The Transfer Pricing Law Review: Brazil
Just over two decades ago, the Brazilian transfer pricing rules were introduced in the Brazilian legal system by Articles 18–24 of Law 9,430, 1996 and, to date, their application gives rise to practical difficulties and disputes between tax authorities and taxpayers.
Transfer pricing rules are intended to ensure that the values of transactions between related parties, involving goods, rights, services and loans, are the same as the values that would be established in transactions between unrelated parties (under normal market conditions).
Transfer pricing rules are designed to restrict improper transfer from Brazil to a foreign country of income taxable by Corporate Income Tax and Social Contribution on Net Profits, as a result of more favourable conditions negotiated between related parties.
Brazilian transfer pricing rules apply to individuals or legal entities resident or domiciled in Brazil who are:
- engaging in transactions with individuals or legal entities resident or domiciled abroad, deemed related parties, even through an interposed person;
- engaging in transactions with individuals or legal entities, even not related, resident or domiciled in a tax-favoured country or dependency; and
- engaging in transactions with individuals or legal entities, even not related, resident or domiciled abroad and that enjoy a preferential tax regime, pursuant to applicable legislation.
For purposes of the transfer pricing rules (Article 23 of Law 9,430, 1996), the following persons are deemed related to the Brazilian company:
- its parent company when domiciled abroad;
- its branch or main branch, domiciled abroad;
- the individual or legal entity, resident or domiciled abroad, whose equity interest in its capital stock characterises it as a controlling person or associate thereof;
- the legal entity domiciled abroad characterised as a controlled entity or associate thereof;
- the legal entity domiciled abroad, when this legal entity and the company domiciled in Brazil are under common corporate or administrative control, or when at least 10 per cent of the capital stock of each one is held by the same individual or legal entity;
- the individual or legal entity, resident or domiciled abroad, which together with the legal entity domiciled in Brazil, holds an equity interest in the capital stock of a third entity, the aggregate sum of which holds them as the controlling persons or associates thereof;
- the individual or legal entity, resident or domiciled abroad, which is its associate, in the form of a consortium or condominium, as defined in Brazilian legislation, in any undertaking;
- the individual resident abroad who is a relative or a relative by affinity up to the third degree, spouse or life partner of any of its officers or of its controlling partner or shareholder under a direct or indirect participation;
- the individual or legal entity, resident or domiciled abroad, holding an exclusive right as its agent, distributor or concessionaire, for purchase and sale of goods, services or rights; and
- the individual or legal entity, resident or domiciled abroad, in relation to which the legal entity domiciled in Brazil holds an exclusive right, as an agent, distributor or concessionaire, for purchase and sale of goods, services or rights.
There are two groups for assessing the related status, so that those persons subject to the Brazilian transfer pricing rules can be determined: (1) the first group comprises legal entities resident and not resident in Brazil (Items a, b, c, d, e, f, g, h, and i); and (2) the second group considers relations between a resident legal entity and a non-resident individual (Items e, f, g, h, i, and j).
The term 'transfer pricing', though not expressly defined, is used to identify the controls applicable to commercial or financial transactions between related parties, headquartered in different tax jurisdictions, or when one of the parties is located in a tax haven.
Despite being inspired by the OECD framework, the Brazilian framework is based on practicality to the detriment of the arm's-length principle, by adopting on a priority basis the fixed (or predetermined) margin method for allocation of a minimum profit margin in Brazil.
The Brazilian framework does not provide for the 'best method approach' prescribed by the OECD framework, so in practice there prevails an objective application of the methods contemplated by the legal text, where the most beneficial method applies to taxpayers, regardless of whether it is consistent with actual market conditions.
Although the idea of standardising market conditions is the key feature of the arm's-length principle, under Brazilian tax legislation, this principle can only be adopted by means of an integrated application of the principles actually provided in the Brazilian Constitution.
This requirement derives not only from the fact that Brazil is not yet an OECD member country, but also from the lack of an express provision dealing with the arm's-length principle in the constitutional text and federal laws.
This does not mean that such principle has no applicability for purposes of interpreting the Brazilian transfer pricing rules. Instead, the arm's-length rule must be deemed to be incorporated into constitutional principles, in particular, the principles of strict lawfulness, equality, legal stipulation of taxable events, ability to pay and the binding nature of the administrative act.
