New Brazilian transfer pricing rules – material change

On December 29, 2022, to the surprise of many, Provisional Measure n. 1,152 was published, which amends the legislation on Corporate Income Tax – IRPJ and Social Contribution on Net Profits – CSLL, to provide for transfer pricing rules.

Initially, it should be noted that under the terms of the Brazilian legal system, such a legal provision was signed by the then President of the Republic, Jair Messias Bolsonaro, who left command of the country from January 1, 2023, giving way to the new ruler, Luiz Inácio Lula da Silva, who has completely opposite objectives, since it is a new government with a leftist political bias.

Thus, when the former government’s lights went out, a whole new legal device related to transfer pricing was published, completely changing the commands in force until then. The new measure enters into force on January 1, 2024, with taxpayers being able to apply it from January 1, 2023.

As it is a Provisional Measure, in practical terms there is a need for approval by the national congress within 120 days, under penalty of becoming null, that is, its effectiveness is provisional and needs to be converted into law.

The government formally spoke about this measure and justified that the urgency stems from the recent change in tax policy in the United States, which no longer allows the tax credit referring to taxes paid in Brazil, due to existing deviations in the Brazilian transfer pricing system in relation to the principle of arm’s length – that is, the condition or fact that the parties to a transaction are independent and on an equal terms. Thus, unless immediate legislative action is taken, the country could experience a significant reduction in current investment and would lose competitiveness in attracting new capital, with an impact on employment levels, the economy, the transfer of knowledge and technology, and ultimately also lead to tax revenue losses.

Another reason exposed is the tax collection losses that Brazil experiences year after year, due to the various deficiencies in Brazilian legislation, which allow the erosion of the taxable base and transfer of profits (BEPS).

In fact, the Federal Revenue of Brazil, together with the OECD, had already been studying the subject for 4 years, so the measure is the result of finding gaps and weaknesses in the current system and problems arising from its misalignment and interactions with the standard established by the OECD, which harm the business environment, the country’s insertion in global value chains, legal security and the collection of tax revenues.

The Brazilian methodology, in general, had been heavily criticized, since it did not respect the arm’s length principle by establishing different hypotheses of minimum and maximum profit margin, through fixed percentages pre-established by law, and which had no economic foundation, generating several hypotheses of double taxation or double non-taxation of income.

The new measure makes it clear that the objective to be achieved is the arm’s length principle, highlighting the following points:

1. Express provision, at the beginning of the measure, that the terms and conditions of a controlled transaction shall be established in accordance with those that would be established between unrelated parties in comparable transactions;

2. Application of a broader concept of what is considered a related party for the application of the Transfer Pricing, taking into account the influence that one party may exert over another, directly or indirectly;

3. Maintenance of the obligation to apply the Transfer Pricing to transactions carried out by an individual or legal entity resident or domiciled in Brazil with any entity, even if an unrelated party, which is resident or domiciled in a country that does not tax income or that taxes it at a maximum rate lower than 17 % (seventeen percent);

4. For the purpose of applying the arm’s length principle, the outline of the controlled transaction will be carried out based on the analysis of the facts and circumstances of the transaction and evidence of the effective conduct of the parties, with a view to identifying the commercial and financial relationships between the related parties and the economically relevant characteristics (contractual terms, functions performed, risks assumed, etc.);

5. The comparability analysis will be carried out with the objective of comparing the terms and conditions of the controlled transaction, with the terms and conditions that would be established between unrelated parties in comparable transactions;

6. Authorization for when it is concluded that unrelated parties, acting under comparable circumstances and behaving in a commercially rational manner, considering the options realistically available to each of the parties, would not have performed the controlled transaction as outlined, the transaction may be disregarded or superseded by an alternative transaction for the purpose of determining the terms and conditions that would be established by unrelated parties under comparable circumstances and acting in a commercially reasonable manner;

7. The most appropriate method, and not the most advantageous for the taxpayer, as the previous rule, will be selected from among the following:

