Doing business in brazil // Coimbra & Chaves // 2014 DOING BUSINESS IN BRAZIL

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1 DOING BUSINESS IN BRAZIL

2 THE OIL & GAS SECTOR IN BRAZIL

3 Brazil has taken an important place in the recent global energy market. In 2012 numbers the domestic production of crude oil has increased 15.4% since the discovery of the so-called pre-salt fields in In the last ten years the growth in domestic oil production reached 29.6%. As far a natural gas production is concerned the growth is even more impressive: 29.7% as compared to 2007 and almost 40% in the last ten years. In this way the country has earned a seat at the table among the largest oil producing nations in the world, currently occupying 12th place among oil producing countries and 28th place among natural gas producing countries, and is accordingly one of the biggest oil & gas producing countries, which is not a member of OPEC. The Oil Law Law nº /97 Constitutional Amendment nº. 9 of 1995 (EC) brought major innovation to the field of oil & gas production in Brazil allowing for innovation in a sector that had to a certain extent been restricted since the formation of the national oil company Petrobrás as part of the national oil policy in The EC eliminated Petrobrás monopoly in the oil & gas sectors and authorized exploration through concession given by the state to private enterprises. The new Oil Law (Law nº /97) while ratifying the state monopoly in the area of oil & gas also permitted companies incorporated in Brazil, with headquarters and administration in the Country, to compete in the market. At the same time it assured that Petrobrás was given the tools to compete on an even footing with such companies. The law has since served as the regulatory framework of the sector and the basis for the national energy policy.

4 The main pillars of this regulatory framework are: (I) preservation of national interests; (II) promotion of development, expansion the labor market and valorization of energy resources; (III) protection of consumer interests in relation to price, quality and availability of products; (IV) protection of the environment and promotion of energy conservation; (V) assuring the supply of oil derivatives in the domestic territory; (VI) increasing the use of natural gas; (VII) identifying the most adequate ways to assure supply of energy in different parts of the country; (VIII) promoting the use of alternative energy through the use of available sources and technologies; (IX) promoting free competition; (X) attracting investments into energy production; (XI) increasing the competiveness of the country in the international markets; (XII) increasing, while assuring economic, social and environmental needs, the use of bio fuels in the domestic energy sector; (XIII) assuring the supply of bio fuels in the entire domestic market; (XIV) incentivizing the production of energy from biomass and sub-products of bio fuels due to their clean and renewable nature, complementing hydro sources; (XV) promoting the competiveness of the Country in the international bio fuel markets; (XVI) attracting investments in infrastructure for the transportation and storage of bio fuels; (XVII) fostering research and development related to renewable energy; and (XVIII) mitigating the emission of green house gases and pollution from the transport and energy production including by the use of bio fuels. Furthermore the law created the National Council for Energy Policy - CNPE, which serves as advisory council for the President on energy policies and directives and The National Petroleum Agency ANP, which regulates the petroleum industry and is in charge issuing rules applicable to private companies in the area of research, exploration, refining, import and export of petroleum and its derivatives.

5 The National Council for Energy Policy CNPE As mentioned above the National Council for Energy Policy CNPE serves as advisory council for the President on energy policies and directives. The Council is linked to the Ministry of Mines and Energy and is lead by a board of 14 members, including eight ministers. The guidelines for the work of the Council is set forth in Art. 2 of the Oil Law and include (I) the promotion and rational use of the Country s energy resources in accordance with the principles mentioned above; (II) assure, with due regards to regional characteristics, the supply of energy supply to the remote and inaccessible regions of the Country in accordance with the policies set forth by Congress in case of creation of subsidies; (III) review periodically the energy matrix for different regions of the Country, based on conventional and alternative energy sources and available technology; (IV) establish directives for specific programs, such as the use of natural gas, coal, thermonuclear energy, bio fuels, solar energy, wind energy and energy from other alternative sources; (V) establish directives for import and export to assure the domestic supply of oil and derivative products, bio fuels, natural and condensed gas in accordance with the annual public supply plans; (VI) suggest the adoption of necessary measures to meet domestic energy demand on a short, medium and long-term basis, with powers to advance projects that due to their strategic and public importance should enjoy preferential treatment to assure stable energy supply pricing and the stability of the domestic power grid; (VII) establish guidelines for the use of natural gas in industrial production in order to assure an efficient use thereof compatible with internal and external market needs (VIII) define the production fields that will be the subject of public concession or shared use; (IX) define strategies and public policies for the development of the oil & gas industries, natural

