Valuation and consulting for financial reporting, federal, state and local tax, investment and risk management purposes.Valuation Advisory
For years, Brazil’s transfer pricing (TP) regulations have stood out as being markedly different from those of other major economies around the world, most of whom follow the OECD’s Transfer Pricing Guidelines (OECD Guidelines). However, in the future, this may not be the case. As part of its efforts to join the OECD and more fully integrate into the global economy, Brazil intends to align its TP system with the OECD Guidelines. The proposed changes to the TP regulations will have a significant impact on multinational corporations (MNCs) that conduct business in Brazil.
This article provides an external, i.e., a foreign perspective from TP practitioners who have conducted TP analyses following both the current Brazilian TP regulations1 and the OECD Guidelines. The following sections of this article will cover: (1) Why Brazil wants to join the OECD; (2) an overview of current Brazilian TP regulations (TP Regs); (3) current gaps between the Brazilian TP regulations and the OECD Guidelines; and (4) potential consequences of Brazil implementing the OECD Guidelines.
Brazil is the largest economy in South America and the ninth largest economy in the world. It is one of the largest economies that is not an OECD member. Democratic governments and market economies characterize OECD member countries, and in total, they represent around 70% of the global economy.2 The OECD provides a forum for governments to work together to seek multilateral solutions to common problems, share experiences and learn best practices from other countries. By meeting international standards and undergoing thorough reviews, OECD member countries are potentially viewed as more attractive recipients of foreign direct investment (FDI). For a country such as Brazil, one of the most significant benefits of joining the OECD is the international recognition that comes with membership, particularly the possibility of increasing FDI in the country.
Over the past decade, Brazil has begun collaborating with the OECD on important international tax matters. In 2010, Brazil joined the Global Forum on Transparency and Exchange of Information for Tax Purposes (Global Forum), an OECD initiative that seeks to strengthen compliance with international tax standards.3 As a G20 member, Brazil took a step toward further cooperation in international tax affairs in 2013 when it joined the OECD/G20 Inclusive Framework on Base Erosion and Profit Sharing (OECD/G20 BEPS or BEPS Project). As a part of the BEPS Project, Brazil and the OECD held dialogues in 2014, 2015 and 2017, allowing Brazil and the OECD to understand each other’s TP systems better.4
In 2017, Brazil expressed interest in joining the OECD. It followed up in May 2019 with a formal request with the OECD to initiate the accession process. Between 2017 and 2019, Brazil recognized that the discrepancies between the Brazilian TP Regs and OECD Guidelines could inhibit its accession to the OECD. The Brazilian tax administration, Recieta Federal do Brasil (RFB), began working with the OECD to evaluate the similarities and differences between the two TP systems. This effort, known as the “Transfer Pricing in Brazil Project,” was launched in February 2018 and entailed an in-depth analysis of Brazil’s TP framework in comparison to the OECD Guidelines. This study represented the first comprehensive review of Brazil’s TP Regs in decades.5 In July 2019, after a 15-month work program, the OECD and RFB jointly announced their conclusion that the Brazil TP Regs are not compatible with OECD Guidelines and suggested that Brazil will need to make changes to its system to better align with the OECD Guidelines to join the organization.6 A formal, detailed report, “Transfer Pricing in Brazil,” was released in December 2019, documenting the findings of this project.7
For a country to formally be admitted to the OECD, the country must demonstrate readiness and commitment to adhere to the two fundamental requirements–a democratic society and an open, transparent, free-market economy. The accession process consists of two stages: (1) a pre-accession evaluation and (2) accession proceedings built on a customized country roadmap, culminating with the final decision.8 This process generally takes at least one year. During this time, the OECD evaluates the institutions of the country wishing to join and also requires unanimous agreement of existing member countries to gain admittance. There are several qualifications for joining the OECD, including adherence to OECD rules on tax and transfer pricing, corporate governance, and foreign investor protection.
