Published by WorldTrade Executive, Inc. LATIN AMERICAN · August 31, 2005 LATIN AMERICAN LAW & BUSINESS REPORT 1 Volume 13, Number 08 August 31, 2005 HIGHLIGHTS Published by WorldTrade

August 31, 2005 LATIN AMERICAN LAW & BUSINESS REPORT 1

Volume 13, Number 08 August 31, 2005

HIGHLIGHTS

Published by WorldTrade Executive, Inc.

CONTENTS

Contents Continued on Page 2

LATIN AMERICANLATIN AMERICANLaw & Business ReportLaw & Business Report

Effect of Brazil’s Corruption Scandal on ForeignInvestors—More than “Just Politics”A political scandal in Brazil has been gathering force,and President Lula’s name, and that of his Minister ofFinance, have recently been brought into the expandingcongressional investigations. Lula’s presidency mayhave already been damaged beyond repair. A specialinterview examines whether Brazil can maintain theeconomic policies that have attracted so much foreigninvestment. Page 4

Mexico’s Energy Shortage Will Force an Openingto Foreign Investments–But When?Mexico faces a real danger of running out of oil, butdespite the challenge, no politician will propose openingthe energy sector to foreign investors. Barring unforeseengood luck, an energy shortage will probably forceMexico’s hand soon. Page 3

Brazil Fashions Incentives for High TechnologyCompaniesThe measures include tax breaks and other benefits, andare designed to push companies toward adoption of opensource software. Page 11

When Will Brazil Start to Lower Interest Rates?The Central Bank is expected to start lowering rates, nowat 19.75 percent, in September. Page 15

Chile Enacts Special Tax on Mining OperationsHaving failed to pass a law mandating a royalty onmining income, a new law will tax profits from miningat up to 5 percent, starting in January, 2006. Page 18

Privately-Held Colombian Companies to Benefitfrom New Rules for Private Equity FundsThe regulations will permit local and foreign fund managersto buy shares of Colombian private companies. Page 19

The Fine Print in the CAFTA AgreementA review of the most important provisions of theagreement, including trade remedies and the specialregimes for textiles and agricultural goods. Page 26

Mexico’s New Tax Rules on Thin CapitalizationLeaves Many Unanswered QuestionsThe rules require taxpayers to reduce excess debt in orderto meet requirements that go into effect in 2010. Whilethe transitory provisions do not include penalties, failureto comply could bring tax liabilities. Page 23

ArgentinaPossible Modification of ArgentineCompetition Law Grants more Power toMinistry of Economy in Control of M&As. ByAlfredo M. O’Farrell and Miguel del Pino(Marval, O’Farrell & Mairal) .................................. p. 6

Argentina further Tightens Foreign CapitalControls. By Carlos E. Alfaro (AlfaroAbogados) ................................................................. p. 8

BrazilPolitical Scandals Threaten Brazil’s EconomicResurgence; The Surprising Fall from Grace forBrazil’s Workers’ Party, and Possibly PresidentLula. Interview with John Welch (LehmanBrothers) .................................................................... p. 4

Recent Antitrust Developments. By Marta Garcia,Priscila Castello Branco and Marcelo Maciel (Trench,Rossi e Watanabe Advogados) ............................... p. 9

Will Brazil Seek Another Victory over the U.S. atthe WTO? By Scott P. Studebaker ......................... p. 10

New Law Provides Incentives for Technology,R&D. By Ricardo Barretto Ferreira da Silva(Barretto Ferreira, Kujawski, Brancher eGonçalves Sociedade de Advogados) ................... p. 11

Private Pension Funds in Brazil: New TaxationRegime. By Vinicius Branco and Luca PriolliSalvoni (Levy & Salomão Advogados) ................. p. 12

Brazil’s Super Federal Revenue Office. By LuizRoberto Peroba Barbosa, Maria Teresa Leis DiCiero and Tércio Chiavassa (Pinheiro NetoAdvogados) .............................................................. p. 13

New “CRA” Agribusiness Security. By JoséBarreto Neto and Claudia Pinheiro (Levy &Salomão Advogados) .............................................. p. 15

Central Bank Hints at Interest Rate Cuts inSeptember. By Edwin Taylor ................................. p. 15

2 LATIN AMERICAN LAW & BUSINESS REPORT August 31, 2005

Contents Continued from Page 1

ChileNew Mining Tax to go into effect in January. By AlvaroMecklenburg (Deloitte Chile) ......................................... p. 18

ColombiaBoost to Private Equity Funds. By Andres Williamson(Baker & McKenzie) ........................................................ p. 19

MexicoMexico’s Oil, Gas, and Energy Policy Options. BySidney Weintraub (Center for Strategic andInternational Studies) ........................................................ p. 3

Renewable Energy Projects Incentives. By Jose RaúlFélix-Saúl and Federico Ruanov-Guinea (Baker &McKenzie) ......................................................................... p. 20

How Mexico Taxes Interest Earned in Mexico and PaidAbroad. By Rene Cacheaux and Miriam Name(Cacheaux, Cavazos & Newton) .................................... p. 22

Thin Capitalization in Mexico: Transition Rules. ByMarc Schwartz (Schwartz Advisory Services, Inc.) andJosé Juan Miranda (M&V Consultores) ........................ p. 23

RegionalAnalysis of the Dominican Republic-Central America-U.S. Free Trade Agreement. By Kirk Ross (KattenMuchin Rosenman) ......................................................... p. 24

VenezuelaOrganic Law on Prevention, Work Conditions andWork Environment (LOPCYMAT). By the LaborDepartment (Baker & McKenzie) .................................. p. 27

Venezuelan Legal and Business Developments. ByVera De Brito de Gyarfas (Travieso Evans Arria Rengel& Paz) ................................................................................ p. 30

ADVISORY BOARD

Frederick R. AndersonCadwalader, Wickersham & Taft

Patricia Lopez AufrancMarval, O'Farrell & Mairal

(Buenos Aires)

Ariel BentataRuden, McClosky, Smith, Schuster &

Russell, P.A.

Nicolas Borda B.Borda y Quintana, S.C. Abogados

(Mexico City)

Laurence E. CranchRogers & Wells

William E. DeckerPricewaterhouseCoopers

Stuart DyeHolland & Knight

David G. EllsworthBaker & McKenzie

Thomas Benes FelsbergFelsberg e Associados, Advogados

(São Paulo)

Georges Charles FischerFischer & Forster

(São Paulo)

Isabel C. FrancoDemarest e Almeida

(New York and São Paulo)

Sergio J. GalvisSullivan & Cromwell

Steven D. GuynnJones Day

William HinmanSimpson Thacher & Bartlett LLP

Salvador J. JuncadellaMorgan, Lewis & Bockius LLP

Hugo Cuesta LeañoCuesta Campos y Asociados

(Guadalajara)

Timothy J. McCarthyHughes, Hubbard & Reed

Thomas P. McDermottTPM Associates

Antonio MendesPinheiro Neto-Advogados

(São Paulo)

John H. Mortonformerly Hale and Dorr

Edmundo NejmLinklaters & Alliance

(São Paulo)

Uriel Federico O’FarrellEstudio O’Farrell Abogados

(Buenos Aires)

Juan Francisco PardiniPardini & Asociados

(Panama City)

Reinaldo PascualKilpatrick Stockton LLP

Robert J. RadwayVector International

Keith S. RosennUniversity of Miami

School of Law

Eduardo SalomãoLevy & Salomão

(São Paulo)

M. Stuart SutherlandTroutman Sanders LLP

Miguel A. ValdesMachado & Associates, LLC

(São Paulo)

Carl ValensteinArent, Fox, Kintner,

Plotkin & Kahn

Juliana L.B. ViegasTrench, Rossi e Watanabe

(São Paulo)

Laurence P. WienerNegri & Teijeiro Abogados

(Buenos Aires)


MEXICO

Energy Sector

The difficulties Mexico faces in making decisions onoil, gas, and energy policy are essentially political, nottechnical. This does not make the problems easier to re-solve; indeed, it makes them harder to deal with becausetechnical issues can be approached head on, whereaspolitical obstacles, rooted in the structure of governmentand society, can be surmounted only by means of com-plicated strategies. Technical operations of Pemex(Petroleos Mexicanos), Mexico’s government-owned oilmonopoly, are entangled in political considerationsfoisted on the company. These contribute to Pemex’s lowproductivity (or, phrased differently, the company’s ex-cess employment for the output generated) and its peri-odic corruption scandals. What follows will deal withPemex’s finances, which are unbelievably complex andchaotic because of political, or should I say extraneous,demands placed on the company.1

Tapping Undersea ReservesPemex, for some years now, has lacked funding to en-

gage in sufficient exploration to find new sources of oil andgas. Deepwater exploration, which is expensive but wherethe prospects of significant findings are promising, has notbeen undertaken for want of money. Pemex also lacks thetechnical expertise for deepwater drilling, but this could behired if funding were available. Exploration is urgentlyneeded because at present rates of use Mexico’s proven re-serves of oil will last only about 12 years. Mexico alreadyimports a considerable amount of natural gas, and the coun-try is in the process of converting the fuel for most of itsenergy generation from oil to natural gas. The domesticshortage and the high cost of imported gas is reducing thecompetitiveness of Mexico’s high energy-using businesses.

Sidney Weintraub holds the William E. Simon Chair inPolitical Economy at the Center for Strategic andInternational Studies, Washington, DC. He is author ofDevelopment and Democracy in the Southern Cone:Imperatives for U.S. Policy in South America (CSIS, 2000).He was deputy assistant secretary of state forinternational finance and development from 1969 to 1974and assistant administrator of the U.S. Agency forInternational Development in 1975.

Mexico’s Oil, Gas, and Energy Policy Options

by Sidney Weintraub (Center for Strategic and International Studies)

But there may well be much gas to be found in the deepwaters of the Gulf of Mexico.

There are three main options for dealing with theseproblems: seek private, necessarily largely foreign,sources of investment for oil and gas exploration andexploitation; reduce the amount of Pemex revenue thegovernment takes for its own budgetary needs; or con-tinue to muddle through and hope for the best. The thirdoption is stated pejoratively, even though the governmentdid luck out in the 1970s when new oil output came onstream; however, running a government based on an as-sumption of repeated good fortune is hardly a rational

Policy Options, Continued on page 20

The danger Mexico faces is running outof oil, both for domestic use and export

in a relatively short period.

choice. Carrying out the first option involves runningroughshod over deeply held emotions stemming fromMexican history, which led to setting up a government-owned monopoly in the first place after foreign ownersof oil companies in Mexico rejected government requests.The second option would require changing the en-trenched Mexican habit of low tax collections to relievePemex of being the cash cow for one-third of the federalgovernment’s budgetary needs.

Reducing Dependency on Pemex Tax RevenuesWith respect to the fiscal option, the current situation

is as follows: Mexico now collects between 11 and 12percent of gross domestic product in taxes; this amountedlast year to about $80 billion. Pemex provided about 6percent of GDP, or $40 billion, to finance the governmentbudget. If the revenue take from Pemex were reducedby, say, one-half, this would leave Pemex with roughlyan extra $20 billion for its own needs. Pemex now obtainsmuch of its needed funds from borrowing and is not in aposition to increase borrowing much more. Pemex alsoobtains appropriations from the central government, but


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BRAZIL

Special Interview, Continued on page 5

Special Interview

For the last two years Brazil seemed on a roll. Ledby surging growth in exports, the economy has grownsteadily, and the growth is finally starting to show upin reduced unemployment figures. The Central Bankhas maintained a relentless battle against inflation, andhas endured harsh criticism from commercial associa-tions for stifling prosperity. But the policy has van-quished Brazil’s economic arch enemy—inflation—andinterest rates are expected to start dropping as soon asnext month. These orthodox economic accomplish-ments are even more remarkable when one considersthat they have been performed with the support of apresident from Brazil’s Workers’ Party, who rose froma humble background to fashion a party that symbol-ized, until recently, grassroots democracy and integrity.Until three months ago, President Luiz Inacio Lula daSilva, buoyed by high popularity ratings, looked likea sure bet to win reelection in October 2006.

Suddenly however, all bets are off. In May a con-gressman under investigation for bribery declared hewould not be a fall guy, and started naming names.Three congressional special investigatory committeessoon started taking testimony, and the fully televisedsessions have dominated the news coverage and cre-ated a press frenzy. What initially started out as “sup-port payments” to secure opposition votes in Congresshas gradually revealed a more insidious network ofslush funds and diversion of state revenues. PresidentLula was able to stay above the fray until two weeksago, when his ratings started dropping like a stone af-ter allegations by a former adviser that Lula’s presiden-tial campaign was partially underwritten by illegallyobtained funds. A few days later a former secretary ofthe Minister of Finance charged that Antonio Paloccitook bribes when he was a city mayor. Investors beganto worry that the managers guiding Brazil’s economicpolicies could be in jeopardy. Mr. Palocci made a per-suasive denial of the charges on national television, andthe financial markets were calmed.

John Welch is Senior Vice President, Sovereign Strategyat Lehman Brothers in New York.

Political Scandals Threaten Brazil’s Economic ResurgenceThe Surprising Fall from Grace for Brazil’s Workers’ Party, andPossibly President Lula

An Interview with Lehman Brothers’ John Welch

To find out just how sanguine investors should beabout the political upheavals in Brazil, LALBR talkedwith Lehman Brothers’ John Welch. John had just re-turned from a week of meetings with clients and man-agers in Brazil.

LALBR: Has the political crisis dampened the robustgrowth of the Brazilian economy?Welch: The Brazilian economy was already going to slowdown this year because of the very conservative stanceof the Central Bank in keeping interest rates elevated. So

If Lula were impeached, we'd have somebig problems.

the question is, has the crisis affected over and abovewhat we already had? Probably not yet. It has probablyleft the Central Bank a little more conservative than itwould otherwise be.

LALBR: As evidenced by its failure to lower interest rates?Welch: Yes. Also, the crisis is starting to affect invest-ment somewhat, although we have not seen the fullsigns of this yet.



BRAZIL

Foreign Investors Not ScaredLALBR: How is the political crisis affecting foreigninvestors?Welch: Investors have generally thought that as long asLula was safe and his Minister of the Economy was safe,that everything would be fine. Well, investigations aregetting very much closer to Lula. Just a few weeks agoBrazil’s Minister of Finance, Antonio Palocci, was accusedof receiving kickbacks when he was mayor of the townof Ribeirão Preto in São Paulo state. This is a serious turnof events because Mr. Palocci is closely associated with

Special Interview (from page 4)

The things that really would affectforeign direct investment are not part of

this crisis.

current economic policies. So you can see that perhapssome foreign investors, I am talking about portfolio man-agers, have been focused too narrowly. In terms of long-term investment, we had a massive amount of direct for-eign investment in July—over $2.2 billion. So, that partseems to be fine and certainly whatever crisis Brazil isfeeling right now is nothing compared to what it has gonethrough in the past. Similarly, multinationals in Brazilhave seen much more significant changes in the past thanwhat they are seeing now. So the crisis is affecting on themargin, but not a huge amount.

LALBR: Judging at least from the amount of foreign capi-tal that is going into Brazil, direct foreign investors do notseem to be taking much notice of this crisis. Why isn’t thiscrisis causing more concern among foreign investors?Welch: Foreign investors make very long term plans. Isthis crisis going to affect whether someone buys a car in10 years or drinks Coca-Cola in the next three? Probablynot. Some sectors perform better during times of crises,such as tobacco and alcohol. Is the current crisis going toaffect how well Vale do Rio Doce [CVRD—the largestmining company in the Americas, and world’s largestexporter of iron ore] is doing on the export markets? No.Should foreign investors be worried that Brazil willhinder the transfer of funds by imposing controls oncapital leaving the country? Well, the probabilities ofthose scenarios happening is quite low. The things thatreally would affect foreign direct investment are not partof this crisis. And politicians are making every effort toinsure that the economy is not affected by the crisis. Theyare trying to make it seem like this crisis will not affectcompanies and investors.

LALBR: You just returned from Brazil. Were the people youmet with worried about the way this crisis is unfolding?

Welch: I think most of them were concerned. They areworried that the crisis could bring market volatility, butI don’t think their long term vision for Brazil being onthe right track has changed.

Problems if Scandal Reaches PresidentLALBR: What is the biggest risk that this crisis posesfor Brazil’s economy?Welch: The biggest risk is a loss in governability. If Lulawere impeached, we’d have some big problems. The vicepresident, José Alencar, is not well known; many do nottrust him to carry on the economic policies of the currentadministration. To add to the uncertainty, there are dif-ferent procedures for impeachment in Brazil. So it is notpossible to say if the vice president would take office ifPresident Lula were impeached. To make matters morecomplicated, investigations centering around violationsof campaign finance rules could implicate both PresidentLula and the vice president. If this were the case, thenSeverino Calvacante, the speaker of the lower house,would take over as president for 30 days. He would callfor an election by members of Congress. The winner ofthe congressional vote would serve out the remainingtime of Lula’s term [the presidential term ends on Janu-ary 1, 2007]. The problem with this procedure is that itconfines the election to members of Congress, and rightnow the reputation of Congress has been sullied by thescandals. Certainly the image of Congress is worse thanthe president’s at this point.

LALBR: What would be the effect on foreign investors ifLula were impeached?Welch: Foreign investors would hesitate, because theywould not know who would be the next president, buta change in the presidency would not signal changesin policies for investors. Foreign investors would paymore because of the turbulence, but this would not bea massive effect.

