the devastation of much of central-southern Chile is going to have major political implications as the country decides how to distribute resources and reconstruct the damaged

latin america is enjoying one of the most prosperous periods of the past century. However, there are major political changes lurking close on the horizon.
regions. There will be major confrontations between the Concertacion and the political right as the government decides whether to focus on spending limited resources on social assistance or infrastructure. Brazil is also on track for important political changes. The looming election of Dilma Rousseff as the next president of Brazil will probably lead to further encroachment into the private sector. Through the use of its state-owned vehicles, such
Political Landscape, Continued on page 6

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Political Landscape (from page 5)

as BNDES, Caixa Economica and Petrobras, the Brazilian state is taking a more dominant role in private sector activities. So far, other than some criticism by former President Fernando Henrique Cardoso, there has been little objection. On the contrary, the states assistance was welcomed as the country navigated the economic turbulence of the global credit crunch. However, such aid always comes with strings attached, and at some point the PT will try to use the economic apparatus to assert its social and organized labor policies. Likewise, Peru is also on the cusp of important political changes. With presidential elections only 13 months away, the country will most likely elect a family member or close ally of former President Fujimori. This will probably lead to his eventual release and the reopening of a very painful and controversial issue. The political pendulum often swings violently in Latin America. The fact that some of the largest Latin American countries are led, or are about to be led, by former guerrillas, subversives or political prisoners says at lot about the region. It does not speak well about the economic establishment and elite, who seem to be incapable of managing their countries political institutions. It also highlights the regions inherent instability. Such personalities, such as terrorists and

political renegades, are often prone to extreme actions and convictions. More importantly, it underscores Latin Americas biggest flaw--the absence of a coherent and functional political party system. Political parties are important vehicles that aggregate preferences and articulate them into political platforms that can be presented to the electorate. In other words, political parties narrow down the diverse needs, desires and pressures of a society into a neat set of competing menus that can be selected during the democratic process. The absence of such a system puts equally everything on the table, and forces the electorate to select the candidate who appeals to the lowest common denominatorwithout any consideration to what will be the wider ramifications. Not surprisingly, the Latin American countries with the best articulated party systems, such as Brazil, Chile, Uruguay and Mexico, are the most economically stable. Colombia may be on the verge of assembling a new party system, and there are thin shadows of the old parties in Argentina taking form. Nevertheless, even the best political parties in Latin America are far from being the representative institutions that are still seen across parts of Europe and North America. Most of them are political machines that mainly serve the interests of the integrants, thus leaving large parts of the population without a voice. Therefore, with the region in the midst of its presidential electoral process, we must be prepared for seismic shifts on the political front. o

2009 Year-End Report

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March 2010

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regional

Pending United States FTAs with Colombia, Panama Not a Priority for United States in 2010
By James Shea (White & Case) On March 1, 2010, the Office of the United States Trade Representative (USTR) released the 2010 Trade Policy Agenda and 2009 Annual Report of the President of the United States on the Trade Agreements Program. The report discusses the Obama Administrations trade priorities for 2010 and presents an overview of 2009 trade activities and USTR initiatives.1 According to the report, the Presidents 2010 trade agenda will focus on: (i) increasing US exports, with the goal of doubling US exports in the next five years; (ii) enforcing labor and environmental provisions in existing and new Free Trade Agreements (FTAs); (iii) updating the model of the US Bilateral Investment Treaty; (iv) supporting the Administrations commitment to the rules-based global trading system; and (v) responding to unfair foreign competition through new dispute proceedings at the World Trade Organization (WTO) or action through other mechanisms. The Administrations report, however, does not prioritize passage of pending FTAs with Panama, Colombia and Korea. Regarding these pending FTAs, the report states that proper resolution and implementation of [these agreements] can bring significant economic and strategic benefits but issues of concern persist, including labor and tax transparency issues in Panama, violence against labor unions and issues with labor rights in Colombia, and outstanding issues as related to automobiles and beef in Korea. The report notes that the Administration will work with Congress on a timeframe to submit the pending FTAs for Congressional consideration but does not provide a clear timeframe for submission of the agreements. On the North American Free Trade Agreement (NAFTA), the report notes that the Administration will examine how to recalibrate the NAFTA and explore how best to make improvements in labor practices and policies, and environmental practices and policies. Days after the issuance of the report, the Senate Finance Committee held a hearing on March 3 on the Obama Administrations 2010 agenda where USTR Ron Kirk provided his views on the report and the Administrations trade stance. The hearing served as an
James Shea (jshea@washdc.whitecase.com) is Director of U.S. Trade Services with White & Case, in the Washington, D.C. office.

opportunity for the Administration to make its case before Congress regarding which trade priorities US legislators should draw their attention to in 2010. US legislators, however, criticized the lack of detail in the Administrations trade agenda, in particular with regards to a timeframe for passage of pending US-Latin American FTAs with Colombia and Panama.

US legislators, however, criticized the lack of detail in the Administrations trade agenda, in particular with regards to a timeframe for passage of pending US-latin american FTas with Colombia and Panama.

Although Senate Finance Committee Chairman Max Baucus (D-MT) endorsed passage of pending FTAs with Colombia, Panama and Korea, he also called on the Administration to ensure that US trading partners do not gain unfair advantage by failing to adopt or enforce basic labor rights and environmental protections. Senate Finance Committee Ranking Member Charles Grassley (R-IA) criticized the 2010 Trade Policy Agenda for gaps in the level of detail provided by the President. He noted that the 2010 trade agenda states that the United States will continue to engage with the Governments of Panama, Colombia, and Korea as the Administration further refines its analysis of outstanding issues but it does not indicate where we are on that engagement, or when future meetings are planned with the governments of Colombia and South Korea to iron out resolutions to the Administrations concerns. He opined that delay in implementation of the pending FTAs hurts US credibility around the world, not just economically, but geopolitically as well and creates some confusion with respect to the Administrations own trade initiatives. USTR Kirk reiterated the Administrations commitment to work with Congress to support passage of the pending FTAs and stated that approval of these FTAs is a priority [and the Administration is] working to resolve the outstanding issues so that we can move
Pending US FTAs, Continued on page 8

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Pending US FTAs (from page 7)

forward on trade agreements with South Korea, Panama and Colombia. In particular, USTR Kirk stated that the Administration would finalize a list of requirements for the Colombian government within the next several months in terms of promoting worker rights and reducing violence against labor officials in that country. USTR Kirk, however, did not provide a deadline for submission of these agreements before the US Congress. Trade observers who were hoping for a clearly outlined US trade policy in the 2010 Trade Policy Agenda may find the report lacking in details and specifics on the Administrations views and approach to trade. In fact, much of the language in the report appeared similar to the 2009 Trade Policy Agenda in terms of general descriptions and vague policy outlines. On the pending FTAs with Colombia, Panama and Korea, the Administration provided no clear indication on the fate of these agreements and reiterated US concerns regarding contentious issues that must be resolved within each agreement before the Administration can submit the FTAs to Congress. When compared to the 2009 Trade Policy Agenda, the 2010 Trade Policy Agenda shows just how little the Administration has moved on the agreements.

In 2009, the Administration noted that it was in the process of developing a plan of action to address the pending trade agreements in consultation with Congress, and even indicated its hope to move on the pending USPanama FTA relatively quickly and its intent to establish benchmarks for progress on the Korea and Colombia agreements.

The current debate on domestic highpriority issues, combined with the lack of FTa activity from the administration and its rather vague trade policy agenda, make it unlikely that Congress will consider the pending FTas with Colombia and Panama in the short-term, and provide more evidence that US-latin america trade will remain a low-priority item in the Administrations trade 2010 agenda.
To date, the Administration has not provided any signal that it intends to move on the Panama agreement in the short-term, and it has not established the benchmarks it promised in its 2009 report, although USTR Kirks statement on the Colombia FTA at the hearing and how the Administration would like to establish those benchmarks could signal renewed hope for these FTAs in 2010. Despite USTRs efforts, the timing of Congressional consideration of pending US FTAs with Colombia and Panama remains unclear. President Obama has not made any statements as to how he plans to work with Congress in moving the pending FTAs forward and according to USTR Ron Kirk, the Administration must still address existing problems before it can move forward on the agreements. Meanwhile, in Congress, legislative votes on other pieces of legislation mainly domestic bills are ahead of the Colombian or Panamanian agreements. The current debate on domestic high-priority issues, combined with the lack of FTA activity from the Administration and its rather vague trade policy agenda, make it unlikely that Congress will consider the pending FTAs with Colombia and Panama in the short-term, and provide more evidence that US-Latin America trade will remain a low-priority item in the Administrations trade 2010 agenda. o
1 The full report is available at: http://www.ustr.gov/2010-tradepolicy-agenda.

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Brazil

Changes to Lease Rules in Brazil

By Ana Beatriz Nunes Barbosa (Denis Borges Barbosa Advogados) The Brazilian Law for real estate leasing was amended and the changes became enforceable on 01/25/10. The amendments pursued, mainly, to expedite the judicial procedures in situations of breaches or termination, enabling the lessor to recover the real estate faster. Thus, injunctions were made possible for cases when the real estate is in need for urgent repairs, lack of substitution for warrants, end of term for commercial leases without judicial dispute for renewal and lack of payment that remains after fifteen days from the summoning for judicial deposit of accrued values. The lessee that is in breach also has the possibility of a fifteen day term for remedying the breach when there is no right to a preliminary ruling. However, there are some temporary limitations: lessee cannot make use of such possibility if he has already has done it twenty four months before the new suit. For the guarantor there were also some changes: i) if there is a transfer of the lessee condition to another person (that can occur, e.g., when the lessee dies or has a
Ana Beatriz Nunes Barbosa (anabeatriz@nbb.com.br) is a Partner with Denis Borges Barbosa Advogados, in the Rio de Janiero office.

divorce, and the former spouse remains as new lessee), guarantor can request his exclusion, while continuing to warrant the situation for additional one hundred and twenty days from notice; ii) the Law now clarifies that the lease warranties remain if there is a contract extension from limited to non limited term (but there can be an exclusion by means of notice to lessor, remaining liable for one hundred and twenty days from notice); and iii) lessor can require the replacement of a warrant if the guarantor is in judicial recovery. Many improvements were made to procedural aspects of the Real Estate Lease Law, adjusting the Law to the process legislation sanctioned in the last years. Regarding this issue, the legislator incorporated into the contract renewal suits the general rule applicable to leasing suits, that appeals against judicial ruling do not have a suspending effect. Therefore, the recovery of the real estate, when decided by the judge, is more effective, and there is no longer the need to wait for all the appeals granted in the judicial procedure code. Hence, the Law seeks to expedite the existing mechanisms and make the procedure more dynamic, as well as to enable that, with a more efficient process, the guarantor might be less required, facilitating the real estate offer in the Brazilian market. o

Cross-retaliation with Respect to Intellectual Property Rights:

Provisional Measure No. 482 of February 10, 2010 - A Step Forward in the Cotton Case Between Brazil and US at WTO
By Andr Zonaro Giacchetta, Ren Guilherme S. Medrado and Mrcio Junqueira Leite (Pinheiro Neto Advogados) Brief Overview of the Cotton Case and Possibility of Application of Countermeasures in WTO Disputes In 2002, Brazil initiated a dispute against the United States at the Dispute Settlement Body (DSB) of the World Trade Organization (WTO) over the legality of certain subsidies which were granted for US cotton
Andr Zonaro Giacchetta (azgiacchetta@pn.com.br) is a Litigation Partner in the Intellectual Property group of Pinheiro Neto Advogados. Ren Guilherme S. Medrado (rmedrado@ pn.com.br) is a Litigation Partner in the International Trade group of Pinheiro Neto Advogados. Mrcio Junqueira Leite (mjunqueira@pn.com.br) is a Litigation Associate in the Intellectual Property group of Pinheiro Neto Advogados. All are in the So Paulo, Brazil office.

production and export and which led the United States to rank second in the worldwide trade of such commodity. Brazil won this dispute (popularly known as the cotton case) in all WTO instances, having DSB confirm that the Unites States failed to implement the recommendation for removal of such subsidies, which caused losses over US$ 800 million to Brazil up to 2009. Under this WTO ruling, Brazil was authorized to apply trade countermeasures, pursuant to article 22 of WTOs Understanding on Rules and Procedures Governing the Settlement of Disputes (DSU). As a rule, the country applying for suspension of concessions or obligations, when a WTO member fails to comply with multilateral obligations, shall first seek
Intellectual Property Rights, Continued on page 10

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Intellectual Property Rights (from page 9)

suspension with respect to the same sector involved in the dispute. If the complaining member evidences that such measure would not be practicable or effective, it may apply for suspension of obligations under another WTO agreement, i.e. the so-called cross-retaliation (article 22.3(b) of DSU). This means that, if the complaining member evidences that retaliation in the sector where the violation occurred (GATT 1994 or Agreement on Agriculture, for instance) would not be practicable or effective, or that retaliation in other sectors covered by the same agreement (GATT 1994) would not achieve the intended results or would injure the domestic market itself (i.e. increase in the import duty rate for goods of paramount importance for the domestic economy), it may apply for retaliation in other sectors covered by other WTO agreements, such as GATS (services) or TRIPS1 (trade-related aspects of intellectual property rights). Even before the end of the WTO dispute, the possibility of cross-retaliations (particularly with respect to intellectual property rights), which affect strategic sectors sensitive to huge economic impacts, had been discussed in Brazil through Bill No. 1893/2007, sponsored by Congressman Paulo Teixeira (PT-SP).2. Within this context, on the initiative of the President of Brazil, Provisional Measure No. 482 (MP) was published on February 10, 2010, establishing measures for suspension of concessions or other obligations of the Country in connection with intellectual property and other rights, if a WTO Member fails to comply with its multilateral obligations, to the extent that Brazil has been authorized by WTOs DSB to suspend application, to that Member, of concessions or other obligations under WTO Agreements. Provisions of the MP - Possibility of Imposing Restrictions with Respect to Intellectual Property Rights As defined by the MP, intellectual property rights are those relating to: (a) literary, artistic and scientific works; (b) performing artists or performers, producers of phonograms (sound recordings) and broadcasting organizations; (c) computer programs; (d) trademarks; (e) geographical indications; (f) industrial designs; (g) invention patents and utility models; (h) cultivars or plant varieties; (i) topographies of integrated circuits; (j) confidential or undisclosed information; and (k) other intellectual property rights prescribed by applicable law. The MP provides for the possibility of adopting the following measures against natural persons who are nationals of or are domiciled in a certain State, or legal persons that are domiciled or have an effective establishment in a certain State, when they fail to March 2010

implement decisions or recommendations of WTOs DSB to the detriment of Brazil: I - suspension of intellectual property rights; II - limitation on intellectual property rights; III - change in measures for application of rules on protection of intellectual property rights; IV - change in measures for acquisition and maintenance of intellectual property rights; V - temporary impediment to remittance of royalties or fees relating to the exercise of intellectual property rights; and VI - application of trade-related rights to the fees of the owner of intellectual property rights.

as stated in the MP, if the owner of the intellectual property rights fails to comply with the countermeasures, it will pay fines and interest, which may be controlled by the Federal Revenue Office and entered in the Federal Debt roster for further collection.

Sole Paragraph. For purposes of application of the measures dealt with in this article, the provisions concerning the registration procedures under applicable laws shall be taken into account, with due regard for the duties entrusted to the National Industrial Property Institute - INPI and to the Ministry of Agriculture, Cattle Breeding and Supply. The MP further provides for the way of implementing the countermeasures, which may be applied individually or cumulatively, in the manner approved in a resolution of the Board of Ministers of the Foreign Trade Chamber - CAMEX, always on a temporary basis: I - postponement of the initial protection as from a date to be defined by the Executive Branch, with the consequent reduction in the term of protection, with respect to applications for protection of intellectual property in progress; II - subtraction of the term of protection, for a definite period, at any time of its duration; III - licensing or public non-commercial use, without the owners authorization; IV - suspension of the owners exclusive right to impede the importation and marketing in the domestic market of products that incorporate patent rights, even though the imported product has not been placed on the foreign market directly by the intellectual property right owner or with its consent; V - increase or creation of a surcharge on the amounts owed 10

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to the bodies or entities of the public administration for registration of intellectual property rights, including acquisition and maintenance thereof; VI - temporary impediment to remittances of royalties or fees relating to exercise of intellectual property rights of the licensees that are nationals of or are authorized in the Brazilian territory; VII - application of trade-related rights to the fees to which the intellectual property right owner is entitled; or VIII - creation of the obligation of registration to acquire and maintain intellectual property rights. As stated in the MP, if the owner of the intellectual property rights fails to comply with the countermeasures, it will pay fines and interest, which may be controlled by the Federal Revenue Office and entered in the Federal Debt Roster for further collection. Difficulties and Possible Obstacles to the Proposed Countermeasures Notwithstanding the outstanding role Brazil has taken in multilateral trade negotiations, particularly after the recent economic crisis, some of the proposed countermeasures are questionable in terms of applicability, causing as well adverse effects on Brazil. This is because, in addition to being questionable as to their effectiveness, most of the suggested retaliations encounter constitutional barriers and cause legal insecurity not only to the owners of the intellectual property rights, but also to the society at large and to those electing to lawfully exploit some of these rights, on a temporary basis, during imposition of the countermeasure. First, measures such as postponement of the initial protection or reduction in the term of protection, with respect to applications in progress, are not very effective, considering that not all intellectual property rights require registration, which is not necessary in the case of copyrights. Moreover, applicants for trademarks, patents and industrial designs at INPI have a mere expectant right, and are not strongly affected by postponement of the term of protection. With respect to patents, there is one more hurdle as their protection is retroactive to the filing date, regardless of INPIs delay in the examination procedure. On the other hand, measures such as subtraction of the term of protection, licensing or public noncommercial use or suspension of the patent owners exclusive right to impede importation of products that reproduce the patent subject matter, are subject to the allegation of unconstitutionality and cause enormous legal insecurity. In fact, subtraction of the term of protection or suspension of the owners exclusive right to prohibit imports, in addition to producing clear economic effects, would render temporarily lawful the performance of an act normally held as a crime, such as undue use of 11 a trademark or improper exploitation of a phonogram protected by copyrights. After reestablishment of the protection and, consequently, of the exclusive right to use the intellectual property right, the respective owners of the suspended rights would face great difficulties in retuning to the status quo ante, i.e. would come across products placed on the market by companies that took advantage of the suspension of intellectual property rights in reliance on the MP.

notwithstanding the outstanding role Brazil has taken in multilateral trade negotiations, particularly after the recent economic crisis, some of the proposed countermeasures are questionable in terms of applicability, causing as well adverse effects on Brazil.
Despite having provided for the retaliations that could be undertaken and implemented, the MP failed to establish the procedure by which the intellectual property right owners affected by the MP can apply for return to and reestablishment of the state of affairs prior to application of the cross-retaliations. Apparently, the only effective countermeasures, among those suggested, which in principle have no immediate adverse effects, are the following: (i) increase or creation of a surcharge on the amounts owed to public bodies; (ii) temporary impediment to remittance of royalties abroad;3 or (iii) application of trade-related rights to the fees payable to the owner of intellectual property rights (which, as defined in the MP, would be in the form of a percentage of the fees, i.e. an extraordinary charge earmarked to the Ministry of Development, Industry and Foreign Trade - MDIC and channeled into foreign trade actions). In other words, the most secure and effective countermeasures refer predominantly to the tax and foreign exchange areas, regarding which the State already has vast knowledge and experience, and their application would not entail immediate problems or legal insecurity to the intellectual property right owners and to society at large. Conclusion The MP shows that the Brazilian government is definitively willing to avail itself of the countermeasures provided in the WTO Agreement to seek effective impleIntellectual Property Rights, Continued on page 12

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Brazil

Intellectual Property Rights (from page 11)

mentation, even forced, of the favorable recommendations obtained in the disputes conducted within the WTO. Undoubtedly, the possibility of adopting countermeasures with respect to intellectual property rights in the Brazilian territory will have repercussions on strategic sectors and cannot be overlooked or ignored by other Brazils partners at WTO. The Brazilian government must carefully evaluate the proposed measures, their nature, experience in their application, legal and economic repercussions and potential adverse effects, so that they can ultimately produce limited and specific effects that focus only on modification of the behavior of the member complained against. For their part, companies having their interests affected by potential application of countermeasures with respect to intellectual property rights may report to the competent authorities the reasons why they believe such countermeasures would be ineffective or abusive if applied to their activities.

In conclusion, the purpose is not to deny the Brazilian government the possibility of undertaking cross-retaliations when the situation so requires (after exhaustion of the possibility or effectiveness of retaliations in the same sector of the dispute) under the WTO rules. However, the Brazilian government must pursue the necessary balance with respect to trade interests, constitutional guarantees, defense of public and eminently private interest, so that this already successful chapter of Brazilian diplomacy culminates in recognition of the countrys fairness in imposing the sanctions authorized by WTOs DSB. o
1. Trade Related Aspects of Intellectual Property Rights TRIPS), adopted by Brazilian law through Decree No. 1355 of December 30, 1994. 2. On August 31, 2008, we published an article titled Bill No. 1893/2007 and Possible Application of Countermeasures to Intellectual Property Rights for Failure to Comply with the Decisions rendered within the Dispute Settlement System of WTO. (available at www.pn.com.br) 3. Such countermeasure was adopted by Ecuador against the European Union for maintaining measures in connection with banana trade in that common market, which were considered incompatible with GATT 1994 and GATS (Case WT/DS27/ ARB/ECU, of March 24, 2000).

