Brazil’s effort to align its transfer pricing rules with OECD standards

By Francisco Lisboa Moreira, Bocater, Camargo, Costa e Silva, Rodrigues Advogados

A joint effort of the OECD and Brazil’s tax authority to reduce the gaps between Brazil’s transfer pricing regime and the OECD transfer pricing guidelines ahead of Brazil’s ascension to the OECD concluded with a public meeting on July 11 in Brasília.

OECD and Brazilian tax officials delivered a clear message at the meeting: contrary to those that argue that the two transfer pricing methodologies can be harmonized, it is impossible for Brazil to fully become an OECD member unless it aligns with the OECD arm´s length principle.

Brazilian tax officials said that such alignment is a political decision. Once the government instructs the Brazilian tax authority to proceed, they will move forward. Moreover, since the issue is on the government agenda, the Brazilian tax officials predicted this would become a reality.

But the path is not going to be easy.

OECD-Brazil transfer pricing project

The joint project between the OECD and the Receita Federal do Brasil (RFB) was formed in 2017. The UK’s Foreign and Commonwealth Office (FCO), HRMC, and HM Treasury provided strong support for the project since its beginning. Grace Perez-Navarro and Tomas Balco led the effort for the OECD, while Claudia Pimentel, Andrea Chaves, and Flavio Araujo represented the RFB throughout the process.

A questionnaire was used to collect input from MNEs that operate in Brazil. The OECD received a total of 52 responses, all from large MNEs that are country-by-country reporting fillers. The answers and suggestions were taken into consideration, OECD and Brazilian tax officials said.

The work was done by the OECD in three main stages. Stage 1 comprised an analysis of Brazil’s legal and administrative transfer pricing framework; stage 2 detailed the strengths and weaknesses of the Brazil’s existing transfer pricing rules; and stage 3 outlined the options for alignment with the OECD transfer pricing standard.  

The group concluded that, in general, the existing Brazilian transfer pricing legislation does not restate the arm´s length principle for cross-border transactions. Moreover, the scope of the Brazilian transfer pricing legislation is too narrow because royalty payments and intra-group technical, scientific, administrative, and similar assistance are excluded.

Moreover, Brazil’s standard of comparability is very limited, and the absence of a basket approach and enhanced guidance on comparability analysis does not exist. This was pointed out as a weakness.

Intangibles, services, safe harbours

Brazil’s lack of special transfer pricing rules and the exclusion of royalties from the scope of the transfer pricing legislation (imposing a limitation on deductibility) makes the Brazilian system inadequate for the current stage of worldwide related-party transactions, the group concluded.

Moreover, the absence of guidance on intra-group services and the limited administrative guidance on cost contribution agreements was highlighted (note, though, that some taxpayers obtain relief for intragroup services in Brazil’s courts in specific situations).

The reports note further that Brazilian transfer pricing safe harbors are applied only to exports and do not distinguish between the size of taxpayers. Safe harbours should most commonly used for small and medium-sized businesses.

Financial transactions, commodities

With respect to financial transactions, Brazil’s rules are very strict, with hard caps for interest rates, and application of thin-capitalization rules. This also creates room for aggressive planning.

The application of transfer pricing methods for commodities is mandatory, with limited adjustments and no functional analysis, the reports note.

Rulings, APAs, MAPs

Moreover, Brazil does not grant tax rulings, nor possesses an in-force advance pricing agreement (APA).

Further, corresponding adjustments are not permitted (absence of paragraph 2 of article 9 of the OECD model tax treaty). Brazil has limited experience with the mutual agreement procedure (MAP) in tax treaties, as the MAP legislation is very recent.

Alignment?

Regarding a possible alignment, much was said at the meeting about the benefits and disadvantages.

There is a general belief that Brazil’s transfer pricing  system brings simplicity and certainty, but at the cost of double taxation (for the taxpayer) and room for tax planning and loss of revenue (for the government).

As an observer, we could assume that, in OECD team´s opinion, there is room for increased tax collection even taking into consideration the obvious reduction of double taxation. Moreover, more certainty would be provided to the taxpayers. However, in Brazil certainty has always been a synonymous of the principle of legality (a reason why Brazil has never committed to an APA, for instance).

The group concluded that to align with the OECD transfer pricing rules, Brazil must adopt the OECD arm´s length principle, transfer pricing methods, and rules for selection of the most appropriate method. Further, changes must be made to Brazil’s rules on comparability analysis (including functional and brief analysis) and prevention and effective avoidance of double taxation. Additionally, special new rules must be adopted on intangibles, intra-group services, cost contribution agreements, attribution of profits to permanent establishments, financial transactions, and on other specific types of transactions.

Whether the alignment should be immediate, gradual and partial alignment was also considered. Partial alignment was discarded because of the additional complexity involved. A gradual alignment seems more likely, as this is most common for major tax law changes in Brazil.

Based on these areas and recommendations, Brazil’s tax officials commented that a broad change to Brazil’s tax legislation would be required as some areas cannot be addressed by regulations. Again, for this reason, most of the process will be political rather than a simple maneuver undertaken by tax officials to change their view and approach.