6 gas or fluid hydro carbons and bio fuels and well as the related supply chain; and (X) increase the minimum content of national goods and services to be observed in public tenders and concessions. The National Petroleum Agency ANP The other important innovation introduced by the Oil Law was the creation of the National Petroleum Agency ANP, which is a regulatory agency under the Ministry of Mines and Energy and has as its main purpose the issuance of regulations for the petroleum industry, natural gas, bio fuels and derivatives industry apart from controlling the supply of public services and exercise of private economic activity by the companies that provide such services. The purpose and objective of the ANP is set forth in Art. 8 of Law 9.478/97. The recent changes to the Oil Law, and there have been more than 10 in the last 15 years, have given this regulatory agency increased regulating and control powers not least due to the innumerous new concessions issued after the discovery of the pre-salt fields. The challenges that the ANP will face in its work in the coming years makes it one of the most important regulatory agencies on the Country. Tax Immunity in Accordance with Paragraph 3 of Article 155 of the Constitution The Brazilian tax system generally taxes the production chain, but in the case of oil & gas Congress decided to transfer taxation to

7 consumption. Thus oil & gas production was exempted from tax to assure that the product could transit free of tax from the place of production to the place of consumption. In exchange assure that the producing state also received tax revenue from the production taking place in its territory the concept of royalties was introduced. Art. 155, II, of the Federal Constitution introduced the tax on circulation of goods and interstate and inter-municipal transport and communications ICMS, which is levied by the states of the Federation. In its paragraph 3 the constitutional norm states that only ICMS and import and export taxes can be levied on transactions involving electric energy, telecommunication services, petroleum derivatives, combustibles and mining output. As far as other taxes are concerned, companies in this sector benefit from a constitutionally based exemption. Tax Immunity in Accordance with Paragraph 2, X, Item b, of Article 155 of the Constitution The abovementioned rule also exempts transactions involving petroleum, including lubricants, liquid combustibles as gases derived therefrom from the ICMS tax when destined for another state of the Federation. What happened in reality is that before the introduction of this rule, ICMS could be charged in the state of origin, i.e. the states where petroleum production takes place could charge the tax. But due to the fact that the Constitution exempted such operations from the ICMS tax,

8 this revenue source was lost. There is a discussion in theory whether the rule establishes the non-existence of the tax or if it is a case of tax exemption in the state of origin where the right to tax is merely transferred to the state of destination. The Brazilian Supreme court has ruled that the immunity only applies to the state of origin and that the state of destination can levy the tax also in relation to later steps of the process. The above discussion is important for understanding the introduction of royalties in the Oil Law to compensate the state in which the production takes place. The Petroleum Royalties To compensate the states where petroleum activities take place the Brazilian Constitution of 1988 introduced the concept of royalties to be charged by such states. Under this scenario the petroleum destination states stay with the revenues from the levy of the ICMS tax and the states of origin with the revenues from royalties. This set-up was mirrored in the Oil Law. But the creation of such royalties was also due to the wish to compensate the states of origin for the loss of natural resources and the infrastructure necessary for such operations. At first sight the indemnification for use of non-renewable natural resources seems obvious. There is, however, no way to completely indemnify for the extraction for economic reasons. That is where another aspect of the royalties comes to bear: The problems caused by the infrastructure necessary for extraction activities such as their environmental and social impact are very relevant. Further,

9 the petroleum extraction makes other kinds of activities in the region unfeasible. Thus the petroleum royalties have both a revenue and indemnity side. It is also worthwhile noting that the discovery of the pre-salt fields re-initiated the discussion about a new legal framework for the petroleum royalties and the amounts involved ignited by the opposite interests of the states of origin and destination. As a result the Brazilian Constitution created a legal treatment of oil & gas activities on three levels: (a) the substitution of a flat tax by the taxes already existing in the Constitution hereby guaranteeing that the activity cannot be subject to further taxation; (b) the transfer of the tax basis from production to consumption including the mentioned exemption for interstate transactions; and (c) the financial compensation for lack of tax revenue and degradation of natural resources through levy of royalties. REPETRO The Brazilian Government, with the purpose of assuring the feasibility of the investments in the oil & gas industry, created the Special Customs Regime for import and export of goods destined for use in the areas of research and extraction of oil & gas reserves called REPETRO, first introduced (in 1999) in the aftermath of the Oil Law and currently regulated by Decree 4.543/02 and Normative Instruction 844/02 of the Brazilian Internal Revenue Service. The Special Customs Regime is currently the main benefit given to the companies in the sector and aims at attracting investments into

10 Brazil through tax exemptions (II, IPI, PIS, COFINS and AFRMM taxes) in order to foster the development of the Brazilian oil & gas sector. The regime is available to companies that have concessions or other authorizations based on the Oil Law to perform research and extraction activities or companies that are subcontracted for leasing of platforms and ships or other support activities. In general the Special Customs Regime consists of the following benefits: (i) export with exit of goods followed by a temporary admission regime for the exported goods; (ii) import, under a draw-back regime with suspension of taxes on raw-materials, semi-fabricated or finalized goods and parts for the production and export of goods under the above mentioned rules; and (iii) concession of a special temporary admission regime in case of foreign goods or denationalized goods that come directly from abroad.

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