Brazilian CFC Rules: Background and Status After Eagle II Case

By Leonardo Freitas de Moraes e Castro (L.O. Baptista Advogados) Worldwide Income Tax and CFC Rules in Brazil Legal Background As a general rule, income by corporations in Brazil is taxed by IRPJ (25%) and CSLL (9%), at an overall income tax burden of 34%. Until 1995, however, the offshore income assessed by corporations was not taxed in Brazil for Income Tax purposes, since the country at that time adopted the Territoriality Principle. Conversely, as from January 1, 1996 Brazil adopted the Worldwide Income Tax for Corporate Income Tax (IRPJ) purposes. Therefore, from that year all profits, proceeds and capital gains derived from offshore jurisdictions had to be added to the Accrual Tax Regime (Lucro Real) through the balance sheet on December 31 of every year (art. 25 of Law 9.249/95). As from October 1, 1999 profits, proceeds and capital gains from offshore jurisdictions were also taxed by CSLL, Leonardo Freitas de Moraes e Castro (lfc@baptista.com. br) is an Associate lawyer at L.O. Baptista Advogados in So Paulo, Brazil, and Professor of tax law at Trevisan Business School. His practice includes tax consulting, international taxation and tax planning. March 2010 and not only by IRPJ (Provisional Measure 1.858-6/99). From such year on, Brazil fully adopted the Worldwide Income Tax Principle for corporations. At that time there was no Controlled Foreign Corporation rule (CFC rules) in force in Brazil. It was in 2001, that Supplementary Law nr. 104 was enacted, and it added paragraph 2 to article 43 of Brazilian Tax Code (CTN), giving it the following wording: Art. 43. Federal Government tax on income and earnings of every nature will be assessed on the acquisition of economic or legal availability(...) 2 In regard to income and earnings from offshore, the law will set forth the conditions and the moment such availability will occur, for the tax mentioned herein Afterwards, in the same year, Provisional Measure 2158-35 finally introduced the supposed CFC rules in Brazil, stating that In regard to the tax base of income tax and social contribution on net profits, according to art. 25 of Law 9.249/95, and art. 21 of this Provisional Measure, the profits received by controlled and associated companies offshore will be considered available to the controlling or associated company in Brazil at the date in which they were accounted through balance sheet, in terms of this code. 12

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Scope of Application of Brazilian CFC Rules The definitions of controlled and associated company are set forth in the Brazilian Law of Corporations, i.e., Law nr. 6.404/76, which were recently broadened by modifications made through Law nr. 11.941, in 2009. Now, the current wording of Law 6.4040 comprises basically almost every related party, as can be verified from the new definitions: Art. 243. (...) 1o Associated companies are the ones in which the investor has relevant influence 2 Controlled companies are the ones in which controlling company, directly or through other controlled companies, is entitled to shareholders rights that assures it, permanently, the preponderance on companys resolutions and the power to elect the majority of its managers. () 4 There is relevant influence when the investor has or exercises the right to participate in the financial and operational policy of the invested company, without controlling it. 5o It is presumed the relevant influence when the investor is holds 20% or more of the voting stock of the invested company, without controlling it. Apart from the wide concept of associated and controlled companies subject to CFC rules, one of the main discussions regarding this matter relies on the legal nature of those provisions. The scholars and courts in Brazil havent reached a conclusion on what is really being taxed by Brazilian CFC rules: deemed dividends or presumed business profits. Firstly, it is important to point out that the foreign commercial legislation is the one applicable to determine the profits subject to taxation in Brazil, and not the fiscal legislation. In our opinion, the Brazilian CFC rule mentioned in Section 74 of Provisional Measure nr. 2158-35/2001 taxes the business profits of controlled/associated companies abroad, and not the dividends presumably distributed to the controlling/associated company in Brazil, since the taxable base is the assessed profit (not deducted from local taxes, legal reserves and others, which are previously deducted for the distribution of dividends be made). One other peculiar aspect of Brazilian CFC rules, referred on art. 74 of Provisional Measure 2.158-35/2001, is that they do not follow the international standards of other countries, which are normally applicable (i) only to passive income (dividends, royalties, interests and real estate/lease); or (ii) only to tainted capital (passive and active income from related parties); or (iii) only to CFCs located in tax havens or low tax jurisdictions; or (iv) also applicable to individual residents in the country imposing the CFC rules, and not just for corporations. In contrary, Brazilian CFC rules only apply to corporations, not necessarily in tax havens and to all their income, both active and passive, notwithstanding existence of substance, business purpose and effective business carried out offshore. March 2010 Current Supreme Court Understandings on CFC Rules The constitutionality and legality of Section 74 of Provisional Measure 2158-35/2001 is being questioned at the Brazilian Supreme Court (STF), through Declaratory Action of Unconstitutionality (ADIN) nr. 2588.

The scholars and courts in Brazil havent reached a conclusion on what is really being taxed by Brazilian CFC rules: deemed dividends or presumed business profits. Firstly, it is important to point out that the foreign commercial legislation is the one applicable to determine the profits subject to taxation in Brazil, and not the fiscal legislation.
The grounds for such claim relies on the presumed taxation of undistributed business profits detained by a controlled or associated company offshore at the end of every fiscal year or whenever the law requires a balance sheet for tax purposes, notwithstanding the judicial or economical availability of income required in Section 43 of the CTN. The ADIN 2588 claims the unconstitutionality of paragraph 2 of Section 43 of CTN, included by Supplementary Law 104/01, and art. 74 of Provisional Measure 2.158-35/2001. So far, the status of the judgment at Brazilian Supreme Court is 3 votes against and 3 votes in favor of the unconstitutionality, from a total of 11 possible votes, which makes this leading case on CFC rules completely unpredictable. CFC Rules and Double Tax Treaties The discussion on whether the CFC Rules in Brazil taxes dividends of business profits gains more importance when applied to cross boarder situations in which there is double tax treaty entered by Brazil and the offshore jurisdiction. Nonetheless, as it will be demonstrated - this qualification issue should not affect the conclusion on the impossibility of taxing foreign profits accrued by associated/controlled companies abroad, although intentional misunderstandings from Tax Authorities may lead to a different conclusion. According to Article 7 of OECD Model Convention (MC), Business Profits can only be taxed by the Residence State, i.e., it set forth the exclusive right to tax by the Residence State (the profits of an enterprise of a Contracting
Brazilian CFC Rules, Continued on page 14

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Brazil

Brazilian CFC Rules (from page 13)

State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein). Since 2003, the OECD has changed its original position from 1992 to state that CFC rules are not in conflict with the Model Convention, for the reason that such rules do not tax the entity (juridical double taxation) but its shareholders (economic double taxation), that being permitted by the Convention itself. Nevertheless, due to Article 7 of OECD MC business profits, i.e., the profits attributable to controlled/associated company offshore, could not be taxed in Brazil until the effective payment/distribution, unless there was a tax evasion, treaty shopping or treaty abuse that justified this procedure. On the other hand, Article 10 of OECD MC establishes that income derived by dividends shall be subject to cumulative taxation, from both Residence and Source States: 2) However, such dividend may also be taxed in the Contracting State of which the company paying the dividends is a resident and according to the laws of that State () The mention of the term paying gives the idea of putting funds at the disposal of the shareholder. In the presumed dividends, even by the wide interpretation, one cannot conclude that such dividends were actually paid to the Brazilian company. By adopting the approach that Article 10 allows the Residence State to tax the income - observing the 15% Withholding Income Tax limit, suggested in OECD MC Brazil could tax such income derived from dividends at the shareholder level, if it wasnt for Article 23 (A or B) of OECD MC, which often grants exemption for such income. For instance, Article 23 4 of Brazil-Spain Treaty provides that Where a resident in a Contracting State derives income from dividends that, according to the provisions of this Convention, may be taxed in the other Contracting State, the first-mentioned State shall exempt such income. In spite of such clear provision, the Brazilian Administrative Court (CARF) rendered the Decision nr. 101-95.802, on October 19, 2006 (Eagle I Case) mentioning that, according to Brazil-Spain Double Tax Treaty the profits accrued by a company resident in Spain cannot be taxed in Brazil (except if attributable to a permanent establishment). Additionally, Brazil is not entitled to tax dividends received by a resident in Brazil that, according to such double tax treaty, are taxable in Spain. However, the Eagle I case was converted into diligence by the CARF in order to check doubtful facts considered relevant to the decision of such case. For that reason, the same taxpayer (Eagle Distribuidora de Bebidas S.A.) was, in 2008, involved in a new administrative tax decision, informally referred as Eagle 2 Case. Although the facts of this second administrative fiscal proceeding were similar to the first case, the legal argu14

ments sustained by Tax Authorities changed, due to the fact that the original arguments from 2006 were not sufficient to rule in favor of the Federal Revenue Office, after the fact checking diligence. The Eagle II Case Eagle Distribuidora de Bebidas S.A, a company resident and located in Brazil, has a wholly-owned subsidiary in the Canary Islands (Jalua), considered as Spanish territory resident. By its turn, Jalua is a shareholder of a company in Uruguay (Monthiers) and Argentina (CCBA).

it is important to note that neither Monthiers or CCBa had distributed their profits to Jalua, neither recognized such results in its books.
As already mentioned herein, according to the Brazilian CFC rules any income (both active and passive) of controlled companies established abroad (in any country, not only in tax havens) will be considered as distributed to the Brazilian company on December 31 of each year (end of fiscal year ) There is no requirement in the Brazilian CFC rules regarding the proof of abusive tax planning, substance over form doctrine, lack of business purpose etc. It simply considers the income distributed on the last day of the fiscal year, and taxes it (granting the correspondent tax credit of what has been paid in the country where the CFC is located). However, in this case there is a double tax treaty entered by Brazil (Eagle) and Spain (Jalua), which led many tax experts to rely on its provisions to state the non-application of CFC rules. Despite such understanding, Brazilian Tax Authorities considered the presumed or fictitious distribution of profits of Jalua to Eagle. The main issue of this case was that Jaluas profits are the result of the business profits and the equity accounting results from Monthiers and CCBA, thus, Jaluas equity in other foreign corporations. It is important to note that neither Monthiers or CCBA had distributed their profits to Jalua, neither recognized such results in its books. One other relevant argument derived from Eagle I Case that was mentioned in Eagle II Case is that Jalua is not subject to the ETVE (Entidad de Tenencia de Valores Extranjeros) tax regime in Spain (which is tax privileged) and it is considered a taxpayer according to the Spanish law (liable to tax). Thus, again, there is evidence confirmed by Spanish Tax Authorities that Jalua is neither subject to tax privileged regimes or is a P.O./mail box company. On one hand, according to Art. 7 the business profits, i.e., the profits attributable to Jalua in Spain, could not be March 2010