The OECD transfer pricing guidelines are not accepted or adopted by the judiciary or the Brazilian tax authorities. However, recent discussions between Brazil and OECD have caused lawmakers to reconsider the Brazilian framework and its convergence with the OECD framework.
In this sense, within the context of the Brazilian adherence to the OECD, currently, representatives of the Federal Revenue Office (RFB), Brazilian Industry and OECD are discussing the replacement of the current Brazilian TP rules by the OECD transfer pricing guidelines, with specific safe-harbour rules.
The Brazilian transfer pricing legislation does not apply to such corporate transactions as payment of dividends, interest on equity and capital contributions. Indeed, the Brazilian TP rules exclusively apply for cross-border transactions involving goods, services and rights.
Considering that Brazilian legislation provides for restrictive methods to determine the arm's-length price (the 'parameter price') and that many transactions are not even covered by transfer pricing legislation, it is extremely important for multinational companies to take due account of the particularities of the Brazilian transfer pricing system.
On the 31 December of each year, Brazilian entities are required to indicate transfer price adjustments in their accounting books for the cross-border transactions with goods, services and rights practised with related parties located abroad. Such information, including the methods to achieve the parameter prices in these transactions, must be provided in the companies' corporate tax return (ECF) in July of the following year.
Taxpayers need not file in advance any report or documentation to circumstantiate or support calculations in transfer pricing transactions. They will only be required to file documents supporting compliance with transfer pricing legislation in the event of a tax audit.
The country-by-country reporting (CBCR) was instituted by Brazilian Federal Revenue Office Normative Ruling - IN RFB 1,681, 2016, in compliance with the commitment undertaken under Action 13 of the BEPS Project. Only international groups, whose aggregate consolidated revenue in the fiscal year preceding that of the reporting is equal to or exceeds €750 million, are required to file the CBCR. One should note that, in practice, the Brazilian tax authorities in tax inspection proceedings do not commonly use the information provided in the CBCR.
Presenting the case
i Pricing methods
For cross-border transactions with related parties, import costs, expenses and charges will only be deductible, in the ascertainment of the Corporate Income Tax (IRPJ) and Social Contribution on Profits (CSL), up to the amount that does not exceed the parameter price determined by one of the following methods:
- PIC – Comparable Independent Price Method (Método dos Preços Independentes Comparados): the weighted arithmetic average of identical or similar goods, services or rights ascertained either in Brazil or abroad in purchase and sell transactions made by the interested party or third parties, under similar payment terms.
- CPL – Production Cost Plus Profit Method (Método do Custo de Produção Mais Lucro): the weighted average cost of production of identical or similar goods, services or rights, in the country in which they were originally produced, plus the taxes and fees charged by that country on export, and a 20 per cent profit margin, calculated on the costs ascertained.
- PRL – Resale Price Less Profit Method (Método do Preço de Revenda Menos Lucro): the weighted arithmetic average of sale prices, in Brazil, of goods, services or rights, under similar payment terms and calculated based on the following variables:
- net selling price;
- percentage of participation of imported goods, rights or services in the total cost of the goods, right or service sold;
- participation of imported goods, rights or services in the sale price of the goods, right or service sold;
- profit margin from 20 per cent to 40 per cent depending on the economic sector; and
- arm's-length price.
