MILLER`S MODEL ON PERSONAL TAXES AND THEBRAZILIAN TRIBUTARY STRUCTURE
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FUNDAÇÃO GETÚLIO VARGAS
ESCOLA BRASILEIRA DE ADMINISTRAÇÃO
PÚBLICA E DE EMPRESAS
CÉSAR SILVA GOMES
MILLER’S MODEL ON PERSONAL TAXES AND THE
BRAZILIAN TRIBUTARY STRUCTURE
Rio de Janeiro
2010
César Silva Gomes
Miller’s Model on Personal Taxes And The Brazilian
Tributary Structure
Monografia apresentada ao curso de Administração da Escola Brasileira de Administração Pública e de Empresas da Fundação Getúlio Vargas do Rio de Janeiro como requisito à obtenção do título de Bacharel em Administração. Orientado pelo Prof. Rogério Sobreira.
Rio de Janeiro2010
César Silva Gomes
Miller’s Model on Personal Taxes And The Brazilian
Tributary Structure
_________________________________________
Rogério Sobreira
_________________________________________
Membro 2
_________________________________________
Membro 3
ABSTRACT
This study shows how the Miller’s Model on Personal Taxes may work in the
Brazilian tributary legislation. Through this work we see the basics of capital structure
theories and how Merton Miller developed his theories to the personal taxes model.
In order to help assess Miller’s model to Brazil this work studies the Brazilian
legislation mainly regarding the income taxes. Following Miller’s model there is an
emphasis on corporate income tax, personal tax on bonds and personal income tax
on stocks. Also it is shown how companies in Brazil may benefit from the interest
over equity, a form of paying dividends to a certain limit (the TJLP) that can be
deducted from the corporate income tax.
In this work there is shown the income tax rates to form Miller’s Model on
Personal Taxes in Brazil. According to the Brazilian legislation these rates are 34%
for corporate income taxes, 15% for personal income tax on stockss and it may vary
between 15% and 22.5% for personal income tax on bonds, depending on the
duration of the bond.
The conclusion of this paper is that according to Miller’s model and the
Brazilian legislation, companies in Brazil have an incentive to issue debt indefinitely,
as this would increase its value.
Key words: Capital Structure; Modigliani & Miller; Miller’s Model; Personal
Taxes; Brazilian Taxes; Brazil; Interest on Equity; Dividends; Income Taxes.
JEL Classification: G32
LIST OF FIGURES
Figure 1 - Value of the leveraged firm as a function of bonds issued........................12
Figure 2 - Cost of as a function of bonds issued........................................................13
Figure 3 - Value of the leveraged firm as a function of the Corporate Income Tax
Rate...........................................................................................................................15
Figure 4 - Value of the leveraged firm as a function of the Personal Income Tax on
Stocks........................................................................................................................16
Figure 5 - Value of the leveraged firm as a function of the Personal Income Tax on
Bonds.........................................................................................................................17
Figure 6 - Gain of leverage as a function of the amount of Bonds issued (each line
represents a different tax bracket on the Personal Income Tax on Bonds)...............25
LIST OF FIGURES
Table 1 - Benefits for the use of Interest on Equity....................................................22
Table 2 - Personal Income Tax Rate on Bonds.........................................................23
LIST OF ABREVIATIONS
B - Value of the firm’s bonds
Bl - Value of the leveraged firm’s bonds
r0 - Return of the firm
rb - The interest rate of the firm’s bonds
rs - The expected return on shares
S - Value of the firm’s shares
Tb - Personal income tax rate on bonds
Tc - Corporate income tax rate
Ts - Personal income tax rate on shares
Vl - Total value of the leveraged firm
Vu - Total value of the unleveraged firm
SUMMARY
1 - INTRODUCTION..........................................................................................3
2 - METHODOLOGY.........................................................................................3
3 - CAPITAL STRUCTURE REVISITED...........................................................3
3.1 - MODIGLIANI & MILLER........................................................................3
3.1.1 - CORPORATE TAXES ON MODIGLIANI & MILLER.......................3
3.1.2 - MILLER’S MODEL ON PERSONAL TAXES..................................3
4 - BRAZILIAN TRIBUTES................................................................................3
4.1 – CORPORATE INCOME TAX................................................................3
4.2 - PERSONAL INCOME TAX ON EQUITY...............................................3
4.3 - PERSONAL INCOME TAX ON DEBT...................................................3
5 - MILLER'S MODEL AND BRAZILIAN TAX STRUCTURE............................3
6 - FINAL CONCLUSIONS................................................................................3
REFERENCES..................................................................................................3
8
1 - INTRODUCTION
One of the important questions that the finance theories have been trying to
answer through the years is which is the best capital structure for each company.