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taxed in Brazil, until the effective payment/distribution. On the other hand, by adopting the approach that Article 10 allows the Residence State to tax the income, observing the 15% Withholding Income Tax at Source State, Brazil could tax it, but would still be subject to Article 23 4 of Brazil-Spain Treaty, which expressly gives exemption to dividends: Where a resident in a Contracting State derives income from dividends that, according to the provisions of this Convention, may be taxed in the other Contracting State, the first-mentioned State shall exempt such income Lastly, it shall be stressed that Federal Tax Secretary Ordinance 06/00 (ADI nr. 06/00), that states that profits and dividends derived from ETVE are not tax exempted in Brazil, is not applicable to such case, since Jalua is not subject to ETVEs tax regime. Hence, by the proper interpretation of either Article 7 or Article 10 of Brazil-Spain double tax treaty it would not be possible for Brazil to tax the income of the controlled company in Spain (Jalua) that was not yet distributed to the controlling company in Brazil (Eagle). Eagle II Case Conclusion and Impact on Application of CFC Rules in Brazil Unfortunately, the Administrative Tax Judges from CARF decided that Article 7 of Double Tax Treaties only includes Jaluas profits itself, i.e., the profits generated by the business activities carried out by Jalua, but not the profits of Jaluas controlled companies located in other jurisdictions (Monthiers, in Uruguay, and CCBA, in Argentina), that Jalua is entitled to receive by distribution or register as equity accounting. The Brazilian Tax Authority argued that, in this case, Article 7 (Business Profits) would not be violated, and Brazil may still tax the profits from the companies indirectly controlled by Jalua. Since Spanish law does not impose the need for equity accounting method (i.e., are not yet reflected at Jaluas level), the only way to tax such income in Brazil would be to consider CCBA and Mothiers profits as fictitiously distributed directly to Eagle, instead of distributed firstly to Jalua and then to Eagle. This interpretation completely disregards the legal entity in Spain (Jalua) as well as the profit accrual method in Spain without even proving any abuse/tax evasion for such procedure, although the leading vote by the administrative tax judge insisted that there was no disregard of legal personality. According to such vote, Brazilian legislation is not properly a CFC Rule, but was inspired by those, mostly by the American one. For that reason, there are specific issues of our legislation that do not fit nor are solved by a mere interpretation of general CFC Rules around the world, including OECD position on such matters. The main argument used by the administrative tax March 2010 judge leading the decision stated that the concept of controlled company used by Brazilian legislation (Section 25 of Law Nr. 9.249/95 and Section 74 of Provisional Measure 2158-35/2001 expressly includes indirect controlled companies, i.e., companies that are controlled by a Brazilian company through an intermediary offshore company, interposed between those two. Consequently, according to such interpretation, all profits accrued by CCBA and Monthiers have to be taxed in Brazil at the end of fiscal year, either if not distributed or accrued for accounting purposes in Jalua (the intermediary company), since they are indirectly earned by Eagle in Brazil. As to the analysis of the possible violation of BrazilSpain double tax treaty in the case, the leading vote affirms that it is not applicable, since the profits that are being taxed by Brazilian so-called CFC rules are not the ones from Jalua but, instead, the profits assessed by Monthiers and CCBA. For that reason, the relationship between Brazil and Argentina and Brazil and Uruguay are not entitled to Brazil-Spain double tax treaty. However, it is important to mention that almost 90% of the profits taxed by Brazilian authorities at Eagle level derived from CCBA, which is the company located at Argentina, and Brazil has entered into a double tax treaty with Argentina. The treaty has been in full force since 1992. What surprises both Brazilians and foreign tax specialists is that this issue was not even tangibly approached in the vote from the administrative tax judge, once construed such peculiar interpretation of taxing indirect controlled companies. If there is a double tax treaty between Brazil and Argentina, article 10 (6) and 23 (2) of such treaty apply. Those articles expressly state that the presumed profits in Argentina cannot be taxed in Brazil, and if such dividends are taxed in Argentina they shall be exempted in Brazil. Moreover, if Article 7 of Brazil-Argentina applies, it would also imply the non-taxation of the profits originated in Argentina and, thus, forbid this absurd interpretation of the Brazilian administrative tax court. The conclusion extracted from Eagle II Case, regarding the supposed Brazilian CFC Rules is that the tax authorities are progressively intensifying the fight against international tax planning and treaty shopping. Unfortunately, this blind witch-hunt is violating several constitutional principles and supplementary legislation in Brazil, not to mention violating tax treaty provisions and international rules. The hope remains with the Judicial Courts, since all tax administrative proceedings can still be submitted to the Judiciary Branch analysis, where legal arguments are more taken into consideration than factual proofs. Finally, it is always important to remind that Brazilian so-called CFC Rules are pending on final decision by the Supreme Court about its unconstitutionality and illegality and, if ruled in favor of taxpayers, it will finally end this controversy as it should be. o

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Brazil Releases Exchange Controls

By Walter Stuber and Adriana Maria Gdel Stuber (Walter Stuber Consultoria Jurdica) On March 24, 2010, the Brazilian Monetary Council (Conselho Monetrio Nacional - CMN) and the Central Bank of Brazil (Banco Central do Brasil - Bacen) adopted a series of measures to consolidate and simplify the normative acts and proceedings applicable to the international capital and the exchange market regulations in our jurisdiction. These measures are summarized below. Consolidation of the Rules on Foreign Capital CMN approved Resolution No 3844, consolidating in only one single normative act, all the general provisions regarding foreign capital in Brazil, dealing exclusively with the registry of flows of direct investments, offshore credits, royalties, transfers of technology and international leasing transactions. Bacen Circular No. 3491 regulated the matter, contemplating operational issues, simplifying the registration procedure of these transactions and eliminating the bureaucratic requirements that cannot be justified nowadays. These new provisions have already been included in the Exchange Market and International Capitals Regulations (Regulamento do Mercado de Cmbio e Capitais Internacionais - RMCCI) in order to organize in an orderly manner all the applicable regulations currently in force. Consequently, as a result of this systematic organization, 60 former normative acts, comprising regulations, circulars and circular-letters, were revoked, including 320 other very ancient measures which were no longer applicable in practice and deemed to be in disuse or completely outdated. These changes are expected to reduce the effective cost of these transactions and the related administrative expenses for both the public and private sectors as well as to provide more legal security to such operations. Other important novelties introduced by the new rules are the following: From now on, all financial transfers from Brazil to other countries and from abroad to Brazil, either in Brazilian currency or in any foreign currency, related to foreign capital flows governed by CMN Resolution 3844, will have to follow the general rules applied to the Brazilian exchange market, that is, they must obey and comply with the law (principle of legality), have reasonable economic grounds and be duly supported by proper documentation.
Walter Stuber (walter.stuber@stuberlaw.com.br) and Adriana Maria Gdel Stuber (adriana.stuber@stuberlaw.com.br) are partners at Walter Stuber Consultoria Juridica in So Paulo, Brazil.

It is no longer necessary to obtain a specific authorization or prior manifestation of Bacen to perform any such transfers. The involved agents are released from the previous obligation of furnishing to Bacen any information that Bacen may obtain through other sources and/or by means of its own internal mechanisms.

in the event that the foreign investor prefers to redeem the Drs and register the corresponding value as a new modality of investment, such as, for example, direct foreign investment or fixed income investment, the change will be conditioned upon the closing of a symbolic exchange transaction.
Rules for Alienation of Depositary Receipts (DRs) Abroad CMN also approved Resolution No. 3845, allowing Brazilian resident companies which are issuers or offerors of Depositary Receipts (DRs) to maintain abroad (i.e. outside Brazil) the proceeds of the sale of the DRs. This permission, however, does not apply to DRs of financial institutions, which continue to be subject to different rules1. The matter has been regulated by Bacen Circular No. 3492, which contemplates operational issues. From now on, for the purpose of updating the foreign investment registration with Bacen, the amount obtained with the sale of the DRs which does not enter into Brazil within a five day-term must be automatically considered by the Brazilian custodian as maintained abroad. In the event that the foreign investor prefers to redeem the DRs and register the corresponding value as a new modality of investment, such as, for example, direct foreign investment or fixed income investment, the change will be conditioned upon the closing of a symbolic exchange transaction. The transfer of funds abroad for the purpose of reimbursement of expenses incurred by the foreign institutions involved in the process of launching the DRs can be performed in the same manner of the other March 2010

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exchange transactions, that is, regardless of any prior manifestation of Bacen. Simplification of Exchange Transactions Bacen Circular No. 3493 was also announced. This updates the RMCCI, giving continuity to the improvement process of the Brazilian exchange market conducted by Bacen during the last years. The main alterations that need to be highlighted are the following: Waiver of the requirement of simultaneous exchange contracts for payment of premiums or indemnities linked to international reinsurance, when the funds transit in foreign currency accounts held in the name of entities of the insurance sector. Permission for Brazilian non-banking institutions authorized to deal in exchange to maintain more than one foreign currency account in the same city of Brazil. The intention of the Brazilian authorities with the adoption of this new measure is to increase the competition in the negotiations of international transfers by means of these agents, in order to benefit ultimately the users that make the remittances and their counterparts that receive the proceeds in foreign currency. Exclusion of the exchange regulations of the need to maintain an exclusive registration form (ficha cadastral) just for exchange transactions, since the general anti-money laundering rules in force already require the existence of a similar registration form that must be kept by all institutions authorized to deal in exchange. Permission for the exchange offices (postos de cmbio) of an institution authorized to deal in exchange to perform the same transactions allowed to its agencies. This measure creates an opportunity to increase the offer of banking services. Creation in the RMCCI of a specific section about the use of payment orders in Brazilian currency originated from abroad, to make it clear to the several participants of the market that there is such possibility. Increase of the term for settlement of exchange contracts entered into by the Secretariat of the National Treasury (Secretaria do Tesouro Nacional - STN) from 360 days to 750 days, counted as from the date of the contract. This measure gives to the transactions to be effected by the STN the same treatment of the exchange transactions made in the inter-banking market. o
1 CMN Resolution No. 3760, of July 29, 2009, authorizes the launching abroad of Programs of DRs linked to shares issued by financial institutions with head office in Brazil, with shares traded at the stock exchanges. Therefore, the proceeds of the sale of DRs of Brazilian financial institutions cannot be maintained abroad.

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Brazil

CVM Latest Rules and Their Impact On International Investors

By Mariana Noronha Muniz (Miguel Neto Advogados Associados)

Two brand-new regulations introduced by the Brazilian Securities and Exchange Commission (CVM), promise to make the market more understandable for the public and the lives of the companies a little bit more complicated to say the least! CVM has recently published rules 480 and 481, creating a new regulatory framework for the companies. Rule 480 changes the rules for companies listing whereas Rule 481 alters the information to be provided by them concerning general meetings calls and Powers of Attorney requests. Rule 480 Rule 480 brought along several new regulations and procedures that shall be put into use regarding the regulated markets of securities. The new rules have changed the old procedures into a stricter and more judicious level, especially when talking about international investments. Effective from January 1st, this new rule is causing many companies to adjust to these new procedures, giving a whole new level of information that now must be provided on a regular basis. CVM changed the old criteria for issuers by dividing them into 2 new categories: A and B. Those on the A category will have an authorization to negotiate any amount in the securities markets. On the other hand, those on the B category will not be able to negotiate stock options, certificates of deposit of shares or securities that are converted or give a right to acquire shares or depository receipts of shares. Once enrolled at one of these categories, it is possible to change the option if the requirements established on CVMs new rule are complied with. Reference Form The obligation to provide information is much more severe now. Issuers must make available to all its investors, for a three-year minimum term, regular information as described in the rule. In addition, as far as A issuers are concerned, such information must be available online for the same period as well. Furthermore, if the information is not provided as required, issuers are subject to a fine equivalent to five hundred reais (R$ 500.00) per day for
Mariana Noronha Muniz (mnm@mnadv.com.br) is a Corporate Law specialist with Miguel Neto Advogados Associados, 55 11 5502-1256.

the ones on the A category and three hundred reais (R$ 300,00) per day for those on the B category. The old IAN (Annual Reports) were replaced by the Reference Form, which is required and intended for more complete information and is in accordance with the international standards for securities markets. The amount and level of information varies according to the category of the issuer.