In the export transactions carried out between related parties (Article 19 of Law 9,430, 1996), the revenues are subject to transfer pricing adjustments when the average sale price of the goods, services or rights is less than 90 per cent of the average price practised in the sale of the same goods, services or rights, in the Brazilian market, during the same period, under similar payment terms. In this case, adjustments are determined based on one of the following methods:
- PVEx – export sales price method (método do preço de venda nas exportações): defined as the arithmetic average of sale prices in exports made by the company itself, to other unrelated customers, or by another national exporter of identical or similar goods, services or rights, during the same period of ascertainment of the income tax base and under similar payment terms;
- PVA – wholesale price in the country of destination less profit method (método do preço de venda por atacado no país de destino menos lucro): defined as the arithmetic average of the selling prices of identical or similar goods, practised in the wholesale market of the country of destination, under similar payment terms, less the taxes included in the price, charged in said country, and a profit margin of 15 per cent on the wholesale price;
- PVV – retail price in country of destination less profit method (preço de venda por varejo no país de destino, diminuído do lucro): defined as the arithmetic average of the sale prices of identical or similar goods, practised in the retail market of the country of destination, under similar payment terms, less the taxes included in the price, charged in said country, and a profit margin of 30 per cent over retail price;
- CAP – acquisition or production cost plus taxes and profit method (método do custo de aquisição ou de produção mais tributos e lucro): defined as the arithmetic average of the costs of acquisition or production of exported goods, services, or rights, plus taxes and contributions charged in Brazil and a profit margin of 15 per cent on the sum of costs plus taxes and contributions; and
- PECEX – price under quotation on export method (método do preço sob cotação na exportação): exclusively applicable to commodities, regardless of the 90 per cent safe-harbour rule, defined as the daily average values of the quotation of goods or rights subject to public prices on internationally recognised commodity and futures exchanges.
In theory, the Brazilian methods are similar to the traditional methods adopted by the OECD. The alternative methods, such as the Transactional Net Margin Method (TNMM) and the Profit Split Method (PSM), have no specific provision in Brazilian legislation.
The Brazilian framework, however, does not provide for the best method approach prescribed by the OECD framework. Therefore, in practice, an objective application of the methods contemplated by the legal text prevails, where the most beneficial method applies to taxpayers, regardless of whether it is consistent with actual market conditions.
Transactions related to technology transfer are not subject to Brazilian transfer pricing rules (those involving the receipt or payment of royalties, as well as related technical assistance), which, pursuant to Article 18, Paragraph 9 of Law 9,430, 1996, remain subject to specific rules set out in the legal system.
The contracting of interest with related parties has started to observe the arm's-length price calculated based on the rate determined by Article 38-A of Normative Ruling 1,312 of 2012, plus spread defined by the Ministry of Finance.
The rules on spread were established by Ministry of Finance (MF) Ordinance 427, 2013. Under its terms, the spread margin percentages (to be added to the interest rates) will be as follows:
- 3.5 per cent for the purposes of deduction of financial expenses in borrowing transactions (loans taken out from related parties or comparables);
- 2.5 per cent for the purposes of recognition of minimum value of financial income in funding transactions (loans granted to related parties or comparables); and
- zero for transactions occurred between 1 January 2013 and 2 August 2013.
ii Authority scrutiny and evidence gathering
Transfer pricing in Brazil is governed by objective methods with predetermined margins, and therefore the tax authorities are not interested in scrutinising the information provided by taxpayers about related foreign companies.
The tax authorities rarely request documents from other companies belonging to the same multinational group, except where the method to determine the arm's-length price is contingent on the review of these documents (e.g., when the parties are disputing the methods CPL, PVA or PVV). There is no legal provision allowing the tax authorities to discuss a certain situation with witnesses or third parties.
Usually, the review is made based on ordinary documents issued by companies connected with the taxpayer's business and commercial transactions, except in cases where fraud or sham is alleged. In addition, taxpayers subject to Brazilian transfer pricing rules are allowed to use other documents as evidence, such as official publications, reports and research carried out by institutions.
A determining factor in the choice of one of the methods set out in Brazilian transfer pricing laws is the confidentiality of the transactions. Companies generally opt to maintain the business information in secrecy to the detriment of a more beneficial tax situation. In view of the breach of confidentiality of foreign documents and information, the methods of PVA, PVV, PVEx (exports) and CPL (imports) are less frequently used than the methods CAP (exports) and PRL (imports). Moreover, Brazilian methodology considers practicability instead of the arm's length, being the methods CAP and PRL, which are the most practical among all the methodologies set forth in the Brazilian legislation.
Ideally, for transactions involving intangible assets, the tax authorities would precisely request and have mechanisms to ensure that multinational groups would be properly allocating the returns generated from the exploitation of a certain intangible asset to the corresponding company. Therefore, functions, assets and risk (FAR) would be reviewed concomitantly with the development, enhancement, maintenance, protection and exploitation (DEMPE) of the intangible asset. This is not, however, the actual Brazilian practice.
