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Tax-free dividends make Brazilian stocks attractive. But will the party end?

. Jun 25, 2020
Tax-free dividends make Brazilian stocks attractive. But will the party end? Photo: Leremy/Shutterstock

Brazilian investors are adjusting to a new reality since the beginning of the coronavirus pandemic. The unprecedented monetary response to the crisis saw benchmark interest rates slashed to just 2.25 percent a year, making variable income investments more attractive than ever. This created a near-immediate impact as Brazil’s stock exchange Ibovespa underwent a miraculous recovery after repeated crashes in March. But there is another factor that may make stocks even more engaging for financiers: dividends. 

In a report, XP Research analysts noticed that, for the first time in history, dividend yields paid by companies listed on the São Paulo stock exchange outpaced the profitability of Brazil’s benchmark interest rate.

Therefore, beyond the prospect of making gains on stocks over time, investors would also receive more returns through dividends than with fixed-income assets.</p> <p>“With dividend yields above the interest rates for some companies, investors have a ‘warranty’ of returns, besides the gains on the stocks performance,” wrote XP, adding that financiers are now looking at dividend performance in 2021, when profits are expected to return to normal levels.</p> <p>Using 2019 as a yardstick, the perspectives are positive. According to Economática, 234 listed Brazilian companies paid a record of BRL 119.2 billion in dividends, 13 percent more than 2018 levels — and an amount that has been growing consistently for the past four years. The champions in dividend distribution were banks, oil and gas companies, and electricity firms.</p> <div class="flourish-embed flourish-chart" data-src="visualisation/2973224" data-url="https://flo.uri.sh/visualisation/2973224/embed"><script src="https://public.flourish.studio/resources/embed.js"></script></div> <h2>Favorite sectors</h2> <p>XP analysts set aside electricity companies and banks as their preferred options. For the former, they believe that major players in the electric energy sector will be able to pay out high dividends in 2020, due to their elevated cash flow. They also estimate an average dividend yield of 5.4 percent for the sector from 2021 to 2023.</p> <p>Banks also have an impressive track record as dividend payers, as 22 institutions distributed BRL 60.4 billion in 2019 — 53.3 percent more than they did in 2018.</p> <p>However, to ensure that part of the measures to boost liquidity during Covid-19 would indeed be directed to credit, the Central Bank has<a href="https://brazilian.report/coronavirus-brazil-live-blog/2020/04/06/banking-regulator-blocks-banks-from-paying-dividends/"> limited dividend payments in 2020 </a>to the minimum amount established by law: 25 percent of profits, or as determined by each company’s statute.</p> <p>XP’s projections for the future are much more positive, though. The analysts expect a dividend yield of 8.2 percent to 12.6 percent for banks between 2021 and 2023, including interests on equity capital. </p> <div id="buzzsprout-player-1516360"></div> <script src="https://www.buzzsprout.com/299876/1516360-can-brazil-approve-a-tax-reform.js?container_id=buzzsprout-player-1516360&#038;player=small" type="text/javascript" charset="utf-8"></script> <hr class="wp-block-separator"/> <h2>Controversy on taxing dividends</h2> <p>Part of the reason dividends are so attractive in Brazil is because, since 1995, they are free of taxes — an attempt of then President Fernando Henrique Cardoso to encourage investments in Brazil. The idea is that company profits would be taxed with corporate income duties, and the state would act to compensate for any<a href="https://brazilian.report/opinion/2020/05/24/covid-19-pandemic-inequality-for-whom-the-bells-dont-toll/"> inequalities</a> by policies to support the most vulnerable.</p> <p>But this view causes controversy to the present day. Ipea researchers <a href="http://repositorio.ipea.gov.br/bitstream/11058/8354/1/TD_2380.pdf">argue</a> that Brazil remains extremely unequal 25 years after the system’s adoption. Moreover, among OECD nations, only Estonia has a similar model, which Ipea researchers see as a sign that this system is <a href="http://repositorio.ipea.gov.br/bitstream/11058/8354/1/TD_2380.pdf">not internationally accepted</a>. They also highlight that the model pushes entrepreneurs to work as companies, paying less taxes than formal workers by reporting their income as dividends.