Nowadays there are infinite ways to structure the capital of a firm, by different equity-
to-debt ratios, or by the use of different ways to obtain capital, like preferred stocks,
convertible bonds among others (ROSS ET AL. 2002).
Since back in the late 50’s Modigliani & Miller tried to solve this matter with
their proposition I and II in their first paper (MODIGLIANI & MILLER 1958). In their
second paper, they published a correction regarding the role of tax rates and its
influence on capital structure (MODIGLIANI & MILLER 1963).
Later on, Miller published another paper with his model on personal taxes,
where he showed the effect of personal taxes on the capital structure of a firm. Miller
divided the effect of corporate income taxes, personal income taxes on shares and
personal income taxes on bonds, to evaluate how they influence in the value of a firm
when deciding to issue bonds or shares.
Although these theories are well known in finance, they were made for the
American tax reality, and are not straightly adapted to other countries with different
legislation regarding income taxes.
In Brazil, there are some differences that must be considered. Through the
research to be made on this study, these differences are to be found and used in the
proposition of an adaptation of Miller’s model to Brazil.
The main relevance of the study is to help understand the capital structure of
Brazilian firms, and also help the companies improve their value by a better
understanding on how their capital structure may or may not influence on their total
market value. Also the adaptation of such a worldwide important theory to Brazilian
9
taxes should help finance students located in Brazil to learn, evaluate and discuss
Miller’s Model.
The objective of this study is then to answer the question on how would the
Miller’s Model on Personal Taxes adapt to the current Brazilian legislation on taxes.
To answer this question first we need to pass through some other smaller problems,
which are, how the Brazilian legislation deals with the payment of dividends, which is
the corporate income tax rate, which is the personal income tax rate on shares and
on bonds. It is also important to find difference in the ways that these taxes may be
applied in Brazil, when compared to the American reality in which the original
theories were constructed.
10
2 - METHODOLOGY
To adapt the Miller Model on Personal Taxes (MILLER 1976) to the Brazilian
tributary reality there is going to be used a bibliographic research on the capital
structure papers of Modigliani & Miller (including here Miller’s paper on personal
taxes) and on the Brazilian Legislation.
On the capital structure papers of Modigliani & Miller there will be analyzed the
major points in which the tax legislations may cause a difference when trying to adapt
the capital structure theories to other countries realities, such as which taxes affect
the models to be studied here, and which differences in the legislations may change,
and how they may change, the model.
On the Brazilian legislation there will be a search for laws that impact the
tributes that may interfere with Miller’s Model on Personal Taxes, as seen in the
previous paragraph. There will be conduct a search through the Brazilian IRS to find
the laws that present relevance to the problem, such as laws on corporate income
taxes, personal income taxes on bonds, personal income taxes on shares, and other
differences to the model that may be relevant to the capital structure of the firms.
11
3 - CAPITAL STRUCTURE REVISITED
Before dealing with the analysis needed to adapt the Modigliani & Miller
theories to the Brazilian tributary reality we have to understand how these theories
deal with, the capital structure of a firm.
The capital structure of a firm is how it finances its assets. It can be done
though equity (or stocks) debt (like bonds and leases) or some hybrid securities
(ROSS ET AL. 2002). These hybrid securities are not going to be discussed here
because although they are largely used in the real market, the analyses get too
complex and don’t bring deepness into the study.
The importance of studying the capital structures of the firms is to try to
answer the question if the debt-to-equity ratio can add value to a company and its
stockholders. And if it is true, which is the best debt-to-equity ratio to maximize the
company and its stocks value.
According to Ross (2003) and to Brealey (2003) the capital structure policy
which maximizes the company value also maximizes the return of the stockholders.
This statement is important because through the theories to be studied we are only
going to find methods to show how to maximize the value of the firm, and then we
can infer that it also maximizes the wealth of the stockholders. We are not going to
see means to maximize the wealth of stockholders directly.
3.1 - MODIGLIANI & MILLER
The Modigliani & Miller theories are considered the most important one in the
field of the capital structure of firm. Although their famous Proposition I is considered
a non-realistic approach, it is considered a very good start for the studies later
conducted (ROSS ET AL. 2002) (BREALEY ET AL. 2003).