Two new regulations introduced by the Brazilian Securities and exchange Commission (CVM), promise to make the market more understandable for the public and the lives of the companies a little bit more complicated to say the least!
International Companies When it comes to International Issuers, the new rules are very specific and quite interesting. Now, the criteria used will consider not only the issuers head offices, but also the amount of assets held in Brazil. According to the new rule, an international company is not allowed to hold more than 50% of all its assets in Brazil in order to be considered as such. With that CVM hopes to end an old procedure that caused many problems to everyone: shell companies that would be organized outside of CVM jurisdiction and later trade in Brazil. Rule 481 Following the same idea, Rule 481 made the level of information requested to be provided to the public and all the shareholders more complete and detailed. Now, companies will need to inform, before their meetings, the business to be transacted thereat, and will have new procedures to grant powers of attorney to vote at these meetings. The idea is generally to make it easier for investors to obtain the information needed. Yet, this will also give to minority shareholders more power over the company. The call notice must list in a very explicit way the businesses that will be transacted at the meeting, and the

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Brazil
phrase general affairs will no longer be valid. Moreover, the company must make available to shareholders on the CVM webpage the documents that will be presented in the meeting and any other that may be relevant to its decisions and voting and this must be done until the date of the first call notice. Rule 481 also establishes new regulations governing the requests for public proxies, giving a chance to the shareholders to participate in the business decisionmaking processes. Basically, the shareholders representing more than 0.5% of capital may include candidates for the Board of Directors or the Supervisory Board. Companies that have an electronic system of proxies need to allow shareholders with more than 0.5% to make public requests through this system. And if the company does not establish an electronic proxies system, it must pay a portion of the costs of public requests promoted by the shareholders representing more than 0.5% of the capital. In addition, all materials used in public applications of proxies, and the information and documents relating to the meeting shall be available to the shareholders at CVM website on the Internet. To prove that they mean business, CVM has already released to the general public names of companies that are in culpable delay for at least three months to comply with any of its new obligations. With that, CVM intends to alert all investors and the general public when dealing with these companies, and, therefore, help them make their best investment decisions. Last January 4th, forty-eight (48) companies had their registration cancelled due to the lack of information requested by the new regulation. And, according to the CVM, this is just the beginning! They will now be more severe and always try to give more stability to the public.

The rules are intended to yield benefits to everyone. and in order to do so, we better run and adjust to that, always keeping our eyes wide open for what will come next.

Whether they like it or not, companies now have a big challenge ahead to adjust their structure to this new regulation. As mentioned by Maria Helena Santana, CVMs chief, it will be necessary for companies to rethink processes, controls for power and information provided to the public. o

CHile

United States and Chile Sign Income Tax Treaty

By Neal A. Gordon and Craig E. Barrere (Morgan Lewis and Bockius LLP)

On February 4, the Treasury Department announced the signing of a new income tax treaty between the U.S. and Chile. The treaty will be presented to President Obama for his signature before it is sent to the U.S. Senate, which must advise and consent to its ratification before the treaty enters into force.
Neal Gordon (ngordon@morganlewis.com) and Craig Barrere (cbarrere@morganilewis.com) are Associates in the San Francisco office of Morgan Lewis and Bockius LLP. The practices of both Mr. Gordon and Mr. Barrere are focused on international tax planning for outbound operations of U.S. multinationals and inbound operations of foreign multinationals. They are members of Morgan Lewiss Tax Practice. 2010 Morgan Lewis & Bockius LLP

The treaty is the first between the U.S. and Chile, and would become only the second bilateral income tax treaty between the U.S. and a South American country (the other being Venezuela). This development coincides with Chiles recent acceptance into the Organization for Economic Cooperation and Development (OECD), an organization with a commitment to fostering financial stability and contributing to growth in world trade by coordinating domestic and international policies. Signing of the treaty by the Treasury Department represents the most recent progress in the Treasurys efforts to expand the flow of cross-border investment between the U.S. and South America. In addition to relieving double taxation and outlining rules that will govern U.S. and Chilean cross-border
Income Tax Treaty, Continued on page 20

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CHile

Income Tax Treaty (from page 19)

investors, the treaty provides for reduced rates of sourcecountry withholding on gross payments of dividends, interest, and royalties. These reduced rates are as follows: Dividends Interest Royalties 5 percent, 15 percent1 4 percent, 15 percent (reducing to 10 percent)2 2 percent, 10 percent3

address: http://www.treas.gov/press/releases/reports/ chiletreaty2010.pdf. o

The treaty contains a comprehensive Limitation on Benefits (LOB) article intended to prevent abuse by third-country investors by restricting the benefits of the treaty only to qualified persons of the U.S. and Chile. The inclusion of a LOB article will require careful consideration in circumstances where a party claims benefits under the treaty. With respect to taxes withheld at source, the provisions of the treaty will be effective for payments made on or after the first day of the second month following the date on which the treaty enters into force. For other taxes, the treaty will become effective for taxable periods beginning on or after January 1 of the calendar year immediately following the date on which the treaty enters into force. A copy of the treaty can be accessed via the following

With respect to taxes withheld at source, the provisions of the treaty will be effective for payments made on or after the first day of the second month following the date on which the treaty enters into force.
The 5 percent rate applies if the beneficial owner is a company that owns directly 10 percent or more of the voting stock of the company paying the dividends. The 15 percent rate applies in the case of all other dividends. 2 The 4 percent rate primarily applies to interest paid to banks, insurance companies, and active lending or financing businesses. The 15 percent rate applies in all other cases for a period of five years from the date the provision is effective, reduced to 10 percent thereafter. 3 The 2 percent rate applies to payments for the use of, or right to use, industrial, commercial, or scientific equipment. The 10 percent rate applies to payments for the use of, or the right to use, any copyright, patent, trademark, or other like intangible property.
1

Chile - New Cabinet Members; Deficit Concerns

By Walter Molano (BCP Securities, LLC) The devastation of the earthquake in Chile will put further stress on the fiscal accounts. The Bachelet Administration announced, in February, that the fiscal deficit was much larger than initially expected. The government shortfall was $7.2 billion. Copper revenues dropped 51.3% y/y and tax revenues dropped 20.4% y/y. Expenditures, however, increased 17.8% y/y, due to the governments fiscal stimulus program. Finance Minister Andres Velaco came under fire from the opposition for allowing the fiscal accounts to deteriorate so badly. President-elect Sebastian Pinera named the senior members of the new cabinet. The new economic group is highly regarded. At the top of the list was Felipe Larrain, who was appointed Finance Minister. Larrain is highly regarded economist, who was trained at Harvard. Juan Andres Fontaine will serve as head of the Economy Ministry. He was trained at the University of Chicago. Rodrigo Hinzpeter will head the Interior Ministry and Cristian Larroulet will be chief of staff. Unfortunately, one of the new tasks for the government will be to address the fiscal deficit, while rebuilding the country. o
Walter Molano (wmolano@msn.com) is head of research at BCP Securities, LLC in Greenwich, Connecticut, tel: 203-629-2759.

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MexiCo

Navigating Mexicos Thin Cap and Related Foreign Party Finance Rules:
An Exclusive Interview with Fred J. Barrett, PricewaterhouseCoopers Mexico
Conducted by Gary Brown and Scott Studebaker Q: How do Mexicos thin capitalization rules work now? BARRETT: The thin capitalization rules are fairly simple in the sense that they are a mechanical calculation. Essentially, if your company exceeds the 3:1 debt equity ratio, which includes all debts not just related parties but also unrelated, as well as foreign and domestic youre potentially in a thin capitalization situation. What does this mean? It means that if you have too much debt, and if some of that debt is from related parties, the tax law considers the debt from related parties not a loan but capital. Why? The theory behind the mechanical calculation is that no third party would lend money to a company that is so thinly capitalized. And so, if you exceed 3:1 considering all of your debts, then Mexico will disallow the related party foreign debt to bring you effectively back down to the 3:1 debt equity ratio. If it is disallowed, it is treated as a non-deductible dividend. So essentially it is a mechanical calculation that does not require a whole lot of thought. Q: What happens if the debt you have is revalued for currency purposes? Is there any kind of currency calculation in all of this? BARRETT: Lets say you have a dollar loan, and at the end of the year, there is a devaluation. That dollar loan would then turn into a lot more debt, and therefore there would be more disallowance because you increased your excess over 3:1. However, conversely, if instead of a devaluation there was a positive valuation adjustment to the peso compared to the dollar, then you would actually reduce your limitation, the problem you had from a thin capitalization standpoint. So, currency changes can either help or hurt you. And in fact, this past year, the peso actually strengthened compared to the dollar. Even though we started out with a big devaluation that occurred in January and February of 2009, the peso is a lot stronger today. Q: So for thin cap considerations, companies are essentially dealing with foreign related loans and not domestic loans and with related parties even if theyre domestic. Is that correct? BARRETT: That is correct. So, related parties domestic loans would not be disallowed.

