CVM Orienting Opinion No. 7 of March 5, 1981

CVM ORIENTING OPINION NO. 7, OF MARCH 5, 1981.

SUMMARY: The Foreign Exchange Operations Tax (IOF) is integrated into the acquisition cost together with the value resulting from the conversion of the foreign currency corresponding to the acquisition price of the imported good.

• Subsequent adjustments to the IOF resulting from changes in the exchange rate are not added to the cost of the imported good; they constitute an expense of the fiscal year in which they are incurred.
• Alternative procedures adopted for accounting for the IOF must be clarified in explanatory notes to the financial statements, disclosing the amounts of the effects resulting from them.
• The omission of disclosure concerning the alternative procedures adopted, as well as the amount of the effects resulting from them, must be the subject of a statement by Independent Auditors.

1. The present orienting opinion analyzes, in accordance with the competence entrusted to the Securities and Exchange Commission (CVM) by Article 22, sole paragraph, item IV, of LAW 6.385/76 and by Article 177, paragraph 3, of LAW 6.404/76, the procedures to be observed by publicly held companies regarding the accounting for the tax on foreign exchange operations (abbreviated as IOF) in the acquisition of imported goods (inventory or fixed assets), as well as regarding disclosure in financial statements both concerning the procedure adopted and concerning the effects resulting from it.

2. IOF in determining the cost of the imported good.
1. The IOF applies to operations related to the importation of goods and services and is due at the time of settlement of the foreign exchange contract.
2. The value of the IOF, consequently, becomes an integral element of the cost of the imported good (inventory or fixed assets), as if it were added to the exchange rate in the conversion of foreign currency, and integrates the cost of sales or depreciation quotas in the calculation of the result of each fiscal year.
3. Between the date of accounting for the cost of the imported good and the date of settlement of the foreign exchange contract, a variation in the exchange rate may occur, with consequent alteration of the amount of IOF to be paid.
4. For accounting purposes, the amounts resulting from variations in the exchange rate are considered as expenses - "Exchange Rate Variations" - that is, they are not added to the cost of the imported good.
5. Therefore, subsequent adjustments to the IOF, resulting from changes in the exchange rate, must be treated as expenses, similarly as exchange rate variations are treated.

3. IOF in determining taxable income for income tax calculation.
1. For the purposes of determining taxable income for income tax calculation, the IOF may only be considered as a deductible expense when the foreign exchange contract is settled.
2. The IOF corresponding to foreign exchange contracts not yet settled, which has been included in the acquisition cost of the imported good (inventory or fixed assets) and which is affecting the result of the fiscal year, by inclusion in cost of sales or by inclusion in depreciation quotas, must be added to the net income of the corresponding fiscal year for the purposes of determining taxable income for income tax calculation.
3. Only in the fiscal year in which the actual settlement of the foreign exchange contract occurs will the deductibility of the IOF that has been included in the cost of sales or in depreciation quotas be permitted.
4. Companies that have reduced operations for the acquisition of imported goods (inventory or fixed assets) will certainly not have difficulty in maintaining effective control of the amounts of non-deductible IOF, which are included in the cost of sales or in depreciation quotas. However, companies that have numerous and continuous transactions regarding the acquisition of imported goods (inventory or fixed assets) will be compelled to maintain an onerous control system to determine the actual amounts of IOF added to the cost of sales or in depreciation quotas.
5. It is appropriate to mention that the estimation of these amounts of IOF added to the cost of sales or in depreciation quotas for the purpose of determining taxable income for income tax calculation will not be admitted.
6. Considering the onerous control system previously mentioned, Revenue Secretariat Normative Instruction No. 131 admits, at the company's option, that any of the following alternatives be adopted:
a) consider the IOF as a tax expense upon settlement of the corresponding foreign exchange contract; b) consider the IOF as an addition to the acquisition cost of the imported good (inventory or fixed assets) with a corresponding entry to a provision account for payment of the IOF.