12
In their Proposition I, Modigliani & Miller use certain assumptions. First the
firms in a given “class” have equivalent return, i.e. their returns are proportional, so
they have a perfect correlation. The importance of this assumption is to make returns
of different firms, within the same class, homogeneous. The next assumption is that
the stocks of these companies are traded in a perfect market, which means, no
taxes, no trading costs and perfect information (MODIGLIANI & MILLER 1958).
Under these conditions Modigliani & Miller stated their Proposition I, which
says “the market value of any Firm is independent of its capital structure”
(MODIGLIANI & MILLER 1958). This statement may sound unrealistic, given the fact
that finance managers spend a lot of time and money in an effort to choose the best
capital structure of a firm. But it has to be recalled that the Proposition I is for a
perfect market situation.
Following the Proposition I Modigliani & Miller stated a second proposition.
From the fact that the total market value of the firm does not depend on its debt to
equity ratio, and manipulating the equation (1) (ROSS ET AL. 2002) so we can
isolate the variable rs we find equation (2). The equation (2) shows Modigliani &
Miller’s Proposition II, where the cost of equity is proportional to the leverage of the
company because the cost of equity rises with the risk brought to the company by its
leverage (MODIGLIANI & MILLER 1958).
r0=SB+S
.r s+BB+S
.r b (1)
Where:
r0: return of the firm;
S: value of the firm’s shares;
B: value of the firm’s bonds;
rs: the expected return on shares; and
13
rb: the interest rate of the firm’s bonds.
r s=r0+BS.(r0−rb) (2)
Where:
r0: return of the firm;
S: value of the firm’s shares;
B: value of the firm’s bonds;
rs: the expected return on shares; and
rb: the interest rate of the firm’s bonds.
According to Brealey (2003) these propositions shows a conservation of value,
that is, the different ways in which the capital of a firm can be divided won’t change
its total value. This means that the only thing at stake when discussing capital
structure, within the assumptions of the propositions, is how the return of the firm is
going to be shared, and not how much of it is going to be created. So, based on
Modigliani & Miller (1958) the capital structure will not affect the firm’s total value, it
will only affect the distribution of its total value.
3.1.1 - CORPORATE TAXES ON MODIGLIANI & MILLER
Following their first paper, Modigliani & Miller (1963) made a correction on
their propositions with the use of tax shields. Tax shields are the benefit the firms can
get on issuing debt because the interest paid for this debt is tax deductible based on
the American tributary legislation.
For their Proposition I, the value of the firm no longer is independent of its
capital structure. Now the firm has an incentive to issue debt, because the interests
paid on them are tax deductible. So with the introduction of taxes the total market
14
value of the leverage firm can be expressed as the value of an all equity firm plus the
tax shield as in equation (3) (ROSS ET AL. 2002).
V l=V u+B .Tc (3)
Where:
Vl: total value of the leveraged firm;
Vu: total value of the unleveraged firm;
B: value of firm’s bonds; and
Tc: corporate income tax rate.
So with the introduction of taxes the total market value of the firm increases
with the issuing of debt. So the firms should issue as much debt as possible as
shown in the figure (1).
Figure 1 - Value of the leveraged firm as a function of bonds issued
For the Proposition II there is also a change because of the introduction of
taxes on the theory. The tax deductibility of interest rates paid on the debt issued
0
Vl
B
Vu
15
change our equation (2) on the cost of equity. With the addition of the tax deduction
on the Proposition II we have the equation (4).
r s=r0+BS. (1−T c ).(r0−r b) (4)
Where:
rs: the expected return on shares;
rb: the interest rate of the firm’s bonds;
r0: return of the firm;
S: value of the firm’s shares;
B: value of firm’s bonds; and
Tc: corporate income tax rate.
So with the new equation we have the figure (2) below on how the cost of
equity rises with the issue of debt.
Figure 2 - Cost of equity as a function of bonds issued
The model with taxes let us see the increase in value when the company
issues bonds. When not considering taxes, the model does not show any change in
16
the value of the firm with the issue of bonds by the firm, the model is then corrected
showing the increase in value of the firm because of the tax deductibility of the
interest paid on the bonds.
3.1.2 - MILLER’S MODEL ON PERSONAL TAXES
On the previous papers, Modigliani & Miller already stated that the gains from
debt financing for the corporations may be reduced by personal income taxes on
interest (MODIGLIANI & MILLER 1963). But they never mention exactly how it is
done, and how much it can reduce the gains on leverage for the firms.