LALBR: Will Lula be reelected?Welch: Well, it is increasingly looking like he will notbe. Our base case, before mid August, was that hewould be reelected, but now it is looking like he maychoose not to run again.

LALBR: Would Lula’s defeat be good or bad for foreigninvestors?Welch: That would be a welcome thing. It would be agood thing.

LALBR: What would happen if Lula announces that hedoes not intend to run again, and Palocci is brought downby the scandal?Welch: Well, this is probably the worst set of circum-stances that could happen, because then Brazil would


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Competition Law, Continued on page 7

ARGENTINA

Antitrust

Immediate Modification of Competition

Law No. 25,156The Executive Power, through the Ministry of

Economy, submitted to the National Congress on August17, 2005 a draft bill (Amending Bill) for the modificationof Argentine Competition Law No. 25,156 (CompetitionLaw). The Amending Bill intends to modify, among othermatters, certain articles of the Competition Law regard-ing term for approval, approval of certain economic con-centrations, set up of the National Tribunal for the De-fense of Competition (Antitrust Tribunal) and appoint-ment of its members.

Initial Comments on the Amending BillAlthough the main terms of the control for economic

concentrations are not modified, the proposed changesgrant more power to the Secretary of Technical Coordi-nation of the Ministry of Economy, as it will have theright to oppose every transaction that involves the in-dustries of mining, defense, energy or transactions withhigh impact on employment and/or investment.

The concept of tacit approval if no decision is issuedby the Antitrust Tribunal is also modified as it will alsoinvolve a communication to the Secretary of Technicalcoordination and the expiration of a term for the men-tioned authority to issue a decision.

Also, with the proposed changes, the NationalCommission for the Defense of Competition (Commis-sion) is transformed into the Antitrust Tribunal andthe former members of the Commission (four mem-bers and the president) are appointed as members ofthe Antitrust Tribunal (and the Ministry of Economyhas to elect two additional members as it should haveseven members). Creation of the Antitrust Tribunalresolves the uncertainty caused by the Province of

Alfredo M. O’Farrell ([email protected]) is a Partner atMarval, O’Farrell & Mairal and co-head of its AntitrustDepartment. Miguel del Pino ([email protected]) is anAssociate with Marval, O’Farrell & Mairal and a member ofits Antitrust Department. They are located in Buenos Aires.

Possible Modification of Argentine Competition Law Grantsmore Power to Ministry of Economy in Control of M&As

by Alfredo M. O’Farrell and Miguel del Pino (Marval, O’Farrell & Mairal)

Mendoza Courts that held in past decisions (seeLALBR, June 30, p. 9) that the Commission does nothave powers to resolve and approve M&A transactionsaccording to the terms of the Competition Law.

Proposed ChangesThe first modification proposed reduces from 45 to

40 business days the term for approval of economicconcentrations by the Antitrust Tribunal. After the


Competition Law (from page 6)

ARGENTINA

issuance of the resolution, the Antitrust Tribunal has twobusiness days to notify its decision to the Secretary ofTechnical Coordination of the Minister of Economy, whowill have three additional business days to request theentire file under certain specific reasons (“nationalgeneral interest reasons” involved and if it relates topublic utilities, or defense, energy or mining activitiesor the transaction has a high impact on employment orinvestment). If the file is not requested within thementioned term, the transaction is considered approved.

On the other side, if the Secretary of Technical Coor-dination requests the file, it will have a term of 10 busi-ness days to analyze the Antitrust Tribunal’s decision,confirm or modify it. It is not clear from the text of theAmending Bill whether the Secretary of Technical Coor-dination needs to ground any possible rejection of a trans-action that is approved by the Antitrust Tribunal.

Therefore, the term for approval may be extended to atotal term of 55 business days (or 45 if there is no interven-tion of the Secretary of Technical Coordination) and it alsogrants the Ministry of Economy the power to reject certaintransactions for national general interest reasons even if theyhave been approved by the Antitrust Tribunal. The bill statesin the “whereas” that this system is also applied in Spain,Germany and the United States.

If the Antitrust Tribunal does not issue its deci-sion within the 40-business-day term mentionedabove, the transaction will be considered as tacitlyapproved by the Antitrust Tribunal. However with thetext suggested by the Amending Bill, at the end of the40-business-day term without an express decision fromthe Antitrust Tribunal, the involved parties will haveto request the Antitrust Tribunal to communicate thetacit approval to the Secretary of Technical Coordina-tion. If the Secretary of Technical Coordination doesnot request the file or issue a resolution within theterms mentioned above (three days to request the fileand 10 business days to issue a Resolution), the trans-action shall be considered as tacitly approved and willhave definitive administrative effects vis-à-vis thirdparties. Based on this scheme, with the new inclusionsof the Amending Bill, the concept of tacit approval hasalso disappeared because the involved parties have torequest of the Antitrust Tribunal that a specific noticebe sent to the Secretary of Technical Coordination.

Independent Status for TribunalThe Amending Bill also states that the Antitrust Tri-

bunal is created as an independent entity within the areaof the Ministry of Economy. Although the CompetitionLaw created the Antitrust Tribunal, it was never set up.The Amending Bill resolves this issue.

The Amending Bill establishes that once it becomesoperative, the first composition of the Antitrust Tribu-nal will be formed by the current members of the Na-tional Commission for the Defense of Competition andtwo additional members (one lawyer and one econo-mist) to be appointed directly by the Executive Power.After completion, the members will decide in a ran-dom election which appointments will be renewed af-ter two and four years and which will be in office forthe entire term (six years).

Members of the Antitrust Tribunal will be appointedby the Executive Power after a public contest of generalbackgrounds and opposition before a special jury. Theirrenewal will be done partially every two years and theycould be reelected by the proceedings established in theprevious paragraph. Members of the Tribunal can onlybe removed after a decision by a special jury.

Enactment of the Amending BillIn order to be enacted, the Amending Bill must be

approved by simple majority of the Senate and HouseChambers and it has to be signed by the Executive Powerand published in the Official Gazette. If no specific termis contemplated by the law, it could become operative assoon as eight days after publication.

Status of Current Transactions under Review ofthe Commission

It is expected that, once the Amending Bill becomesoperative and the Competition Law is modified, its termswill be applicable to transactions under review. Therefore,transactions currently being reviewed by the Commissionwill continue to be analyzed by the Antitrust Tribunal andthe Secretary of Technical Coordination may also intervene,as detailed above. This modification will affect importanttransactions such as Ahold/Cencosud (acquisition of Discoand Vea Supermarkets) and Camargo Correa/Lacroze deFortabat (acquisition of Loma Negra Group). The new ruleswill surely be applied to them. Also, the new rules couldimpact on certain transactions that are pending to be ap-proved as their approvals were subordinated to the com-pliance of conditions (divestments). This last group includestransactions such as Telefónica/Bell-South (acquisition ofMovicom cellular company), AmBev/Bemberg Group (ac-quisition of a stock participation of Quilmes brewery) andthe acquisition of Fargo by the Mexican Bimbo.

Final WordsAlthough it is not possible to assess when this Amend-

ing Bill will be considered by both Chambers of the Na-tional Congress, it is expected that approval may come soon,probably before the end of the year. The Amending Billmodifies material aspects of the Competition Law. Thechanges make it easier for the government to intervene inmaterial transactions for political reasons. ❏


Controls, Continued on page 9

ARGENTINA

by Carlos E. Alfaro (Alfaro Abogados)

The Executive Power has recently issued a series ofdecrees and resolutions adopting further capital controlsto the ones already in force.

30 Percent Reserve WithholdingDecree No. 616/2005 and Minister of Economy’s

Resolution 365/2005 establishes restrictions and a reserverequirement of 30 percent on inflows of foreign capitalfor investments. The decree imposes the obligation of es-tablishing a cash reserve in dollars during one year tothe funds of non-residents entering the country for theacquisition of pesos, active or passive financial transac-tions, and investments in the secondary market.

365-day Term to Refund AbroadDecree 616/2005 also ratifies the 365-day term (set

forth by a former Resolution) during which funds thatentered the Argentine exchange market need to remainin the country. All funds that entered into the Argentineexchange market may only be transferred abroad after365 days. Furthermore, inflows and outflows of curren-cies from said market must be registered before the Ar-gentine Central Bank.

Main Points of the DecreeBonds and Shares

The restrictions will be applied when a foreign in-vestor wishes to purchase public bonds issued by the Ar-gentine Central Bank for the monetary regulation eitherin the primary or secondary market. To the contrary, ifthe foreign investor wishes to purchase public bonds—others than those issued by the Central Bank—in the pri-mary market or company shares it will be exempted fromthese restrictions.

Foreign Direct InvestmentsForeign Direct Investments are exempt of restrictions

when a foreign investor contributes to a direct investment.

Financial LoanIf the loan is related to (i) foreign trade, or (ii) direct

investment, or (iii) investments in non-financial assetsobtained and canceled within a term over 24 months,

Mandatory Corporate Capital Reductionand Dissolution Provisions, Once Again

Suspended

Due to the 2001-2002 economic crisis in Argentina,the Executive Power suspended the application of twoprovisions of the Companies Act No. 19,550, amongother measures.

One of the provisions suspended Section 94, subsec-tion 5, which includes as one of the causes for company’sdissolution: when a company losses its capital.

The other provision suspended Section 206, whichestablished a compulsory capital reduction: everytime that losses are superior to the reserves plus 50percent of the capital.

The term of the suspension began on July 18, 2002up to December 10, 2003. Afterwards, the ExecutivePower extended the term up to December 10, 2004.

Now, through Decree 540/2005, dated June 1, 2005,the Executive Power extended once again the term ofsuspension up to December 10, 2005. — by Carlos E.Alfaro, Alfaro Abogados, Buenos Aires

Carlos E. Alfaro ([email protected]) is a Partner withthe Buenos Aires and New York offices of Alfaro Abogados.Mr. Alfaro’s practice focuses on International Insolvency,Project Finance, M&As, Arbitration and Aviation Law.

Argentina further TightensForeign Capital Controls

including the payment of principal and interest, is exemptof restrictions.

Other Financial LoansThe following are operations subject to the 365-day

term restriction to transfer abroad, but not to the 30 per-cent reserve retention: (i) loans granted by bilateral ormultilateral financial entities; or (ii) other foreign loansapplied to the acquisition of foreign currency within thesame bank that receives the inflows, for the cancellationof the principal of a foreign debt and/or to create exter-nal assets of long-term periods.

Repatriation of FundsThe inflows of foreign currency to the country by

Argentine residents (foreigners nationals or not) arenot restricted by the decree as long as the original out-flow from the country had been declared, and in thecase of sales of foreign assets the amount resulting isless than $2 million. Anytime the amount is over$50,000, the resident shall inform the Federal Tax Bu-reau of the operation.

New Information RegimeArgentine residents have to inform the Central Bank

of direct and real estate investments if their value (calcu-lated on the basis of the net worth of the relevant foreigncompanies and/or the fiscal value of real estate abroad)equals or exceeds $1 million. If the relevant investmentdoes not reach this threshold, filing of the report is op-tional. When the value of the direct and/or real estate


Controls (from page 8)

Antitrust, Continued on page 10

ARGENTINA

investment is between $1 million and $5 million, the re-port may be filed annually at the end of each calendaryear. Information relating to direct and/or real estate

investments shall be provided by the entity or personrequired to report through an electronic form developedby the Central Bank and to be provided by financial en-tities. Once the form is completed, it shall be filed with afinancial entity, which will then process and deliver theform to the Central Bank. ❏

BRAZIL

by Marta Garcia, Priscila Castello Branco andMarcelo Maciel (Trench, Rossi e WatanabeAdvogados)

Gravel Cartel is Fined by CADEOn July 13, 2005, the Brazilian Competition Commis-

sion (CADE) fined companies operating in the gravelmarket in the São Paulo region for illegal cartel activity.Fines ranging between 15 percent and 20 percent of thecompanies’ gross revenues in the year prior to the inves-tigation were imposed, depending on whether or not thecompany had participated in the “Management Commit-tee” of the cartel. The Sindipedras labor union which wasresponsible for organizing the cartel and arranging thelocation of cartel meetings was fined R$300,000.

The Secretariat of Economic Law (SDE) received, inApril 2002, information that 17 companies operating inthe gravel market had formed a cartel. It was in this in-vestigation that the SDE, together with the Federal Po-lice and a Federal Attorney, for the first time ever in anantitrust investigation, conducted a dawn raid in orderto collect sufficient evidence to convict the companies ofcartel activity.

Among the material that was seized, the authoritiesfound computer software programs which gathered datarelating to clients, quotations, prices, etc. One of the pro-grams found collected information on clients and dailyquotations for prices, which allowed the monitoring ofquotas allocated to each participant of the cartel. Anotherprogram controlled the quotas by registering informa-tion on clients, prices charged and distribution regions,which served to verify if the agreed price was being ob-served. In addition, the Federal Police, which had inves-tigated the headquarters of Sindipedras as requested bySDE, reported that several meetings were held frequently

Marta Garcia ([email protected]), Priscila CastelloBranco ([email protected]) and MarceloMaciel ([email protected]) are members of theAntitrust Practice Group of Trench, Rossi e WatanabeAdvogados, associated with Baker & McKenzie.

Recent AntitrustDevelopments

in a closed room with security cameras that could onlybe entered by using magnetic entry cards. According tothe documents that were seized, the companies wouldagree on matters in the interests of the cartel in suchmeetings.

The Reporting Commissioner, Mr. Prado, notwith-standing adverse opinions, stated that cartels in Brazilare per se illegal. According to the Commissioner, if theclassic conditions of a cartel are present—as was the casein the gravel cartel—conviction of the companies in-volved in the cartel is almost a certainty. For this samereason, Mr. Prado and the remaining CADE membersdisregarded econometric studies presented by the SDEin this case. The gravel companies and the labor unioncannot appeal CADE’s decision in the administrativesphere, but they may still appeal CADE’s decisions inthe Federal Courts.

CADE Decides Proceedings Relating to MedicalPrice Guides

On July 13, 2005, the Brazilian competition authori-ties decided to terminate administrative proceedingsconcerning an investigation into the pharmaceuticalsindustry by the Parliamentary Commission of Inquiry(CPI), which commenced in 2000. The object of the pro-ceedings was to evaluate the influence of prices set outin pharmaceutical guides produced by BRASINDICE andABCFARMA on the prices of medicine in the market.

According to the CPI’s findings, the guides publishedby the defendants led to higher prices of medicines inthe market, whereas, the defendants claimed that theobjective of the guides was only to inform customers ofprices of medicines. The guides played no role in settingprices of medicines in the market and there were vari-ous Orders and Laws, which required the publication ofprices of medicines to the public.

Commissioner Cueva, the reporting commissionerin this case, agreed with the arguments of the defendants.The Orders and Laws supported the defendant’sstatements that the only function of the guides was toreveal prices to consumers and not to interfere with thesetting of prices or any increases in prices of medicinesin the market. In addition, the Commissioner explainedthat the pharmaceutical sector had special characteristics


Antitrust (from page 9)

BRAZIL

requiring intervention by the State—in particular, giventhat asymmetry of information prejudiced the consumer.To this end, therefore, the price guides represented abenefit to consumers, reducing search costs for the pricesof medicines and ensuring prices of medicines were madepublicly available to consumers.

In accordance with the information provided dur-ing the proceedings, the guides only set down themaximum prices that could be charged for each medi-cine. Hence, one other concern raised was the possi-bility that pharmacies might end up charging the maxi-mum price for medicines, facilitating tacit collusionprejudicial to the consumer. In Commissioner Cueva’sopinion, a response by the Brazilian competition au-thorities to an inquiry in 2002 demonstrated that thepublication of maximum resale prices in the guideswas unlikely to lead to tacit collusion between thepharmacies, given that there was a possibility of ne-gotiating discounts from these maximum resale pricesbetween consumers and pharmacies.

In the final decision, which resulted in terminationof these proceedings, the Brazilian Authorities recom-mended that the defendants include on each page of theguides a statement explaining that all prices containedin the guides were maximum resale prices and that con-sumers would have the right to negotiate discounts fromthese maximum resale prices with pharmacies.

CADE Approves with Restriction Transactionbetween Koch and Dupont

The Brazilian Competition Commission approved atransaction between Invista (Dupont’s textile division)and the Koch Group subject to one restriction. The re-striction imposed by CADE concerns an exclusivityclause contained in the acquisition agreement that wasentered into by the parties.

The main antitrust concern that this transactionraised related to the exclusivity agreement. Invista is amanufacturer of polyamide (nylon), which is used in theproduction of textile fibers, engineering plastics and tires.The companies decided to enter into an exclusivity ar-rangement because Dupont decided not to sell its engi-neering plastic’s business. Under the agreement, Kochwould be able to sell its excess production of polyamideonly to Dupont.

The Italian group Radici participated in the proceed-ings, arguing that the exclusivity arrangement betweenthe merging parties would give rise to anticompetitiveconcerns in the Brazilian market. Radici is active in theengineering plastics business and, therefore, uses polya-mide as an input.