As mentioned above, royalties associated with several types of intangible assets, as well as administrative, scientific and technical assistance fees are not subject to transfer pricing rules in Brazil.
Brazil adopts fixed and strict percentages, which are not mixed up with the transfer pricing regime. Despite that, the transactions of export of intangible assets are challenging for taxpayers who must apply traditional transfer pricing methods to assess the suitability of the adopted price.
The transfer pricing regime is structured in Brazil, and therefore it lacks interaction between tax authorities and taxpayers to settle disputes. In this environment of uncertainty surrounding the resolution of disputes, taxpayers are limited to the submission of advance tax ruling requests to the tax authorities on the interpretation of legal rules, although the outcome of these requests is not binding.
In view of the practical difficulty in implementing agreements between tax authorities and taxpayers, although the possibility of requesting alternative margins is provided in Law 9,430, 1996, we are not aware of any Advance Pricing Agreement (APA)/Mutual Agreement Procedure (MAP) requests whose outcome has been favourable to taxpayers. In this sense, the Brazilian treaties, to avoid double taxation, do not allow the 'corresponding adjustments', which are largely used by OECD members. Without the possibility of corresponding adjustments, APAs and MAPs tend to be inefficient in solving double taxation issues arising from the application of the Brazilian transfer pricing rules.
The tax authorities have five years to investigate transfer pricing transactions and, if they find any irregularity, to issue the corresponding infraction notice.
The counting of the five-year time limit varies according to the characteristics of each case. In situations where wilful misconduct, fraud or sham is not alleged, the five-year time limit starts from the year of the triggering event (31 December of the year under scrutiny). In cases where wilful misconduct, fraud or sham is demonstrated, tax authorities have one more year to complete the investigations, since the five-year time limit starts from the fiscal year subsequent to the fiscal year of the triggering event.
As a rule, the taxpayer receives a notice from the tax authorities that its transactions and transfer pricing adjustments related to certain calendar year(s) are being inspected. The tax authorities usually request documents and information from the taxpayer about the period under scrutiny and issue other notices depending on the taxpayer's answers or on the finding of new information during the investigation. By the end of the tax inspection proceeding, if the tax authorities have disregarded the transfer pricing methodology adopted by the taxpayer, a new calculation (based on other methods) may be presented within a 30 day term.
As seen above, the interaction between tax authorities and taxpayers is very limited when settling transfer pricing disputes. For this reason, any irregularity found in the application of the methods or calculations to determine the arm's-length price will result in the issuance of an infraction notice, which will demand the payment of a principal plus fine (75 per cent or 150 per cent in cases involving wilful misconduct, fraud or sham) and interest (calculated according to the Special Settlement and Custody System – Selic rate). The taxpayer may opt to oppose or pay the debt within 30 days from the notification of the infraction notice (with a 50 per cent discount on the fine).
Transfer pricing disputes may be dealt with in the administrative or judicial sphere. The taxpayer can choose the sphere in which to litigate.
The disputes usually start in the administrative sphere and, if necessary, they are taken to the judicial sphere. This happens because the option to directly litigate in the judicial sphere entails the waiver of the right to litigate in the administrative sphere. In addition, a final decision favourable to the taxpayer in the administrative sphere cannot be judicially questioned by the tax authorities, while a final decision favourable to the tax authorities in the administrative sphere can be opposed by the taxpayer in the judicial sphere.
To discuss debts in the administrative sphere, which is made up of three instances, taxpayers are not required to provide any type of bond, while in the judicial sphere, taxpayers must post bond to avoid any tax liens.
The Regional Judgment Offices (DRJ) have jurisdiction to decide first-instance administrative proceedings, reviewing the assessment and the taxpayers' arguments. The decisions, in this first stage, are usually unfavourable to taxpayers, except in cases where there is a clear mistake in the assessment. The taxpayer may file an appeal against the unfavourable decision rendered by DRJ, pay the debt and dismiss the proceeding, or even discuss the debt in the judicial sphere. Conversely, the cases settled in favour of taxpayers in the first administrative instance, which involve a debt value exceeding 2.5 million Brazilian reais, are dealt with in a mandatory appeal.