Given the differences between Brazil’s TP Regs and the OECD Guidelines, Brazil’s convergence with the OECD Guidelines will have a significant impact on MNCs conducting business in Brazil, tax compliance and tax revenues for the Brazilian government.
Brazil initially enacted the Brazilian TP Regs in 1996 with the passage of Law 9430/1996.9 The 1979 OECD Guidelines inspired the 1996 version of the Brazilian TP Regs. During the 1990s, Brazil saw an influx of foreign investment into the country and developed its transfer pricing (TP) regime with an emphasis on streamlining tax compliance, while also preventing entities from manipulating prices to extract resources from the country.10 The 1996 TP Regs were primarily designed for dealing with tangible goods transactions and do little to address the challenges presented by intangible transactions and business restructurings (not to mention challenges associated with the digital economy that are currently being analyzed by the OECD).
From a domestic perspective, the Brazilian TP Regs are often characterized by their practicality and predictability, providing tax certainty and simplicity.11 Since Brazil did not have a highly specialized tax administration when its TP rules were adopted in 1996, one objective of the regulations was to reduce tax uncertainty and minimize compliance and administrative costs for both the government and taxpayers.12 Towards this objective, the Brazilian TP system prescribes fixed margins, allows taxpayers the freedom to select any method (i.e., no “best” or “most appropriate” method requirement) and does not require a comprehensive comparability analysis. The use of fixed margins often does not reflect results consistent with an arm’s length outcome for many types of services.
Under the Brazilian TP Regs, certain commodity transactions are not afforded the freedom of method choice provided for other transactions. In 2013, specific methods were introduced for commodities in Article 18A and Article 19A, which establish the transfer price through averaging published commodity prices from exchange or securities markets on the transaction date on a transaction-by-transaction basis.13 Although these methods are broadly equivalent to the Comparable Uncontrolled Price (CUP) method defined in the OECD Guidelines, they are arguably less flexible because the permitted adjustments are limited and may not fully capture all relevant economic circumstances. Additionally, the fact that the application of these methods is mandatory excludes the use of more appropriate methods in instances where reliable comparables exist.
The assessment of Brazil’s TP Regs conducted jointly by the OECD and RFB found that further complexities arise from other features of the Brazilian TP Regs. These complications are strict standards of comparability, the item-per-item approach and simplified documentation requirements, which make the Brazilian TP Regs incongruous with the OECD Guidelines.14 While the Brazilian TP Regs have remained mostly static with minimal changes since their inception, the OECD Guidelines have undergone multiple revisions in the last few decades. Consequently, there are several critical gaps between the Brazilian TP Regs and the OECD Guidelines that need to be resolved before Brazil receives its OECD membership.
In addition to the absence of the arm’s length standard, the Brazilian TP Regs have documentation requirements that are different from the documentation standards outlined in the OECD Guidelines.15 Other significant differences include the application of transfer pricing (TP) methods, the use of safe harbor provisions, and the lack of special considerations for certain types of transactions other than tangible transactions (i.e., intangible transactions, business restructurings and intercompany services).
Absence of Arm’s Length Standard
Although Brazil has adopted TP methods that are broadly inspired by the traditional transaction methods specified in the OECD Guidelines (i.e., the CUP, resale price and cost-plus methods), the Brazilian methods present several differences. For instance, the Brazilian versions of the CUP method (one for imports and another for exports), set benchmark prices with the weighted average of purchase and sale prices between unrelated parties for similar goods, rights or services under similar conditions for import and export transactions, respectively.16 As mentioned in the previous section, the Brazilian version of the CUP method diverges from the OECD in its treatment of transactions covering commodity products. Under the Brazilian rules, the transfer price for commodities is established through the weighted average of published commodity prices from public exchanges. For purposes of applying this method, the use of the taxpayer’s transactions with third parties is only acceptable to the extent that the comparable transactions are equivalent to at least 5% or more of the tested transactions. The other TP methods approved for use under the Brazilian TP Regs are inspired by the OECD’s cost plus and resale price methods. However, incorporating fixed margins yields significant differences relative to the arm’s length standard. The results also have the potential for double taxation due to differences in answers under the Brazilian TP Regs relative to those that would be realized under the arm’s length standard used under the tax law of transaction partner countries.