   1. Comparable Independent Price – PIC, which consists of comparing the price or value of the consideration of the transaction with the prices or values of the consideration of comparable transactions carried out between unrelated parties;

   2. Resale Price Less Profit – PRL, which consists of comparing the gross margin that an acquirer of a transaction obtains in the subsequent resale carried out to unrelated parties with the gross margins obtained in comparable transactions carried out between unrelated parties;

   3. Cost plus Profit – MCL, which consists of comparing the gross profit margin obtained on the supplier’s costs in a controlled transaction with the gross profit margins obtained on costs in comparable transactions carried out between unrelated parties;

   4. Net Transaction Margin – MLT, which consists of comparing the net margin of the controlled transaction with the net margins of comparable transactions carried out between unrelated parties, both calculated based on an appropriate profitability indicator;

   5. Profit Distribution – MDL, which consists of the distribution of profits or losses, or part of them, in a controlled transaction in accordance with what would be established between unrelated parties in a comparable transaction, considering the relevant contributions provided in the form functions performed, assets used and risks assumed by the parties involved in the transaction; and

   6. other methods, provided that the adopted alternative methodology produces a result consistent with that which would be achieved in comparable transactions carried out between unrelated parties.

8. Broader definition of commodity as the physical product, regardless of its stage of production, and derivative products, for which quoted prices are used as a reference by unrelated parties to establish prices in comparable transactions. Previously, there was an exhaustive list of what a commodity was;

9. Indication that the PIC method is the most suitable for the commodity;

10. Definition and application of TP rules on intangibles, the previous rule determined that such controls were not applied over it;

11. Repeal of the other strict rules of deductibility limits for the purpose of Corporate Income Tax in force in Brazilian legislation, that is, such rules were replaced by the TP, within the scope of the arm’s length principle;

12. Definition and specific rules for transactions related to intragroup services, despite the fact that such transactions are already subject to TP since the previous legislation;

13. Definition and specific rules for cost-sharing contracts and business restructuring, the previous norm did not address the issues;

14. Regarding financial transactions:

    1. It will be evaluated whether, in the provision of financial resources formalized as a debt operation, the transaction will be delineated, in whole or in part, as a debt or capital operation. Interests and other expenses related to the transaction defined as a capital operation will not be deductible for purposes of calculating the Income Tax Basis;

    2. Application of the arm’s length principle for financial transactions, contrary to the current interest rate and fixed spread provided for in the previous law, despite the measure mentioning situations in which certain rates must be applied as a limit;

15. General rules related to the required documentation;

16. Definition of penalties related to non-compliance with the new legislation;

17. Authorization for the Special Secretariat of the Brazilian Federal Revenue Service (RFB) to establish specific rules to discipline the application of the arm’s length principle;

18. Authorization for the Brazilian Revenue (RFB) to establish a specific consultation process regarding the methodology to be used by the taxpayer;

19. Legal determination that in cases of results agreed upon in a dispute settlement mechanism provided for in the scope of an international agreement or convention to eliminate double taxation to which Brazil is a signatory, the tax authority must review, ex officio, the entry made, in order to to implement the agreed result in accordance with the provisions, object and purpose of the international agreement or convention.

Despite the changes being awaited and welcomed, they now raise several questions and insecurities, as Brazilian taxpayers do not know and are not familiar with the arm’s length principle. Another aspect that worries taxpayers is the absence of the necessary database for comparing transactions, since Brazil has few economic and financial studies that could be used with reasonable security.

In general, the Provisional Measure presents only the main commands of the new Brazilian rule of Transfer Price, being necessary and awaited all its regulations and procedures from the point of view of its operationalization.

Make sure to contact our team of specialists and understand more details about this topic: ppc@ppc.com.br or 55 11 3883-1600.

Content written by Marcus Vinicius Montanari, Tax Partner at PP&C Auditores Independentes (mv.montanari@ppc.com.br).