Appeals in administrative proceedings are filed to the second-instance Administrative Tax Appeals Court (CARF), which consists of representatives of the National Treasury and a same number of representatives of Taxpayers. CARF has authority to judge taxpayers' voluntary appeals and those filed ex officio by the Treasury. In the past, tied decisions were settled by a 'casting vote' issued by the panel chief, who was a Treasury's representative. However, Law 13,988, 2020 abolished the casting vote at CARF and determined that in case of a tie, the dispute must be resolved in taxpayer's favour.
The last and final administrative instance is the Superior Tax Appeals Chamber, which reviews special appeals filed by taxpayers and by the National Treasury.
In the judicial sphere, transfer pricing cases are initially reviewed and judged by a single judge (first instance) and then by a competent appeals court (second instance), for mandatory re-examination of decisions unfavourable to the Treasury and for taxpayers' appeals. Notably, these decisions may be analysed by the Superior Court of Justice (STJ) and by the Federal Supreme Court (STF) whenever they involve a legal or constitutional concern raised by the parties. However, such higher courts cannot review the facts of the proceeding.
For both administrative and judicial litigation, taxpayers in view of the objective parameters of the Brazilian transfer pricing rules, it is common that taxpayers make use of opinions and studies prepared by experts to support their defence or challenge the Treasury's arguments. The tax authorities, in turn, do not resort to formal opinions, but only to their own analyses and arguments.
ii Recent cases
In regulating Law No. 9,430, 1996, the Brazilian tax authorities issued normative rulings (instruções normativas) that actually innovated vis-à-vis the aforesaid law and, specifically with regard to the PRL (the most common Brazilian method adopted for control of imports), resulted in distortions and mounting litigation.
The main disputes on applicability of the PRL method were filed during the effectiveness of Normative Ruling 243, 2002, which established an unprecedented method to calculate the PRL by applying a fixed margin of 60 per cent over the net income on local resale of the imported input.
The disputes under Normative Ruling 243, 2002 were judged in favour of the tax authorities in the administrative sphere, resulting in several judicial disputes. The argument that the Normative Ruling is illegal is rarely accepted by the Brazilian courts. An assessment of the cases judged by the Regional Federal Court of the Third Circuit (TRF-3) shows that only 6 of 24 cases judged between June 2010 and March 2021 were favourable to taxpayers. This issue, however, has not yet been analysed by the superior courts (STJ and STF).
Secondary adjustment and penalties
Brazil does not have any secondary transfer pricing adjustment mechanism. There is no legal provision authorising tax authorities to impose secondary adjustments to correct price differences in cases where adjustments are imposed to reflect a more appropriate price.
For this reason, transfer pricing adjustments result in differences between accounting and tax books. Overpaid or underpaid amounts recognised in a controlled transaction cannot be considered dividends or loans to related parties or those deemed to be third parties abroad.
Broader taxation issues
i Diverted profits tax, digital sales taxes and other supplementary measures
The Brazilian legal system does not yet provide for a tax applicable to undue transfer of profits, or any other measures in response to BEPS Project; nor have mechanisms been created to neutralise unduly profit transfer practices that would be covered by such tax.
Currently, the adjustment of the CIT tax base is the sole effect of the base erosion resulting from artificial practices.
ii Tax challenges arising from digitalisation
The Brazilian transfer pricing rules have no elements related to Pillars One and Two. Notably, although OECD is currently discussing with Brazil the possibility of replacing the Brazilian methodology by the OECD transfer pricing guidelines, the current project has no measures related to Pillars One and Two. As a result, although the Brazilian model may be fully replaced by the OECD model, a new tax reform may be possibly implemented to contemplate Pillars One and Two, with the purpose of introducing in Brazil the global taxation rules intended by such Pillars.
iii Transfer pricing implications of covid-19
The Brazilian transfer pricing rules did not change during the covid-19 pandemic. However, as a result of the pandemic, the administrative tax courts (i.e., CARF and CSRF) are not currently judging administrative disputes of amounts higher than 36 million reais. Accordingly, because the transfer pricing disputes usually involve considerable amounts, most administrative proceedings are currently delayed, without prevision to be judged.
iv Double taxation
Without prejudice to all other points surrounding the complex realm of transfer pricing, the fixed-margin method is the origin of practically all strengths and weaknesses of the Brazilian transfer pricing framework.