1. The chosen alternative must be adopted uniformly in all fiscal years and with respect to all imported goods (inventory or fixed assets); that is, differentiated treatment for the IOF included in inventory and for the IOF included in fixed assets, nor for the various types of imported goods, will not be admitted.
2. The first alternative admits that the IOF on the foreign exchange operation regarding the acquisition of imported goods (inventory or fixed assets) has the treatment of a tax expense, and is therefore not added to the acquisition cost of the imported good. The tax expense, however, can only be deducted in determining taxable income when the payment of the IOF is made in the settlement of the respective foreign exchange contract.
3. The adoption of this alternative conflicts with the technical accounting procedure for calculating the costs of inventories and the costs of fixed assets, because the acquisition cost must include, in addition to the price of the acquired good, all additional expenses and charges incurred and due until the effective arrival of the good at the company, whether for commercialization purposes or for use in the operational process.
4. Furthermore, the inclusion of the IOF as a tax expense in the fiscal year in which the foreign exchange contract is settled entails a distortion of the results calculated when it does not coincide with the fiscal year in which the sale or depreciation of the imported good is processed.
5. The second alternative admits that the IOF on foreign exchange operations is added to the acquisition cost of the imported good (inventory or fixed assets), with a corresponding entry to a separate provision account for payment of the IOF, establishing conditions for the deductibility of this provision.
6. Thus, the value of the provision for payment of the IOF, in the fiscal year in which it is established, must be added to the net income for the purpose of determining taxable income. Also, for this purpose, additions to the provision account resulting from new foreign exchange contracts, as well as additions to the provision resulting from changes in the exchange rate, must be added to the net income of each fiscal year.
7. The value of the provision established, as previously explained, can only be admitted as a deductible expense in determining taxable income for income tax calculation, to the extent that the payment of the IOF is being made in the settlement of the foreign exchange contracts.

4. Audit Aspects.
1. The optional alternatives, established by Revenue Secretariat Normative Instruction No. 131, aim solely and exclusively to facilitate the supervisory action exercised by the Federal Revenue Secretariat. The adoption of any of the alternatives in commercial bookkeeping entails a distortion in the configuration of the financial position presented in the Balance Sheet and in the determination of the results presented in each fiscal year.

• First Alternative
  The accounting of the IOF as a tax expense in the fiscal year in which the settlement of the foreign exchange contract occurs results in the following consequences:
  Balance Sheet

1. inventories and fixed assets will be undervalued due to the non-inclusion of the IOF in the acquisition cost;
2. the amount of IOF to be paid will not be presented in the current liabilities;
3. shareholders' equity will be increased by the portion of IOF not considered in the results, with consequent reflection in the monetary correction charge on Shareholders' Equity, until the fiscal year in which the payment of the IOF is accounted for.

Result of the Fiscal Year

1. The IOF will be accounted for as an expense in a fiscal year not coincident with the fiscal year in which the imported good is accounted for in the cost of sales or not coincident with the fiscal year in which the depreciation quota is accounted for.

• Second Alternative
  The accounting of the IOF as an integral part of the acquisition cost with a corresponding entry to a separate provision account for payment of the IOF results in the following consequences:
  Balance Sheet:

1. there will be no distortions to consider;
2. the effects cited in the first alternative are eliminated.

Result of the Fiscal Year
1. the establishment of a provision corresponding to the IOF included in the cost of the imported good entails as a consequence an increase in taxable income for income tax calculation and will have a compensatory effect when the payment of the IOF is made in the settlement of the foreign exchange contract.
2. the income tax corresponding to the increase in taxable income, if accounted for as an expense in the fiscal year in which the provision is established, entails a distortion of the result with a reflection in the configuration of shareholders' equity.

2. Certainly, Independent Auditors must note that simple disclosure in an explanatory note of the optional alternative adopted in commercial bookkeeping is not sufficient. Complementary information must be disclosed regarding the amount of the effect, both on the financial position and on the result of the fiscal year.

3. Independent Auditors must be attentive so that company results are not influenced by distortions resulting from alternatives adopted in commercial bookkeeping. For the perfect understanding of the financial statements, Independent Auditors must state regarding the omission of information involving issues of relevant importance and decide on the need for mention in their opinion, in light of the circumstances and facts that are within their knowledge.

5. Conclusion.
1. In summary, it is concluded in this opinion:
a) the IOF integrates the cost of the imported good (inventory or fixed assets) together with the amount resulting from the conversion of the foreign currency of the acquisition price, as if it were added to the exchange rate. b) subsequent adjustments to the IOF, resulting from changes in the exchange rate, are not added to the cost of the imported good. These adjustments must be accounted for as expenses in the calculation of the result of the fiscal year in which the change in the exchange rate occurs, similarly as exchange rate variations are accounted for. c) alternative procedures adopted in commercial bookkeeping, with respect to the accounting of the IOF, must be clarified in explanatory notes to the financial statements, disclosing the amounts of the effects on the configuration of the Balance Sheet and on the calculation of the result of the fiscal year. d) the omission of information in an explanatory note regarding alternative procedures adopted in commercial bookkeeping, as well as the omission of the amounts of the effects on the financial position presented in the Balance Sheet and the omission of the amounts of the effects on the result of the fiscal year, must be the subject of a statement by the Independent Auditor.

SUPERINTENDENCY OF ACCOUNTING STANDARDS AND AUDIT Original signed by ANTÔNIO CARLOS DE SANTANA Analyst of Accounting Standards Original signed by ÁLVARO AYRES COUTO Superintendent