Use of Safe Harbors
The three safe harbor provisions provided under the Brazilian TP system are intended to offer simplicity in administration and compliance related to export transactions. These provisions exclude the application of the Brazilian TP Regs to certain transactions when the taxpayer meets specific conditions. For instance, the “de minimis” export amount applies a materiality threshold, where Brazilian taxpayers with export revenues of 5% or less of total revenue (considering both related and unrelated party export revenues) are not required to apply transfer pricing (TP) methods to their export transactions.17 Secondly, if the export price is equal to at least 90% of the domestic market price, then the export price adopted by the taxpayer is considered acceptable.18 This creates an issue when the prices in Brazil’s domestic market are significantly different from the prices for the same goods in foreign markets due to different market conditions. Lastly, the Brazilian TP Regs also provide a safe harbor profitability test such that exporters who can demonstrate that their exports to related parties generate at least a 10% net profit margin for the exporter are deemed to meet acceptable transaction conditions.19 This safe harbor only applies to taxpayers with outbound intercompany transactions, where net revenue from related parties is less than 20% of total export revenue. In such cases, one could presume that there would be sufficient information to apply Brazil’s version of the CUP method for exports using the remaining 80 plus percent of export volume as a benchmark. Additionally, the use of the safe harbor regime potentially leads to under-taxation if a 10% net profit margin is below an arm’s length rate of profit.20
Special Consideration for Intangible and Service Transactions and for Business Restructurings
Brazil’s TP regulations lack special considerations for more complex transactions, such as those involving services, intangible goods and business restructurings. Since the Brazilian TP legislation does not provide specific definitions or guidelines for transactions covering these items, the general TP rules apply.21 These types of transactions have increased in frequency and importance since Brazil’s regulations were enacted in 1996. Additionally, the Brazilian TP Regs only allow for the deduction of certain types of outbound payments. MNCs can deduct outbound royalty payments and other payments involving technical, scientific, administrative and similar assistance up to a specific percentage limit only after obtaining a cumbersome and challenging approval by the Instituto Nacional da Propriedade Industrial (INPI), the Brazilian government body regulating intellectual property. For transactions related to patents, industrial processes, manufacturing formulas or similar assets, taxpayers are permitted to deduct up to 5% of the net revenue of the product manufactured or sold, depending on their industry. The deductible amount for trademark royalties is limited to one percent of net sales. These deductibility limits clearly have income recognition effects that are inconsistent with the arm’s length standard.22 These circumstances create tax uncertainty and the potential for double taxation. They also generate BEPS risks and the potential loss of tax revenue for the RFB.
It is often the case that intercompany transactions within MNCs are closely interrelated, making it difficult to evaluate them on an individual basis. In instances where it would be impractical to determine pricing for each product or transaction, the OECD Guidelines permit such transactions to be evaluated on a combined basis using the most appropriate arm’s length method.23 Conversely, the Brazilian TP Regs strictly require intercompany transactions to be analyzed on a transaction-by-transaction basis. Taxpayers operating in Brazil must demonstrate that each cross-border transaction meets the fixed margins established by the Brazilian regulations, with netting and offsetting of margins prohibited. The transaction-by-transaction policy requires taxpayers to gather and maintain a significant amount of data, which often requires the purchase of software to process large amounts of information only relevant to Brazil.
Given the risks and burdens associated with the existing Brazilian TP Regs, many MNCs choose to contract with third parties for their Brazilian operations because the additional costs of outsourcing are preferable to the costs and risks associated with the Brazilian transfer pricing (TP) environment. For Brazil, all of these factors contribute to a reduction of inbound FDI and prevent the country from further integrating into the global economy.