On a later paper, Miller (1976) introduces the actual impact of personal taxes
on the capital structure of a firm. In this paper he shows how the total market value of
a leveraged firm can be expressed as a function of the value of the unleveraged firm,
and the tax rates for corporations and for stock and bond holders.
In this new model the total market value of the leveraged firm is shown as the
value of the unleveraged firm plus an expression (the tax benefits in function of the
tax rates for corporation and for personal income on stocks and bonds) multiplied by
the amount of debt issued by the firm, as seen in equation (5) (MILLER 1976).
V l=V u+(1− (1−Tc ) . (1−T s )(1−T b ) ) .B l (5)
Where:
Vl: total value of the leveraged firm;
Vu: total value of the unleveraged firm;
Tc: corporate income tax rate;
Ts: personal income tax rate on shares;
Tb: personal income tax rate on bonds; and
Bl: value of the leveraged firm’s bonds.
17
From equation (5) we can see that when all tax rates are equal zero then the
value of the leveraged firm is equal the unleveraged firm, just as the original
Proposition I. And also when the tax rates for personal income from stocks and from
bonds are equal, the value of the leveraged firm becomes the value of the
unleveraged firm plus the tax shield Tc.Bl, exactly like the equation (3) (MILLER
1976).
Also, in special cases where (1-Tc).(1-Ts)=(1-Tb) – like the case stated above in
which all the taxes are equal to zero – there is no advantage in acquiring debt, i.e.
the value of the leveraged firm is equal to the unleveraged. That happens because
the tax benefit from interest on corporate taxes will be exactly offset by the higher
taxes on personal income from bonds and stocks (ROSS 2003).
On the graphs below we can see how the tax rates influence on the gain from
leverage for the firms, keeping everything else constant. On figures (3) and (4) we
can see how the increase on corporate income taxes and on personal income taxes
from stocks increases the gains from leverage. It happens because with the high
taxes on income from stocks the cost of bonds becomes smaller.
18
Figure 3 - Value of the leveraged firm as a function of the Corporate Income Tax Rate
Figure 4 - Value of the leveraged firm as a function of the Personal Income Tax on Stocks
On the figure (5) we can see how the gains from leverage decrease
exponentially with the increase on the tax rate from personal income from bonds. We
0
Vl
Tc
Where (1- Tc) x (1- Ts) < (1- Tb)
Vu
0
Vl
Ts
Where (1- Tc) x (1- Ts) < (1- Tb)
Vu
19
can also see that for certain high rates, the taxes on bonds eat up all the tax benefits
from leverage, to a point that the gains from leverage actually become a lost.
Figure 5 - Value of the leveraged firm as a function of the Personal Income Tax on Bonds
20
4 - BRAZILIAN TRIBUTES
As we could see before the Modigliani & Miller theories on capital structure are
fundamentally based on the tributary legislation of their context. The problem to be
here attacked is the fact that the U.S. tributary system of the 50’s and 60’s is very
different from the tributary system we have in Brazil nowadays.
To try to solve this question we are going to see the Brazilian tributes that may
affect Miller’s theory on the capital structure subject to the Brazilian Tributary Code.
To analyze Miller’s model on personal taxes we have to discuss the three kind
of taxes used in the model, the corporate income tax, the personal income tax on
bonds, and the personal income tax on stocks. In Brazil, the taxes on corporate
income are the income tax (Imposto de Renda) on corporations, and the social
contribution over net profit (Contribuição Social Sobre Lucro Líquido), and there are
some differences to the American law on the deductibility.
On the personal taxes, we can divide in the same way as Miller (1976) in
income tax from bonds and from stocks, but there is also some differences on the
personal taxes when compared to the American law (Lei 7.689/88) (Lei nº 11.033, de
2004) (RIR/1999).
4.1 – CORPORATE INCOME TAX
On the corporate income tax, in the Brazilian regulation there are two brackets
to define the tax rate to be charged by the state in the form of income tax. The
companies are subject to a tax rate of 15%, on income lower than R$20,000.00 per
month. And are subject to a tax rate of 25% on income over the limit of R$20,000.00
per month (Lei 9.249/95).