According to the Reporting-Commissioner’s deci-sion, the exclusivity clause was indeed anticompetitiveand could not generate any efficiency gains. The Com-missioner found that competitors’ prices would increaseas a result of the exclusivity clause. According to his de-cision, several market conditions led to theanticompetitive effects of this exclusivity agreement, suchas high barriers to entry of new polyamide producers,high cost of importation and the difficulty that small andmedium-sized producers would have to manufacture bythemselves this input (since production facilities mustbe very large in order to be cost-effective).

CADE, by majority vote of its members, decided notto intervene in respect of another clause that was underdiscussion. The non-competition agreement betweenDupont and Koch had a seven-year term, which is longerthan the five-year term that CADE’s case law establishesas being reasonable. The Commissioners, however,agreed that this longer term was reasonable, given thatthe transaction involved several brands that had strongconsumer appeal (e.g., Lycra). ❏

Will Brazil Seek Another Victory overthe U.S. at the WTO?

For many years Brazil has complained that someof its major exports have been constrained by hightariffs and threats of dumping and countervailingduties at ports of the U.S. and Europe. In the lastthree years Brazil has changed its trade disputestrategy from bilateral negotiations to dispute reso-lution at the WTO. The strategy has paid off, withthe WTO recently siding with Brazil on cotton ex-ports to the U.S., and sugar exports to the EU. A long simmering dispute between Brazil and

the U.S. over orange juice might be the latest issueto be sent to a WTO panel. Brazilian officials havelong complained over the high tariffs on Brazilianorange juice charged by the U.S.: $418 a ton. Nowthe duties will rise even more. On August 17 the U.S. Department of Com-

merce announced dumping duties on Brazilianorange juice of 25 to 60 percent. The duties willvary for different Brazilian producers. The deci-sion by the U.S. cited the plight of the Florida or-ange juice industry after successive hurricanes. Officials at Brazil’s Foreign Ministry said they

could demonstrate that no dumping had occurred.They said that they would first focus on bilateraltalks with the U.S. to reverse the decision. — byScott P. Studebaker


BRAZIL

by Ricardo Barretto Ferreira da Silva (BarrettoFerreira, Kujawski, Brancher e GonçalvesSociedade de Advogados)

Important measures recently have been adopted toboost and foster the information and communicationtechnology sector.

The Innovation Law, which was approved at the endof 2004, brought incentives for innovation, scientific andtechnological research. The concept of creation contem-plated by law includes inventions, utility models, indus-trial drawings, computer programs, integrated circuit to-pographies, new essentially derived varieties and any othertechnological development that leads to or could lead tothe emergence of a new product, process or incrementalupgrade, obtained by one or more than one creator.

The Innovation Law determines that the federal gov-ernment, ICTs1 and related agencies will promote andstimulate development of innovative products and pro-cesses at national companies and at not-for-profit pri-vate national entities focusing on research activities,through the granting of financial, human, material or in-frastructure resources, to be agreed on in specific arrange-ments or contracts, designed to support research and de-velopment activities, to address the priorities of the na-tional industrial and technological policy.

Designed to Increase ExportsAlthough the law determines that such priorities

should be established in a regulation, it should be em-phasized that among the Guidelines of the Industrial,Technological and Foreign Trade Policy (PITCE) launchedby the government in March 2004, the drive for techno-logical innovation and education become the focus of thecountry’s agenda. The measures announced in the gov-ernmental guidelines aim to fulfill the needs of nationalcompanies to keep track of new demands of the globalmarket, seeking to move and expand the flow of exports,to enable the country to have greater participation andcompetitiveness in international trade.

Software SectorOne of the priorities of the government is the software

sector. Discussions involving fiscal and political issues ofexclusive financing for the area have become more intense.

Ricardo Barretto Ferreira da Silva ([email protected])is the founding and senior Partner of Barretto Ferreira,Kujawski, Brancher e Gonçalves Sociedade de Advogados,São Paulo.

New Law Provides Incentivesfor Technology, R&D

With the signing of “MP do Bem,” which was the nameby which Provisional Measure 252, signed on June 15th ofthis year by President Luiz Inácio Lula da Silva becameknown, some benefits, especially of a fiscal nature, weregranted, including the areas of software and TI, digital in-clusion projects and technological innovation.

Tax BenefitsA “Special Taxation Regime for the Information Tech-

nology Service Export Platform” (REPES), was created,whereby the beneficiaries will be companies that: (i) arein a regular situation with their federal tax obligations(the adhesion of companies electing for SIMPLES is pro-hibited); (ii) execute software development and informa-tion technology service rendering on an exclusive basis;(iii) assume an export commitment over 80 percent oftheir annual gross revenue from the sale of goods andservices. Companies that adhere to REPES will be ableto suspend the imposition of certain taxes, the ImportPIS/PASEP and of Import COFINS levied on imports ofnew goods earmarked for the development of softwareand information technology services.

Open Source SoftwareThe REPES beneficiary company should utilize a

computer program in open code, through which theInternal Revenue Service will have access to informa-tion for auditing purposes (control of production andof the proof that the contracting party of the renderedservice resides or is domiciled abroad). Other impor-tant aspects include the Special Capital Goods Acqui-sition Regime for Exporting Companies—RECAP andthe Digital Inclusion Program.

Special benefits were also granted to micro and smallcompanies under the MP do Bem, such as elimination ofthe retroactivity of the exclusion of Simples, when re-sulting from the entry of debits in the Outstanding Debtwith the federal government or of INSS, in addition totax incentives for technological innovation.

The MP do Bem still has to be voted on in the Na-tional Congress.

It is also important to observe the existence of spe-cific legislation for the tax benefits for information tech-nology and automation goods (Information TechnologyLaw); also at the end of 2004, the aforesaid InformationTechnology Law was amended, guaranteeing the reduc-tion of IPI (Excise Tax) until the year 2014.

Generally speaking, the measures currently in forceare expected to be effectively implemented, pushing thecountry toward escalating development.___________1Scientific and Technological Institution, a public administra-tion agency or entity whose institutional mission includes, inaddition to other aspects, execution of basic or applied researchactivities of a scientific or technological nature. ❏


BRAZIL

by Vinicius Branco and Luca Priolli Salvoni (Levy &Salomão Advogados)

Law No. 11,053, of December 29, 2004, and NormativeInstruction No. 497, of January 24, 2005, brought severalchanges to the taxation rules applicable to private pensionfunds in Brazil, especially with regard to the so-called indi-vidual programmed retirement fund (Fundo deAposentadoria Programada Individual—FAPI), the supple-mentary social security plan (Plano Gerador de BenefíciosLivres—PGBL) and life insurance plans featuring a survivalcoverage clause (Vida Gerador de Benefícios Livres—VGBL). FAPI and PGBL are the most frequently recom-mended options for employees and executive officers whoseincome is subject to Brazilian withholding tax (WHT), whileVGBL is recommended for individuals who do not havetaxable income.

Rules Applicable to Legal EntitiesExpenses incurred by Brazilian legal entities making

contributions to FAPI and PGBL are deductible for purposesof Brazil’s corporate taxes on profits (IRPJ and CSLL taxes),provided that the contributions assessed in each base pe-riod do not exceed 20 percent of the compensation (em-ployee wages and executive remuneration) linked to theFAPI and PGBL plans. Beginning in 2005, VGBL contribu-tions paid by Brazilian legal entities will also be deductiblefor purposes of the IRPJ and CSLL taxes, subject to the sameconditions applicable to FAPI and PGBL. This is the mostimportant change introduced by the new legislation fromthe perspective of Brazilian companies.

Rules Applicable to IndividualsFor Brazilian individuals, no changes have been made

to deductibility rules. Contributions made/paid by partici-pants to PGBL and FAPI plans may be deducted from theirIndividual Income Tax (IRPF) up to the limit of 12 percentof their gross income. Contributions to VGBL plans maynot be deducted.

For taxation of redemptions and payments of benefits,beginning January 1, 2005, participants of FAPI, PGBL, andVGBL plans may choose a withholding taxation regime fea-turing regressive rates and set with reference to the accu-mulation/accrual term of the subject proceeds. In such cases,

Vinicius Branco ([email protected]) is aPartner, and Luca Pr io l l i Sa lvoni ( lsa [email protected]) is an Associate, with the São Paulooffice of Levy & Salomão Advogados. Both are membersof the Tax Group of the firm.

Private Pension Funds inBrazil: New Taxation Regime

the WHT is levied equally on redemptions and paymentsof benefits, on a definitive basis, at rates that vary from 35percent to 10 percent. Such rates decrease as the accumula-tion/accrual term increases. Individuals who do not optfor regressive rates will be subject, starting in 2005, to WHT

Expenses incurred by Brazilian legalentities making contributions to FAPI andPGBL can be deductible for purposes of

Brazil’s corporate taxes on profits.

levied at (i) 15 percent on advance redemptions of amountsaccrued on the funds; and (ii) progressive rates of up to27.5 percent on benefits received. In both cases, WHT paidis only an estimate or advance collection of the IRPF (indi-vidual income tax) due on the annual tax return, which islevied at progressive rates of up to 27.5 percent. Thus, atthe end of each year, amounts received will be subject toIRPF assessed in the annual tax return in accordance withsaid progressive rates.

Rules Applicable to Private Pension Funds andInsurance Companies

Since January 1, 2005, earnings that derive frominvestments made by private pension funds and byinsurance companies, during the plans’ accumulation/accrual period, are not subject to WHT or to incometax payable separately. ❏

Published by WorldTradeExecutive, Inc.

Tel: 978-287-0301; Fax: 978-287-0302www.wtexec.com

Publisher: Gary A. Brown, Esq.Managing Editor: Scott P. Studebaker, Esq.

Assistant Editor: Edie CreterSpecial Interviews: Scott Studebaker

Feature Writers:Judy Kuan, Amanda Johnson

Production Assistance: Edie CreterMarketing: Jon Martel


Revenue Office, Continued on page 14

BRAZIL

by Luiz Roberto Peroba Barbosa, Maria Teresa LeisDi Ciero and Tércio Chiavassa (Pinheiro NetoAdvogados)

Provisional Measure 258 (MP 258) was publishedin the Official Gazette of the Federal Executive on July22, 2005. MP 258 is primarily designed to unify into asingle body the administration, inspection, collection,assessment and regulation of federal taxes, formerlyunder the authority of the Federal Revenue Office andthe National Social Security Institute (INSS). As a re-sult, the beefed-up Brazilian Federal Revenue Office(Receita Federal do Brasil) will encroach upon socialcontributions until then administered by INSS, namely:(a) contributions owed by companies on the payroll;(b) contributions payable by domestic employers; (c)contributions payable by workers on their contribu-tion salary, as well as contributions payable by thirdparties that are similar to such contributions.

Once again the federal government has adopted aquestionable practice by issuing a Provisional Measureto carry out significant changes in powers, duties andpositions, without justifying their urgency and impor-tance as required under the Brazilian Constitution. A bet-ter alternative would have been to include such changesin a bill sponsored by the Brazilian president.

The Brazilian Federal Revenue Office will be headedby the Secretary General (Secretário-Geral), a new officecreated by MP 258. The Brazilian Federal Revenue Of-fice is a body of the direct administration reporting tothe Ministry of Finance. It may also, by means of a con-vention and upon remuneration, collect contributionspayable to another body that has the same assessmentbase as the contributions assessed on the amounts paidthose qualifying for the General Social Security System,as set out in MP 258.

The proceeds from collection of these “social secu-rity contributions,” which are now under the authorityof this recently-instituted Brazilian Federal Revenue Of-fice, will be exclusively earmarked for payment of ben-efits under the General Social Security System.

One of the innovations is the transfer of tax admin-istrative proceedings to the Brazilian Federal RevenueOffice, including those formalized or being formalized,

Luiz Roberto Peroba Barbosa ([email protected])is a Partner, and Maria Teresa Leis Di Ciero([email protected]) and Tércio Chiavassa([email protected]) are Associates in the Tax-Labor area of Pinheiro Neto Advogados.

Brazil’s Super FederalRevenue Office

as well as of payment forms and statements submittedto the Ministry of Social Security and the INSS. EffectiveAugust 2006, the rules set out in Decree 70235/72 willalso apply to such “social security” contributions thatwere incorporated into the authority of the Brazilian Fed-eral Revenue Office. Such deadline may be changed bythe Executive Branch for tax proceedings and first-in-stance authority for judgment of those disputes.

An important aspect is that MP 258 maintained therules dealing with offsetting, refund, reimbursement,immunity and exemption, which continue to be regu-lated by the rules in effect at the time MP 258 was pub-lished. Article 74 of Law 9430/96, however, does notapply to the contributions formerly under the authorityof the INSS, which are now entrusted to the BrazilianFederal Revenue Office.

Advance Tax RulingsRequests for advance tax ruling will observe a single

system, in accordance with the rules set forth in Decree70235/72 and articles 48 and 49 of Law 9430/96. Requests

Tax hearings and other taxadministrative proceedings are

transferred to the Brazilian FederalRevenue Office.

pending review and determination by the Social Secu-rity Revenue Office of the Ministry of Social Security willbe voided and must be resubmitted. Taxpayers shouldcheck carefully whether this case applies to them.

On the other hand, MP 258 does not change the INSSauthority, which is established in specific legislation,particularly in connection with (i) granting and paymentof benefits and rendering of social security services; (ii)services provided to those qualified for such benefits; (iii)review of administrative proceedings involving entitle-ment to social security benefits and services linked orrelated to the social contributions addressed above; and(iv) issuance of a certificate for length of contribution.

MP 258 transfers the authority to rule on appeals filedin relation to contributions, which are now under theauthority of the Brazilian Federal Revenue Office, fromthe Social Security Appeals Board to the 2nd Taxpayers’Council of the Ministry of Finance. Cases currently un-derway at the Social Security Appeals Board will be sentover to the 2nd Taxpayers’ Council within 30 days fromcreation of the new chambers. Until then, the Social Se-curity Appeals Board will continue with authority to ruleon existing appeals.


Revenue Office (from page 13)

BRAZIL

Office of Tax AuditorMP 258 created the office of Tax Auditor of the Brazil-

ian Federal Revenue Office to exercise the authority of theBrazilian Federal Revenue Office. The Tax Auditor will (i)exclusively, formalize, by assessment, the tax liability aris-ing from taxes that fall under the authority of the BrazilianFederal Revenue Office; (ii) make and render decisions onand take part in tax administrative proceedings, and in re-quests for advance ruling involving refund, offsetting andacknowledgment of tax benefits; (iii) conduct inspectionprocedures, including customs inspection procedures; (iv)examine the accounting records of business companies,bodies, entities, funds and taxpayers in general, withoutapplying the restrictions set out in articles 1190 and 1192,but with due regard for article 1193, all of the Civil Code;and (v) audit the collecting network in connection with re-ceipt and transfer of taxes collected by the Brazilian Fed-eral Revenue Office.

The National Treasury Attorney’s Office will act asadvisor, represent the federal government in and out ofcourt, and determine the liquidated nature and certaintyof the debts posted in the federal overdue tax liability

MP 258 has modified article 44 of the Social SecurityOrganic Law (Law No. 8212 of July 24, 1991), providingthat the Brazilian Federal Revenue Office, through theNational Treasury Attorney’s Office (charged with rep-resentation in court), will also be responsible for collect-ing social security contributions levied on paymentsmade in labor claims. The other provisions of Law 8212/91 remain in full force and effect.

MP 258 will come into force on the date of its publi-cation in relation to articles 32 and 37, which state, re-spectively, that DATAPREV will be authorized to pro-vide services to the Ministry of Finance for the purposesof MP 258, and that the Federal Revenue Office and theSocial Security Revenue Office will issue up to August14, 2005 the joint rules required for operation of the Bra-zilian Federal Revenue Office as from August 15, 2005.The other articles of MP 258 become effective as fromAugust 15, 2005.

The notion of consolidating the INSS and the Fed-eral Revenue Office duties is not new, having been heardof since the former administration, particularly due tothe Federal Revenue Office’s constantly-improved anddynamic procedures, which increased considerably taxrevenues and improved the efficiency and automationof such office. Inspection activities have been divided byspecific matters (Department of International Affairs,Special Financial Institutions Office, etc.). Such efficiencywill be very useful to manage social security liabilitiesand reduce costs, since only one body will be in chargeof tax revenues.

Confusion Caused by Recent ChangesHowever, one can’t be careful enough! Automa-

tion and development of the Federal Revenue Officehave greatly helped to increase tax revenues in recentyears. Several hurdles were created for taxpayers, es-pecially a good number of new tax statements, whichhinder the issuance of debt clearance certificates as aresult of errors in the information filled out or absenceof correlation in the information obtained by the Fed-eral Revenue Office, and so forth. Hopefully, the newBrazilian Federal Revenue Office will not create fur-ther difficulties for taxpayers, but rather make theirlife easier.

At first impression, it appears that the federal gov-ernment has hit the target, since MP 258 is extremelysalutary in several aspects. However, the tool chosento carry out the purpose has once again proved to beinadequate, as such a significant change would bemore legitimate if made via a law proposed by thepresident of the Republic rather than via such a pre-carious instrument as a Provisional Measure, encroach-ing once more upon the full authority of the NationalCongress. ❏

MP 258 created the office of Tax Auditorof the Brazilian Federal Revenue Officeto exercise the authority of the Brazilian

Federal Revenue Office.

roster in connection with the “social security” contribu-tions transferred to the Brazilian Federal Revenue Of-fice. Such powers were previously entrusted to the INSSAttorney General’s Office. Until July 31, 2006, INSS willbe represented by the federal government Attorney’sOffice in issues involving tax liabilities predating the ef-fectiveness of MP 258. A Transition Committee was cre-ated, and will report to the Attorney-General of the fed-eral government and to the Minister of Finance.