Q: Are there any ambiguities in the rules that should be highlighted? BARRETT: No, there are no ambiguities. The thin cap rule was enacted in 2005, and there was a five year transition rule, which provided that if you exceeded the 3:1 ratio at the end of 2004, the authorities would give you five years to bring down that difference. It was unclear in the way the law was written whether a company had to actually reduce the difference proportionally over five years or if the company just had to comply by the end of the five-year period. So, some companies took the position that you just had to comply by

The thin capitalization rules are fairly simple in the sense that they are a mechanical calculation. essentially, if your company exceeds the 3:1 debt equity ratio, which includes all debts not just related parties but also unrelated, as well as foreign and domestic youre potentially in a thin capitalization situation.
the end of 2009, and the Hacienda appears to have accepted that argument. However, if a company did not reduce the difference by the end of 2009, then the Hacienda would take the position that the companys tax returns were wrong for all of the years: 2005, 2006, 2007, 2008 and 2009. So, that was really the only ambiguity: whether a company had to reduce the difference proportionally every year or whether it just needed to be reduced by the end of the fifth year. Q: How do the tax authorities measure the 3:1 ratio? BARRETT: The measurement is based on GAAP, Mexican Generally Accepted Accounting Principles. On a balance sheet, you simply look at the ratio of the liabilities on the financial statement compared to the equity, and if its more than 3:1, you do an average of the beginning and end of the year for equity, and an average monthly determination for debts. So mechanically, it is simply looking at the book
Mexico's Thin Cap, Continued on page 22

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MexiCo

Mexico's Thin Cap (from page 21)

equity, or the financial statement equity at the beginning and end of year, compared to the average end of month financial statement debt, which is based on the terms of the loans in the applicable contractual agreement. For instance, if it is debt on the basis of a dollar currency, you have to adjust that dollar currency to the peso balance at the end of the applicable month. Advance Pricing Agreements Q: Is there much use or experience with advance pricing agreements to address situations where the ratio is higher than 3:1? BARRETT: There is a specific provision that allows you to exceed 3:1 if you get an advance pricing agreement (APA). There have not been many; but just from knowing and talking to the tax authorities on a regular basis, I would not be surprised if there were less than half a dozen cases in the entire country. It is probably a low priority for the authorities, because it would mean that they would collect lower income taxes. So it has been done, but it is not very usual. A company would have to have a really good story as to why it should exceed 3:1. It would have to show the authorities really strong comparables in the same industry, demonstrate how companies are always leveraged at a higher than 3:1 ratio in that specific industry with unrelated parties, and just generally make a good case supported by transfer pricing studies. I am personally aware of about three APAs; one of them took four months, another of them took about a year, and another has not even been finished yet and has been going on for two years. So, basically, the tax authorities are not going to be very compelled to help you exceed the 3:1 ratio. Q: Im told that the 3:1 could be exceeded for certain infrastructure projects in strategic areas. What are some examples of exceptions? BARRETT: There are exceptions to the extent that certain industries are financed abroad for dams, ports, airports and highways. Those industries include: Oil and gas Basic petrochemistry Electricity Nuclear energy generation Radioactive minerals Telegraphy Radiotelegraphy Mail Money printing Control, supervision and surveillance of ports, airports and heliports In those situations, you are exempted from those rules, and for those specific industries, you would be able to exceed the 3:1 ratio. 22

Q: What are some of the strategies for coping with thin capitalization rules? BARRETT: The easy strategy is to capitalize the debt if you exceed 3:1, because if you do exceed that ratio, it is treated as a non-deductible dividend. This could hurt you, because it would reduce your after tax earnings account, known as CUFIN in Mexico, and you would want a high CUFIN so that you could distribute your earnings tax free to the shareholders.

a company would have to have a really good story as to why it should exceed 3:1. it would have to show the authorities really strong comparables in the same industry, demonstrate how companies are always leveraged at a higher than 3:1 ratio in that specific industry with unrelated parties, and just generally make a good case supported by transfer pricing studies.
A second alternative is to try to reroute your debt, by using either more domestic or more unrelated party financing. This can be done easily enough, especially if you have some sort of implicit guarantee from your corporate parent abroad and certain other requirements are satisfied. There is also a calculation option permitting you to elect to use tax basis equity instead of GAAP equity. In this case, tax basis would consist of the sum of CUFIN and CUCA (meaning basis in shares without counting CUFIN), but you have to stick with that option for a 5 year period. That option often proves beneficial from a calculation standpoint. Q: Is there any way to use hybrid loans as a work around? BARRETT: No, you cannot have a hybrid loan from a Mexican standpoint, but you can from a foreign one. It will always be treated as a loan in Mexico, even if it is a hybrid for another country. A loan is a loan in Mexico, and therefore you are still going to have the 3:1 issue on those hybrids. Sometimes hybrids do provide benefits from a global standpoint; even though it is interest in Mexico, it is not income in another country, and therefore you will get a deduction in Mexico. A hybrid loan might not be taxed in another country, but that would not help you avoid the 3:1. That is just an overall tax planning strategy so that on a global basis you might get a lower effective tax rate. March 2010

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Q: Mexicos thin cap rule seems fairly generous in the sense that many countries are below that ratio, even in Latin America. Additionally, the rules look to group related and non-related companies as well as cover guarantors when a company has parallel loans. Is there any movement within Hacienda to tighten up the thin cap rules? BARRETT: No, not really. I think that if Hacienda believes you are abusing the rules, they can get you under regular transfer pricing concepts. If the loan does not smell like a loan, if it has more characteristics of capital, Hacienda can disallow the interest. They can argue that, on an arms length basis, an independent party would not pay that interest. Balloon loans are often looked at from a related party standpoint, where you do not pay anything back until the end of 15 or more years. If you cannot find unrelated parties that have those terms, you are going to have a much more difficult time convincing the tax authorities that it is interest and not really an element of capital. So, from a transfer pricing perspective, the tax authorities have all of the flexibility in the world to attack abusive situations. They probably do not consider that they need to enact major changes there. From a fairness standpoint, it appears that they should allow you to carry it forward like the US does, at least for whatever is disallowed under the mechanical 3:1 calculation. In the US there is a 1.5 to 1 ratio, but any excess kicked out under the mechanical computations can be used in future years. However, in Mexico, when the excess is kicked out, it automatically becomes a dividend. So, that is kind of harsh in my view. Q: Short of a formal advance pricing agreement, is there any way to get guidance in this area from the tax authorities? BARRETT: If you exceed the 3:1 ratio, there really is no guidance. It is non-deductible unless you get an APA. However, before you submit an APA, you might want to get a feel for whether the authorities would actually give you one allowing a greater than 3:1 ratio. On a no-name basis, I might recommend going to the tax authorities and saying, Look. This is my industry. This is my study. These are my comparable transactions for my unrelated independent parties. What do think my chances are of you giving me an APA? You can get a feeling from them on that issue. Otherwise, the rules are generally black and white; if the law says you exceed 3:1 and it is nondeductible, then it is non-deductible. There is no flexibility other than through this APA process. Q: And are there any restrictions relating to loans from companies in low tax jurisdictions? BARRETT: Mexico has a harsh rule, which says that withholding tax is extremely high for loans from low tax jurisdictions. There is a 40% withholding rate. Therefore, it makes such loans cost-inefficient. You would not even get to the thin cap rules. March 2010 Q: What are some other problem areas for the ability to deduct interest, such as the use of back-to-back loans? BARRETT: Foreign banks that are registered in Mexico have a 4.9% withholding rate. However, if a taxpayer uses its related party to obtain a loan, it could involve a withholding as high as 25%, or sometimes 10% or15% under an applicable treaty. For example, what you might do is get an intermediary a bank to lend the money to your subsidiary; but you would also deposit an equal amount of funds within that bank, so that effectively you were really financing the subsidiary while still being able to get a lower withholding tax through this banking intermediary. As a result, the Mexican tax authorities enacted the rule that if one party lends money to another party, who in turn uses those funds to lend money to the first party or its related party, then it is considered a backto-back loan. Thus, even many valid loan transactions could potentially fall victim to this rule, and it would cause that interest to be non-deductible. The back-to-back loan provision was a theoretical risk until 2009, at which time the tax authorities, to my knowledge, first challenged a decution under this provision. It has not been in court yet, but nonetheless it has become something more than a theoretical rule as a result of this audit.

What are some other problem areas for the ability to deduct interest, such as the use of back-to-back loans?
Q: So, the back-to-back loan rules sounds like a game changer within your jurisdiction. BARRETT: Yes. Everybody is now more nervous that the authorities might allege the back-to-back loan rules, as it is worded so broadly. It is imperative to evaluate your loan terms and see if there is a way around them, because this rule is very harsh and would basically treat interest paid abroad as non-deductible. It does not matter if it is a related or non-related party. As mentioned, the rules basically state: A back-to-back loan is considered a situation applied when a person provides assets or services to another person, and that other person in turn provides directly or indirectly assets or services to the first person or related party of the first person. It is not clear whether there is a direct tracing of the money that is transferred and the money that is sent back. It is worded so broadly that it could be interpreted as trapping many taxpayers in that situation. The tax authorities would probably only use this rule when they are desperate, such as when they see that somebody has done a debt restructuring transaction, such as some sort of debt push down, and they do not have another way to attack it. For example, if a transaction
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Mexico's Thin Cap (from page 23)

is properly structured under the law, has economic substance, and there is a business purpose to it, but the tax authorities simply do not like the fact that there is interest that is draining the revenues of the country from a tax perspective, then they might attack this via the back-to-back loan rule. So, the word of caution would be to not engage in abusive debt restructurings and properly document and support your transactions with competent transfer pricing analysis showing how cash earnings of the company will fund the debt. By its very nature, 3:1 debt to equity planning is not abusive, so it would have to be some other transaction where you had a purely tax motivated transaction and had developed some loophole around the 3:1, and you avoided the withholding tax by using a bank intermediary. Essentially, if the tax authorities perceive that you are strictly trying to obtain a tax benefit, they might assert back-to-back loan disallowance and, therefore, disallow the interest deduction. Q: Do you have any other observations about debt restructuring for Mexican subsidiaries? BARRETT: Notwithstanding the 3:1 requirement, it is still very viable to do debt structuring transactions with debt being pushed down into the subsidiaries. It is often necessary from a business standpoint, as well as very beneficial from a global standpoint, to do it as long as you have economic substance. These loans are going to be scrutinized, but you should be sustained on audit in keeping the deduction as it makes its way to the tax tribunals. At the end of the day, you should be sustained day as long as there is economic substance to the structuring. Another important factor to consider is that

any debt needs the support to show that the cash flows would cover the funding of the principle and interest. If your cash flow projections do not demonstrate the ability to repay the debt, you are going to have a hard time sustaining deductibility of your interest in Mexico. Q: Can you give an example of the problem? BARRETT: Lets say I do a debt restructuring showing a very large debt. Even if I meet the 3:1 ratio, the debt will be disallowed under transfer pricing concepts if the cash flows that I expect to generate from my business would not be able to fund the principle and interest over the term of the related party loan. The tax authorities would say that that is not interest, because an unrelated party would not loan money that cannot be payable from the cashflows of the company. They would argue that an independent party would not have loaned that money because it was not payable. So, if your cash flows dont show that you are going to have enough cash flow earnings to service the debt, the tax authorities are simply going to disallow the interest to related parties. And they would be completely justifiable in those circumstances. Sometimes there are restructurings, which do not demonstrate that the debt is clearly fundable from the cash flow of the business. How do you determine this? You look at the debtor companys history. If a company has a history of doing business in Mexico and if that history shows a prevailing tendency of cash flows and you cant justify a change in that cash flow, the tax authorities are going to say you never intended to repay that loan in the first place and that, therefore, it is not a loan from a transfer pricing perspective. You effectively might have loaned the money, but you capitalized it because there was no reasonable prospect to collect the cash based on the companys individual earnings in Mexico. o

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Since 1991, WorldTrade Executive, has published periodicals and special reports concerning the mechanics of international law and finance. See http://www.wtexecutive. com. If you have authored a special report of interest to multinationals, or compiled data we want to hear from you. By publishing with WorldTrade Executive, a part of Thomson Reuters, you establish your firm as a thought leader in a particular practice area. We can showcase your work to the many corporate leaders and their advisers who turn to us for insights into complex international business problems. To discuss your project, contact Gary Brown, 978-2870301 or Gary.Brown@Thomsonreuters.com.