21
There is also another tribute to be paid by the corporations over income, which
is the social contribution over net profit. This contribution is charged on a certain rate
over the net income before the income tax provision, so the income tax paid is not
deductible from the contribution. The rate of this contribution is 9% over the net profit
before the income tax (Lei nº 11.727, de 2008).
The total corporate income tax rate can be defined then as the sum of these
two tax rates. Considering the reality that listed companies all have an income higher
than R$20,000.00 the income tax rate of the companies can be considered as 25%.
And as the social contribution over net profit is 9%, the total corporate income tax
rate in Brazil is 34%.
It is also important to note that the dividends paid by the companies to its
shareholders cannot be deducted from these corporate taxes. On the other hand,
there is an instrument on the Brazilian legislation that allows the payment of profit to
the shareholders to be deducted from those taxes mentioned above.
This instrument is the interest paid on equity, which is the amount paid to the
shareholders as an interest rate over the capital invested on stocks of the company.
It is limited to the long term interest rate (TJLP1) which is the interest rate used by the
government to concede long term loans. Also, the interest rate paid on debt issued
by the company is deductible on the income tax and the social contribution over net
profit (Lei 9.249/95).
The firm has then, the option to pay its dividends all in the form of dividends
itself, or partly as interest on equity to the limit of the long term interest rate in
accordance to the Brazilian legislation (Lei 9.249/95). The choice for the firm is then
1 The TJLP is the long term interest rate instituted by MP 684/94 to regulate the tax rate used by the BNDES (National Bank for Economic and Social Development) for its activities in the economic and social development of the country, mainly directed for credit issued for entrepreneurs and for the custody of a variety of worker funds.
22
between paying all the dividend as dividend itself with a 34% tax rate (the corporate
income tax rate), or pay it partially as the interest on equity with a 15% tax rate (the
personal tax on equity, as seen in the next section). The optimum choice for the firm
is then to pay its profits to the shareholders as interest on equity to the limits
established by the law, before paying dividends.
In the table 1 below we see the benefits for the use of interest on equity. It
shows how the net profit can increase by 34% (the corporate income tax rate) of the
interest on equity paid to the shareholders when compared to a company that does
not use interest on equity, and use only dividends.
Table 1 - Benefits for the use of Interest on Equity
With Interest on EquityWithout Interest on Equity
(+)Income (P) P P P(-)Interest on Equity TJLP x Equity TJLP.S
(=)Income Before TaxIncome - Interest on Equity
P-(TJLP.S) P
(-)Income Tax (Tc) Income Before Tax x Tc [P-(TJLP.S)].34% P.34%
(-)DividendsDividends (or Dividends- Interest on Equity)
D- (TJLP.S) D
(=)Net ProfitIncome - Interest on Equity - Income Tax - Dividends
P-(TJLP.S)-{[P-(TJLP.S)].34%}-[D-(TJLP.S)] P-D-34%.(P-TJLP.S) P-D-34%.P + (34%.TJLP.S)
P-P.34%-D P-D-34%.P
4.2 - PERSONAL INCOME TAX ON EQUITY
On the personal income tax on equity, the Brazilian legislation establishes a
tax rate of 15% on the net profit from stocks, to be paid on the sale of the stock.
Another point to be considered when analyzing the personal income tax on
equity is the fact that dividends paid by the corporations are free of taxes for the
stockholders, as corporations cannot deduct it from their income taxes. On the other
hand, shareholders have to pay the 15% income tax on the interest over invested
capital when it is paid by the firms. So, when the companies can deduct a payment to
stockholders from their income taxes, the stockholders themselves have to pay
23
income tax on it, and when the companies cannot deduct it, the stockholders are tax
free on this payment (Lei nº 11.033, de 2004).
4.3 - PERSONAL INCOME TAX ON DEBT
The personal income on bonds is taxed in a different way. It has tax brackets
depending on the duration of the bond, or the duration holding the bond (Lei nº
11.033, de 2004).
The tax bracket is higher for bond hold for less than six months, which are
taxed at a rate of 22.5%. For bonds between six and twelve months the tax rate is
20%. A tax rate of 17.5% is charged over bonds lasting from twelve to twenty four
months. And for bonds of over twenty four months the tax rate is only 15% as in the
table 2 bellow (Lei nº 11.033, de 2004).
Table 2 - Personal Income Tax Rate on Bonds
Duration of the bond Personal Income Tax Rate on
Bonds
b < 6 months 22.5%
6 months < b < 12 months 20%
12 months < b < 24 months 17.5%
b > 24 months 15%
It is also important to remember that the firms can deduct the interest rates
paid to bondholders from their corporate income taxes.
