The publication of Brazil’s new Transfer Pricing regulations has been an important and critical step in the country’s integration to the OECD (Organization for Economic Cooperation and Development). But what is the purpose of Brazil’s integration to the OECD, the reason for the amendment to its regulations and the economic impact for the country?
Transfer Pricing is the most controversial and complex issue in international taxation. It is also the most widely used mechanism by multinational companies to transfer their profits from one jurisdiction to another.
Transfer Pricing rules arise mainly to protect country tax bases in international transactions, seeking to make such transactions obey market reality as much as possible. These rules are based on the assumption that companies or related parties benefit from a more advantageous tax treatment by using strategies to transfer their profits to jurisdictions with lower tax rates. In other words, the expectation is that, through a properly implemented transfer pricing practice, transactions between related parties will be carried out arm’s length, avoiding profit shifting or tax evasion.
Now, why should such rules be aligned with OECD standards?
The OECD is an organization of 38 member countries whose purpose is to set international standards and propose solutions to various social, economic and environmental challenges. The Organization provides a forum for governments to compare policy experiences, seek answers to common problems and identify best practices, striving to promote prosperity and combat poverty through economic growth and financial stability.
Four Latin American countries are currently members of the Organization: Chile, Costa Rica, Colombia and Mexico. Mexico joined in 1994. Brazil, Argentina and Peru are currently holding discussions with the OECD Council to join the Organization.
On December 29, 2022, the Brazilian Economy Ministry took a decisive step in the process that the country is undergoing to join the OECD, by publishing new Transfer Pricing rules, contained under Provisional Measure No. 1,152 (“MP 1,152”).
The current Brazilian Transfer Pricing Legislation, provided under Law No. 9.430/1996, is not fully aligned with the OECD suggestions, since it considers certain predetermined methods with fixed margins. In other words, Brazil’s Transfer Pricing system does not follow the market competition or arm’s length principle. This has been widely criticized and questioned for differing from the international practice adopted by many countries, and has even caused economic detriment to the country.
The new Transfer Pricing rules seek to correct existing gaps and weaknesses in the current system and problems resulting from inconsistencies with the OECD standard. These divergences deteriorate international business relationships, the country’s insertion in global value chains and the collection of tax revenues.
The federal government claims that the implementation of such measure is urgent due to a recent change in U.S. tax policy, which no longer recognizes or allows tax credit for taxes paid in Brazil, due to existing deviations or loopholes in the Brazilian Transfer Pricing system.
Another reason is the tax losses that Brazil experiences year after year, due to the various deficiencies within the Brazilian laws, which allow for tax base erosion and profit shifting.
If immediate legislative measures are not taken, the country could experience a significant reduction in current investment and lose competitiveness in attracting new capital, negatively impacting employment levels and the national economy.
The implementation of this new framework, despite the loss of simplicity and practicality of the current model, is expected to allow greater integration of the Brazilian economy into the international market, eliminating barriers that hinder and harm trade any foreign investment due to the existing double taxation risk.
It is important to mention that the new law has 40 articles, while the current law has only six articles. This legislative change stems from a project that began more than four years ago, under the collaboration of OECD with the Brazilian Federal Revenue Service (Receita Federal do Brasil or “RFB”), which produced a detailed report on the Brazilian transfer pricing methodology and its transition to OECD rules (Convergence Report). Based on the findings of this assessment, the project explored Brazil’s potential to move closer to the OECD’s Transfer Pricing standard, which is a critical reference for OECD member countries, and followed by most countries in the world.
Although the new rules will be effective until 2024, there is an option to adhere to such standards in 2023. Whatever the case may be, Brazilian companies and legal entities that enter into transactions with them must take into account that there is still a lot to regulate, business arrangements to analyze and modify for enabling a convergence or approximation to the required standards, alongside a myriad of administrative processes as a consequence.
Technically, the content of MP 1.152 is broadly descriptive and provides the necessary elements for the intended alignment with OECD standards. There are also subsections with special treatment for commodities (which still depend on a more specific regulation), and more complex issues such as the application of Transfer Pricing adjustments and their interrelation with double taxation treaties.
Chapter 3 deals with specific provisions and it contains six sections that address more specialized issues: transactions with intangibles, intangibles that are difficult to value, intra-group services, cost-sharing contracts, corporate restructuring and financial operations.
The current law, due to its limited scope and practicality, lacks documentation and a specific sanctioning regime. Therefore, Chapter 4 of MP 1.152 establishes the required documentation and the applicable sanctions.
In addition, although the new Transfer Pricing framework is committed to objectivity and almost completely eliminate certain existing gaps, certain issues that could give rise to endless controversies or questioning remain.
Considering the high degree of subjectivity in Transfer Pricing practice, one of the most relevant issues in the implementation of the new system would be the questioning of the interpretative weight of the OECD Transfer Pricing regulatory guidelines and/or the UN Manual to resolve regulatory conflicts.
For example, in Mexico, the Income Tax Law (“ITL”) establishes that for the interpretation of its provision, the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, approved by the OECD Council will apply. Such guidelines currently contain more than 650 pages. Using the OECD guidelines as a reference avoids endless disputes due to subjectivity and/or interpretation of the current law.
Finally, it is worth remembering that Transfer Pricing is not an exact science but it does require the exercise of judgment by the tax administration and taxpayers. It is expected that in the regulation and implementation phase of the new Brazilian regulatory framework, public consultations and further discussions will be carried out to provide clear answers and avoid disputes and controversies for taxpayers.
*This article was drafted by Lic. Isadora Thurm Filardi Pereira and may contain personal opinions independently of the law firm for which they work. In case you intend to apply any of the provisions or interpretations mentioned above, we recommend that you consult Jáuregui y Del Valle, S.C. or another qualified labor and tax advisor in a formal manner before doing so.
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