Published on December 28, 2007, Law No. 11,638/07 has brought a series of alterations to Brazil’s Law of Corporations (Law No. 6,404/76), especially in what concerns the accounting control systems for activities undertaken by corporations.
Furthermore, Article 3 of the mentioned statute extended to large companies (sociedades de grande porte), even if they are not formed as corporations, the rules provided by law concerning the necessity for bookkeeping and preparation of financial statements, and the obligation to carry out independent auditing.
On this point, it should be made clear that a “large company” is a company or group of companies under common control which had total assets during the previous financial year of over R$240 million or gross annual income of over R$300 million.
In respect of large companies, the new law has generated controversy from legal and business experts over whether these companies should be obligated to publish their financial statements in the Brazilian Official Gazette and large-circulated newspapers.
The outcome of this controversy appears clear to us in that this obligation, and specifically that affecting large companies, was expressly excluded during the legislative revision process of Law No. 11,638/07. Further, it should be stressed that upon its preliminary announcement of the alterations introduced by Law No. 11.638/07, the Brazilian Securities Exchange Commission (CVM), through the Formal Notice of January 14, 2008, confirmed the lack of any express reference as to the obligatory nature of the publication of financial statements by large companies, simply highlighting the obligations outlined in Article 3 mentioned above.
It is important to mention that this is not the first attempt at imposing upon companies not necessarily organized as a corporation the obligation to publish their financial statements, an example being Bill No. 2.813/00 which contemplates said obligation as concerns Brazilian limited liability companies.
The mentioned Bill is currently undergoing examination by the House of Deputies where it has been for seven years, without a foreseeable date for its approval. Amid the principal innovations brought about by Law No. 11,638/07, long awaited by accountants and already in use by the majority of the more developed countries, is the substitution of the Statement of Origin and Utilization of Resources (“DOAR”) for the Statement of Cash Flows (“DFC”).
Publicly-held corporations have also been ordered to draw-up the Value-Added Statement (“DVA”), which up until now has been optional in accordance with item 8 of Official Letter CVM/SNC/SEP No. 01/00. Another innovation outlined by the new legislation opens the possibility of creating statements specifically for tax purposes, in addition to the already existing accounts statements, with the intention of improving control over the examination of taxes owed by corporate entities. Previously, fiscal control was done separately through secondary tax records. The form of control for permanent assets has also been altered, in that a new subgroup has been created, in addition to the fixed, deferred assets and investments: the intangible assets.
This new group has arisen out of the segregation of fixed assets, as a means of separating the intangible assets from the tangible ones (fixed assets per se). A new division was also created for the net worth accounts, as a means of substituting the “reevaluation reserve” with “equity evaluation adjustment”.
Due to this alteration, the counterentry arising from the rises and falls in the values attributed to those elements of the assets and liabilities will be entered in the new record of equity evaluation adjustments. Previously, only the estimation of asset elements, based on technical reports, was accounted by way of the reevaluation reserve.
It is important to note that the balances existing in the reevaluation reserves should be maintained until their effective realization or cancelled by the end of the 2008 financial year.
Further, in respect of net worth, the “accumulated profits and losses” account was extinguished. From the start of the period in which the new legislation will take effect, there will only exist the “accumulated losses” account, the profits moving under the control of the “profits reserve” account. Similarly, the balance of the profit reserves may not exceed the capital stock.
Under the terms of the new law, “in reaching this limit, the Shareholders’ General Meeting shall make a resolution on the allocation of the excess to the payment or increase of the capital stock or to the distribution of additional dividends to the shareholders.” (new wording of article 199 of Brazil’s Law of Corporations), which, in a sense, enables the shareholder to receive profits, in addition to the mandatory dividends. The entries as capital reserves, a record also included in the net worth, were reduced, no more being able to be accounted under capital reserve the premium received in the issue of debentures, the donations and the subsidies for investment. Additionally, the new legislation has brought new criteria in the evaluation of assets and liabilities in an attempt to update the accounting control within the reality of the contemporary market.
Of all the alterations, two are worthy of particular attention. Firstly, those elements of the assets and liabilities arising from long term operations should be adjusted to the current value. Such methodology has already been accepted by the Securities and Exchange Commission itself (CVM Normative Ruling No. 346/00), but has never been widely used. Another relevant point concerns the fact that there is no longer an obligation to amortize deferred assets within a maximum of ten years. From now on, the criteria used in determining the estimated lifespan of the sums registered as fixed, deferred and intangible assets, for the purpose of depreciation, amortization and depletion, should be periodically revised and readjusted. In the same manner, the “losses of the sums of applied capital [should be] registered when there has been a decision to interrupt the enterprises or activities for which they were destined or once it has been proven that they cannot produce results sufficient to recuperate the sum.”
Another important alteration brought about by the new legislation, given importance by the numerous corporate transactions that have been carried out, is the determination that the assets and liabilities of a corporate entity to be merged or arising from a consolidation or spin-off, are to be accounted by their market value should the operation be effected on an arm’s length basis and imply an effective transfer of control.
Thus, if on the one hand, the rule under discussion aims at avoiding losses, mainly for minority shareholders of companies which are subject to a change of control, on the other, it will certainly affect the tax burden of these operations and, ultimately, price negotiations. The principal tax effect concerns the fact that accounting of the market value will possibly reduce the premium existent in these operations. This is due to the fact that because the premium is deductible for the calculation of Income Tax, the reduction of such premium will, therefore, imply a lower deduction of the cited tax.
Further, it is important to mention that the new legislation altered the requirements for the use of the investment evaluation method in affiliated companies by the net worth value (Equity Accounting Method or Método da Equivalência Patrimonial – “MEP”).
Before the enactment of such law, the condition precedent for the use of the MEP evaluation was that the investment had to be considered relevant, i.e., (i) the sum of the investment in a controlled or affiliated company was equal or superior to 10% of the net worth of the investor; and/or (ii) the sum of the investment in controlled or affiliated companies, together, was equal or superior to 15% of the net worth of the investor.
With the recent alteration, it is enough for the investment to be in an affiliated company in which the investor has significant power, or in which it holds 20% or more of the voting capital or in a controlled company and in other companies which form part of the same group and which are under common control. In view of the above, we can conclude that in addition to the simple alterations in the accounting control mechanisms of corporations and its effects on large companies, the recent alterations may have a serious impact on the companies’ tax system, a detailed examination of recent legislation and the possible repercussions on its main business activities being absolutely indispensable for each taxpayer.
It is important to stress that although the stated alterations have been in immediate effect since January 1, 2008, many of them will be subject to regulatory acts and supplementary technical orientations by government bodies and departments directly involved in accounting, corporate and fiscal matters, to which Law No. 11.638/07 allows the execution of agreements and conventions with organizations designed to study and release the principles, norms and models for accountancy and auditing, such as the CPC (Committee on Accounting Decisions or Comitê de Pronunciamentos Contábeis), in this way allowing an integration of the efforts striving for the correct interpretation and application of the new law.
Finally, specifically in respect of publicly-held corporations, the Formal Notice of January 14, 2008 issued by the CVM determines that such companies must release footnotes not only on their 2008 Quarterly Reports (Informações Trimestrais – ITRs), but also on their financial information ended December 31, 2007, of events contemplated in the new law that may influence such companies’ financial statements for the next financial year and, whenever possible, an estimation of the impacts of such events on the assets and results for 2007 or the relevance level over the 2008 financial statements.