24
5 - MILLER'S MODEL AND BRAZILIAN TAX STRUCTURE
In the previous sections it was seen how the capital structure theories, mainly
Miller’s Model, work on the United States tax environment, helping to increase the
value of a firm. There was also seen how the Brazilian legislation works on income
taxes, both corporate and personal, either for equity or for debt. Now it will be shown
how these theories may work in the Brazilian Taxes environment.
First, the Modigliani & Miller Proposition II depends on the corporate income
tax as seen in equation (4). In the Brazilian legislation the rates for corporate income
tax is 34%
Exchanging the value of the tax rate mentioned above in the equation (4) will
give us equation (6), where we can see the effects of the Brazilian tax rates on the
equation, to show how the value of the company is affected by the issue of bonds in
Brazil.
r s=r0+BS.66% .(r0−rb) (6)
As seen previously, the personal income tax on bonds will depend on the
duration of the bond, but this will make a small difference in the capital structure of
the firm, as will be shown here. Using equation (5) and exchanging Tc and Ts for its
rates in Brazil, we will get equation (7).
V l=V u+(1− 0.561
(1−Tb ) ). Bl (7)
Where
Vl: total value of the leveraged firm;
Vu: total value of the unleveraged firm;
Tb: personal income tax rate on bonds; and
Bl: value of the leveraged firm’s bonds.
25
From equation (7) we may have four different rates for Tb depending on the
duration of the bonds, and from those four different rates we get equation (8) for
22.5%. From equation (8) we can see that if the firm decides to finance itself with
bonds that have durations of less than six months it will increase the value of the
leveraged firm on 0.276 dollars per dollar issued in bonds when compared to the
unleveraged firm.
V l=V u+0.276Bl (8)
Where
Vl: total value of the leveraged firm;
Vu: total value of the unleveraged firm; and
Bl: value of the leveraged firm’s bonds.
In equation (9) we see how the Miller’s Model works for the 20% personal
income tax on bonds rate, that is when the bonds duration is between six and twelve
months. From equation (9) we can demonstrate how the firm will increase its
leveraged value in 0.299 dollars per dollar of bonds issued when compared to the
unleveraged firm, if it decides to issue bonds with duration between six and twelve
months.
V l=V u+0.299Bl (9)
Where
Vl: total value of the leveraged firm;
Vu: total value of the unleveraged firm; and
Bl: value of the leveraged firm’s bonds.
Equation (10) shows the Miller’s Model on Brazilian taxes with debt issued
with durations between twelve and twenty four months, with the 17.5% tax rate. The
equation (10) shows how the firm can increase its leveraged value by 0.32 dollars
26
per dollar issued in bonds with durations between twelve and twenty four months
when compared to the value of the unleveraged firm.
V l=V u+0.320Bl (10)
Where
Vl: total value of the leveraged firm;
Vu: total value of the unleveraged firm; and
Bl: value of the leveraged firm’s bonds.
When adapting Miller’s Model to the 15% tax rate of personal income tax on
bonds with duration of over twenty four months we get equation (11). It shows how
the value of the leveraged firm can be increased by 0.34 dollars per dollar issued on
bonds with durations of over twenty four months, when compared to the value of the
unleveraged firm.
V l=V u+0.340Bl (11)
Where
Vl: total value of the leveraged firm;
Vu: total value of the unleveraged firm; and
Bl: value of the leveraged firm’s bonds.
From the results above we can see how the value of the leveraged firm is
always increased by the issuing of debt. Also the issue of debt increases the value of
the firm indefinitely. There is only a difference in the amount of value added by the
firm with the issue of debt depending on its duration, where the shorter the duration
of the bond, the slower the value of the firm will be increased by the issue of debt.
Figure (6) shows how the different gains of leverage apply depending on the duration
of the bonds, and so the tax bracket in which the personal income tax rate on bonds
the bondholders will be included.
27
Figure 6 - Gain of leverage as a function of the amount of Bonds issued (each line represents
a different tax bracket on the Personal Income Tax on Bonds)
0
Vl
B
28
6 - FINAL CONCLUSIONS
This study started from the question of how the Miller’s Model on Personal
Taxes would apply to Brazilian tributes. To solve the question there was made a
bibliographic review of the papers leading to the final Miller paper defining the model.