In order to accommodate the recently-created dutiesand obligations, MP 258 has instituted 120 National Trea-sury Regional Attorney’s Offices to be set up by a rulingof the State Ministry of Finance in cities where there arefederal lower courts, as well as 1200 new National Trea-sury Attorney positions. Likewise, the Brazilian FederalRevenue Office will have five Judgment Boards and 60Judgment Panels to take joint internal resolutions, withauthority to render a first-instance decision on proceed-ings claiming taxes administered by the Brazilian Fed-eral Revenue Office. Such measures will be implementedin accordance with the need for the services and avail-ability of budgetary resources.


Interest Rate, Continued on page 16

BRAZIL

by José Barreto Neto and Claudia Pinheiro (Levy &Salomão Advogados)

Brazil’s Congress passed a law in 2004 creating anumber of new securities, the most notable of which isthe “agribusiness receivables certificate” (CRA) that aimsto facilitate access to capital in Brazil’s agribusiness sec-tor. CRA securities are registered and freely negotiable,and represent a promise to pay in cash funds. They arebased upon credit rights deriving from the production,sale or manufacture of agribusiness products and ma-chinery, including financial operations between farms,cooperatives and third parties.

While the new certificates have been authorized byCongress, the application of Brazil’s CPMF1 tax to thecommercial or industrial agribusiness transactions un-derlying CRAs has discouraged agribusinesssecuritization companies from issuing CRAs. In contrast,Brazil’s CPMF tax is not levied on the proceeds of real

José Barreto Neto ([email protected]) andClaudia Pinheiro ([email protected]) are with theSão Paulo office of Levy & Salomão Advogados. Mr.Barreto Neto’s practice is focused on the local capitalmarkets sector, securitizations and structuredtransactions. Ms. Pinheiro’s practice is focused on thelocal capital markets sector, banking sector andsecuritizations.

New “CRA” AgribusinessSecurity

estate and financial credits deposited into securitizationcompanies’ accounts. In addition, real estate and finan-cial securitization companies could deduct expenses in-curred in raising capital for the determination of the as-sessable basis of the PIS and COFINS2 tax, this benefitagain being unavailable to issuers of CRAs, as such se-curities are based on commercial or industrial activities.On June 15, 2005, however, a provisional measure waspassed that extends to CRA issuers the deductibilityprivilege previously extended only to real estate and fi-nancial securitization companies.

The advent of CRAs demonstrates that Brazil’sCongress is serious about creating new sources of capi-tal for the country’s agribusiness sector. Nevertheless,only when the tax cost associated with the transactionsunderlying CRAs achieves full parity with that oftransactions underlying comparable real estate or fi-nancial credits will CRA issuances be rendered viableand permit the agribusiness sector in Brazil to havefull access to capital markets.___________1The Provisional Contribution on Financial Transfers tax(Contribuição Provisória sobre Movimentação ou Transmissãode Valores e de Créditos e Direitos de Natureza Financeira—CPMF) is levied on proceeds deposited into companies’ ac-counts at a rate of 0.38 percent.2Both the Contribution for the Social Integration Plan tax(Contribuição para o Programas de Integração Social—PIS) andContribution for Social Security Financing tax (Contribuição paraFinanciamento da Seguridade Social—COFINS) are levied on thegross income of companies at a rate of 0.65 percent and 4.00 per-cent, respectively (subject to alteration due to the entry into lawof Provisional Measure No. 252, of June 15, 2005). ❏

by Edwin Taylor

For the third consecutive month, Brazil’s CentralBank in August chose to hold the Selic (Brazil’s overnightrate) at 19.75 percent a year. The conservative decisionof the bank’s monetary policy committee (Copom) camedespite the fact that inflation is in decline and the projec-tion of the financial market for the Broad Consumer PriceIndex (IPCA) has fallen for thirteen straight weeks, nowstanding at 5.4 percent, close to the Central Bank’s targetof 5.1 percent. Copom gave no explanation for its deci-sion but analysts speculated that it was caused by risinginternational oil prices and concerns with the impact of

Edwin Taylor is a LALBR special correspondent in Riode Janeiro.

Central Bank Hints at InterestRate Cuts in September

the political crisis on the financial market. Business lead-ers attacked the decision which they warned will main-tain this year’s stunted growth into 2006. Paulo Skaf,president of the São Paulo State Federation of Industries(Fiesp), charged that Brazil continues to be “an obstinatechampion of high interest rates.”

The minutes of the August meeting, however, indi-cated that bank directors will likely begin to lower theSelic rate starting in September. In the minutes, Copom

Despite a stronger local currency,exports continue to grow.

described the inflation scenario as “benign” and droppedthe language of the previous two months which spokeof holding the Selic rate unchanged for “a long time.”The only inflationary pressure cited by Copom was thethreat of an increase in the price of gasoline which has


Interest Rate (from page 15)


BRAZIL

not risen this year despite the record highs for the inter-national barrel price of petroleum.

According to the National Petroleum Agency, thesector watchdog, there is a 30 percent gap between thedomestic and international prices of gasoline. Part of this,however, has been covered by the year’s firming of thereal against the dollar. In the minutes, Copom pointedout that not only is inflation in decline but the projec-tions of the financial market are moving closer to theCentral Bank’s year-end target.

Public AccountsBrazil’s consolidated public sector posted a primary

budget surplus of $2.1 billion in July, the highest surpluson record for the month and 32.9 percent over July 2004.

For the year through July, the primary surplus to-taled $28.6 billion. The annualized surplus at the end ofJuly was $40.4 billion, the equivalent of 5.16 percent ofGDP, well in excess of this year’s target of 4.25 percent of

The continued strengthening of Brazil'sforeign accounts has reduced

significantly the country's vulnerabilityto foreign shocks.

Although the unemployment rate remained stable,July’s job figures contained one worrisome develop-ment—industry registered a net loss of 40,000 jobs in thecities surveyed. July is normally a month when indus-trial firms begin hiring in preparation for the usual surgein demand in the final quarter.

This reluctance to hire is a reflection of the twinconcerns of the private sector—interest rates and theexchange rate.

“The uncertainty regarding monetary policy inhibitsinvestments and consequently the opening of new jobposts,” said IBGE employment coordinator Cimar Azeredo.

The annual job figure also showed a significant de-cline in July. For the 12-month period ending in July,445,000 new jobs were created but this was far from June’sannualized result of 647,000.

Foreign Investment Remains StrongBrazil in July posted a current account surplus of $2.6

billion, the highest monthly total on record. This raisedthe year’s surplus to $7.9 billion, also an all-time recordfor the period and 27 percent over the total for the firstseven months of 2004. The annualized surplus in Julywas $13.9 billion, the equivalent of 1.9 percent of GDP,up from 1.9 percent in June.

The continued strengthening of Brazil’s foreign ac-counts has reduced significantly the country’s vulner-ability to foreign shocks. In July, the current account sur-plus was once more guaranteed by the trade surpluswhich also set a record for the month at $5.0 billion. Forthe year through July the trade surplus totaled $24.7 bil-lion versus the year’s services deficit of $18.8 billion.Another $2 billion entered the country through remit-tances from Brazilians living abroad.

For the year through July, the travel deficitwidened to $408 million as Brazilians continued totravel abroad more, taking advantage of the year’sfirming of the real against the dollar. The Central Bankhas now raised its projection for this year ’s traveldeficit to $800 million.

Profit remittances, which averaged over $1 billion amonth in the first semester, declined in July to $681 mil-lion. Central Bank economic department head AltamirLopes said companies accelerated their remittances inthe first half of the year because of the weakened dollarand are now reducing them.

Foreign direct investment also produced a surpris-ingly strong result in July, registering net inflows of$2.0 billion, the second highest total of the year. Forthe year through July, FDI stood at $10.6 billion andshould easily reach the Central Bank’s year-end pro-jection of $16 billion.

GDP. To reach the year-end target, the government mustaverage a monthly surplus of $1.2 billion for the remain-der of the year. The public sector’s combined debt alsorose in July, increasing from 51 percent of GDP in June to51.3 percent of GDP. Because of the year’s increase in theSelic rate, which adjusts 52.9 percent of the public debt,debt servicing costs have jumped 27.7 percent this yearto $38.4 billion. This increase led the Central Bank to raiseits projection for the year’s nominal budget deficit from2.67 percent of GDP to 3.6 percent.

LaborThe unemployment rate in Brazil’s six largest met-

ropolitan areas remained stable in July at 9.4 percent,according to the government’s statistics bureau IBGE.

But while the job market stagnated, income levelsimproved. The average wage in July rose 2.5 percentfrom June and 1.6 percent versus July 2004. This wasdue almost entirely to the month’s decline in inflationcoupled with lingering effects of May’s readjustmentin the minimum salary.




BRAZIL

In July, the private sector continued to pay off a largeportion of its maturing foreign debt. Only 45 percent ofthe maturing debt was rolled over in the month and theaverage for the year is now 68 percent. This is the reasonwhy Brazil’s foreign debt in May fell to $198.3 billion,the lowest level since December 1997.

Because of the government’s decision to pay aheadof time a $5 billion debt with the IMF, Brazil’s reservesdeclined in July from $59.9 billion to $54.7 billion. Netreserves, however, discounting IMF funds, showedlittle variation ending July at $40.4 billion versus $40.5billion in June.

Exports and Consumer Credit Purchases SpurIncreases in Industrial Production

Brazil’s industrial production expanded 1.6 percentin June from May, the fourth consecutive monthly ex-pansion and the largest since May of last year.

Compared with June 2004, industrial output rose 6.3percent and ended the first semester with growth of 5percent over the same period last year. In the secondquarter, production expanded 2.1 percent from the firstquarter in which growth was stagnated.

June’s results were led by durable consumer goodswhose output rose 8.1 percent from May and 23.6 per-cent compared with June 2004. Intermediate goods ex-panded 0.9 percent versus May and 2.9 percent year-on-year. Capital goods also continued their expansion whichbegan in May with a 5.2 percent increase and rose an-other 4.2 percent in June from the previous month.

The only area to present a reduction in the secondquarter was semi- and non-durable consumer goodswhose output fell 0.9 percent. In June, this sector ex-panded 0.7 percent.

Exports and expanding consumer credit were cited asthe main factors behind June’s strong growth results. Pro-duction of automobiles, appliances and cellular phonesexpanded at rates of 7 percent to 8 percent in June.

“Despite the firming of the real, we have not seenany sign of this appreciation in the export numbers. Onthe contrary, exports have surprised and set records. Theother impulse has come from expanded credit. These twofactors pushed up the sector of durable goods which hasbeen showing the best results,” said Sílvio Sales, coordi-nator of the industrial production survey for the Brazil-ian Institute of geography and Statistics (IBGE).

Industrial sales increased 1.53 percent from May,hours worked in production improved 0.68 percent, theindustrial work force rose 0.08 percent and industrialpayroll climbed 0.60 percent. Average capacity utiliza-tion went from 81.9 percent in May to 82.6 percent.

In the second quarter, sales rose 1.5 percent from thefirst quarter which had registered a 1.4 percent declineversus the final quarter of 2004. For the semester, salesincreased 4.5 percent compared with the same period lastyear, hours worked expanded 7.2 percent, employmentimproved 6.4 percent and payroll climbed 9 percent.

In June, nationwide retail sales volume rose 1.2 per-cent from May, according to the government’s statisticsbureau, IBGE. Versus June 2004, sales expanded 5.3 per-cent and ended the semester with a 4.6 percent increaseversus the first half of 2004.

June’s sales were again led by the sector of appliancesand furniture. Heavily dependent on credit sales, thesector registered a 4.3 percent expansion in volume fromMay. For the semester, the sector’s sales jumped 19.7percent. Sales of office equipment and technologicalgoods climbed 37.6 percent in the semester, anotherreflection of the importance of credit sales.

Semester sales of supermarkets, more dependent onsalaries, rose only 3.3 percent and sales of clothing and

Foreign direct investment is expected toreach $16 billion this year.

footwear expanded a weak 2 percent. In addition to in-creased credit, economists attributed June’s increasedsales volume to the readjustment of the minimum salaryin May and the decline of inflation.

InflationIn July Brazil’s Broad Consumer Price Index (IPCA)

measured inflation of 0.25 percent. Although this wasabove June’s deflation of 0.02 percent, the result waswithin the range expected by the financial market. Alsofor the year through July, the IPCA recorded an inflationrate of 3.4 percent, the lowest for the period since 2000.

July’s rate would have been much lower were it not forthe month’s 4.2 percent increase in phone rates which ac-counted for 60 percent of July’s inflation. Fuel prices alsorose with gasoline increasing 0.9 percent and alcohol fuelclimbing 2 percent—the two together were responsible foranother 20 percent of the month’s IPCA. None of the othercategories, however, showed any sign of inflationary pres-sure, leading analysts to celebrate the July figure as anotherindication that inflation is under control.

Thanks in part to the weakening of the dollar, foodprices declined 0.8 percent. Electricity rates fell 0.4 per-cent and urban bus fares dropped 0.2 percent.

The annualized IPCA fell from 7.3 percent in June to6.6 percent, continuing a trend that has existed over thelast three months.



BRAZIL

TradeBrazil in July continued to set trade records, regis-

tering the country’s highest monthly surplus and largestexport result in history.

Exports totaled $11.1 billion, 28.9 percent more thanin July 2004 on a daily average while imports rose 14.7percent to $6.05 billion. The resulting surplus of $5 bil-lion was nearly $1 billion more than in June, the previ-ous all-time high.

With July’s result, the year’s surplus jumped to $24.7billion, 33.6 percent over the surplus for the same periodin 2004. Exports for the first seven months of the yearclimbed 24.6 percent year-on-year to $64.7 billion. Im-ports rose 19.2 percent to $40.1 billion. The annualizedsurplus in July was $39.9 billion, another record.

Exports in July were helped by rising internationalprices for iron ore, coffee, sugar and pork. The exportrecord was also assisted by $300 million in petroleumexports that actually were shipped in June but did notenter the country’s books until last month.

On the import side, purchases of capital goods ex-panded 30 percent in July versus July 2004. Imports ofraw materials and intermediate goods increased 15.7percent and consumer goods rose 11.5 percent.

Following the release of July’s trade figures, theBrazilian Foreign Trade Association (AEB) announcedit was raising its projection for this year’s trade sur-plus from $32.1 billion to $42.1 billion. While AEB re-mains critical of the exchange rate, it now believes thatworld demand for Brazilian products will remainstrong through the end of the year. At the same time,imports are not increasing at the pace expected at thestart of the year. ❏

CHILE

by Alvaro Mecklenburg (Deloitte Chile)

After extensive debate and controversy, a tax on min-ing income in Chile will be levied as from January 1, 2006.The new law imposes a tax of 5 percent of operating prof-its on mining operators that produce more than 50,000metric tons of copper per year. A previous attempt toimpose a royalty on mining income failed because theproposal was unable to get the requisite number of votesin the Congress.

The tax will be imposed on a progressive scale onthe taxable operating income of mining operatorsdepending on the amount of copper produced eachyear. Taxable operating income is calculated by makingadjustments to the normal net taxable income of thecompany. Companies that produce less than 12 metrictons per year will not be subject to the tax; the rate forcompanies with a small amount of sales is between0.5 percent and 4.5 percent, increasing up to amaximum of 5 percent for companies with annual salesof more than 50,000 metric tons of copper. To prevent

Alvaro Mecklenburg ([email protected]) is aPartner with Deloitte Chile in Santiago.

New Mining Tax to go into effect in January

taxpayers from using artificial structures and/orallocations to avoid or reduce the mining tax, the lawprovides that, in calculating the tax rate, the mineoperator must include the total value of sales of miningproducts of the group of entities related to the miningoperator (to the extent such persons are engaged inthe exploitation of mining). Further, the Chilean taxauthorities will be allowed to challenge transfer pricesand make relevant adjustments to income as needed.

Taxpayers subject to the mining tax will be requiredto make monthly provisional payments at a rate that willbe calculated on the basis of sales (monthly gross income),but at a minimum of 0.3 percent. The law introducingthe mining tax also amends the foreign investment law(Decree Law 600) so that the tax treatment of mining in-vestments protected under Decree 600 is in conformitywith the new mining tax.

Investors in mining projects valued at more than $50million will be entitled to enter into a “stability pact”with the Chilean government, whereby the rate of themining tax will not increase for a period of 15 years. Chileis the world’s largest producer of copper and the miningindustry represents nearly 10 percent of GDP. ❏


COLOMBIA

by Andres Williamson (Baker & McKenzie)

In an effort to diversify and attract investment intothe productive sector, which would, in turn, expandthe public securities market, the ColombianSuperintendency of Securities issued Resolution 470of June 16, 2005, under which the Superintendency willintroduce certain rules fostering the establishment ofPrivate Equity Funds. The main change introduced byResolution 470 is to allow the incorporation ofportfolios comprised primarily of assets other thansecurities registered in the National Securities andIssuers Registry, which traditionally form part of theportfolio of the securities investment funds thatcurrently exist in Colombia.

