It is not unusual for companies to negotiate their products altogether, regardless of their individual prices, as they aim to reach an overall profit. The price of a product is cut down to stimulate the purchase of a more profitable one among a group of products. In these cases, when the transactions are carried out between associated companies, the appropriate ascertainment of transfer prices and of the arm’s length principle should take into account the set of assets as compared to a pack of similar assets, which is referred to as the basket approach. However, the use of this method in Brazil still raises debate.
In fact, Law no. 9430/96, which establishes Brazilian transfer pricing rules, does not mention the basket approach as a way to ascertain transfer prices, nor requires taxpayers to treat products separately when using the transfer pricing methods.
However, such requirement is established in articles 4 and 20 of Federal Revenue Service’s Normative Ruling – IN/SRF no. 243/02, which determines that the method chosen by the taxpayer be used “by asset, service or right”. This means that, from a tax standpoint, transfer prices should be ascertained by product. Accordingly, the information provided by taxpayers on their income tax returns is also provided by product, identified by tariff code (Mercosur Common Nomenclature – NCM) and indicating the method adopted for each product.
Tax auditors are required to apply such a rule, even though it refers to an administrative rule that, in theory, could not alter or expand the scope of the law it intends to govern.
In addition, we should point out that this normative ruling acknowledges, in articles 9 and 15, that the quantity traded may influence the practiced price. Considering that variations of term or quantities traded may be adjusted for comparison purposes, product price reductions should be accepted when making up for bigger margins of other products sold altogether, under the penalty of not reaching the arm’s length principle.
Although Brazil is not a member of the Organisation for Economic Cooperation and Development (OECD), and, therefore, is not required to comply with any of its resolutions, it is undeniable that Brazilian legislation was inspired in the rules of said agency. In view of that, we should check OCDE’s understanding.
Article 9 of the OECD Model Convention with respect to taxes on income and on capital (associated enterprises) does not seem to require making adjustments of profits on transactions between associated enterprises by product or service, on an individual basis. That is because said article only establishes that if the transactions between associated parties are carried out differently from what would be agreed between independent parties, profits unearned owing to these special conditions could be taxed.
In order to reach the arm’s length principle, OCDE (Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations) acknowledges that there are cases in which transactions must be analysed altogether, for instance, if the company engages transactions with independent parties involving a set of high-profitability products, but varying according to each item of the set.
In Brazil, doctrine advocates adopting the basket approach, but the matter is not seen in case law. Only two relevant Congress bills are found, one directly referring to the matter, while the other mentions it indirectly.
The first was Bill no. 4695/01, which intended to implement several changes to transfer pricing legislation, including, among others, the possibility to apply the transfer pricing methods: (i) on sets of products traded as a whole or that have their commercial application connected to other products, or (ii) on products gathered if their commercial proximity is proven – considering prices and target market – or (iii) altogether on the set of assets imported or exported from or to the same partner. However, such bill ended up being shelved.
The second bill, announced but still not sent to Congress, refers to the so-called tax transaction, a tool that allows prior negotiation between the taxpayers and the tax authority aiming to avoid future contingencies. A preventive transaction may be intended to allow application of the basket approach and to check and ascertain transfer prices.
In summary, although there is no legal provision for adoption of the basket approach in transfer pricing methods, tax authorities have issued resolutions requiring the application of the methods individually by product. Therefore, the use of the basket approach will very likely be subject to assessment, seeing that tax authorities adopt normative rulings even if those have exceeded their regulatory power.