There was also made a bibliographic review on the Brazilian legislation,
regarding the laws that could interfere in the adaptation of the model to Brazilian
companies. These laws were referring to income taxes, either corporate or personal,
either on bonds or stocks.
Analyzing the Brazilian law we found that the corporate taxes were divided in
two tributes, the corporate income tax, and the social contribution on net profit that
combined become what here was called as corporate income tax. The total corporate
income tax in Brazil is then 34%. 25% of corporate income tax plus 9% on the social
contribution on net profit (Lei 9.249/95) (Lei nº 11.727, de 2008).
Also it is worth noting the existence of the interest on equity which may be
used by corporations to pay dividends, up to a limit established by law (TJLP), that
can be deducted from the corporate income tax. This is important, because the firms
should then, when willing to pay dividends, pay as much of it as possible as interest
on equity, which will suffer a 15% tax rate, and only then pay dividends at a tax rate
of 34%. There was also showed how it interferes in the value of the firm when opting
to use the maximum interest on equity as possible in conformation with the advised
(Lei 9.249/95).
On the matter of the personal income taxes, the personal income tax rate on
shares in Brazil is 15%.
The personal income tax rate on bonds on the other hand, depends on the
duration of the bond, and may vary from 15% on the longer bonds to 22.5% on the
29
shorter bonds (Lei nº 11.033, de 2004). This different tax brackets depending on the
duration of the bond makes it preferable for the firm to issues long term bonds,
because of the lower taxes for longer bonds.
With these rates we may see that with Brazilian taxes, the firms have an
increase in value by the issuing of debt. The durations of the bonds will change the
pace in which the value of the firms will be increased, but despite it, we saw that at
any duration of bonds, the firms will increase its value indefinitely when issuing
bonds. By this model then, the firm should indefinitely issue debt to increase its value
as much as possible.
Besides that, it is widely known that there are some limits to the use of debt by
the companies that are not accounted for in Miller’s Model on Personal Taxes. The
limits to the use of debt are bankruptcy costs and agency costs.
The bankruptcy costs can be divided in direct and indirect costs, basically the
direct costs are the legal and administrative costs of liquidation or reorganization of
the company, usually in these situations lawyers, administrators and accountants
may charge big fees, which make these costs very high. The indirect costs are the
difficults that arise to conduct the business during finance distress situations. It
becomes harder to negotiate with customers and suppliers, making supplier’s prices
higher and sale prices lower (ROSS ET AL. 2002).
Agency costs occur when there is a conflict of interest, in this case between
bondholders and stockholders. These agency costs arise in moments of financial
distress, when there are incentives to stockholders to take more chances, to
underinvest and to take extra dividends from the company. It may happen because
the stockholders do not have the majority of the money invested, but have the control
of the company, creating then a conflict of interest (ROSS ET AL. 2002).
30
The next step on this work should now to make a field research to analyze
how Brazilian companies choose their capital structure in the market. Searching for
listed companies and their debt to equity ratio to define if they are in accordance or
not to the results found on this study, and how much the limits on the use of debt
applies to these companies.
31
REFERENCES
Modigliani, F.; Miller, M. H. The Cost of Capital, Corporation Finance and
the Theory of Investment. The American Economic Review, v. 48, n. 3, p. 261-297,
Jun,1958.
Modigliani, F.; Miller, M. H. Corporate Income Taxes and the Cost of
Capital: A Correction. The American Economic Review, v. 53, n. 3, p. 433-443,
Jun, 1963.
Miller, M. H. Debt and Taxes. The Journal of Finance, v. 32, n. 2, p. 261-275,
mai, 1977.
Ross, S. A.; Jaffe, J. F.; Westerfield, R. W. Corporate Finance. 6ª Edição.
São Paulo: McGraw-Hill, 2002.
Brealey, R.A.; Myers, S. C. Principles of Corporate Finance. 7ª Edição. São
Paulo: McGraw-Hill, 2003.
BRAZIL. Lei nº 11.033, de 19 de janeiro de 2004
BRAZIL. Lei nº 9.249, de 26 de dezembro de 1995
BRAZIL. Lei nº 11.727, de 23 de junho de 2008
BRAZIL. Lei nº 7.689, de 15 de dezembro de 1988
BRAZIL. Decreto nº 3.000, de 26 de março de 1999 (Regulamento do Imposto
de Renda - RIR/99)
BRAZIL. Medida Provisória nº 684 de 31 de outubro de 1994
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