Under Resolution 470, fund administrator companies(as broker dealers, fund managing companies or trustcompanies) will be able to set up closed funds thatdesignate at least two thirds of the contributions madeby the investors to purchase or acquire (i) shares or quotasof companies that are not listed in the Stock Exchange orregistered with the National Securities and IssuersRegistry, (ii) negotiable instruments issued by entitiesother than financial institutions, or (iii) any other assetswith an economic value (oil wells exploration andexploitation rights, participation in commercial trusts,real estate projects, etc.).

More Attractive to Foreign Investment FundsResolution 470 creates possibilities for developing

projects by attracting private equity, giving investorsthe possibility of a secondary market for liquidity, sincethe subscription rights of private equity funds aresecurities that must be registered in the NationalSecurities and Issuers Registry and listed on the StockExchange. Because the securities are registered, foreignportfolio investment funds as well as Colombianinstitutional investors (such as pensions and severancepay funds) can invest in Private Equity Funds, therebygenerating important dynamics for this type ofinvestment, which are widely developed in theinternational markets.

Andres Williamson ([email protected]) isa Partner with the Bogotá office of Baker & McKenzie.His practice is focused on banking & finance, insurance,mergers & acquisitions, and utilities privatization.

Boost to Private Equity Funds However, there are some economic restrictions.The minimum investment amount is 600 legalminimum monthly wages (about COP $230,000,000).Nevertheless, this requirement applies only atsubscription of the investment and can be variedthroughout the duration of the fund.

Another innovation introduced by Resolution 470 isthat it introduces flexibility into the obligation to appraisePrivate Equity Funds, requiring valuations at least every

The resolution is expected to increasethe amount of savings that will be

invested in private projects.

six months. Furthermore, the resolution demands theintegration of a Surveillance Committee for the PrivateCapital Funds, which must act as an executive branch ofthe fund and monitor compliance by the fund managers,investment analysis committees and professionalmanagers (another new feature) with their functions andto ensure, among others, that investments are made incompliance with applicable law.

ManagementPrivate Equity Funds can now hire professional

managers for the purpose of taking control of themanagerial duties of the Private Equity Fund, but suchdelegation will not release the fund administrators fromtheir responsibilities.

The professional manager can be a national orforeign individual or legal entity that can demonstratenational or international experience in managingPrivate Equity Funds.

The amendment is designed to implement commonstandards of practice in the international Private EquityFunds market, where it is customary to find professionalsspecializing in the administration of investmentportfolios, usually with extensive knowledge of theindustry or sector in which the investment is to be made.

Resolution 470 opens the door to increase the flowof savings towards investment in private projectsrequiring capital, whether start-up companies orcompanies in expansion. The possibility of an activeparticipation by foreign portfolio investment funds andinstitutional investors in Private Equity Funds, as wellas the creation of liquidity conditions required to facilitatethe settlement of investments on the secondary marketwill contribute to greater dynamism in the Colombiansecurities market. ❏


MEXICO

by Jose Raúl Félix-Saúl and Federico Ruanov-Guinea (Baker & McKenzie)

Mexico’s current legal framework allows powergeneration projects that may use renewable energysources under self-supply, small production, indepen-dent production and export schemes. The Law for thePublic Service of Electrical Energy (Ley del ServicioPúblico de Energía Eléctrica) does not restrict powergeneration to a specific technology. Although environ-mental costs are not expressly considered when pric-ing in the Mexican power market, there are a few pro-visions under Mexican law that promote the use of re-newable energy.

The General Law of Ecological Balance and Environ-mental Protection (Ley General del Equilibrio Ecológicoy la Protección al Ambiente) requires federal, state andlocal authorities to develop, within their respective ju-risdiction, sound policies that include economic, finan-cial, tax and market schemes that must grant a high pri-ority to activities related to “the research and implemen-tation of energy-saving mechanisms and the use of en-ergy sources that reduce pollution.”1 This law proposestax incentives to those who “conduct technology researchleading to a reduction of pollutants.”2 Based on theseprovisions, a proposal was submitted to Congress to in-clude article 227 of the Mexican Income Tax Law (ITL).

Jose Raúl Félix-Saúl ([email protected]) is anAssociate at Baker & McKenzie in the Juarez office, wherehe is the coordinator of the Environmental and NaturalResources Practice Group. Federico Ruanov-Guinea([email protected]) is a Partner withthe Tijuana office of Baker & McKenzie and coordinatorof the environmental practice group in Mexico. His practicefocuses on water, power and environmental issues.

Renewable Energy ProjectsIncentives

How Incentives Would WorkThis proposal was filed on March 1, 2005, by Senator

Gloria Lavara Mejia of the Mexican Green Party. If ap-proved by the Mexican Congress, the proposal wouldgrant the following tax incentives:

• Accelerated depreciation equal to 100 percent of thecost of the investment made in machinery and equip-ment that (i) diminishes pollutant gases that producea greenhouse effect, and (ii) substitutes the use ofsubstances that directly affect the ozone layer.

• Tax credits equal to (i) 10 percent of the taxable in-come in a given year to those taxpayers that performservice activities related to the maintenance of themachinery and equipment mentioned above, (ii) 30percent of the amount of investments made in a giventax year to preserve agricultural soil, (iii) 50 percentof the total amount of investments made in a givenyear in research that aims to determine the actualbehavior of pollutant gases and their effects to theozone layer, and (iv) 100 percent in investments madein machinery and equipment that promote the us-age of renewable energy.The purpose of the initiative is to broaden the tax in-

centives already in place in the ITL since FY2004, whichcurrently provides a tax incentive equal to depreciating thefull costs (100 percent) of machinery and equipment thatgenerate energy from alternative sources (solar, wind, ni-trogen, etc.), in the year that it was purchased. This incen-tive is only valid where the machinery and equipment be-ing depreciated at a 100 percent rate is placed to work atleast for a five-year period. Where the machinery and equip-ment is not operated at least for the five-year period, thetaxpayer will be required to recapture the percentage of thedeductions corresponding to those years in which the ma-chinery was not operated and characterize the recapturedamount as taxable income.__________1Ley General del Equilibrio Ecológico y la Protección alAmbiente-General Law of Ecological Balance and Environmen-tal Protection, section III, article 22 Bis.2Id, section III, article 166. ❏

Policy Options (from page 3)

this is an uncertain and variable source. Furthergovernment appropriations for Pemex might be feasiblethis year and next because the government calculated itsrevenue from oil based on a price of $27 per barrel forthe Mexican oil mix, and the actual average export pricehas risen to almost $40 per barrel. This kind of financingmay not be available year after year.

In other words, in order to let Pemex keep an extra$20 billion each year, tax collections would have to riseby at least that amount—and probably more, because abudget of 18 percent of GDP is inadequate to meet the Policy Options, Continued on page 21

need for better education and health care and a safetynet for the old and the poor. The question of privatizationcould be finessed for now if Mexico were able to letPemex operate as a normal company using its own earn-ings to make and carry out its own investment decisions.The “if” is a big one, but many Mexicans prefer this op-tion in order to keep oil in Mexican hands. Earlier in itshistory, Pemex was able to make investments from itsown revenue even after paying federal taxes, but this hasnot been the case for several decades.

The Mexican Congress recently passed legislation toreduce the taxes Pemex pays as of January 1, 2006. The


Policy Options (from page 20)

MEXICO

bill is complex and the tax imposed on Pemex would varywith the price of oil and gas, but it was an effort to addressthe problem of Pemex financing. The early indication is thatPresident Vicente Fox will veto the bill, presumably becauseit does not specify how the Treasury would get the revenueneeded to make up the shortfall that would result. The presi-dent has until September 1 to act on the bill. If he does exer-cise his veto, a two-thirds majority in each chamber of theCongress could override it.

Opening to Private InvestmentChoosing the other option of permitting private invest-

ment does not require the privatization of Pemex, only awillingness to allow joint ventures between Pemex and pri-vate interests, including foreign direct investment. Mexicowould still own the oil in the ground, but the private in-vestment would permit a risk-reward model that does notnow exist. This model exists in Canada and Brazil and othercountries that have government-owned oil companies. Ac-tion like that of Argentina, where the government-ownedoil company YPF (Yacimentos Petrolíferos Fiscales) wascompletely privatized in 1995 during the Menem adminis-tration, is not necessary in Mexico. The Brazilian and Ca-nadian models are working well.

The Mexican government could, of course, do both:relieve Pemex of some of its tax burden so that it can oper-ate as a normal oil company; and also accept private-pub-lic joint ventures, especially for expensive deepwater ex-ploration. When I last discussed the issue of deepwater drill-ing, several Mexican officials and experts said they hopedit would be possible to identify a suitable site that straddledthe territorial waters of Mexico and the United States,thereby permitting a joint venture that did not require aconstitutional amendment, obviating the need to face thecontroversial and emotional issue of private investment inMexico’s oil and gas resources.

The dangers Mexico faces are running out of oil bothfor domestic use and export in a relatively short period;of having to meet a growing bill for natural gas imports;and of failing to provide energy to all would-be users, orproviding it at a cost that is so high as to encourage pro-ducers to move to locations where energy is cheaper.Unless good fortune intervenes, the decisions will prob-ably have to be taken in the new administration thatcomes into office next year. Mexico has shown that it isable to make controversial decisions when it looks as ifthere will be economic hardship if nothing is done buteconomic benefit if long-standing policy is revised. Onegood example of this was the abandonment of importsubstitution policy—keeping high import barriers in or-der to protect domestic industries—following the finan-cial collapse in 1982. This led to lowering import protec-tion, joining the General Agreement on Tariffs and Trade,

and later entering into the North American Free TradeArea with the United States and Canada. The two issues,trade protection and permitting private risk ventures foroil and natural gas, do not have the same emotional reso-nance in Mexican history, nor is trade policy a constitu-tional issue. But both require the readiness to adapt whenthe economic well-being of the population is at stake.

The internal debate on oil, gas, and energy policy isgoing on, as the recently approved bill on Pemex shows.The head of Pemex has declared that he believes policychange is urgently needed. President Fox tried early inhis administration to change tax policy, but he failed tomake headway because of congressional opposition. Thedebate may take on new resonance in the campaign forthe presidency once it moves into high gear later this yearand early in 2006, but a frontal argument in favor ofchange is unlikely. Those who seek change will probablyseek to frame the debate around economic growth andmeeting the country’s social needs, while opponents willlikely emphasize the constitutional question of accept-ing private investment and advocate spending cuts ratherthan raising tax collections. The presidential candidatesare apt to discuss the future of Pemex but dance aroundthe policy issues involved.

The Political ProblemIt would be hard, probably suicidal in terms of win-

ning an election, for a presidential candidate to runon a platform that goes against a history of shunningforeign investment in the oil sector or that favors rais-ing taxes. Carlos Salinas did not run in 1988 on a plat-form of free trade with the United States. He came tothat position subsequently, when it became evidentthat the needed foreign investment for developmentwould not come from Europe, or elsewhere, without awelcome mat of legal assurance for investment inMexico and the promise of the large U.S. market. Inhindsight, it is clear that Salinas chose the right mo-ment for his free-trade initiative; and he made his caseon economic development grounds.

It is hard to predict when these two fundamentalcriteria—the impending energy shortage and theproper timing—will become simultaneously evidentto the Mexican public. Unless something unforeseenhappens soon, such as a new oil find or discovering alarge deposit of unassociated (i.e., not associated withoil) natural gas, the timing for some action to changeoil, gas, and energy policy will probably come sometime after the 2006 election, but during the next presi-dential sexenio (six-year term)._________1The May 2005 Issues in International Political Economy, no. 65,dealt with this theme of politics dominating oil and gas policyin many Latin American countries.

© 2005 by the Center for Strategic and International Studies ❏


MEXICO

by Rene Cacheaux and Miriam Name (Cacheaux,Cavazos & Newton)

Making interest payments to residents abroad is com-mon when dealing with countries such as Mexico, par-ticularly in cases where domestic companies receivemoney from their foreign parent companies or loans fromthird parties residing outside Mexico. In general terms,Mexican interest rates are higher than U.S. rates. This istrue even when one takes into consideration the dollar-peso devaluation factor.

Mexican law considers a taxable source of wealth toexist in Mexico when: (i) loan proceeds are invested inMexico; or (ii) interest is paid by a Mexican resident, or by aforeign resident with a permanent establishment in Mexico.

Broad Definition of InterestMexican law defines interest as including not only

payments made in connection with loans and publicdebt, bonds and obligations, but also payments result-ing from stock loans, factoring and similar transactionswith bonds or placement of debt obligations, commis-sions or payments made for obtaining or guarantee-ing loans, payments made to a third party for the ac-ceptance of an unconditional guaranty or collateral,and payments resulting from profits from the sale andtransfer of publicly-traded stock.

The Mexican Income Tax Law also considers as “in-come” any yield from a loan obtained by a foreign resi-dent resulting from acquisition of credit rights of anytype, whether present, future or contingent. In this case,the source of wealth is considered to be in Mexico whenthe credit right is sold and transferred by a resident inMexico, or by a foreign resident with a permanent estab-lishment in Mexico.

The Fifth Paragraph of Article 11 of the Tax Treatybetween Mexico and the United States includes withinthe definition of “interest,” income considered by the lawin the country of origin as proceeds resulting from moneythat has been lent. That said, the United States Depart-ment of the Treasury has interpreted this definition notto include penalties or fines for late payment.

Rene Cacheaux ([email protected]) is a Partner andMiriam Name ([email protected]) is an Associate atCacheaux, Cavazos & Newton, L.L.P.

How Mexico Taxes InterestEarned in Mexico and PaidAbroad

Tax CapsThus, under Article 11 of the Treaty, interest ac-

crued in one country and paid to a resident in anothercountry may be subject to taxation by the latter coun-try. That is, interest originating in Mexico paid to aUnited States resident may, in addition to being taxedin Mexico, also be taxed in the United States; however,if the effective beneficiary of the interest is a residentof the United States, or in the opposite case a residentof Mexico, limits exist on taxable rates that can be im-posed in the source country. In Mexico’s case, this ratemay be up to 30 percent in 2005. The treaty imposesthe following rate caps:

• 4.9 percent of the gross amount of interest arisingfrom loans granted by banks or insurance compa-nies, as well as those derived from bonds and/ornegotiable instruments that are traded in a recog-nized stock market;

• 10 percent if the effective beneficiary is not a finan-cial institution and the interest is paid by banks orby the purchaser of machinery and equipment soldand transferred by means of a credit sale;

• 15 percent in all other cases.Additionally, the Treaty establishes certain cases in

which interest may not be subject to taxation by the coun-try in which the interest accrued, for example, when theeffective beneficiary is the other country.

In Mexico, the tax is paid by means of a withholdingmade by the person that is making the interest paymentand is computed by applying the corresponding rate,taking into consideration the rate limits set forth in theTreaty, to the interest received by the taxpayer, withoutany deductions.

Payments by Company OfficeFor Mexican permanent establishments of foreign

residents, when payments for interest and other itemsdiscussed above are made by the main office or otheroffice of the company abroad, the withholding shouldbe made within 15 days following the date on whichthe payment is made abroad, or the payment is de-ducted by the permanent establishment, whicheveroccurs first.

Account statements and payment receipts issued byfinancial institutions, money exchange houses or retire-ment fund administrators, function as withholding re-ceipts for interest paid.

Notwithstanding the fact that the Treaty does notrequire foreign residency certification, Mexicanmiscellaneous tax regulations provide that a foreignresidency must be demonstrated to the authoritiesthrough a corresponding residency certificate in orderto take advantage of the Treaty’s preferential tax rates. ❏


MEXICO

by Marc Schwartz (Schwartz Advisory Services, Inc.)and José Juan Miranda (M&V Consultores)

Mexico’s new tax law incorporates thin capitaliza-tion rules, which in theory become fully effective on Janu-ary 1, 2010. This article examines the broadly drafted tran-sition rules which discuss how taxpayers should man-age their debt:equity ratio in the five-year period priorto January 1, 2010.1

Transitory RulesIn general, the transitory provisions provide a mecha-

nism for taxpayers whose debt:equity ratio exceeds 3:1on January 1, 2005 to comply with the ratio by the Janu-ary 1, 2010 date. The rules stipulate that taxpayers shouldreduce such excess debt in equal parts in each of the fol-lowing five years (i.e., 20 percent per year) until reach-ing the established limit.

While the tax authorities have attempted to pro-vide helpful guidance for taxpayers to meet the re-quirements of the thin capitalization rules by the 2010date, the role of the transitory rules is not clear.Whether the current wording of the transitory rulesresults from a mere oversight or an intention for tax-payers to reduce the excess debt by 20 percent per year,there is no stipulated consequence for taxpayers thatdo not meet the 20 percent reduction.

Practical IssuesTaxpayers and advisors are currently struggling with

very real, practical issues regarding the transitory rules.For instance:

• What happens if a taxpayer does not meet the tran-sitory rules’ 20 percent reduction each year but fullycomplies with the thin capitalization rules by Janu-ary 1, 2010? Here, the taxpayer would technicallyseem to be in compliance because it would have an“appropriate” debt:equity ratio by the effective dateof the thin capitalization provisions in 2010.

• What happens if a taxpayer meets the 20 percent re-duction in some years and not in others? Does theanswer change if the taxpayer also does not meet the3:1 ratio by 2010? In other words, does meeting the

Marc Schwartz is President of Schwartz Advisory Services,Inc., a tax consulting firm specializing in Latin American-U.S. transactions. (www.Schwartz AdvisoryServices.com)José Juan Miranda is President of M&V Consultores(Miranda, Sanchez & Asociados), a tax advisory firmfocusing on Mexican taxes.

