Name: Course: College: Tutor: Date: Brazilian fiscal policy Fiscal policy refers to use of government revenue collection and expenditure to influence its economy. Fiscal policy targets a country’s budget of its economic activities. Government can adjust its spending and taxation levels through changing the income distribution, resource allocation or level of aggregate demand and economic activity. In the context of Brazil, in 1970s, the government put some stringent penalties to regulate its imports. The government kept the import tax and penalties high.
To implement the policies, the government applied tax deduction on imports, for instance, a Brazilian resident who imported intangibles like knowhow, software and royalties would be subject to withholding tax from remittances, this was equivalent to 25% of an individual registered capital. If a Brazilian taxpayer bought software from abroad, worth ? 100, the seller would be receiving ? 15 while the ? 85 would be remitted to the government. Brazilian tax rule treated any payment of intangible imports as a profit distribution regardless of their justification.
This meant that in any importing individual or company would pay more than its income a year (Poterba, 1999). Q2 Policy impact The policy was set to discourage imports and promote the countries’ economic activities by ensuring that companies like Commutronics, which had their operations in the country were purchasing materials from within instead of importing. The policy would benefit domestic companies since companies like Commutronics Do Brazil (CdB) who had to use the local supplies and services bought from them.
Such a fiscal policy would work for the interest of Brazilian economy, commodities, which could fairly be bought from their domestic market instead of importing would be reduced their in imports, particularly for luxurious items, and products whose substitutes are available in the local market. In 1970s, Brazil’s export sector was affected by the oil shock of 1973 and mostly the exports were overvalued. This saw a decline in performance of the economy’s export sector. The pressure of trade imbalance and oil shock sharply increased the import bill (Pessoa, 2004). The stringent policy of imports tax and duties was seen as a high growth policy.
The strategy can be effective in enhancing growth but the main components considered should be basic industrial inputs like fertilizers, steel, petrochemicals etc. However, import substitution and restrictions policies do not favor intangible good especially technology software and knowhow which are often bound to importation. Concerning the companies that require inputs like software, the policy is likely to result in reduced public investment. For instance, the inflation and crisis that followed in 1981 to 1983 so a reduction Brazils gross investment from 21% to 16%.
Some of the things that have been quoted as the reasons for the declines was increased uncertainties in the future of the economy. Such uncertainties are posed by unfavorable fiscal policies. In the case of Commutronics, the company fought to invest in the country in amidst of unfavorable policies, however, few companies would stand such policies such policies particularly where the deductions were affecting shareholders capital as was the case for Commutronics (Poterba, 1999). Q3 Commutronics argument for and against market solution Commutronics had not accumulated enough profits and had no sufficient capital reserves.
The company’s registered capital was therefore very low. The withholding tax rate of 85% was therefore virtually applied to distributions. Brazilian tax law did not recognize that the price of the software had an element of cost recovery for developing the tax control system and largely the portion of it was to go to software application to develop its density, topographical and characteristics. This therefore meant direct cost to Commutronics. The company was advised that the 85% tax was seen as an addition to the import deposits and duties, which was to be offered and allowance of 100% in price.
This allowance meant that software had to be supply by Aberdeen to CdB freely or Commutronics had to withdraw. Arguments for the free issue of software were that Commutronics do Brazil initial business dint have enough orders and required to get the contract with Commutronics in order to carry on with business. This was a valuable foothold for CdB since the market for computerized systems of market was growing. Only a few cities had such systems worldwide. The contract would have worked as a demonstration for Aberdeen to indicate that the traffic control system actually worked.
Competition for the order was high since the new concept of traffic control was new in the global market (Poterba, 1999). Q4 Commutronics argument for and against a financial solution Contract withdrawal entailed redundancies in Rio and Aberdeen and the free issue had no impact on pre-tax results. Any loss in UK would have been offset through CdB’s gain. Against the free issue were several views, cost incurred by UK would not be covered while the parent company, Commutronics required dividend for its shareholders. To drain the distributable cash and profits was not easy for the company.
Borrowing from the tentative tender price, the company’s board had just reviewed the issue of repatriating the overseas’ profits share to UK for the parent company’s divided and also the board had stated that they had to reverse the cash and profit drain from UK the company’s subsidiary. This was vital because the company had made all its profits outside UK while the parent company in UK bore the burden of servicing shareholder’s dividends and management burden. It is worth recognizing that the shareholders’ dividend cover for Commutronics, the parent company, had a cash dimension in addition to its accounting dimension.
In such instances, dividends are paid out of the profit available for shareholders distribution, which may include any previous undistributed earnings. The company required a financial solution since all its operations were overseas from where its profits rose. With the tax law in Brazil, the impact on the company financial performance was at stake and there was need to ensure that sales resulted in cash collection from subsidiary instead of focusing on notional sales or profits. CdB and Aberdeen, which were the parent company’s two subsidiaries, had to operate as cash and profit centre.
The company needed to avoid blocked bank accounts and the directives by the board intended to reduce bad debts and sales made on no-convertible currencies. According to the parent company’s board, to accept the contract with the Brazilian tax laws would have undermined the disciplined (Poterba, 1999). Q5 Recommendation The company’s board did not want to invest further in Brazil and CdB was not successful given the political, currency and economic risks that were far too great in Brazil. Where foreign investment is faced with economic and political risks, it is good to consider the eminent losses that may result from such investments.
Although the market for the new traffic control system was promising, the fiscal policies in Brazil were unfavorable for growth. Companies’ performance owes much to the economic policies imposed by government. With the tax law in Brazil, it would not be advisable for Commutronics to accept the contract since the loss making is far too imminent (Pessoa, 2004). References Pessoa, M. F. (2004). Fiscal Policy In Brazil And Japan, What Can Be Learned. Ministry of Finance – National Treasury, Brazil. Poterba, James M. , & Hagen, J. (1999) Fiscal Institutions and Fiscal Performance. Chicago: The University of Chicago Press.