</p> <p>In <a href="http://unafisconacional.org.br/UserFiles/2020/File/Nota-Tecnica_Tributacao-Lucros_Dividendos.pdf">another study</a>, the National Association of Tax Auditors (Unafisco) shows that the current system favors the wealthy while creating a heavier burden on the poor. According to their data, Brazil’s taxes on income, profits, and capital gains make up for 6.5 percent of the country’s overall tax burden, while OECD countries average 11.5 percent. When it comes to tax on consumption, the situation is the opposite: 11.2 percent among OECD members, versus Brazil’s 15.4 percent.</p> <div class="flourish-embed flourish-chart" data-src="visualisation/2973220" data-url="https://flo.uri.sh/visualisation/2973220/embed"><script src="https://public.flourish.studio/resources/embed.js"></script></div> <h2>A share for the government</h2> <p>Unafisco’s estimates also <a href="https://valorinveste.globo.com/mercados/brasil-e-politica/noticia/2020/02/17/governo-pode-arrecadar-r-597-bi-se-tributar-lucros-e-dividendos.ghtml">point out</a> that the country could raise almost BRL 60 billion by taxing dividends, calculations that have not been forgotten by authorities.</p> <p>Over the years, legislators have proposed several bills to bring back a tax on dividends, while Economy Minister Paulo Guedes has reiterated that he intends to follow international models in the government’s yet-to-be-seen tax reform. His plan includes lowering the current 34 percent tax rate on corporate profits to somewhere around 20 percent — similar to the U.S. — and then charging dividends by an additional 15 percent.</p> <p>With Covid-19 causing havoc on Brazil&#8217;s public accounts, the debate has returned to the forefront. On June 22, Special Tax Reform Advisor Vanessa Canado <a href="https://epocanegocios.globo.com/Economia/noticia/2020/06/epoca-negocios-guedes-apresentara-planos-para-reforma-tributaria-nas-proximas-semanas-diz-assessora.html">said</a> the government is including a tax on dividends in its reform project, set to be presented “in the next few weeks.”</p> <h2>Ripple effect</h2> <p>Reforming Brazil’s tax system is anything but simple. With the tax burden reaching 33 percent of the GDP as of 2018 — a comparable level to OECD countries but with far less returns on social welfare — creating new taxes or increasing existing ones are highly unpopular measures.</p> <p>As <a href="https://www.conjur.com.br/2020-mar-31/projeto-preve-tributacao-lucros-dividendos-2020#:~:text=Para%20compensar%20esse%20aumento%20na,bilh%C3%B5es%20e%20R%24%20124%20bilh%C3%B5es.">new bills</a> on taxing dividends pop up in Congress to bear the cost of the Covid-19 fight, experts warn of the dangers of making such major changes on the spur of the moment.&nbsp;</p> <p>Fagner Souza, a tax expert at consultancy firm Mazars, warns that without mechanisms to create compensation — such as diminishing the tax burden on profits proportional to dividends, or defining whether the dividends would be charged on companies or on shareholders’ income tax — the move could generate cases of double taxation. A potential example would be taxing company holdings. “Imagine a holding with 20 companies invested. You would tax the same group over and over. Without compensation, you could argue that this goes against the constitution,” he tells <strong>The Brazilian Report.</strong></p> <p>Mr. Souza reckons that taxing dividends is a more effective way to reduce inequality than simply making changes to income tax or taxing large fortunes — measures that have been proven fruitless abroad.&nbsp;</p> <p>“By taxing dividends, you can tax a part of the society that currently is not paying them and you can force companies to be more creative in their remunerations (in case of associate professionals). It is good from a social point of view, but companies mustn’t be overtaxed for that,” he said.&nbsp;</p> <hr class="wp-block-separator"/> <h4>Key takeaways</h4> <ul><li>With interest rates at their lowest level ever in Brazil, dividend yields of listed companies are outpacing fixed-income assets.</li><li>Dividend payouts have been affected by the pandemic, but prospects for 2021 are better; analysts recommend banks and electricity companies as the best gambles.</li><li>Dividends are not taxed in Brazil, but this may change in a future tax reform.

 
Natália Scalzaretto

Natália Scalzaretto has worked for companies such as Santander Brasil and Reuters, where she covered news ranging from commodities to technology. Most recently, she worked as an Editor for Trading News, the information division from the TradersClub investor community.

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