OECD, Brazil tax officials provide update of transfer pricing alignment project

By Francisco Lisboa Moreira, Tax Partner, Bocater Advogados, São Paulo, Brazil

The joint project between the Brazilian tax agency and the OECD to align Brazil’s transfer pricing laws with global standards continues, despite the Covid-19 situation. On September 15, an online event was held by officials of both bodies, hosted by the Brazilian IFA branch (ABDF).

Claudia Pimentel of the Brazilian tax agency provided an overview of achievements of the joint project. She said its five main focus areas are prevention of base erosion and profit shifting (BEPS), legal certainty, the prevention of double taxation, and simplicity for tax authorities and taxpayers.

Pimentel said that, during the study, the Brazilian tax agency had identified several situations where the gaps between the two systems may lead to a double non-taxation, which would result in a large loss of revenue to the country.

The general view of the Brazilian government, Pimentel said, is that despite the fact that simplification presents an advantage, this benefit is outweighed by the loss of revenue.

As the project progressed, Pimentel said, the first conclusion was the obvious need to improve and enhance the rules.

A Brazil/OECD joint report issued in December 2019 recommended two options to merge the systems: a gradual or a direct/immediate merger. But several issues must be considered, the report noted, including the critical issue of capacity building.

Also, Pimentel explained that the adoption of the arm’s length standard does not represent a full adoption of the OECD transfer pricing guidelines, but rather an adherence to existing transfer pricing principles and the arm’s length standard.

Pimentel said that the safe harbors are already embedded in the Brazilian system, should be improved to allow a closer convergence.

Pimentel later explained that since the issuance of the report, Brazil has designed an action plan to take the project forward. The key pillars of the action plan are to define the policy guidelines for the new legislation, prepare a primary legislative text, establish simplification measures, and address capacity building, she said.

Pimentel later explained that since the issuance of the report, Brazil has designed an action plan to take the project forward. The key pillars of the action plan are to define the policy guidelines for the new legislation, prepare a primary legislative text, establish simplification measures, and address capacity building, she said.

A research poll is now underway to collect information to aid in designing the transfer pricing rules and safe harbors, Pimentel said.

The goal is for simplification of the transfer pricing calculation with legal certainty, she said.

Pimentel said she approved of the use of advanced pricing agreements (APAs), which could anticipate the transfer pricing analysis of the business model and provide more certainty for both sides.

The deadline for submitting comments to the Brazilian study is October 30. The main goal is the development of appropriate safe harbor rules and to obtain help prioritizing the work.

Brazil safe harbors

Grace Perez-Navarro, Deputy Director of the Center for Tax Policy at the OECD explained that the Inclusive Framework’s digital economy agenda and the Brazilian convergence project are running simultaneously.

Perez-Navarro said that Brazil is a very active member of the digital economy framework discussions, including pillar one.

At this point, one should note that although several isolated digital tax bills are pending in the Brazilian Congress, they do not represent the position of the executive branch, which seeks a consensus solution under pillar one. Traditionally, the introduction of new or amended taxes in Brazil are executive branch initiatives – so it is likely that the executive branch will work towards the consensus under pillars one and two, rather than following a unilateral path.

Perez-Navarro pointed out that despite the fact that some commentators may have developed an impression that, in the context of ongoing work on pillar one, the world is moving towards fixed margins as featured in the current Brazilian model, this is actually not the case.

Perez-Navarro pointed out that despite the fact that some commentators may have developed an impression that, in the context of ongoing work on pillar one, the world is moving towards fixed margins as featured in the current Brazilian model, this is actually not the case.

Perez-Navarro clarified that although certain changes to the international tax framework are under discussion, which could notably include moving beyond the arm’s length standard in Amount A (the new nexus and profit allocation rules), and which contemplates a fixed remuneration for baseline marketing and distribution in Amount B (to be designed consistently with the arm’s length principle), there is no reason to think that the Brazilian fixed margins currently applying across the board to all taxpayers and all types of activities constitute a feasible transfer pricing approach.

Perez-Navarro recognised the risks and adverse consequences of an approach that would attempt to apply rigid, fixed margins to all taxpayers regardless of their functional profile and the nature of the transactions in scope leads to risks of double taxation and also BEPS outcomes.

Perez-Navarro stressed that Brazil’s objectives are to increase tax certainty and increasing tax certainty by applying rules more consistent with the international standard is an obvious way. In contrast, an approach that would call for using fixed margins for every type of transaction and functional profile would not achieve those objectives, and the simplification measures, notably in the form of safe harbour regimes, should be applied in appropriate circumstances, in line with the recommendations provided in the OECD transfer pricing guidelines.

Perez-Navarro stressed that Brazil’s objectives are to increase tax certainty and increasing tax certainty by applying rules more consistent with the international standard is an obvious way. In contrast, an approach that would call for using fixed margins for every type of transaction and functional profile would not achieve those objectives, and the simplification measures, notably in the form of safe harbour regimes, should be applied in appropriate circumstances, in line with the recommendations provided in the OECD transfer pricing guidelines.

Safe harbors are indeed not always recommended. Perez-Navarro noted that Mexico, while in the process of ascending to the OECD, removed safe harbors from its transfer pricing legislation because they were not consistent with the arm’s length principle. Today, Mexico’s transfer pricing system does include safe harbours, which have been designed in a way consistent with arm’s length principle.

Perez-Navarro explained that the OECD recommendation on safe harbors has been gradually evolving, and since the 2013 revision to the OECD transfer pricing guidelines, safe harbors are recommended when carefully designed for appropriate cases.

Also, in 2015 with the reports of the BEPS project, the sixth method for commodities transfer pricing and the approach for low value-added services are mentioned as widely accepted simplification measures.

Brazil and digitalization

In the tax and digitalization work, simplification aspects have been taken into consideration, particularly in the pillar one (nexus and profit allocation) proposal, Perez-Navarro explained.

She said that the nexus and profits allocation revision for the digital economy is grounded in the existing transfer pricing guidelines principles  – for determination of a “residual profit” – and a share of this “residual profit” could be allocated to for market jurisdictions based on fixed margins or percentages.

There is also a fixed margin approach for certain distribution and marketing based activities under evaluation, in the search for simplification, she said

The principal takeaway is that a solution on pillar one retains the current transfer pricing rules based on the arm’s length principle but creates an exception.

According to Perez-Navarro, the alignment of the Brazilian rules with OECD’s is consistent with the existing pillar one work. Brazil plays a key role in the steering group, and the Brazilian transfer pricing alignment project is informed by the discussions in the Inclusive Framework.

According to Perez-Navarro, the alignment of the Brazilian rules with OECD’s is consistent with the existing pillar one work. Brazil plays a key role in the steering group, and the Brazilian transfer pricing alignment project is informed by the discussions in the Inclusive Framework.

We come back to the transfer pricing questionnaire, as it is aimed at supporting the design of quality safe harbor rules, especially in situations where comparables are scarce or nonexistent, and safe harbors would provide legal certainty.

Those best qualified to respond to these questions are in-house tax personnel.

The poll, if responded to correctly and accurately by companies, with concrete examples, would assist in the proper development of these rules.

This represents, in Pimentel’s words, a stimulus for a fair and open communication between taxpayers with the tax authority.

The inputs from the poll will be used to design the transfer pricing legislation, including potential legislation for APAs, Pimentel said.

Editors Note: This article was modified on September 30, 2020, to clarify Ms. Perez Navarro’s comments with respect to fixed margins.