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Brazil: Advancing towards global transfer pricing convergence

Carlos Ayub of Deloitte Brazil examines how Brazil is progressing with its goal of attaining OECD membership.

Since the beginning of his presidential campaign, President Jair Bolsonaro has made it clear that one of his administration's goals would be to make Brazil's membership of the OECD a reality. To deliver on his campaign promise, the Bolsonaro administration's economic team has organised a series of meetings between the Brazilian Federal Revenue Service (RFB) and OECD officials to discuss and address the main issues where there is disagreement, including on the topic of transfer pricing (TP).

Accordingly, on February 28 2018, the OECD and Brazil launched a joint working programme to assess Brazilian TP legislation in terms of its compliance with international guidelines. The purpose of this project was to examine the similarities and differences between Brazilian and international frameworks in the evaluation of cross-border transactions for taxation purposes.

On that occasion, the Secretary-General of the OECD, Angel Gurría, announced that a 15-month project would be conducted involving the OECD and the RFB, with the support of certain professional entities, for the purpose of seeking greater convergence of the Brazilian model with the international standard.

A follow-up meeting was held after the deadline on July 11 2019, with the OECD's head of the TP unit, Tomas Balco, in attendance. The completion of the project was announced and the convergence possibilities were discussed based on inquiries with several multinational companies and the tax administrations of Brazil's largest business and investment partners.

Based on the assessment of the strengths and weaknesses of Brazil's existing TP framework, possible options were explored for Brazil's alignment with the OECD standard. The options taken into consideration were either immediate alignment or gradual alignment. Both options contemplate enforcing the arm's-length principle, including streamlining measures to ensure tax compliance obligations are simplified, the efficiency of tax administration, and legal security from an international standpoint.

Five months later, on December 18 2019, a third meeting was held in Brasilia for the official release of an extensive report entitled 'Transfer pricing in Brazil: Towards convergence with the OECD standard'. The event was attended by Balco, RFB officials, Ministry of Economy representatives, diplomatic representatives of some countries, and representatives of multinational companies with a stake in the matter.

The report aimed at compiling the gaps, inconsistencies, achievements, and developments relating to Brazil, in comparison to the international standards and the OECD guidelines. It recommended alignment with suggested policies and corrected the distortions for transactions subject to TP rules.

A fourth meeting was scheduled for March 10 2020 to proceed with the convergence work but it was cancelled due to the restrictions created by the COVID-19 pandemic. As of June 2020, no alternate date has been suggested, however, it is known that the work on the new TP system is underway and OECD representatives are in regular contact with RFB virtually.

Gaps and divergences identified

What would be the main gaps and divergences identified between Brazil's existing legislation and OECD standards?

To put it briefly, while mentioning some of the main themes, these divergences include:

  • The prevalence of fixed profit margins to set a benchmark price (ignoring the reality of each industry sector);
  • The complexity of 'product-by-product' calculations;
  • The taxpayer's freedom to select a TP method;
  • The focus on goods at the expense of the so-called 'intangibles';
  • The absence of express mention of the arm's-length principle;
  • The misalignment with international methods such as the absence of the transactional net margin method (TNMM) and the profit split method;
  • The absence of specific considerations regarding the treatment of financial transactions;
  • The scope extended to exclusive distributors and tax havens;
  • Limiting the safe harbour rule to exports;
  • The absence of rules for permanent establishments (PEs);
  • The absence of advanced price arrangements (APAs);
  • Undeveloped mutual agreement procedures (MAPs); and
  • The absence of rules for secondary adjustments (true up).

A further necessary alignment measure is to balance analytical representativeness in both goods and services transactions, financial transactions, and royalties among other intangibles.

Main recommendations

In addition to the gaps and divergences identified above, the OECD assessment project also identified distortions and considered the potential impact that businesses withstand due to the local standards. These include:

  • Risk of double taxation, which hinders both international trade and foreign investments in Brazil, even though the existing system is perceived as practical and predictable;
  • Absence of specific considerations for more atypical cases and lack of rules to handle such transactions;
  • Favouring some categories of taxpayers to the detriment of others. While one group benefits from under-taxation, other taxpayers suffer over-taxation due of the use of fixed margins;
  • Legal uncertainty for companies operating abroad. Under Brazilian law, legal security in tax matters is generally found from a domestic standpoint due to the greater objectiveness of domestic rules compared to those adopted internationally. On the other hand, significant legal uncertainty is observed at an international level, as a result of the absence of special considerations or guidance, limited almost exclusively to specific transactions;
  • Loss of tax revenues resulting from the high volume of administrative and judicial litigation because of weaknesses found in the Brazilian legislation, as well as the lack of rules based on the assumption that Brazilian subsidiaries record profits;
  • The existing safe harbour regimes may lead to misreported results; and
  • The general difficulty of attracting foreign investments to Brazil.

As for the timing of the alignment, even though the RFB does not want to commit itself to any dates, it is known that ideally it should happen by the end of President Bolsonaro's term, which comes at the end of 2022.

Even though the alignment deadline has not been set, the alignment method was discussed in previous meetings. Thus, two possibilities were suggested:

  • Immediately: New rules consistent with the OECD standard and the arm's-length principle applicable to all taxpayers as from a given date; or
  • Gradually: New rules would progressively apply to different groups of taxpayers.