Thin Capitalization in Mexico:Transition Rules

20 percent reduction in a “transitory” year provideany type of safe harbor for that year?

• What role should new business-related debt play inthe interim five-year period? Should it matterwhether new debt results from a merger or acquisi-tion, as opposed to an internal financial restructur-ing not related to a specific business endeavor?An interesting aspect is that the law passed by Con-

gress provides that the new thin capitalization rule takeseffect in 2010. If there are tax consequences of not meet-ing the annual 20 percent requirement, have the tax au-thorities in effect applied separate thin capitalizationrules prior to 2010 and, if so, do the tax authorities have

Taxpayers and advisors are currentlystruggling with very real, practical

issues regarding the transitory rules.

such power? Taxpayers and their advisors are debatingthese very issues since there could potentially be largedollar amounts at risk.

ConclusionIt would seem that the five-year period in the transi-

tory rules exists to encourage taxpayers to begin address-ing thin capitalization today, as opposed to waiting untilDecember 31, 2009. In that regard, the transitory rulesprovide helpful guidelines. However, in our experience,unless there are real consequences (i.e., tax and/or pen-alties due) for not complying with the 20 percent rule, itis unclear whether many companies will attempt to meetsuch guidelines. Tax and finance departments face suchpressure from supporting company operations, includ-ing assisting with new projects and investments, merg-ers and acquisitions, and sales, that even when there istime to focus on the internal financing structure,debt:equity ratios are constantly changing and difficultto manage. This situation is made even more tenuouswhen it is not clear whether there are “real” consequencesto not meeting the 20 percent rule.

It is our understanding that Congress has empow-ered the tax authorities to provide additional guidanceon this issue. Hopefully the tax authorities will issuesuch guidance sooner rather than later, especially ifnot meeting the 20 percent annual rules could create atax liability._________1This article focuses solely on the transition rules. It doesnot discuss the general nature of the thin capitalization rulesand the mechanics of the 3:1 debt:equity ratio. It also doesnot examine the potential legal arguments behind whetherthe rules should successfully withstand a constitutionalchallenge. ❏


DR-CAFTA, Continued on page 25

REGIONAL

by Kirk Ross (Katten Muchin Rosenman)

On August 2, 2005, President Bush signed H.R. 3045,the Dominican Republic-Central America-U.S. Free TradeAgreement (DR-CAFTA or Agreement) ImplementationAct (Act). The law implements the DR-CAFTA, a freetrade agreement among the United States, Costa Rica,the Dominican Republic, El Salvador, Guatemala, Hon-duras and Nicaragua.

The DR-CAFTA is the latest in a string of free tradeagreements (FTAs) entered into by the United States inrecent years. After passage in the Senate, the Act was ap-proved in the House of Representatives, but only afterseveral weeks of intense lobbying by the White House.

The razor thin margin by which the Act passed theHouse (217-215) suggests that future FTAs may be atough sell in Congress.

Implementation of the DR-CAFTA is not expectedto have a major impact on the U.S. economy or those ofthe other party-countries. The combined 2004 gross do-mestic product of the six Central American countriesparty to the Agreement was about $92 billion, approxi-mately one-seventh that of Mexico’s. In addition, roughly80 percent of U.S. imports from the other parties are al-ready duty free. However, the Agreement eliminatesmost remaining duties and, importantly, eliminates orreduces duties on U.S. exports to the other parties.

The Act authorizes the president to enter into the Agree-ment by proclamation for those parties that have also rati-fied it. The DR-CAFTA has already been ratified by El Sal-vador, Honduras and Guatemala. Costa Rica, Nicaraguaand the Dominican Republic are expected to do so soon.The Agreement will not actually enter into force until thepresident makes the authorized proclamation.

General Market AccessUnder the DR-CAFTA, duties on most types of indus-

trial and consumer “originating” goods will be eliminatedas soon as the Agreement enters into force. However, tar-iffs on U.S. automotive exports will be phased out over fiveyears, and most of the few remaining tariffs (excepting ag-riculture) will be phased out over ten years.

One foundation concept in the DR-CAFTA is that of“originating goods.” Only goods that qualify as

Kirk Ross ([email protected]) is an Associatewith the Chicago office of Katten Muchin RosenmanLLP. His pract ice is focused on customs andinternational trade matters.

Analysis of the DominicanRepublic-Central America-U.S. Free Trade Agreement

“originating” under the Agreement’s Rules of Origin canqualify for the DR-CAFTA’s preferential tariff treatment.Subject to a number of exceptions (which will beexplained below), the Agreement generally provides fourcriteria under which goods may qualify as originating:first, goods that are wholly obtained or produced in aparty-country, i.e., crops grown or minerals extracted inthat country; second, goods that are manufactured orassembled from non-originating materials that undergoa specified change in tariff classification within one ofthe party countries (a “Tariff Shift”); third, goods thatmeet an applicable regional value content requirement;fourth, goods that are produced in a party-countryentirely of other originating materials.

Under the Tariff Shift criterion, goods may stillqualify as originating goods even if they are not madewholly of materials that have undergone a tariff shift. Ifthe value of non-originating materials in the goods which

The Agreement maintains tariff ratequotas for some agricultural products,although they will be phased out over

time.

do not undergo a tariff shift do not exceed 10 percent ofthe adjusted value of the goods, then the goods may stillqualify as originating. This de minimis exception does notapply to certain agricultural or textile goods or in calcu-lating regional value content.

In order to meet the applicable regional value con-tent criterion, a specified percentage of the value of thegoods must be attributable to originating materials. Ingeneral, the Agreement provides for two methods forcalculating that percentage: (1) the “build-up” methodwhich is based on the value of non-originating materialsin the goods; and (2) the “build-down” method which isbased on the value of originating materials in the goods.However, a special exception is made for certain auto-motive goods, whose regional value content may bebased on the net cost of the goods.

In order to claim preferential tariff treatment underthe DR-CAFTA, an importer must be prepared to submita statement to the appropriate customs authority,explaining why its importations qualify as originatinggoods. A party-country may only deny a claim forpreferential tariff treatment in writing and must providelegal and factual findings. A claim for preferential tarifftreatment may be made up to one year after importation,including a refund of any overpaid duties.

AgricultureThe Agreement includes special provisions for trade

in agricultural goods. As with other types of goods, duties


DR-CAFTA (from page 24)

DR-CAFTA, Continued on page 26

REGIONAL

on most agricultural goods will be eliminated as soon asthe Agreement enters into force. However, the duties ona specified list of agricultural products will remain inplace, to be phased out over various periods of time. Mostof those will be phased out over ten years. A few morewill be phased out over fifteen years. The final ones willbe phased out over twenty years.

The Agreement maintains tariff rate quotas (TRQs)for some agricultural products, although they will bephased out over time. The Agreement requires each ofthe parties to administer its TRQs in a transparent, non-discriminatory manner, and each party may not condi-tion utilization of its TRQs on the re-export of goods.

In addition, each party has agreed to eliminate allagricultural subsidies for goods that are destined for

Duties on most originating textile orapparel goods will be eliminated when

the Agreement comes into force.

another party, although there is an exception for situ-ations where one party believes that a third party issubsidizing competing exports. In that case, the twoinvolved parties will consult in order to address theproblem.

As a protective measure, the parties retain the rightto temporarily impose additional duties on specifiedagricultural products if imports of those products exceeda volume trigger established in the Agreement. The safe-guard duty will remain in force until the end of the cal-endar year in which the measure is applied.

Some of the most publicized elements of the DR-CAFTA are its special provisions applicable to the im-portation of sugar into the U.S. from other party-coun-tries. Imports of sugar are subject to relatively low TRQs.Sugar imports are then limited to the lesser of (i) the quan-tity established in the TRQs or (ii) the exporting party’strade surplus in certain sugar goods, specified in theAgreement. The quantities established in the TRQs be-gin at 107,000 metric tons in the first year and increase to151,000 metric tons in year fifteen.

The DR-CAFTA also contains special provisions re-lated to trade in ethanol. Specifically, the United Stateshas agreed to continue to treat the other party-coun-tries as beneficiary countries under the Caribbean Ba-sin Initiative (CBI) for ethanol imports. In other words,the other party-countries will continue to share in theduty-free quota for ethanol that the U.S. makes avail-able to CBI beneficiary countries.

TextilesThe DR-CAFTA also includes a special regime for

trade in textiles. As with other categories of goods, dutieson most originating textile or apparel goods will beeliminated when the Agreement comes into force. In aprovision that offers a potentially significant opportunityfor U.S. textile importers, the preferential duty treatmentunder the Agreement may be made retroactive to January1, 2004. Such action would allow importers to recoverany duties paid after that date on any textiles that wouldhave qualified as originating if the Agreement had beenin force at the time of importation.

The textile provisions of the Agreement include par-ticular protective measures. Each party may impose asafeguard duty—up to its normal duty rate—on textileimports from another party that cause or threaten to causeserious damage to a domestic industry. However, a partycannot impose a safeguard duty on the same productmore than once, and the duty can only last for three years.The ability to impose these safeguards will expire fiveyears after the Agreement enters into force.

A party that chooses to impose such safeguard du-ties on particular textile imports must provide the af-fected exporting party with mutually agreed-upon com-pensation in the form of trade concessions on other tex-tile goods. Those trade concessions must be substantiallyequivalent in value to the increased duties resulting fromthe safeguard measures. In the event the involved par-ties cannot agree on the right form of trade concessions,the exporting party may raise duties on any imports fromthe importing party in an amount that is substantiallyequal to the value of the increased duties resulting fromthe safeguard measure.

As a general rule, textiles will qualify as originatinggoods under the Rules of Origin only if all the process-ing after fiber formation takes place in a party-countryor there is an appropriate tariff shift under the specifiedschedule. However, there are a number of special originrules applicable only to textile goods. First, a textile-spe-cific de minimis rule provides that textile goods that wouldordinarily not be considered originating because certainof their constituent fibers do not undergo an applicabletariff shift will still qualify as originating as long as thenon-tariff shift fibers constitute ten percent or less of thetotal weight of the component of the good that deter-mines origin.

Second, the Agreement includes a list of fabrics, yarnsand fibers that party-countries have determined are notavailable in a timely manner from producers in DR-CAFTA countries. Consequently, textile goods that con-tain these materials will still be considered originatingas long as they meet the other applicable requirements.This list is subject to on-going revision.


DR-CAFTA (from page 25)

REGIONAL

Trade RemediesBeyond the various safeguard measures available for

agricultural and textile goods, the Agreement also pro-vides general safeguard measures that are available forall classes of imports. Each party retains the right to imposetemporary duties on imported originating goods if, as aresult of the reduction or elimination of duties providedfor under the DR-CAFTA, the goods are being imported insuch increased quantities or under such conditions that theycause or threaten to cause serious injury to a domestic in-dustry which produces a “like” or “directly competitive”product. These general safeguards, unlike those for agri-cultural goods or textiles which are applied only againstspecific parties, are applied to imports from all party-coun-tries, unless a particular party’s import market share forthe good is de minimis.

For the majority of goods, a safeguard measure can onlybe imposed during the ten-year period following the entryof the Agreement into force. However, for those goodswhose duties under the Agreement are phased out over aperiod of longer than ten years, a safeguard may be im-posed until the end of the applicable phase-out period.

The Agreement allows for two types of safeguardmeasures. A party may increase duties on a particularproduct up to its normal tariff level, or a party may sim-ply suspend further reductions in the preferential dutyprovided for under the Agreement. In either case, thesafeguard may only be in place for a maximum of fouryears, including extensions. As with textiles, if a partyimposes a safeguard measure, it must compensate otheraffected parties with trade concessions that offset thevalue of the safeguard.

Beyond the safeguards included in the DR-CAFTA,the party-countries explicitly retain their trade remedyoptions available under their membership in the WorldTrade Organization.

Other TopicsThe Agreement also addresses a number of other top-

ics that relate to various aspects of trade relations betweenthe parties. For government procurement, the Agreementprovides that each government and its various procuringentities must treat goods, services and suppliers from otherparty-countries in a manner that is no less favorable thanthe treatment it affords their domestic counterparts. Theprovisions on government procurement only apply to pur-chases of goods and services that exceed threshold amountsincluded in the Agreement.

The Agreement also provides protections for inves-tors from one party who attempt to invest in another

party. In the Agreement, the term “investment” is con-strued broadly and includes investments already in placewhen the Agreement enters into force. Most generally,the DR-CAFTA requires that foreign investors enjoy treat-ment no less favorable than that enjoyed by domesticones. In addition, the Agreement provides a number ofother protections to investors such as the free transfer offunds related to an investment and the power to hire keymanagerial personnel without regard to nationality.

Financial services provided in one party-country byinstitutions of another party also enjoy the right to treat-ment no less favorable than that enjoyed by domesticinstitutions. In addition, the Agreement prohibits certainquantitative restrictions on market access for financial

The Agreement also providesprotections for investors from one partywho attempt to invest in another party.

institutions and disallows restrictions on the nationalityof senior management.

In the area of intellectual property, the Agreementobligates the parties to ratify or accede to severalinternational agreements. By the date of entry intoforce of the DR-CAFTA, the parties must accede to theWIPO Copyright Treaty and the WIPO Performancesand Phonograms Treaty. Within specified time periods,the parties must also accede to several otherintellectual property agreements. The United States isalready a party to each of the applicable agreements.In addition, each party is obligated to adopt a seriesof other measures that are intended to broadly protectintellectual property rights.

The Agreement also contains provisions fortelecommunications, electronic commerce, labor andenvironmental concerns. The provisions for thetelecommunications industry are designed to ensurethat service suppliers of each party have non-discriminatory access to the telecommunicationsnetworks of the other parties. The provisions onelectronic commerce establish rules designed toprohibit discriminatory regulation of electronic tradein digitally-encoded products such as computerprograms or sound recordings. In particular, no partymay impose duties on products transmitted digitally.The labor provisions obligate each party to enforce itsown labor laws effectively and transparently. Last, theenvironmental provisions obligate each party tomaintain a high level of environmental protection. ❏


LOPCYMAT, Continued on page 28

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by the Labor Department of the Caracas office ofBaker & McKenzie

The restated Organic Law on Prevention, Work Condi-tions and Work Environment (New Law) was published inOfficial Gazette No. 38,236 on July 26, 2005. The New Lawrevokes and supersedes the Organic Law on Prevention,Work Conditions and Work Environment published in Spe-cial Official Gazette No. 3850 of July 18, 1986 (Former Law)and it became effective on the date of its publication, ex-cept for those provisions concerning the monetary indem-nities provided by the Occupational Safety and Health Sys-tem that will enter into effect on the date of implementa-tion of the Social Security Treasury.

The purpose of the New Law is: (i) to establish insti-tutions, rules, and guidelines for the policies, agencies,and entities intended for guaranteeing the workers safe,healthy and comfortable conditions in adequate workenvironments, favorable for the full exercise of theirphysical and mental faculties through the promotion ofsafe and healthy work, the prevention of work accidentsand occupational diseases, the integral redress of inju-ries suffered, and the promotion and incentive for thedevelopment of programs intended for recreation, useof leisure time, rest, and social tourism; (ii) to regulatethe rights and duties of workers and employers in con-nection with the safety and health of the work environ-ment, as well as in connection with recreation, the use ofleisure time, rest, and social tourism; (iii) to develop pro-visions of the Constitution and the Occupational Safetyand Health System set forth in the Organic Law of theSocial Security System; (iv) to establish penalties for vio-lation of the law; (v) to regulate benefits derived fromthe substitution by the Social Security System of thematerial and objective responsibility of employers uponthe occurrence of work accidents or occupational dis-eases; and (vi) to regulate the responsibility of the em-ployer and its representatives for the occurrence of workaccidents or occupational diseases in the cases of fraudor negligence on their part.

Following is a summary of the more salient aspectsof the New Law.

For further information, please contact Carlos Felce, Partner([email protected]) or Manuel Diaz Mujica, Partner([email protected]) at the Caracas office of Baker& McKenzie. This version has been shortened for publication.Full versions can be requested from the Editor by writing [email protected].

Organic Law on Prevention,Work Conditions and WorkEnvironment (LOPCYMAT)

Registration with, Affiliation, and Contributionsto the Indemnity System

Obligation to RegisterAll employers are obliged to register with the Social

Security Treasury. Also cooperatives and other forms ofcommunity association of a productive or service kindare required to register.

Obligation to AffiliateEmployers that have one or more dependent work-

ers are required to register them with the Social SecuritySystem within the first three business days following thecommencement of the employment relationship. Theworkers’ affiliation must be made by the employer re-gardless of the form or terms of the employment con-tract. Cooperatives and other forms of community asso-ciation of a productive or service kind also have this ob-ligation for their dependent workers and their associates.

ContributionsContributions will be the sole responsibility of the

employer, the cooperative or other forms of communityassociation of a productive or service kind. Such contri-butions may range between 0.75 percent and 10 percentof each worker’s salary or of the income of each associ-ate to the cooperative or other form of community asso-ciation of a productive or service kind.

