Three Main Aspects of Brazil’s Transfer Pricing Overhaul Plan

On Dec. 29, 2022, in his final days in office, former Brazilian President Jair Bolsonaro enacted Provisional Measure No. 1,152/2022, which would overhaul the country’s transfer pricing rules. In principle, a provisional measure takes effect immediately but requires congressional approval within 60 days, which can be extended by another 60 days.

In practical terms, Congress will have more time to examine the matter because it was enacted during the congressional recess. The 120-day limit will start only after Congress resumes its activities in February. Notwithstanding this, the proposed new transfer pricing legislation already has been subject to heated discussions among tax practitioners as to its implications.

Expected Convergence With the OECD Standard

Transfer pricing is one of the most important tax aspects of cross-border transactions, particularly with respect to related parties. By manipulating prices, they can easily avoid taxation when transferring profits to low tax jurisdictions. Transfer pricing rules aim to prevent it by adjusting transactions between related parties as if negotiated between unrelated parties.

Brazil has had a particular approach to transfer pricing that differs from the international practice reflected in the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administration, which is based on the arm’s length principle. The proposed new rules somewhat align Brazil’s legislation with those guidelines and the arm’s length principle.

The idea of conforming Brazilian transfer pricing rules with the OECD guidelines isn’t new. In 2018, Brazil and OECD launched a cooperation project to assess the similarities and differences between their frameworks. The project resulted in a joint report that concluded that Brazilian rules needed to conform to prevent problems such as double taxation and tax uncertainty.

Because tax practitioners were aware of potential changes coming to Brazil’s transfer pricing rules, the country’s formal invitation to enter the organization has been considered as an extra incentive for alignment with the OECD benchmark. The rules unveiled later last year, explained below, shed light on the extent to which the proposed framework conforms.

Enlarged Scope of the Proposed Legislation

The new rules enlarge the scope of Brazilian transfer pricing rules. Currently, those rules apply only to certain transactions, such as tangible assets, services, and interests. Intangibles fall out of their scope. In contrast, royalty and technical assistance payments are subject to a deductibility cap. The new rules apply to all types of transactions between related parties and put an end to the deductibility cap.

Similarly to Brazilian current framework, the proposed rules apply to transactions involving unrelated parties to the extent that one party is situated in a low tax jurisdiction. In this respect, Brazil’s new rules reduce the threshold of effective tax rate to be considered a low tax jurisdiction to 17% from 20%.

The proposed legislation also contains particular sections on intangibles and hard-to-value intangibles, intragroup services, cost contribution arrangements, business restructurings, and financial transactions that reflect updates introduced in the OECD transfer pricing guidelines over the years to address specific concerns.

New Methods and Introduction of APAs

Currently, Brazil’s transfer pricing rules use traditional transaction methods: the comparable uncontrolled price method, cost plus method, and the resale price method. Comparable uncontrolled price is based on comparables in line with the OECD guidelines. The cost plus and resale price methods, however, use pre-fixed margins instead of comparables to determine market conditions.

Pre-fixed margins were adopted to reduce transfer pricing’s inherent complexity, making it easier for taxpayers to comply with it and the tax administration to audit it. But they have been controversial for not adequately reflecting market conditions, potentially causing double taxation or double non-taxation when statutory margins differed from reality.

The proposed legislation maintains the traditional methods but moves away from pre-fixed margins for cost plus and resale price methods using comparables as benchmark. It also introduces the profit split method and transactional net margin method and allows the use of an alternative method when it proves consistent.

Additionally, the new legislation ends taxpayers’ choice of method. Taxpayers currently can choose which method to adopt among the methods available—except for commodities. The proposed rules provide that taxpayers should select the most appropriate method according to different aspects including the circumstances of the case and availability of comparables.

Another change is a sort of an advance pricing agreement. Right now, taxpayers cannot make use of APAs to determine in advance how transfer pricing should be applied. The proposed legislation conforms Brazilian transfer pricing rules with the international practice, providing that the tax administration may establish a procedure under which taxpayers can file for a ruling request regarding their transfer pricing methodology.

Adoption Fraught With Uncertainties

If approved, the proposed legislation is expected to be mandatory for taxpayers starting in 2024. The idea is to provide enough time for taxpayers to familiarize themselves with the rules and plan ahead. Taxpayers also may opt to apply the new rules already in 2023; those who have a statutory pre-fixed margin higher than their real mark-up might have an incentive to do so.

Anticipating the application of the new rules for 2023 can be problematic, however. The legislation still needs to be regulated by the tax authorities—and the devil lies in the details of such regulation. Besides, the new rules pend congressional approval and may be subject to amendments during the legislative process, which could result in changes to the proposed framework. To top it all, taxpayers’ option to adopt the new rules in 2023 is irrevocable.

Last but not least, a final remark as to the political context. It is still uncertain how Bolsonaro’s successor, Luiz Inácio Lula da Silva, and his team view the new legislation. Their support or rejection will certainly have some bearing on the rules’ approval or not in Congress.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Phelippe Toledo Pires de Oliveira is a tax attorney at the Office of the Attorney General for the National Treasury in Brazil (PGFN) and a lecturer at IBMEC-Brasília.