While the Brazilian authorities have shown resistance to giving up on the existing system altogether and emphasised its strengths (mainly its objectivity), defending a type of mix of local and international rules, the OECD has taken a firm stance requiring full compliance with OECD rules, even if either gradually or immediately.

In light of the apparent unwavering position of OECD representatives requiring full compliance with the international TP system, it seems reasonable to establish at least a transition period so that businesses can get used to and structure themselves for the changes as smoothly as possible, regardless of each individual company's group, size or industry.

Thus, taking into consideration the practical complexities that both taxpayers and the tax authorities will face, it is suggested that the most appropriate line of action would be to set a period during which a taxpayer could exercise the option to apply the international standards (in case such taxpayer feels it has the capacity and structure to do it) or continue to use the prevailing standards until the time these are no longer accepted, which would allow an uniform, progressive learning curve on both sides.

Even though alignment with the OECD framework presupposes the simplification of existing calculations, the subjectivity and capacity for economic analysis required by the international framework will require a certain level of specialisation on the part of both taxpayers and the tax authorities.

It is no news for taxpayers that, once again, they will have to seek resources and support to comply with international standards should they, in fact, be implemented in Brazil. However, some paradigms and resistance typical of governmental structures will have to be overcome in order to build capacity to properly review and judge the issue.

Accordingly, it is to be expected that the RFB will have to build the capacity of its staff through intensive training of its agents and the design of specific inspection procedures. It will also have to define regional competence and create a database of comparable data, in addition of training CARF (Chamber of the Administrative Tax Appeals Council) members.

Thus, additional aspects will have to be added to the tax authorities' restructuring discussion agenda, such as to:

  • Create a nationwide team of TP experts;
  • Start to hire career tax agents with a proper educational background through a competitive process;
  • Create a culture of communication between taxpayers and tax authorities.

Localisation mechanism

One of the foreseen challenges is the development and implementation of safe harbour regimes that streamline and provide assertiveness to the taxpayer, since transactions covered by such mechanisms would require a much lower level of documentation than what is required in a conventional analysis.

In principle, the safe harbour would be used for low materiality transactions both in imports and exports, as well as for entities of lower economic representativeness.

Even though the RFB, as well as some professional entities, have expressed the desire to keep part of the rules conceptually active as a sort of safe harbour regime, little is known about what to expect from these schemes.

The route forward

Technical work will continue in 2020 as the project enters a second phase. Authorities will prepare a proposal for a system blueprint and an implementation roadmap that describes the transition process, including for guidelines on the revamped system's development policy and the RFB's assessment of the tax impact.

Even though the RFB had not committed to a deadline, until the arrival of the COVID-19 pandemic, it was expected that a first draft of the updated legislation, even if nascent, would have become available by the end of 2020. With the entire focus of the government's economic team concentrated on mitigating the effects of the pandemic, this deadline becomes even more uncertain.

In any case, for Brazil to successfully and swiftly join the OECD, the government is expected to undertake some initiatives that make this process transparent and ensure taxpayers' compliance. Therefore, it is necessary to constitute technical groups focused on specific areas, carry out public hearings on the proposed law, and keep a structured dialogue with the participants, drawing on the contributions of businesses, trade associations, and professional entities.

However, it is important that the tax managers of companies operating in Brazil also do their part by getting ready for this radical change, which will require restructuring their trade with related entities.

Thus, assessing the international TP framework in force in your company and discussing it with the global officer responsible for this issue is of paramount importance. This would involve addressing the group's policies, checking if the Brazilian company is already qualified and if there is a pricing expectation by function, and finding out how the Brazilian company is portrayed in the ultimate parent company's master file, are key first steps to determine the tax impacts that would result from this transformation.

It is recommended and healthy that the Brazilian entity conducts an exercise to anticipate the impacts of this change on its business. Therefore, our recommendation as professionals acting in the TP area is that companies start mapping and segregating their transactions according to the OECD Guidelines. Companies should carry out their functional analysis by outlining risks and functions in the context of the transactions carried out, and identify which international methods would be applied considering which would be the tested part for each identified function/transaction.

Finally, it is also recommended that companies carry out their economic analysis taking into account the selected methods and tested parties, by searching possible comparable markets to assess the limits and identify the related profitability or pricing determined by a tested party.

These are preventive tasks that the managements of the companies established in Brazil should consider, which will increase their preparedness to enter the evolving TP landscape, while avoiding higher disbursements both of compliance costs and taxation itself.

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Carlos Ayub

Partner
Deloitte Brazil

T: +55 11 5186 1227
carlosayub@deloitte.com

Carlos Ayub has worked as TP partner in Brazil for 12 years, among which, he has served eight years as the national TP practice leader.

In the TP area, where he has been working since 1999, Carlos has provided services to local, European, Asian, Latin American and North American clients operating in various industries, such as automobile, chemical, pharmaceutical, and electronics.

Carlos has more than 30 years of professional experience, which besides TP services includes accounting audits and corporate tax. In 2001, he moved to the Mexico City office to work with TP projects under the OECD approach, matching Brazilian and international rules.

Carlos has authored various articles on TP for reputable magazines, newspapers and other publications with national and international circulation. He is a member of the Brazilian TP group, which has been recognised by different institutions for several years as having the best TP team in Brazil.

Carlos has been recently cited as one of the best references for TP in the Brazilian territory by Euromoney's Expert Guides publication.


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