For the fixing of contribution rates, companies, ex-ploitations, establishments, or tasks will be classified intothe following types of risks:

Type I Minimum RiskType II Low RiskType III Medium RiskType IV High RiskType V Maximum Risk

Risk types, in turn, comprise a risk degree scale rang-ing from 14 through 186. For each type a minimum limit,a weighted average value, and a maximum limit are es-tablished according to the following chart:

Risk DegreesType Minimum Average Maximum

I 14 21 28II 21 35 49III 35 64 93IV 64 93 122V 93 102 186

The amount the employer will have to pay for com-pany workers is determined by multiplying the aggre-gate amount of salaries by the risk degree assigned tothe company and by a constant factor equal to 5.375, di-vided by 10,000. Thus, for instance, a Type V company(maximum risk) qualifying in the weighted average andpaying salaries in a monthly amount of Bs.40,000,000,


LOPCYMAT (from page 27)


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should contribute the amount of Bs.2,193,000 monthlyto this indemnity system.

Other Obligations of the EmployerEmployers must adopt such measures as may be re-

quired in order to guarantee their workers health, hygiene,safety, and well-being in conditions at work, as well as rec-reation programs, use of leisure time, rest, and tourism.Among their specific obligations are the following:

• to consult workers, their organizations, and the Oc-cupational Safety and Health Committee beforeimplementing any measures implying changes in thework organization that might affect any or all theworkers, or important decisions concerning thesafety and hygiene at work;

• to notify workers, in writing, about the principlesfor prevention of unsafe or unhealthy conditions,both upon their hiring and upon the occurrence ofany changes in the work process or in the job, andtrain and instruct them for the promotion of healthand safety, the prevention of accidents and occupa-tional diseases, as well as for the use of personalsafety and protection devices;

• to refrain from showing any offensive, malicious, orintimidating conduct or form any other act that maycause psychological or moral damage to workers;

• to notify in writing the National Institute for Occu-pational Prevention, Health and Safety and the Na-tional Institute for Workers Training and Recreationabout any programs developed for workers’ recre-ation, use of leisure time, rest, and social tourism,the condition of the infrastructure for the executionthereof, the impact on life quality, health, and pro-ductivity, as well as any difficulties in the workers’incorporation and active participation therein;

• to prepare, jointly with workers, the company’s Oc-cupational Safety and Health Program, policies andcommitments, as well as any internal regulationsconcerning the matter, and plan and organize pro-duction in accordance with such programs, policies,commitments, and internal regulations;

• to take adequate measures to avoid any form ofsexual harassment and establish a policy intendedfor the eradication thereof from the work place;

• to refrain from discriminating employment candi-dates and workers and, within the requirements ofthe productive activity, respect workers’ freedom ofconscience and of speech;

• to take adequate measures to guarantee workers’right to privacy regarding mail and communicationsand free access to all data and information directlyconcerning them;

• to mandatorily notify the National Institute forOccupational Prevention, Health and Safety of any

occupational diseases, work accidents, and any otherpathological conditions that may occur and keep arecord thereof;

• to keep an updated registry of all occupational pre-vention, safety and health conditions, as well as ofthe recreation, use of leisure time, rest, and socialtourism activities;

• in case of activities that the Regulations of the NewLaw deemed to be susceptible of special controlsbecause of the damage that they might cause to work-ers or the environment, to notify the National Insti-tute for Occupational Prevention, Health and Safety,in writing, of the unsafe conditions and of any mea-sures developed to control such conditions under thecriteria as may be established by said institution;

• to organize and maintain the Occupational Safetyand Health Services provided by the New Law.

Administrative Responsibility of the Employer;Cases of Administrative Infringements

The employer’s administrative infringements areclassified as follows:

• Minor infringements: These are punished with finesof up to 25 Tax Units per exposed worker. This pun-ishes conduct such as not guaranteeing all the ele-ments of basic health in the work place; failure to

The new law provides for fines and evencriminal sanctions.

place in public and visible areas of the company up-dated records of the indices of work accidents andoccupational diseases; failure to provide workerswith sufficient training in the prevention of workaccidents and occupational diseases, among others.

• Serious infringements: These are punished with finesranging between 26 and 75 Tax Units per exposedworker, and include acts such as failure to notifyworkers, in writing, the principles for prevention ofhazardous or unhealthy conditions; the failure tosubmit for approval by the National Institute for Oc-cupational Prevention, Health and Safety the draftOccupational Prevention, Safety and Health Pro-gram; failure to provide workers with adequate per-sonal protection equipment and utensils; failure todevelop programs for promoting safety and healthat work and preventing occupational accidents anddiseases, among others.

• Very serious infringements: These are punished withfines ranging from 76 to 100 Tax Units per exposedworker. The closing of the company for up to 48 hoursby the National Institute for Occupational Preven-tion, Health and Safety is also contemplated. Very




VENEZUELA

serious infringements include and penalize acts suchas failure to guarantee the effective enjoyment ofworkers’ annual vacation period; failure to guaran-tee effective rest from the daily work; violation ofrules concerning the maximum work hours and nighttime work, or provisions concerning business days;failure to provide immediate help to an injured orsick worker; failure to report work accidents or thediagnosis of occupational diseases to the NationalInstitute for Occupational Prevention, Health and

The actions of sub-contractors canexpose contractors to liability.

Safety within 24 hours following the occurrencethereof; failure to constitute, register, or maintainoperative the Occupational Safety and Health Com-mittee; dismissal, impairment or transfer of workersdue to the exercise of their rights under the New Law;failure to relocate workers in positions or to adapttheir chores for reasons of health, rehabilitation orlabor reinsertion; and obstructing, impeding or hin-dering any inspection or supervision performed bythe National Institute for Occupational Prevention,Health and Safety.

• Recidivism: An infringement repeated within a 12-month period will be regarded as recidivism. Insuch cases, the relevant punishment may be in-creased twofold.

Punishment in Case of Infringementsconcerning Contribution and Affiliation Matters

An employer that infringes the provisions of the NewLaw concerning the contributions and affiliation of work-ers will be punished with a fine of up to 100 Tax Units foreach worker not affiliated or affiliated outside the regula-tory period, or for any inaccurate information provided,according to the seriousness of the infringement, withoutprejudice to any civil, administrative and criminal liabilityfor damages caused to its workers. In such cases, the em-ployer will also have to pay all unpaid contributions andthe relevant interest for late payment, and will have to re-fund in full to the Social Security Treasury the payment ofindemnities and expenses generated from work accidents,occupational diseases, or the death of its workers.

Suspension of the Company BusinessWhere there is a serious or imminent danger, or

where there occur situations that pose a threat for thesafety and health of the workers, the National Institutefor Occupational Prevention, Health and Safety may

suspend, either in whole or in part, the business orproduction of the company, establishment, exploitationactivity or task until it is demonstrated that suchsituations have ceased to exist, without prejudice of thecorresponding sanctions. In cases of suspension, theinfringer employer will be obliged to pay the salaries andother socio-economic benefits of its workers for theduration of the sanction or measurement adopted, as ifthey had effectively been rendering services.

Labor and Civil Liability of the Employer:Indemnities

Regardless of any monetary indemnities payable bySocial Security, the employer will be liable for work acci-dents or occupational diseases occurring as a result ofthe violation of rules governing safety and health at work.The indemnities provided for by the New Law do notexclude indemnities for economic and moral damages(these being additional thereto), and do not prevent theestablishing of criminal liability.

The amount of the indemnity payable in these casesby the employer will depend on the type of disabilitysuffered by the worker, according to the following scale:

• temporary disability: twice the salary correspondingto the sick leave days;

• permanent partial disability of up to 25 percent of thephysical or intellectual capacity for performing the pro-fession or usual trade: salary corresponding to not lessthan one year and not more than four years calcu-lated in calendar days;

• permanent partial disability greater than 25 percent ofthe physical or intellectual capacity for performing theprofession or usual trade: salary corresponding to notless than two years and not more than five years cal-culated in calendar days;

• permanent total disability for performing the usual trade:salary corresponding to not less than three years andnot more than six years calculated in calendar days.

• permanent absolute disability for performing any type oflabor activity: salary corresponding to not less thanfour years and not more than seven years calculatedin calendar days;

• great disability: where associated with permanentabsolute disability, the indemnity will be equivalentto that payable in the case of death of the worker.Where it is associated to temporary disability, theindemnity will be equivalent to three times the sal-ary corresponding to the duration of the disability;

• death: salary corresponding to not less than fiveyears and not more than eight years, calculated incalendar days.

Criminal Liability of the Employer or itsRepresentatives

Where the employer has committed serious or very



Update, Continued on page 31

VENEZUELA

serious infringements of the rules governing occupationalsafety and health and as a result a worker has died orbeen disabled, the employer or its representatives willbe subject to the following sanctions:

• temporary disability: imprisonment from two monthsto two years or from two to four years if the workeris not able to perform the most elementary acts ofdaily life;

• permanent partial disability: imprisonment from twoto four years;

• permanent total disability for performing the usual trade:imprisonment from four to seven years;

• permanent total disability for performing any type of la-bor activity: imprisonment from five to eight years;

• permanent total disability associated to the worker’s in-ability to perform the most elementary acts of daily life:imprisonment from five to nine years;

• death: imprisonment from eight to ten years.

Joint Liability with Contractors, Sub-Contractors, and Temporary Work Companies

The contracting or principal company will be jointlyliable with any intermediaries, contractors, and sub-con-tractors for infringement of rules on occupational safetyand health matters applicable in connection with work-ers rendering services at the contracting or principalcompany’s work centers. When contracting the servicesof workers supplied by temporary work companies, the

principal company (beneficiary) will inform said work-ers and the temporary work company, in writing, of therisks associated to the work and any prevention mea-sures required for facing them. The beneficiary will beresponsible for any work accidents or occupational dis-

The employer or its representatives canbe imprisoned for up to two years whena violation has disabled an employee.

eases caused to the temporary worker due to its fault oron account of its failure to comply with the rules gov-erning occupational and health matters.

Express Derogation of the Rules RegulatingTemporary Work Companies

The New Law expressly derogates Articles 23, 24,25, 26, 27 and 28 of the Regulations of the Organic LaborLaw, which constitute the only regulation existing inVenezuela concerning temporary work company matters.Also, the New Law provides that temporary work com-panies duly registered with the competent authority willhave the status of intermediaries. The hiring of workersthrough labor intermediaries entails the joint responsi-bility of the beneficiary company and the intermediaryfor the payment of rights and benefits of theintermediary’s workers, and generates the right of suchworkers to receive the same benefits and work condi-tions enjoyed by workers of the beneficiary company. ❏

by Vera De Brito de Gyarfas (Travieso Evans ArriaRengel & Paz)

EnergyPDVSA (Venezuela’s state oil company) announced

that it will build an asphalt refinery next to the Guanoconatural asphalt lake (with an estimated investment of$600 million) and expand its existing San Roque refin-ery, which currently produces 60,000 tons of keroseneper annum to 80,000 tons.

It was announced that PDVSA is considering devel-oping the Abreu E’Lima refinery in Pernambuco (Brazil)

Vera De Brito de Gyarfas ([email protected]) isa Senior Associate with Travieso Evans Arria Rengel &Paz in Caracas.

Venezuelan Legal andBusiness Developments

to which heavy crude would be shipped and undertak-ing offshore exploration in Argentina.

CVG Ferrominera Orinoco (FMO) entered into a fi-nancing agreement with ABN AMRO Bank N.V. for $135million in order to progress in the construction of an ironore concentration plant.

Chevron found four trillion cubic feet of gas in oneof the Plataforma Deltana exploration blocks.

PDVSA will invest approximately $500 million in theinstallation of three new thermoelectric generation plantslocated in the States of Anzoátegui, Falcón, and Zulia.

SENIAT (Venezuelan Tax Administration) has madetax claims against Harvest Vinncler and Shell of Bs. 183billion (approximately $85 MM) and Bs. 281 billion (ap-proximately $130 MM), respectively, for income tax, onthe theory that their service agreements with PDVSAshould instead be taxed as oil exploitation activities.

The Ministry of Energy and Petroleum (MEP) autho-rized the company Termobarrancas C.A. to generate elec-tric power at the Central Temprana Sipororo located be-tween the Municipalities of Guanare and San Genaro de


Update (from page 30)


VENEZUELA

Boconoito, Portuguesa State, and to connect to the Na-tional Electric System (Sistema Eléctrico Nacional—SEN).

The Caracas Energy Cooperation Agreement be-tween Venezuela and the Republic of Bolivia executedon December 9, 2004 was published in Official GazetteNo. 38,226 dated July 12, 2005.

It was reported that Venezuela will invest up to $1billion in the enlargement and modernization of the LaTeja refinery in Uruguay in order to process heavy crude.

The following resolutions issued by the Ministry ofEnergy and Petroleum were published in Official GazetteNo. 38,226 dated July 12, 2005: (i) Resolution No. 247 thatestablishes the provisions for ground transportation of re-fined products, hydrocarbon derivatives, their waste, andproducts resulting from the industrialization activity ofhydrocarbons or refined products, other than fuel; and (ii)Resolution No. 248 that governs the issuance of permitsand registries, as well as the follow-up, control, and super-vision of companies engaged or to be engaged in the activ-ity of industrialization of hydrocarbon refining derivativesor refined products obtained from the same.

Banking and FinanceThrough a resolution published in Official Gazette

of July 15, 2005, the National Securities Commission is-sued new Instructions establishing the documents andinformation required to request authorization to make apublic offer of securities.

Resolution No. 05-06-01 of the Venezuelan CentralBank was re-published on July 18, 2005. Said resolutionprescribes that the interest rate to be paid by the banks,savings and loan associations, and other financial insti-tutions will only be applicable to the certificate of invest-ments issued for terms equal to or longer than 28 days.

The National Securities Commission issued instruc-tions to request authorization to act as securities broker-age houses and companies that manage collective invest-ment entities and request the ratification of such autho-rizations. These are additional to the existing norms thatestablish as a new obligation the presentation of an eco-nomic-financial feasibility study and business plan, aswell as the request for ratification of the authorizationby the persons who purchase securities brokerage housesor companies that manage collective investment entitiesthat have already been authorized.

LaborThe Organic Law on Prevention, Work Conditions

and Environment was published in Official Gazette No.38,236 of July 26, 2005. The law substantially expandsthe scope of responsibility of employers for work-relatedhealth and safety obligations, placing upon them jointand several liability for health and safety of workers of

contractors and outsourcing firms. The new law expresslycovers domestic and janitors’ work, as well as that per-formed by those who work at cooperatives or other formsof community associations with a productive or servicecharacter, including non-profit activities.

The main purposes of said Law are:• to establish the institutions, standards, and guide-

lines of the policies, and the agencies and entitiesallowing to guaranty to the workers safety, health,and well-being conditions in an appropriate workenvironment that favors the exercise of their physi-cal and mental abilities, by means of the promotionof safe and healthy work; prevention of industrialaccidents and occupational diseases, integral repa-ration of damage suffered, and promotion of, andincentive to, development of programs for recreation,use of free time, and rest and social tourism;

• to regulate workers’ and employers’ rights and dutiesin relation to safety, health, and work environment andrecreation, use of free time, rest, and social tourism;

• to develop provisions of the Constitution of theBolivarian Republic of Venezuela and the Regimeregarding the Benefits of Safety and Health at Workestablished in the Organic Law of the Social Secu-rity System;

• to establish the penalties for non-compliance withthe provisions;

• to rule the benefits and obligations derived from thesubrogation of the Social Security System to employ-ers’ pecuniary and strict liability in the event of anindustrial accident or occupational disease; and

• to rule the liability of employers and their represen-tatives in the event of an industrial accident or occu-pational disease when there is willful misconduct ornegligence on their part.The provisions of the Law are applicable to works

performed under a subordinate relationship for the ac-count of an employer, whatever the nature of the worksand the place where they are performed may be, with orwithout profit-making purposes, whether they be pub-lic or private, existing or established in the territory ofthe Republic and, in general, any provision of personalservices in which there are employers and employees,whatever the form adopted may be.

This Law constitutes a change in direction in thesafety and health policy adopted by the National Execu-tive since 1986. It includes, among other importantchanges, a modification of the criteria regarding employ-ers’ civil and criminal liability, the establishment of a newterm for the statute of limitations of the actions derivedfrom the Law, the inclusion of a significant number ofnew notices to governmental entities, the granting ofcompetence to the communities to supervise and de-nounce violations of the safety and health technical stan-dards by employers, as well as new responsibilities andcompetence of the safety and health committees of com-




VENEZUELA

panies. Employees are now entitled to participate in de-cisions concerning safety matters. Compliance with thisLaw is mandatory as from the date of its publication inthe Official Gazette.

TaxationThe Supreme Tribunal of Justice issued a clarifica-

tion of the March 4, 2004 decision regarding the right ofmunicipalities to tax activities carried out offshore or inaquatic spaces by stating that such interpretation is validas from the date of enactment of the new Constitution,1999, and not as from March 4, 2004 (the date on whichthe decision was issued).

Ruling No. 0503 was published on July 20, 2005 (Of-ficial Gazette No. 38,232). It establishes that taxpayerscategorized as special taxpayers by the SENIAT and thosereceiving Certifications of Exempted Fiscal Debit mustfile the value added tax returns through the Site http://www.seniat.gov.ve. According to Article 3, the SENIATwill only acknowledge excess fiscal credits generated inreturns filed through the Site after the entry into force ofthis ruling. The obligation to file the returns as aforesaidwill become applicable as from January 2006.

