Transfer pricing in Brazil:

Towards convergence with the OECD standard^[1]

The OECD and the RFB (Brazilian Tax Authorities) presented the report of the joint work to assess the similarities and differences between the Brazilian and OECD frameworks at the end of 2019. The 15-month work program carried out by both entities included an in-depth analysis of the Brazilian transfer pricing legal and administrative framework.

The broad and detailed report is divided into 3 parts:

1. Background of the OECD-Brazil dialogue on transfer pricing matters and overview of transfer pricing in Brazil,
2. Assessment of the strengths and weaknesses of existing transfer pricing rules and administrative practices in Brazil, and
3. Options for aligning the Brazilian transfer pricing rules with the OECD transfer pricing guidelines.

Before describing the outcome of the report, it is important to describe the origins of the Brazilian transfer pricing legislation which was enacted in 1996. During the 1990s, the Brazilian Government broke from decades of protectionism and decided to open the economy to imports and free trade. Following this decision, foreign investment inflow increased significantly, and Brazil concluded that an adoption of transfer pricing legislation would be necessary, aimed at “preventing the detrimental transfer of resources to foreign countries through the manipulation of prices used in the importation or exportation of goods, services and rights, in transactions with non-resident related parties”.

Clear rules were created in relation to transfer pricing on goods, the most relevant type of asset traded at that time, since the economy had been open. Local rules determine the maximum tax-deductible price for imports and the minimum taxable price for exports. In general, the same set of rules as for goods is also applied for services and rights. The transfer pricing legislation has been amended several times since 1996, with relevant changes in 2012 and the latest one in 2019, but always keeping the original concept of ignoring the arm’s length principle, fixed profit margins, absence of non-transactional methods, best method approach, etc. According to the RFB, the Brazilian legislation was created to: (i) protect the tax basis, (ii) ensure predictability, (iii) respect strict legality and (iv) be practical (both for the Tax Administration and taxpayers).

Any professional that works with transfer pricing as well as with MNEs with business in Brazil will have noticed that, unfortunately, these aims in the paragraph above were not completely met along the years. The existing rules very often create double taxation, do not effectively protect the tax basis from relevant BEPS risks (mainly in high value-added services and intangibles), and are not always very practical, depending on the industry and method chosen by the taxpayer.

The report assessed the strengths and weaknesses of the current rules and was divided into two main work streams: gap analysis (Brazil/OECD differences) and an assessment of effectiveness of the system based on five objective criteria:

1. Prevention of BEPS risks
2. Prevention of double taxation
3. Ease of tax administration
4. Ease of tax compliance, and
5. Tax certainty.

The assessment also followed the topics and chapters of the OECD Transfer Pricing Guidelines, as follows:

Topic	Benchmark
The arm’s length principle	Chapter I of the OECD Guidelines
Transfer pricing methods	Chapter II of the OECD Guidelines
Comparability analysis	Chapter III of the OECD Guidelines
Administrative approaches to avoiding and resolving transfer pricing disputes	Chapter IV of the OECD Guidelines
Documentation	Chapter V of the OECD Guidelines
Special considerations for intangibles	Chapter VI of the OECD Guidelines
Special considerations for intra-group services	Chapter VII of the OECD Guidelines
Cost contribution arrangements	Chapter VIII of the OECD Guidelines
Transfer pricing aspects of business restructurings	Chapter IX of the OECD Guidelines
Transfer pricing aspects of financial transactions / intra-group financing	Chapter I-III of the OECD Guidelines and discussion draft
Attribution of profits to a permanent establishment	Guidance on attribution of profits to permanent establishments

Analysing each of the topics above, it is possible to conclude that, in general, the current transfer pricing legislation does not achieve the objectives proposed by the Brazilian Government. We summarise below a few comments on the five criteria:

• Prevention of BEPS risks: best method approach, weaknesses in the safe harbour rules, absence of specific legislation for intangibles and services, attribution of profits to permanent establishments.
• Prevention of double taxation: Brazil does not follow the arm’s length principle, absence of transaction profit methods (TNMM and PSM), relevant divergences in relation to performing a comparability analysis, scope of the rules, absence of specific legislation for intangibles and services.
• Ease of tax administration: fixed formulas and margins, best method approach and safe harbour simplify the administration, but the RFB is certainly losing revenues.
• Ease of tax compliance: depending on the industry and method chosen by the taxpayer, this could be true. However, in practice, there are several taxpayer cases where compliance does not seem to be simple, and it is time-consuming to prepare the transfer pricing analysis on a product-by-product basis.
• Tax certainty: one could argue that the legislation provides certainty for a domestic perspective, but it does not provide tax certainty from an international perspective.

After assessing the topics listed in the table, the report comments on the way forward to achieve full alignment with the OECD guidelines, suggesting what must be done in the Brazilian legislation to align with the internationally accepted framework.

The way forward also follows the topics mentioned above, but in view of the size of the table, we reproduce only the first two topics analysed in the report^[2].

Issues/divergences/considerations	Way forward
OECD Council Recommendation on the Determination of Transfer Pricing between Associated Enterprises and future BEPS Recommendations
Aligning transfer pricing outcomes with value creation (BEPS Actions 8-10)	Implement BEPS Actions 8-10 recommendations, including guidance on accurate delineation of transactions, framework for analysis of risk, non-recognition of transactions and guidance on location savings and other local market features, assembled workforce, and MNE group synergies, intangibles, including hard-to-value intangibles, low value-adding intra-group services and cost contribution arrangements.
Guidance on transfer pricing documentation (BEPS Action 13)	Implement the remaining of the BEPS Action 13 recommendations, namely the master file and the local file.
2. Statement and application of the arm’s length principle
Restatement of the arm’s length principle	Restate the arm’s length principle in the primary law.
Deviations from the arm’s length principle	Change or refine elements in the system that deviate from the arm’s length principle (e.g. fixed margins, comparability issues, etc.) – see relevant sections.
Scope of application of transfer pricing rules	Refine the scope as necessary by addressing issues related to the personal material, and territorial scopes.

The final part of the report explores possible options for aligning the Brazilian transfer pricing rules with the OECD guidelines. The discussion is whether full alignment will be immediate or gradual, i.e., there is no room for a partial alignment, as some professionals were requesting in the past, as a dual system could have a negative impact on tax collection, and doors and creativity in tax planning would remain open.

According to the report, the gradual full alignment option applied first to a group of taxpayers rather than a group of transactions is more likely to be the way forward, as it would allow small and medium companies to address the challenges, and provide the opportunity to prioritise and sequence the implementation of the different components of the system.

The alignment of the legislation with the OECD guidelines will need to be designed and conducted very carefully by the RFB, as it is not the transfer pricing legislation that has to be changed, but a large section of legislation such as Income Tax regulations, CFC rules, Tax Treaties, dispute resolutions, etc. Furthermore, changes to the tax administration and its human resources will be required and will be very challenging.

There is no defined date for draft legislation yet, but considering the great impact of transfer pricing legislation in the Brazilian tax system, it is not expected to have new legislation within the next two or three years at the earliest.

The good news is that the alignment will occur in the near future - there is no way back. The ninth largest economy of the world cannot remain outside internationally accepted practices, and alignment with the OECD guidelines will certainly contribute to attracting new investments and businesses to Brazil.

Hugo Amano
hugo.amano@bdo.com.br

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