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Mexico's Supreme Court Ruling on Flat Tax Law

By Jorge Narvez-Hasfura (Baker & McKenzie, S.C.) (EDITOR's NOTE: For more information on the 2010 Tax Reform, see the January/February 2010 Practical Mexican Tax Strategies, also published by WorldTrade Executive.) Entrepreneurial Flat Tax (IETU) Constitutional Challenge of the IETU Law Just recently, the Mexican Supreme Court of Justice ruled that the IETU is constitutional and thus a valid tax. The Supreme Court of Justice ruled that the IETU Law does not contravene the Mexican Constitution by limiting the right of taxpayers to recoup certain favorable balances of the already abrogated Asset Tax. The Court also concluded that the IETU Law provision denying the deduction of royalty payments between related parties does not transgress the constitutional principle of equal treatment under the law while the deduction is allowed in connection with royalty payments between unrelated parties. There were a number of arguments developed against the IETU Law, 15 of which were considered the most relevant. All of those 15 arguments were rejected by the Court. Based upon this decision, lower courts will start ruling on the legal actions (amparos) filed by the taxpayers. In general, the Court ruled that the nature of the IETU is different from that of the Income Tax; therefore, it is legally feasible to analyze the constitutionality of the IETU from a perspective different from the one used for income tax purposes. Because of this approach, the Court concluded that some of the items that are deductible for income tax purposes should not necessarily be deductible for IETU purposes. Foreign Tax Credit Concerns Taking the foregoing into account (the amendment to the 2010 Revenue Law and the Supreme Court Decision) the question arises of whether or not the IETU shall continue being considered complementary to the income tax. Now that the nature of the IETU appears to be different from that of the income tax, foreign companies with business in Mexico would need to confirm if the tax agencies of their corresponding countries will continue considering this tax as creditable for foreign tax purposes in terms of the corresponding tax treaties signed with Mexico. Until 2009, foreign tax agencies have considered the IETU complementary and, therefore, creditable. In dealing with the United States of America, so far no specific notice has been issued by the Internal
Jorge Narvez-Hasfura (jorge.narvaez-hasfura@bakernet. com) is Tax Principal with Baker & McKenzie, S.C. in Mexico City.

Revenue Service (IRS) to the contrary. FY 2010 is now well underway and it seems unlikely that the IRS will rule differently from what it was stated in December 2007 . Having said that, it seems that at least, for what the US relates, the IETU would continue being creditable for US tax purposes. We expect the IRS, during the current FY, to further analyze how this tax should be considered for FYs 2011 and beyond. The effect of not considering the IETU as creditable

The Court ruled that the nature of the ieTU is different from that of the income Tax; therefore, it is legally feasible to analyze the constitutionality of the ieTU from a perspective different from the one used for income tax purposes.
internationally represents a potential unrecoverable cost for foreign companies doing business in Mexico. These concerns need to be addressed promptly by the Mexican Government, in order not to discourage potential crossborder transactions and foreign investments. In any event, we need to realize that the actual potential negative effect would not be as important as to effectively discourage foreign investments in Mexico. There are certain types of activities that will endure a more important economic burden than others, like those in which a relevant economic component is related to related-party crossborder royalty payments. o

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PerU

Economy, Foreign Investment Thriving Under Stabilization Agreements

By Luis Sotelo (DLA Piper) During the 1980s, Latin America was involved in one of the worst economic crises in the regions history. After many states debts reached dizzying heights, financial institutions cut off loans, triggering macroeconomic disruptions throughout the region--underutilization of productive capacity, plunging productivity, widespread unemployment, falling wages, and a decrease in tax revenue. Peru ended the 1980s with one of the worst recessions in Latin America, including an inflation rate of 7,000 percent, one of the highest rates in the world. Access to foreign capital and international financing sources was practically non-existent in Peru. To address the crisis, repair its economy and regain the confidence of the international financial system, Peru was compelled to change its approach to foreign investment. A factor in Perus repair of its economy was the enactment of its latest constitution, the Constitution of 1993, which adopted an economic stabilization and liberalization program that lowered trade barriers, eliminated restrictions on capital flows and opened the economy to direct foreign investment. Today, Peru has become one of the most open investment regimes in the world and, despite the economic turmoil that has swept the globe, it is enjoying excellent economic growth. As identified in the first chart below, foreign direct investment in Peru has experienced steady growth in recent years. Similarly, the Peruvian economy is also expanding, and did so even in 2008, as seen in the chart on page 27. Stabilization Agreements: Overview Prior to the enactment of its new constitution, Peru was often criticized for constantly changing its legal framework. To address such criticism, the Peruvian government established the current regime, which allows investors to enter into so-called Stabilization Agreements. In summary, Stabilization Agreements ensure investors that the particular legal framework in place at the time they enter into a contract will continue to apply to their investments for a set period of time. For instance, under a Stabilization Agreement, if the income tax rate increases

Luis Sotelo (Luis.Sotelo@dlapiper.com) is an Associate in the Litigation and Regulatory Department with DLA Piper in the office in Madrid, Spain. His practice is focused on the areas of Competition and Regulatory Law, as well as regulated sectors (telecommunications, energy, transport, etc). He has practised in Spain, but also in Peru, and has been involved in many investments projects carried out in Peru. 2010 DLA Piper.

the year after an investor has entered into a contract, the investor will still be taxed at the tax rate that was in effect on the date it signed the contract. Stabilization Agreements have proven very important for Peru, and underlie its excellent economic performance.

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PerU

Stabilization Agreements have usually been applied by emerging countries in order to attract foreign investment: offering investors the promise of offsetting the risks that the laws applicable to their investments may change in future. Sometimes such agreements may take a slightly different form, such as a Stabilization Contract or Stabilization Clause, as further described below. Countries like Peru have granted foreign investors certain stability guarantees by contract or agreements, including freezing clauses (aimed at freezing the law applicable to the contract for a certain period of time) and economic equilibrium clauses (aimed at providing economic compensation in those instances where changes in the applicable laws have an adverse economic consequence for the investor). A Stabilization Agreement freezes specific legal regimes, for a specific investment and for a specific period of time. The contractual right to stability granted by these agreements is characterized by law as the extraordinary applicability of the stabilized laws that is, the applicability of those laws beyond their actual term of effectiveness, whether or not such laws are subsequently modified or repealed, or whether any amendments are more or less favorable to the affected investors. In the case of foreign investors, the laws that may be stabilized are those laws relating to taxes, availability of foreign currency, free remittance of profits and capital, exchange rates and non-discrimination. Legal Basis for a Stabilization Agreement In Peru, a Stabilization Agreement is regulated by the following legislation: Law of Foreign Investment Promotion (Legislative Decree No. 662, approved in August 29 of 1991), which recognizes certain guarantees to foreign investments

Framework Law for Private Investment Growth, approved by Legislative Decree N 757 (approved November 8, 1991) Regulations of the Private Investment Guarantee Systems, approved by Supreme Decree N 16292-EF of October 9, 1992, as well as its modifying regulations. Since Peru enacted these laws, the country has attracted numerous foreign investors and opened its markets. Nature of the Stabilization Agreement Stabilization Agreements in Peru are not regulated under the scope of the Public Law. In fact, the Government of Peru has expressly waived its sovereign rights in that respect, by recognizing, as part of its commitment to guarantee investments, that Stabilization Agreements fall under private contract law. Stabilization Agreements are governed by the general provisions established in the Civil Code. This fact allows private investors, in the case of any controversies arising as a result of the execution of a Stabilization Agreement, to bring claims directly to the Government of Peru, which is represented by its investment agency PROINVERSIN, before the national courts or before any arbitral tribunal agreed upon in the Stabilization Agreement. Further, a Stabilization Agreement is not subject to any legislative modification by the Government of Peru. Thus, Stabilization Agreements level the playing field for investors. The Government of Peru relinquishes its sovereign authority and is treated the same as the investor to wit, subject to the rules of private law. This result has created a more dynamic scenario for investments.
Stabilization Agreements, Continued on page 28

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Stabilization Agreements (from page 27)

Conditions and Requirements for Stabilization Agreements Stabilizations Agreement are open to any foreign or domestic investors, without any restrictions.1 No prior authorizations are required for foreign investments, and the acquisition of the shares of domestic companies is fully permitted through a stock exchange system or any other similar mechanism Nevertheless, the investor must commit, at least for a term of up to two years from the date the Stabilization Agreement was signed, to abide by the following: (i) For any economic activity other than mining or hydrocarbon activities, the investor make monetary contributions of an amount greater than US$5 million through Perus National Banking System to the capital of an established company or a company that is in the process of being established, 2 or (ii) For mining or hydrocarbon activities, to make at risk investments with third parties, for an amount not greater than US$10 million. It is important to note that, according to article 38 of Legislative Decree 757 and article 10 of Legislative Decree 662, investors national and domestic may execute a Stabilization Agreement either before making the relevant investments or within a 12-month period after the investor has obtained the necessary regulatory approvals allowing it to initiate its operations. Guarantees Granted by the Stabilization Agreement In a Stabilization Agreement, the Government of Peru provides the following guarantees to foreign investors: Stability of the right to non-discrimination. Foreign and domestic investments will be treated in a similar, non-dsicriminatory manner Stability of the income tax system, applicable to investors, that is in effect when the agreement is executed. Thus, an investors projects economic returns will not be diminished by any potential increases in the income tax rate Stability of the system of free availability of foreign currency and remittance of profits, dividends and royalties Freedom to use the most favorable exchange rate available in the market Irrevocability of an investors consession agreement, unless such investor fails to comply with its obligations In cases where a company, already established in Peru, receives the investment, the Government of Peru grants the following guarantees: Stability of the income tax system applicable to the investment when the agreement was executed, which will not be affected by any subsequent modification

Stability of the Special Regime of Advanced Recovery of the Value Added Tax applicable at the time that the agreement is executed Stability of any tax on net assets, if applicable at the time the agreement is executed Stability of the applicable labor laws and regulations in effect when the agreement is executed Stability of the system of export promotion in effect when the agreement is executed

Stabilization agreements ensure investors that the particular legal framework in place at the time they enter into a contract will continue to apply to their investments for a set period of time.
Persons Entitled to Enter into a Stabilization Agreement New investors and companies receiving capital investments3 (in the case of new enterprises or in the case of capital increases of existing enterprises) are entitled to enter into a Stabilization Agreement. The Government of Peru is represented by its investment agency, PROINVERSION,4 which carries out the relevant negotiations and enters into a Stabilization Agreement Maximum Term of a Stabilization Agreement The maximum term of a Stabilization Agreement is 10 years. However, in the case of concessions of public services, the term of the Stabilization Agreement will be extended to the term of the concession. Sectorial Stabilization Contracts and Stabilization Clauses There are other economic sectors such as mining and hydrocarbons where it is possible to enter into certain additional agreements with characteristics similar to a Stabilization Agreement. Mining Stabilization Contracts For the mining sector, the General Law of Mining (Supreme Decree No. 014-92-EM) allows investors to enter into Stabilization Contracts, which grant companies the possibility of stabilizing the current legal regimes with respect to such areas as tax, foreign currency exchanges and administration. Stabilization Contracts are negotiated and entered into with the Ministry of Mining and Energy (MINEM)