Ruling No. 0456 that establishes the special Provi-sions on invoicing for Service Stations was published onJuly 21, 2005 (Official Gazette No. 38,233). It prescribesthat authorized service stations that sell fuel will substi-tute invoices for each sales transaction with a statementreflecting the daily total transactions (except for the salesinvoiced to taxpayers requiring the invoice as a proof ofthe expense). The statement may be issued in the sameform as that of the invoices, indicating that they are is-sued in accordance with this ruling.

Resolution No. 1661 was published on July 22, 2005(Official Gazette No. 38,234), issuing the Instructions onthe Procedure for Issue, Placement, Custody, and Han-dling of Tax Refund Special Certificates (CERT). Said In-structions detail the procedure for the issue and use ofcertificates, and clarify that the recovery of taxes will bemade only through the CERTs, which fact will be placedon record in the rulings providing for the recovery offiscal credits.

Decree No. 3774 was issued on July 27, 2005 (OfficialGazette No. 38,237). Said Decree exempts from the ValueAdded Tax transactions of national sale of goods and theprovision of services made, or benefited from, in thecountry that are necessary for construction works andfor reconditioning of works and outfitting of the samewith educational purposes in the framework of the Pro-gram Fortalecimiento, Modernización, y Reactivación de lasEscuelas Técnicas Industriales, Comerciales y Agropecuarias(Strengthening, Modernization, and Reactivation of Tech-nical Industrial, Commercial, and Agricultural Schools)of the Ministry of Education and Sports.

On July 28, 2005, (Official Gazette No. 38,238), theLaw of Partial Amendment to the Law of Tax on Alcoholand Alcoholic Species was enacted.

TelecommunicationsOn July 10, 2005, CONATEL (National Telecommu-

nications Commission) published the Schedule of Tele-communications Tax Obligations corresponding to thesecond quarter of 2005. Said Schedule is also availableon the following web page: http://www.conatel.gov.ve/

Anti-dumpingDecision CASS-ADP-004/05 issued by the Venezu-

elan Antidumping Commission was published in Offi-cial Gazette No. 38,222 dated July 6, 2005. The Decisioninitiates an investigation aimed at determining if the ex-piration of the definitive antidumping duties establishedthrough Decision No. 006/00 dated June 19, 2000 wouldgive rise to the continuation or repetition of the damageto the national production of similar goods.

Consumer ProtectionA Joint Resolution of the Ministries of Light Indus-

tries and Commerce, Agriculture and Land, Food, andHealth and Social Development published in OfficialGazette No. 38,233 dated July 21, 2005 established therequirements of commercial and health information thatmust be contained on labels of canned preserved tunafish and preserved tuna fish-based products for humanconsumption.

MiscellaneousThe Regulations on the Andean Migration Card for

purposes of the Registry of Migratory Movements en-trusted to the Ministry of Interior and Justice were pub-lished in Official Gazette No. 38,224 dated July 8, 2005.

The Ministry of Housing and Habitat providedthrough a Resolution published in Official Gazette of July7, 2005 that long-term mortgage loans granted at the so-cial interest rate under the Special Law for the Protec-tion of the Mortgagee Debtor that qualify for the mini-mum mandatory percentage of 10 percent over the grosscredit portfolio of banks and other financial institutionswill be only those granted to family groups with amonthly income that does not exceed 500 Tax Units (cur-rently Bs. 14,700,000).

The Law of Civil Aeronautics was published againin Official Gazette No. 38,226 dated July 12, 2005.

Resolution No. 297 of the Ministry of Health andSocial Development was published in Official GazetteNo. 38,226 dated July 12, 2005. A rate of 700 Tax Units isestablished by said Resolution as the rate to be paid forthe request of the control number of the cigarettes manu-factured, imported, and commercialized in the national




VENEZUELA

territory or intended for exportation. Such control num-ber must be annually renewed.

The X Exceptional Plan of Economic and Social De-velopment for the Reactivation of Small and Medium-sized Industries was published in Official Gazette No.38,228 dated July 14, 2005.

Through Decision No. 1376 dated June 28, 2005 pub-lished in Official Gazette No. 38,231 dated July 19, 2005,the Constitutional Chamber of the Supreme Tribunal ofJustice partially annulled Letter b) of Article 34 of theLaw on Lease of Real Property. The reference to “adoptedchildren” for purposes of requesting that a real propertybe vacated was prohibited.

The Law of Partial Amendment to the Law of theVenezuelan Central Bank was published in Official Ga-zette No. 38,232 dated July 20, 2005. PDVSA is now al-lowed to keep dollar proceeds in offshore accounts to

meet its dollar investment and expense obligations. Theexcess is to be contributed to a social development fundcontrolled by the National Executive through FONDES.The Central Bank must also make a one-time contribu-tion to said Fund of $6 billion.

The following Rulings issued by the National Insti-tute of Civil Aviation (INAC) were published in OfficialGazette No. 38,234 dated July 22, 2005: (i) Ruling No.PRE-CJU-020-05 that issues Venezuelan Aeronautic Regu-lation 80 RAV 80 on Inspection, Certification, Continu-ous Monitoring, Permanent Supervision, and Investiga-tion into ATS Incidents to support Administrative Penal-izing Procedures conducted by the Aeronautic Author-ity; (ii) Ruling No. PRE-CJU-156-05 that issues the Normsgoverning Air Transport Specialized Services; (iii) Rul-ing No. PRE-CJU-157-05 that issues the Norms govern-ing the Services of Air Works; and (iv) Ruling No. PRE-CJU-158-05 that issues Venezuelan Aeronautic Regula-tion 3 RAV 3 on Procedures for Consultation on Aero-nautic Regulations. ❏

have a lame duck president in a weakened position, andthe extreme left wing of the PT [the Workers’ Party ofPresident Lula] would try to change the direction of theeconomic policies. And there will not be anyone in powerin the PT who will stand as the defender of the currenteconomic policies. The likely replacement for Palocciwould be Murilo Portugal [the current Secretary of Eco-nomic Policy]. He is very competent, and would carryon the current policies. The problem would be that hisability to withstand the pressure of the left wing of thePT would be limited if Lula is a lame duck. But even ifLula declares that he will not run again, so long as Palocciremains in the government the current economic poli-cies will be continued.

LALBR: Should we be surprised by the extent of corrup-tion that is being revealed in the Brazilian Congress?Welch: No, but neither should we be surprised to seethat others in Congress are weeding out this corruption.Brazil’s democracy is quite mature, and the way that thisscandal is being investigated and revealed is evidenceof this maturity.

Silver LiningLALBR: So, you see a silver lining to this crisis?Welch: Absolutely. Just like there was a silver lining tothe Collor resignation [see box]. This crisis is a littledifferent; it looks like part of the PT tried to set itself upas government and party at the same time concentratinga huge amount of power in a few people’s hands, à laChavez [i.e., Hugo Chavez, President of Venezuela]. You

Special Interview (from page 5) can see how this type of thing is anathema in Brazil.Brazilians will never accept something like that, whichis also positive.

LALBR: You are saying that Lula will not be impeachedgiven what we know so far?Welch: I don’t think so; at least no one wants him to beimpeached.

LALBR: Lula took office promising that he would dosomething for the poor in Brazil. Are the programs that

Latin American Law and Business Reportinvites experts in Latin American legal andbusiness issues to submit articles. Authorswill be advised promptly if the publicationintends to publish the article. LALBRreserves the right to edit articles for clarityand style.

Please send manuscripts to the Editor, LatinAmerican Law and Business Report, byemail, fax, or mail.

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BRAZIL


The Scandal that Brought Down

an Earlier Brazilian President

Fernando Collor de Mello was elected in 1989 bywinning over labor party candidate and current presi-dent Lula da Silva. In early 1992, allegations surfacedin the press of possible corruption in the government.The Congress impeached Mr. Collor in Septemberafter four months of lengthy televised congressionalhearings in which officials and the president’s brotherrevealed bribes and kickbacks to the closest aids toCollor and possibly the president himself. The vice-president assumed the presidency when Collor wassuspended by the Congress in October. Collor resignedin December, 2002, rather than face a trial in theBrazilian Congress.

In addition to his impeachment, Mr. Collor isremembered–not fondly–as the president who lockedup bank accounts of most account holders for 18 monthsin an ill-conceived attempt to stop inflation. — SPS

were targeted at the lower sector of the Brazilianeconomy dashed?Welch: No, but this is not because the PT did so well indesigning programs that would help Brazil’s poor. Ratherthe present government has benefited by expanding thebolsa escola program that was put into place by Cardoso(Fernando Henrique Cardoso, Brazil’s president from1995 until 2002).

Lula has Delivered Economic GrowthLALBR: Lula came to office promising growth in theeconomy. Has he kept that promise?Welch: Yes and no. The question is; at what rate should theeconomy grow? If you think Brazil can grow 5 percent yearin, year out—which is what I think many of the people inthe PT think—then you would probably say no. Brazil’slong run growth rate is structurally about 3.5 percent, sowe saw a very strong recovery last year. It will slow downa little bit this year and probably go back up next year, so Iwould say that he has delivered. The other thing Lula hasdelivered is stability, and certainly stability is one of thenecessary ingredients needed to bring down inflation,which is also compatible with long-term growth.

LALBR: Is the level of investments enough to sustaingrowth at 4 percent?Welch: Right now, Brazil’s growth investment rate isabout 19 percent of GDP, depreciation is 5 percent whichgives a net investment rate of about 14 percent. It’s notbad; it is about 2 percentage points above what it hasbeen since the 1980s but it still should be a bit higher.

Investments in Capital and EquipmentLALBR: The economy is running at close to full produc-tive capacity. Are companies investing so that they canproduce more?Welch: They have been investing. Last year we had ahuge growth of investment, mostly in the exporting sec-tor, with agro industry investing the most. For one rea-son or another, agriculture is not going to have that gooda year this year. Some of the prices have come down.They had some serious problems with drought. That is aproblem that Brazil faces right now but the investmentrate is pretty robust. It is being affected on the margin,not on the whole.

LALBR: Is the export sector largely immune to thepolitical crisis?Welch: Yes, unless the political crisis should suddenly trans-late into something really bad. I am speaking of somethinglike the government or regulators imposing capital controlsor other blocks on investor-money getting out of the coun-try. But I do not expect these kind of actions to happen.

Export Growth Not Dampened byStronger Currency

LALBR: The real is strengthening, which tends to makeBrazilian goods more expensive in foreign markets.Will the stronger real dampen sales of the importantexport sector?Welch: Well, some of the export sectors are certainlyimport intensive. But generally speaking, we have beenseeing continued strong exports despite a strengthen-ing real. So the currency fluctuation is not making muchof a difference.

LALBR: What are the prospects for steady growth ofthe local economy? By that, I mean the local consumermarket.Welch: It is very good. We are seeing a little bit of a contrac-tion with job creation and in income this last month. Butonce the Central Bank gets things back to more normal in-terest rates, I think growth of the local economy will be good.

Increases in both Formal and Informal SectorsLALBR: Estimates vary, but about half of Brazil’s work-ers are employed outside the formal economy, where theymay work selling goods on the street or in the informallabor market. Are more workers being brought into theformal economy?Welch: We have not yet seen a reduction in the informaleconomy but we are seeing an increase in formal em-ployment. [Editor’s note: Estimates as to the size of theparallel economy vary by region, but in many states 25percent to 50 percent of the work force is employed inthe informal economy.] Both sectors are growing, which




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Bolsa Escola Program

Adopted by the Brazilian federal government in2001, the bolsa escola program was designed to counterthe high rate of dropouts of children from school, of-ten after just a few years of elementary school educa-tion. The program provides cash payments to lowincome families who keep children in school. The cashpayments are designed to offset the money that thechild might bring home if the child were working. Toqualify, a poor family must maintain all school-agedchildren [between the ages of 6 to 15] in the class-room. Families can be dropped from the program if achild misses more than two days of school a month.Monthly payments are made directly to families byway of bank ATMs and special access cards. The fed-eral government adopted the program after severalstates and municipalities started similar programsbeginning in 1995.

We have been seeing continued strongexports despite a strengthening real.

means that many frustrated workers are coming back towork again which is a sign of economic health. The gov-ernment has made changes to the tax system to make iteasier for workers to enter the formal economy, and thesechanges are having an impact. The government wants todo more to reduce the tax burden on small and mediumsized businesses, and this is all for the better.

True Interest Rates are Lower than Selic RateLALBR: The Central Bank left interest rates (i.e., the Selicrate) unchanged at 19.75 on August 17. Many analysts wereexpecting to see the bank drop rates. What happened?Welch: The crisis may have influenced the bank to a moreconservative position. But we are continuing to seedeflation of general price levels and consumer prices arefalling as well. So there is room for the Central Bank toease interest rates. I think that this delay in cutting interest

rates is going to cause some bad news to come out ofindustry, although so far there are no signs that interestrates are having a huge negative effect on growth. Whenthe Central Bank increased rates by a full point back inFebruary it seemed to me that it could have halted theincreases. At that time I revised my growth rate to 2.8percent and it is still there. So, I think we will see lowergrowth for a little while. On the other hand, certainly theCentral Bank has done a very good job overall. We haveinflation converging very, very quickly to this year-endnumber and well below next year’s target. On the wholethese are good things. My criticism is that of timing anddegree rather than what the Central Bank has done.

LALBR: Why are interest rates in Brazil so stubbornly high?Welch: The question is, what is the best way to fashion amonetary policy? If you have raising interest rates butyou are buying dollars at the same time—which Brazildid through May—then you are basically undoing thetightening of higher interest rates by printing moneywhen you buy dollars. The bank has stopped buyingdollars and the dollar, as a result, has fallen, and inflationhas fallen. The Central Bank is more or less hitting itstargets. There is another aspect to the interest rate issuein Brazil. When one talks about interest rates, we need toask which interest rates do you mean? Because the Selicrate is not the average rate for the financial system. Brazilstill has a very segmented financial system. For theCentral Bank to control the system through the interestrate, it affects a quite small part of the financial systemand a small part of the real sector. Brazil still has manypolicies of directed credits in effect. These are basically

programs where the government, through social orindustrial programs, requires banks to lend to certainsectors or groups at below market interest rates. If youlook at average borrowing costs even for private-sectorborrowers, apart from directed credits, those interest rateshave actually fallen; they’ve gone up on the margin butover a five-year term, they have fallen rather significantly.The average rate is much less than 19.75 but rates arestill quite high. And I do not think they have to be ashigh as they are.

Reducing the “Crowding Out” of AvailableCredit by Government

LALBR: You wrote recently that the Brazilian govern-ment could well balance its budget within three yearseven if legislation that forces a balanced budget is notpassed. What would the effect of a balanced budget beon interest rates? Aren’t the interest rates kept high bygovernment borrowing?Welch: Certainly. If the government balanced the bud-get, real interest rates would come down. Risk premiumand government debt would come down; that wouldfurther bring down interest rates. But, a country doesnot earn credibility overnight. It can lose it overnight butit can’t earn it overnight. The government is just goingto have to stick to the straight and narrow and at somepoint we will see a very significant drop in the interestgoal especially as a percentage of GDP.

LALBR: What interest rates be in three years?Welch: We are forecasting sixteen percent. I was quite con-servative with the interest rates. But even under a ratherconservative interest rate scenario, the nominal debt willdecline to zero, because the debt will continue to fall as apercentage of GDP.

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Diverse ExportsLALBR: The export sector has been one of the most robustpieces of the Brazilian economy. But some have criticizedBrazil’s exports as being too concentrated in basic goods,such as soy beans and iron ore. Are Brazilian companiesnot focused enough on higher value-added goods?Welch: I don’t think so. Brazil already exports quite a bit offinished goods, including capital goods, and the countryhas a good diversity of exports, as shown by the exportdata. I do not think there is any reason for Brazil to try toshape exports by a controlled industrial policy. Rather, Bra-zil needs to rationalize its imports. It could do this by mak-ing import tariffs more even across different sectors. If itdid this, we would see the emergence of further strategicadvantages. Brazil is well on its way to having a very dy-namic export sector. But to export and compete in interna-tional markets manufacturers must be able to import thelatest technology and the lowest cost inputs. This govern-ment has made some progress in this area, but there is stillplenty of room for improvement.

Basic Problems in Basic EducationLALBR: Foreign companies that are operating in Bra-zil have long complained that their workers come tothe job without adequate basic education. Has thisgovernment, headed as it is by the former head of theWorkers’ Party, made significant progress in reformsto basic education?Welch: The average level of schooling in Brazil hasincreased. However, one of the most difficult problemsfacing not just Brazil but many governments in LatinAmerica is to refocus education to the primary andsecondary levels. Much of the education budget isspent on universities, and any government that triesto change this situation runs into some very strongspecial interest groups, in this case mainly professorsand others with an interest in a well-funded universitysystem. Brazil’s Minister of Education has proposedthat more of the education budget go toward basiceducation. We may see some progress yet on theseproposals, but as long as the current scandals continueto come out of Brasilia, I do not think that muchattention will be given to this area. ❏


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Documents

Published by WorldTrade Executive, Inc. LATIN AMERICAN · August 31, 2005 LATIN AMERICAN LAW & BUSINESS REPORT 1 Volume 13, Number 08 August 31, 2005 HIGHLIGHTS Published by WorldTrade