It is the fixed-margin method that allows the tax authorities and taxpayers to easily identify the parameter prices (simply by applying a fixed margin on the operating cost or on the resale value), which are compared to the values of transactions between related parties to determine whether the transaction value should be adjusted for tax purposes. This simple method, in addition to lowering costs and simplifying taxation, reduces the number of disputes between tax authorities and taxpayers, while ensuring transparency and legal certainty.
The fixed-margin method, based on fixed margins that do not necessarily reflect market reality (i.e., the arm's-length standard) may, however, result (and in many situations actually results) in distortions characterised by scenarios of double taxation or double non-taxation. To mitigate such distortions, we recognise that the OECD framework contains more effective mechanisms when compared with the Brazilian framework, although its application results in excessive costs and lengthy procedures, which would necessarily affect practicality and simplicity as the great trump cards of the Brazilian framework.
v Consequential impact for other taxes
Transfer pricing rules are limited to the CIT and social contribution on profits, and cannot be confused with laws on import rights. Although both rules have the same purpose – reaching an arm's-length price for imports, they are dissociated provisions with different rules that must be dealt with separately.
Outlook and conclusions
The continuous and unrestricted search for the arm's-length standard, as prescribed by the OECD framework, has become costly and complex. Its subjective approach is disadvantageous vis-à-vis the objective approach of the Brazilian rules. The OECD framework does not capture the very synergy of companies of the same economic group by requiring that their prices should be determined as if they were negotiating with independent third parties.
In this context, this problem is not likely to be resolved by merely introducing the OECD standard in the place of the Brazilian standard, as suggested by OECD. On the contrary, the most appropriate path to be trodden seems to enhance the Brazilian standard, which could also become an inspiration in many aspects for enhancement of the OECD standard itself.
Notably, Brazilian legislation has made significant advances with respect to the approach based on fixed margins, especially those applicable to the resale price less profit (PRL) method, which is the method most frequently used in Brazil. Initially, there was an intense dispute between tax authorities and taxpayers over lawfulness of the normative rulings (INs) that regulated application of the PRL method (between 1996 and 2012, period of effectiveness of INs 38/97, 32/01 and 243/02). In 2012, Law 9,430/96 was amended by Law 12,715/12 creating a 'new PRL', in which the fixed margins of 20 per cent and 60 per cent (applicable to imports of finished products and to imports of inputs for local production, respectively) were replaced with fixed margins ranging from 20 per cent to 40 per cent (variable depending on the economic activity of the taxpayers).
The new law has drastically reduced the volume of infraction notices and disputes between tax authorities and taxpayers in transfer pricing matters, bringing practicality into a scenario of greater legal certainty. However, the distortions caused by indistinctly applying the fixed margins have not been resolved, especially the situations involving double taxation (with simultaneous adjustments in Brazil and abroad) and double non-taxation (with no adjustments in Brazil and abroad).
Although Brazilian legislation has clearly evolved over the years, it therefore still calls for enhancements. The optimisation of the Brazilian framework would depend on the creation of practical mechanisms for using alternative margins (replacing Brazilian Federal Revenue Office – RFB Ordinance 222/08 and IN 1,312/12) to implement the corresponding adjustments (putting aside the limitations of Brazilian treaties that discard this mechanism, contrary to other treaties signed by other countries), among others (e.g., creation of specific rules for intangibles, intra-group services, business restructuring, cost sharing, attribution of profits to permanent establishments and alternative methods – TNMM and PSM, MAPs and APAs), with respect to which Brazilian legislation still requires considerable improvement.
The focus on the enhancement of the existing framework should be the guidepost of the Brazilian authorities, both in tax overhaul projects and negotiations for Brazil's accession to the OECD. The mere adherence to the OECD framework does not seem the best alternative, especially in transfer pricing matters. There is still a long way to go, but each step should be taken with the utmost care and responsibility for the sake of national interest.
1 Luciana Rosanova Galhardo is a tax partner and Felipe Cerrutti Balsimelli is a tax associate at Pinheiro Neto.