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and not with PROINVERSION. Stabilization Contracts may only be entered into by companies operating in the mining sector. Investors may enter into a Stabilization Contract for either a 10 or 15 year period, depending mainly on the amount of investment that the investor is prepared to make: Ten-Year Stabilization Contracts Companies developing mining activities that will undertake mining projects with operations greater than 350 MT/ day and up to 5,000 MT/ day, or investment programs greater than US$2 million, will be guaranteed tax and administrative stability for a term of ten years. The investors will be guaranteed stability in the following matters: a) Tax stability (i) The income tax regime applicable at the date of entry into the Stabilization Contract (the rate in effect plus two additional percentage points will be stabilized) (ii) Export regimes (iii) Value added taxes (with regard to their transferable nature) (iv) Special regimes for the refund of taxes (v) Tax exemptions and incentives and benefits with respect to the taxes stabilized (according to the terms and conditions established by the legal rules in effect on the date of the Stabilization Contract) b) Free disposition of currency generated by their exports. c) Non-discrimination with regard to the exchange rate. d) Free commercialization of mineral products, and e) Administrative stability (right and obligations of the holders of mining activities). Fifteen-Year Stabilization Contracts Companies developing mining activities that will undertake mining projects with an initial capacity greater than 5,000 MT/ day, or that present investment programs of at least US $20 million for beginning any new mining activity, or that present investment programs of not less than US$50 million for investments in already existing mining companies may execute a Stabilization Contract with MINEM, that will guarantee legal stability for a term of 15 years. In addition to the guarantees provided in tenyear Stabilization Contracts, fifteen-year Stabilization Contracts provide guaranteed stability in the following matters: a) Accelerated annual depreciation for machinery, industrial equipment, other fixed assets and buildings and construction, and b) The right to maintain their accounting in foreign currency. A company operating in the mining sector has the right to enter into both a Stabilization Agreement and a Stabilization Contract. In other words, an investor is permitted to enter into a Stabilization Agreement with PROINVERSION, and, if the investor is also an operator in the mining sector, it may also enter into a Stabilization Contract with MINEM. Hydrocarbons Stabilization Clauses In the hydrocarbons sector, Stabilization Clauses are typically incorporated into the relevant concession contracts or agreements with PERUPETRO granting such investor the rights to explore for and produce hydrocarbons. These agreements can come in the form of license contracts5 and/or service agreements6 and are based on the Law of Hydrocarbons (Law N 26221, enacted on August 19, 1993 and made effective on November 18, 1993). The Law of Hydrocarbons promotes the development and production of natural resources based on free competition and access to economic activity, guaranteeing the jurisprudential stability of investment contracts according to provisions set forth in article 62 of the Peruvian Constitution. Similarly, the law guarantees those entering into contracts stability with respect to the taxation and foreign exchange regimes that are in effect on the date of the contract.

TYPE OF CONCESSION Exploration of hydrocarbons (gas and oil) Exploitation of crude oil

TERM 7 years 30 years

Exploitation of non-associated natural gas; 40 years and non-associated natural gas and condensates
Stabilization Agreements, Continued on page 30

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Stabilization Agreements (from page 29)

It is important to note that the Stabilization Clauses which are part of a license contract or a service agreement are governed by the private contractual law, and that, after being approved and signed, such clauses may only be modified according to a written amendment executed by both parties (PERUPETRO and the investor). The term of these contracts, which are also applicable to Stabilization Clauses, depends on the type of hydrocarbon concession, which may be for the following periods: A company operating in the hydrocarbons sector has the right to enter into both a Stabilization Agreement and an agreement containing a Stabilization Clause. In other words, an investor may enter into a Stabilization Agreement with PROINVERSION, and, if the investor is an operator in the hydrocarbons sector, it is also entitled to benefit from a Stabilization Clause in its agreement with PERUPETRO. Conclusion Peru has developed a welcoming environment for foreign investments. Its legal framework has successfully stimulated direct foreign investment through Stabilization Agreements, Stabilization Contracts in the mining sector and Stabilization Clauses incorporated in contracts in the hydrocarbon sector. o

1 The Constitution of 1993 establishes that foreigners may not acquire mines, lands, woods, water, fuels or energy sources within 50 kilometers of Perus borders, except in case of public necessity. 2 If the investment is made by acquiring a national company, the investor shall have acquired at least 50 percent of the capital shares. 3 In the case of companies receiving investments, it is possible that, in addition to PROINVERSION, the ministry of the sector where the company develops its activities can participate in the negotiations for the Stabilization Agreement. 4 PROINVERSION, the Peruvian Investment Promotion Agency, has been created as a strategic ally for the promotion of investments in Peru in order to boost Perus development. As part of its duties, PROINVERSION is in charge of developing, proposing and executing the national policy on the treatment to private investment. Furthermore, PROINVERSION registers foreign investment; handles and enters into legal stabilization agreements established under Legislative Decrees N 662 y N 757; and investment contracts in the framework of the Regime of Anticipated Recovery of the Value Added Tax. It also promotes private investment in utilities and public infrastructure; as well as in state assets, projects and companies. 5 A license contract is the one entered into by PERUPETRO S.A. with the contractor and through which the contractor is authorized to explore and exploit, or to exploit hydrocarbons in the contract area, on the basis of which PERUPETRO S.A. transfers to the contractor, who must pay a royalty to the government, the property rights over the hydrocarbons extracted. 6 A service contract is the one entered into by PERUPETRO S.A. with the contractor, for the contractor to exercise the right to carry out hydrocarbon exploration and exploitation, or exploitation activities in the contract area and the contractor receives compensation based on the taxable hydrocarbon production.

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VenezUela; regional

Are Your Companys Investments Abroad Adequately Protected?

By Oscar M. Garibaldi and Miguel Lpez Forastier (Covington and Burling LLP) Many governments around the world are following policies leading to a State takeover of private enterprises and economic sectors that were previously left to private initiative. For example, the Venezuelan Government has directly or indirectly nationalized a broad range of investments, both foreign and domestic, including investments in the oil and gas, agriculture, consumer goods and banking sectors. It has also taken other adverse measures against investors, often as a prelude to expropriation. Recently, President Chvez ordered the nationalization of a supermarket chain because the company allegedly failed to observe price controls imposed by the Venezuelan Government. Other States in Latin America, Eastern Europe and Asia are following similar policies. They have adopted measures that directly expropriate foreign investment, substantially impair the value of the investment or the investors control over it, or renege on commitments made to foreign investors to induce them to make the investments. To protect qualified foreign investors and their investments from adverse governmental measures, States have entered into bilateral and multilateral investmentprotection treaties. If your companys investments in Venezuela and elsewhere are not protected by adequate investment treaties, your company may have no effectual remedy in the event of nationalization or other governmental measures adversely affecting those investments. (Some States have also adopted internal laws to protect foreign investment. Those laws raise issues that cannot be addressed in this note.) Today there are more than 2,500 bilateral investment treaties involving most countries in the world, as well as an increasing number of multilateral agreements containing provisions on investment protection. For example, Venezuela has entered into more than 28 investment treaties with other countries, but some of those treaties are not (or no longer) in effect. There is no investment treaty
Oscar M. Garibaldi (ogaribaldi@cov.com) is a Partner at Covington and Burling LLP in Washington, DC, where he specializes in Investor-State and Commercial Arbitration. Tel. (202) 662 5624. Miguel Lpez Forastier (mlopezforastier@ cov.com) is a Special Counsel at Covington and Burling LLP in Washington, DC, where he specializes in Investor-State and Commercial Arbitration. Tel. (202) 662 5185. The views and opinions expressed in this article are those of the authors and shall not be attributed to Covington and Burling LLP or any of its clients.

between the United States and Venezuela. Investment treaties typically provide that each contracting State is obligated to afford to the investors of the other contracting State: (i) treatment that meets substantive international standards of protection, and (ii) access to international arbitration of disputes concerning the investment. Many investment treaties require the following substantive protections, subject in some cases to exceptions or qualifications: Prohibition against expropriation of investments or measures having equivalent effect unless the measures are taken for a public purpose, on a nondiscriminatory basis, and against prompt, adequate and effective compensation consisting of fair market value; Obligation to afford fair and equitable treatment, which several arbitral decisions have interpreted to include the obligation to provide a stable and transparent legal and business environment and the obligation not to frustrate the investors legitimate expectations; Obligation to afford full protection and security to the investment; Prohibition not to impair by arbitrary or discriminatory measures the management, maintenance, use, enjoyment or disposal of foreign investments; Generally, prohibition to treat foreign investors or investments less favorably than the way investors or investments of the host State or a third State are treated; and Prohibition against imposing restrictions on the transfer of funds, including the repatriation of dividends, loans and investments. Most investment treaties provide for the settlement of investment disputes by means of binding international arbitration. Often the investor is given a choice of submitting a dispute to institutional arbitration (administered by an institution such as ICSID, ICC or SCC) or ad hoc arbitration conducted under rules such as those elaborated by UNCITRAL. The arbitral tribunal normally has the power to award damages in case of breach of the treaty. Although most investment treaties contain similar provisions, they do not necessary cover investors or investments with equal breadth or afford the same level of protection to the investments they cover. For example,

Company's Investments, Continued on page 32

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Company's Investments (from page 31)

some treaties impose more stringent requirements than others for an investor or an investment to qualify for protection. Some treaties require substantive standards of treatment that are more protective than the standards required by other treaties. Each investment treaty must be examined on its own and the degree of protection it affords must be compared with the degrees of protection provided by other available treaties. Any company contemplating an investment abroad should study the investment treaties that may be in force for the host State and structure the investment accordingly, just as companies routinely do in respect of tax treaties. Generally, a company would be well advised to use an investment vehicle incorporated in a State that has entered into a highly protective investment treaty with the host State. A U.S. based company should not simply assume that U.S. investment treaties, if available, offer the highest degree of protection. Investment treaties made recently by the United States are in some respects less protective

of investments than past U.S. treaties or treaties made by other countries. As new investment treaties come into force, companies should keep the structure of their overseas investments under periodic review, especially in the case of investments that were initially structured without considering the availability or relative merits of investment treaties. It is seldom too late to restructure an investment to increase the degree of protection. But an investor should not wait for clouds to gather on the horizon before buying a good umbrella, and should certainly not wait until it starts to rain. The longer an investor waits to take protective action, the greater the likelihood that the host State will challenge the validity or effects of the restructuring or question the investors motivation. Even if such charges have no merit, they will increase the costs, delays, and risks of arbitration. As the recent actions of the Venezuelan Government illustrate, foreign investors in Venezuela and elsewhere need the protection afforded by investment treaties and would be well advised to consider whether their current level of protection is adequate to meet the increased risk. o

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