There are tangible benefits of Brazil gaining accession to the OECD. However, Brazil’s alignment of its TP regulations with the OECD Guidelines remains a significant undertaking that will need to be completed before Brazil is able to attain OECD membership. The biggest obstacle Brazil faces in adopting the OECD Guidelines is the Brazilian Congress approving and codifying these changes into the Brazilian TP Regs. This may not be an easy vote since the changes proposed by the OECD may not necessarily align with the constituents’ needs for certain members of Congress. Specifically, Brazilian districts that rely on the export of natural resources may earn less under the OECD framework. The congressional vote may delay or derail Brazil’s application process to the OECD.
If Brazil decides to align its TP Regs with the OECD Guidelines, there will be several consequences for both the RFB and Brazilian taxpayers. These growing pains must be taken into consideration by MNCs, so they are prepared to implement new pricing policies under the new TP regime and can optimize tax planning opportunities in Brazil and abroad.
The acceptance of the OECD Guidelines in Brazil will necessitate a shift in both the philosophy and enforcement by the RFB, when auditing TP matters. The existing TP environment is very rigid and audits are mechanistic. RFB officials will need to embrace the guiding principles of the arm’s length standard, which will require careful consideration of functional and economic analyses that are less mechanistic to determine compliance. Given deviation from the current approach, the RFB will need to retrain all of its field auditors on the principles of the OECD Guidelines. Retraining will take significant effort and resources, and the RFB will need sufficient time to transition to the new TP regime successfully.
There are several analyses that Brazilian taxpayers will want to conduct in preparation for the potential changes to the Brazilian TP Regs. Since the Brazilian TP Regs put greater emphasis on transactional methods, Brazilian taxpayers have developed enterprise resource planning (ERP) systems that track profitability on a transaction-by-transaction basis. These systems provide taxpayers and Brazilian TP specialists the information necessary for completing TP documentation, calculating adjustments and defending tax audits. After the change in the TP regulations, Brazilian taxpayers will need to modify their data collection processes, to collect the data necessary to apply the TP methods in the OECD Guidelines. These changes to data collection processes may end up creating substantial cost efficiencies in the long run. Still, in the short term, it may require considerable time, effort and resources to ensure that Brazilian taxpayers will be able to extract the necessary data, to apply the OECD methodologies and to compile the required TP documentation. Brazilian taxpayers will also need to retrain their tax staff to learn the new TP methods specified in the OECD Guidelines and be able to compute appropriate TPadjustments to maintain compliance.
Finally, there are also several TP items that Brazilian taxpayers can review to be proactive on TP planning strategies. Brazilian taxpayers will have access to competent authority mechanisms once they join the OECD. This mechanism will help Brazilian taxpayers and their foreign affiliates minimize double taxation in Brazil and foreign jurisdictions. Brazilian taxpayers should also reevaluate their existing TP policies, to determine what pricing changes will be necessary to comply with the arm’s length standard, under the OECD Guidelines. Brazilian taxpayers will also be able to pay royalties in exchange for exploiting intangible property. This will allow MNCs to better align profit with the economic ownership of intangible property. These regulatory changes are likely to increase FDI into Brazil, since MNCs will now have remedies to extract profits related to the exploitation of intangible property in Brazil that is owned elsewhere, without being subject to double taxation. Finally, TP compliance and planning for Brazilian operations will likely become more integrated with the rest of many MNCs’ tax operations. Historically, many companies left these activities to local Brazilian teams, given the specific nature of the Brazilian TP environment. This will likely not be the case once the arm’s length standard is adopted, especially given the lack of experience of local Brazilian tax teams with the OECD Guidelines.
Jaime Sepulveda, Analyst in Duff & Phelps’ Transfer Pricing practice, is a contributing author.
1.For the purposes of this article, we will refer to the Brazilian transfer pricing rules as published in Law 9.430/1996 and amended by Law 12.715/2012 by the Receita Federal do Brasil (RFB) as the “Brazilian TP Regs”
2.Interamerican Development Bank, “The Benefits of Being an OECD Member,” accessed February 1, 2020, available at: https://conexionintal.iadb.org/2016/01/29/costos-y-beneficios-de-formar-parte-de-la-ocde/?lang=en
3.OECD, “Global Forum on Transparency and Exchange of Information for Tax Purpose”, accessed February 1, 2020, available at: https://www.oecd.org/tax/transparency/.
