Brazilian transfer pricing rules: a new approach?

A guest article by Tatiana Falcão, a member of Machado Associados e Consultores. This blog contains only the preamble to a much longer, more detailed article which is available here, and which will be available as a permanent item on our transfer pricing page.

The Brazilian Transfer pricing rules: a new approach to transfer pricing?
By Tatiana Falcão, Machado Associados e Consultores

The Brazilian legal system is a wild hairy beast, topped with a crust so thick it takes a vast amount of time, experience and expertise to get to the bottom of the policy underlying much of the legislation. And if the piece of legislation at hand is a tax law – well let´s just say that this is any entrepreneur´s worst nightmare. Brazilian tax laws are said to be confusing and complicated, because Brazil tends to “do its own thing” when it comes to regulating cross border and international tax situations. Brazil is averse to international conventions, mainly because they tend to reduce Brazilian tax authorities’ ability to tax. That does not mean that Brazil ignores intergovernmental organizations such as the Organization for Economic Cooperation and Development (“OECD”) entirely. What it means is that it takes international tax conventions and regulations only to be an inspiration for the creation of its own international tax laws.

Brazil´s failure to follow through with international tax standards brings about several cross border tax problems, many times resulting in over taxation for taxpayers involved in the transactions. Such additional costs resulting from the Brazilian legislation’s inefficiency, bureaucracy and lack of uniformity with international standards sum up to become the “Brazilian cost” in transactions involving Brazilian suppliers, service providers or counterparts. This problem appears to be most acute upon execution of the terms of the Double Tax Conventions for the Avoidance of Double Taxation and Evasion (DTC). That is because the Brazilian Federal Revenues Service´s (and the judiciary´s ) interpretation of the DTCs it has signed with other countries, tend to favor the Brazilian Federal Revenues Service, hence resulting in excessive taxation for the taxpayer(s) involved in the transaction.

More recently, transfer pricing has also started being a concern for multinational companies operating in Brazil. For many other reasons which go beyond the scope of this text, it is virtually impossible for a foreign company to regularly establish itself in Brazil by making use of a Permanent Establishment (PE). Therefore, most of the companies wishing to establish themselves in the country do so by establishing a subsidiary. Seeing as subsidiaries are independent entities endowed with legal capacity, they ought to obey transfer pricing provisions when transacting with their foreign related counterparts.

That interaction is in itself a conundrum, due to conflicting interaction between enforceable transfer pricing rules in (i) OECD member countries; and (ii) Brazil. The Brazilian transfer pricing regulations are unique in the world in the sense that Brazil aims to achieve the arm´s length standard by making use of a series of safe harbors and fixed formulae which are made available to the taxpayer for import and export transactions, respectively. The formulae will be further discussed under sections B.2. and B.3. below. The point being that because the Brazilian methodology approaches the arms length price objectively, through a mathematical formula, and the OECD transfer pricing regulations determine subjective approaches to achieve the arm´s length price in a transaction between related parties, sometimes the taxpayer is faced with a tough practical reality where he would need to apply one price in order to fit into the Brazilian transfer pricing standards, and another different price, in order to apply an arm’s length price which is compatible with the OECD transfer pricing regulation. Considering Brazil has never issued any rules or regulations of conciliation between the Brazilian and the OECD methodology, it is up to the taxpayer (and his or her lawyers) to “do his magic” and get by without a tax assessment.

On the other hand, the Brazilian system is unique in the sense that Brazil has been able to come up with an objective method which would allow the taxpayer to mathematically prove and determine what his transfer pricing benchmark is, without having to go through a search for comparables. This search for comparables is one of the main developing country concerns, seeing as they do not have such a wide and open market apt to produce reports on the prices practiced by competing companies commercializing comparable or similar products. Sometimes, a company might be the only producer of a specific type of product, making comparable search impracticable if not impossible.

Another criticism to the OECD proposed transfer pricing methodology that has been resolved by the Brazilian method, is the search for concurrent prices. Because developing countries’ markets tend to be concentrated with only a reduced number of players, new entrants to the market might not be able to access other companies’ product´s prices. For some companies, price strategy has a direct correlation with their competitiveness. By adopting fixed profit margins over the company´s own applied production or resale price, Brazilian tax authorities managed to develop a method which relies on the company’s/taxpayer’s own data, thereby removing the pressure from acquiring new data from the market.

Last but not least, Brazil managed to develop a system which in itself is endowed with juridical certainty. For developing countries, whose tax laws tend to be inconsistent and burdened by bureaucracy, the development of an objective methodology is therefore a plus, reducing the transaction’s overall risk of assessment.

Read the rest of the article here. See our transfer pricing page here.