Explanatory Note to CVM Instruction No. 349 of March 6, 2001

EXPLANATORY NOTE TO CVM INSTRUCTION NO. 349, OF MARCH 6, 2001.
Ref: CVM Instruction No. 349, of March 6, 2001, altering CVM Instruction No. 319 which provides for merger, consolidation, and spin-off operations involving publicly-held companies.

CVM Instruction No. 319/99, by providing that the consideration for goodwill could be registered entirely in a special reserve account (Art. 6, § 1), ended up enabling, in cases of goodwill based on economic grounds such as intangibles or future profitability prospects, the recognition of a net asset increase without effective economic substance. The creation of a company with the sole purpose of serving as a vehicle to transfer, from the original controlling company to the controlled company, the goodwill paid in its acquisition, ended up distorting the figure of merger in its economic dimension. This distortion occurs because, when the merger process of the vehicle company is concluded, the investment and, consequently, the goodwill remain unchanged in the original controlling company.

On the other hand, the creation of the vehicle company and the transfer, to it, of the original investment and, also, the goodwill allowed, through this model of merger, the possibility of its tax benefit, giving rise, accountingly, to a kind of tax credit based on the future decrease of income tax and social contribution, due to the possibility of amortizing this goodwill. Therefore, this tax benefit is the only portion of the goodwill that can be utilized in the controlled company and which has economic substance. This is also the portion of the goodwill that the CVM has understood, as established in CVM Instruction No. 319, can be capitalized to the exclusive benefit of the controller. Therefore, only this portion with economic substance can be considered an asset and could come to be capitalized.

Some companies, based on the action of their auditors and with the agreement of the technical areas of this Commission, constituted a provision for the full or partial value of the transferred goodwill, in order to recognize as an asset and as a special reserve only the amount related to the tax benefit.
The constitution of this provision also allowed these companies to fully meet another requirement of CVM Instruction No. 319, which establishes that dividends to non-controlling shareholders cannot be reduced by the amount of amortized goodwill.

The CVM formally pronounced itself on this matter in CIRCULAR LETTER/CVM/SNC/SEP No. 01/2000, in which it mentions that the analysis regarding the recoverability of the goodwill value must also be made "upon the incorporation of the controlled or controlling company by a publicly-held company. If, as a result of this analysis, it is verified that the goodwill may not be recoverable, partially or totally, the company must constitute a provision for the amount of value it expects not to recover, and this provision must be presented as a deduction from the account in which the goodwill was registered". Notwithstanding this manifestation, it has been argued that the absence of a mandatory CVM norm determining the obligation to constitute this provision could give rise to the adoption of non-homogeneous procedures for the same economic event, with differentiated effects on the net assets and results of publicly-held companies.

As a result, Art. 1 of the new Instruction came to fill this gap by ultimately determining that goodwill in the incorporation of the controlling company, whose foundation was future profitability perspective or even concession rights, be recognized in the accounting statements of the acquiring company only by the amount of the expected tax benefit. The aforementioned article also allows that, for disclosure purposes, this tax benefit be classified, according to its nature and realization term, in a specific account of current assets and long-term receivables.

This form of classification, as a tax credit, aims to register the economic essence of the realizable right, namely, the possibility of its transformation into a positive cash flow as a result of tax deductibility. It must, therefore, be treated as a Deferred Tax Asset subject to the recognition and disclosure rules provided in CVM Deliberation No. 273/98.

It must be emphasized that the mandatory adoption of the provisions contained in Art. 1 only reaches incorporations occurring from the date of publication of the new Instruction in the Official Gazette of the Union.

There are, however, some companies that adopted procedures different from the present norm, supported by CVM Instruction No. 319 and even by the regulatory vacuum existing before the issuance of the aforementioned Instruction. In these circumstances, it is evident that the provisions contained in Art. 1 cannot have mandatory scope over these companies. However, aiming to allow uniform treatment of this matter, facilitating comparison between the accounting statements of various companies that adopted this model of incorporation, especially among those operating in the same economic segment, Art. 2 came to allow these companies to adjust their accounting statements, constituting the aforementioned provision without passing directly through the result of the fiscal year, with the balance of the special goodwill reserve as the counterpart. This possibility also reaches incorporations that occurred in the fiscal year ending 12.31.2000. In this case, the Instruction provides for the possibility of companies making this adjustment from the date of the beginning of the fiscal year, but must, however, restate and submit new Quarterly Information Reports (ITR) duly adjusted to the CVM and Stock Exchanges.

It was mentioned that, upon conclusion of the vehicle company's incorporation process, the investment and, consequently, the goodwill remain unchanged in the original controlling company. Thus, it becomes necessary that, in the evaluation of the investment in the controlling company, the amounts of equity method investment and remaining goodwill be restored.

Although the new Instruction does not address the disclosure of material fact, it is important to mention that, if there is a relevant effect resulting from the option provided in Art. 2, the provisions contained in CVM Instruction No. 31/84 must be observed.

Finally, it is worth noting that, aiming to enable publicly-held companies to opt for the adjustment provided in Art. 2 still in their accounting statements of 12.31.2000, the CVM, on an exceptional basis, did not use the process of placing this Instruction in a public hearing. The subject, however, was the object of analysis within the scope of the Advisory Commission on Accounting Standards – a working group created by the CVM, under the terms of CVM Deliberation No. 161/94, and integrated by representatives of the Brazilian Association of Capital Market Analysts (Abamec), the Brazilian Association of Publicly-Held Companies (Abrasca), the Federal Council of Accounting (CFC), the Institute of Accounting, Actuarial and Financial Research Foundation (Fipecafi) and the Brazilian Institute of Accountants (Ibracon).

Signed original by
JOSÉ LUIZ OSORIO DE ALMEIDA FILHO
President