4.OECD and RFB, “Transfer Pricing in Brazil: Towards Convergence with the OECD Standard,” accessed February 1, 2020, available at: https://www.oecd.org/tax/transfer-pricing/transfer-pricing-in-brazil-towards-convergence-with-the-oecd-standard.pdf.
5.OECD and RFB, “Transfer Pricing in Brazil: Towards Convergence with the OECD Standard – Highlights,” accessed February 1, 2020, available at: http://www.oecd.org/tax/transfer-pricing/transfer-pricing-in-brazil-towards-convergence-with-oecd-standard-brochure.pdf.
6.OECD and RFB, “Joint Statement on the OECD-Brazil Transfer Pricing Project,” 11 July 2019, accessed February 1, 2020, available at: http://www.oecd.org/tax/transfer-pricing/joint-statement-oecd-brazil-transfer-pricing-project-july-2019.pdf.
7.OECD and RFB, “Transfer Pricing in Brazil: Towards Convergence with the OECD Standard,” accessed February 1, 2020, available at: https://www.oecd.org/tax/transfer-pricing/transfer-pricing-in-brazil-towards-convergence-with-the-oecd-standard.pdf.
8.Trade Union Advisory Committee (TUAC) to the OECD, “OECD Membership and the Values of the Organization,” May 28, 2018, accessed February 1, 2020, available at: https://tuac.org/news/oecd-membership-and-the-values-of-the-organisation/.
9.Bloomberg Law, “Chapter 25: Transfer Pricing Rules and Practices in Brazil.”
10.OECD and RFB, “Transfer Pricing in Brazil: Towards Convergence with the OECD Standard – Highlights,” accessed February 1, 2020, available at: http://www.oecd.org/tax/transfer-pricing/transfer-pricing-in-brazil-towards-convergence-with-oecd-standard-brochure.pdf.
12.OECD and RFB, “Transfer Pricing in Brazil: Towards Convergence with the OECD Standard,” accessed February 1, 2020, available at: https://www.oecd.org/tax/transfer-pricing/transfer-pricing-in-brazil-towards-convergence-with-the-oecd-standard.pdf.
17.Article 49 of Normative Ruling 1312/12
18.Article 19 of Law 9430/1996
19.Article 48 of Normative Ruling 1312/12
20.OECD and RFB, “Transfer Pricing in Brazil: Towards Convergence with the OECD Standard,” accessed February 1, 2020, available at: https://www.oecd.org/tax/transfer-pricing/transfer-pricing-in-brazil-towards-convergence-with-the-oecd-standard.pdf
22.Article 18, paragraph 9, Law 9430/1996 and Article 55 of Normative Instruction 1312/2012
23.OECD Guidelines, paragraphs 3.9 through 3.12
Valuation and consulting for financial reporting, federal, state and local tax, investment and risk management purposes.Valuation Advisory
Comprehensive transfer pricing advisory covering compliance, planning, controversy and implementation.Transfer Pricing
Economic review, analysis of proposed settlements and objective expert testimony in litigation.Transfer Pricing Controversy/Expert Services
Value a range of intangible property, functions and other interests for tax purposes.Transfer Pricing Valuation Services
Valuation and strategic implementation of financing arrangements covering loans, guarantees, cash pools and preferred equity.Financial Transactions Transfer Pricing Services
Global and local transfer pricing documentation, benchmarking and Country-by-Country reporting compliance.Transfer Pricing Global Compliance Services
Enhance internal strategic reviews, implementation strategies and assistance in evaluating planning structures and third-party tools.Transfer Pricing Operational Services
Duff & Phelps’ Transfer Pricing Strategic Planning Services are designed to assist companies when setting up new operations, integrating new acquisitions and divesting existing business lines.Transfer Pricing Strategic Planning Services