June 29, 2018 / 3:23 PM / in 4 months

Huge Brazil tax liability slows sale of funds' Vale stakes: sources

SAO PAULO (Reuters) - A potential tax liability in the billions of dollars is delaying the sale of major stakes in miner Vale SA (VALE3.SA) by Brazil’s largest pension funds, according to two sources with knowledge of the matter.

FILE PHOTO: Brazilian mining company Vale S.A. logo and trading symbol are displayed on a screen at the New York Stock Exchange (NYSE) in New York, U.S., December 6, 2017. REUTERS/Brendan McDermid/File Photo

Discussions over the tax issue are adding to uncertainty about when and how pension funds will unload their shares in Vale, which is among the most traded stocks in Latin America.

Previ, Petros, Funcef and Fundação Cesp, which manage pensions for the employees of state-controlled Banco do Brasil SA (BBAS3.SA), Petroleo Brasileiro SA (PETR4.SA), Caixa Economica Federal and CESP Companhia Energetica de Sao Paulo (CESP6.SA), respectively, have hired tax experts to determine the best way to sell their stakes with a lower tax burden, sources said, asking for anonymity to discuss the matter freely.

Previ and Funcef declined to comment. Petros and Funcef did not reply to requests for comment.

The four pension funds own 21.3 percent of Vale through holding company Litel Participações SA (LTEL3B.SO), acquired in large part when the mining company was privatized by the Brazilian government in May 1997.

Reuters reported in March that the pension funds planned to sell 10 percent to 12.5 percent of their Vale stakes this year, or about 3 percent of total Vale shares outstanding, but the tax issue has delayed the transaction.

Litel’s profit is subject to a 34 percent tax rate, but the pension funds are exempt from capital gains and other taxes.

The most tax-efficient way to sell the stakes would be for Litel to distribute the Vale shares to the pension funds for them to sell tax-free.

The funds have been hesitant to go ahead with distribution, however, because of concerns that it could be considered tax evasion by authorities and subject to fines, the sources said.

HUGE LIABILITY

If the shares are not distributed, Litel will eventually incur a staggering tax bill as it liquidates the Vale shares so the pension funds can pay retirements.

Vale’s total market capitalization has risen from around 8 billion reais in 1997, when it was privatized, to 258 billion reais currently. Selling the 21.3 percent stake held by Litel at current prices would therefore represent a capital gain of 53 billion reais over the last 20 years.

The resulting tax liability associated with selling the entire stake, including accounting items that reduce taxable profit, could reach 12 billion reais ($3 billion), according to Reuters simulations confirmed by one pension fund executive.

To be sure, the funds are not planning to immediately liquidate their full stakes and could not if they wished to. Part of the shares held by Litel are subject to lock-up agreements through 2020.

Still, the tax lawyers hired by the pension funds are eager to resolve the long-term tax liability before clearing any sales, the sources said. They have offered a range of solutions.

For example, funds that can afford to hold their stakes for longer could receive shares from Litel and keep them for up to five years before selling.

For the more cash-strapped funds, another solution could be for Litel to sell a small fraction of the shares in late 2018 or early 2019, taking advantage of the stock’s more than 20 percent rise so far this year and accepting a hefty tax bill.

The sources said the funds under the most pressure to sell are Funcef and Petros, which is facing a 27.7 billion reais actuarial deficit. The chief executive of Petros, Walter Mendes, said this month that the fund expected to sell part of its Vale stake this year.

By comparison, Previ posted a surplus in early 2018 and Funcesp has enough liquidity to delay a sale, the sources said.

Reporting by Carolina Mandl; Editing by Steve Orlofsky and Alistair Bell

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