By Debora De Souza Correa Talutto (Group Transfer Pricing Manager, Temenos Banking Software Co.)
The Brazilian transfer pricing rules were created to address the maximum tax deductible costs or expenses when domestic taxpayers buy goods and services from foreign suppliers, and the minimum taxable revenues when local companies sell goods and services to foreign customers.
Therefore, transactions carried out by an individual or a legal entity resident/domiciled in Brazil with a related entity domiciled abroad must be done in accordance with the Brazilian transfer pricing legislation to obtain deductibility of the costs of imported goods, services, and rights; and recognition of income and revenues derived from export transactions.
Deviation from OECD’s transfer pricing guidance
However, Brazilian transfer pricing rules are not just applied to transactions between related parties; it is also applicable for transactions with entities located in low tax jurisdictions, which is very different from the OECD guidance.
According to common international tax practice, to determine the amount of income that a multinational enterprise (MNE) earns in each jurisdiction where it does business, it is necessary to apply the arm’s length standard, which has been the basis for the development of transfer pricing rules and is recognized by the OECD as the best practice. Under the arm’s length standard, a MNE has to price the transactions with its affiliated entities “as if” those transactions had occurred with unrelated entities.
Although Brazilian transfer pricing rules make indirect reference to the arm’s length standard, it is a consensus between practitioners that the Brazilian transfer pricing rules are a deviation from such standard because they are based on a mathematical approach that considers peculiarities of the Brazilian market and uses fixed margins without the possibility of applying a proper statistical analysis.
There are similarities between the transactional methods prescribed by the OECD and the Brazilian transfer pricing rules; however, the use of fixed margins constitute a clear conflict with the arm’s length standard, as they do not constitute a market comparison. In addition, the Brazilian transfer pricing methods use a legal presumption of profit margin, which does not reflect the reality of the market.
Transfer pricing methods, safe harbor provisions
Law No. 9.430/96 determined the details for the application of the Brazilian transfer pricing methods which:
- Are based on the nature of the transaction: import, export, or interest (contracts); and
- Use fixed percentages in the determination of prices, even though it is clear that market prices are not fixed.
Some of the methods cited in Brazilian legislation are based on the annual weighted average, which may suffer great variations at certain times, and cause distortions in the interpretation of the result.
Additionally, Brazilian TP regulations include safe harbors concerning export transactions, which significantly differ from the transfer pricing regulations in other countries. If the taxpayer qualifies for the safe harbors, it may prove the adequacy of the prices charged on those exports, for the same period, exclusively with the documents related to the operation itself, considering solely what is accounted for in its balance sheet. Although these safe harbors might provide more certainty to the taxpayers, it increases the compliance burden and the potential risk of double taxation.
Aligning transfer pricing regime with OECD guidance
These factors corroborate the conclusion that the prices obtained by applying the Brazilian TP legislation are considered a distortion of the arm’s length standard and do not provide an accurate comparability with unrelated transactions. Now that Brazil has applied to join the OECD, how can the Brazilian transfer pricing rules be aligned with the international standards?
Currently, the main issues the Brazilian tax authorities will have to overcome are: the application of fixed margins should become more flexible; the application of simplistic cost formulas should take into consideration cost sharing structures and other “production” costs that might be relevant in the digital economy; and excessive control over comparables must be minimized.
 Related company is defined in Normative Ruling No. 1.312/2012. Note that transfer pricing rules also apply to transactions with companies situated at tax haven countries (the concept of tax haven is defined in Law No.11.727/2008)
 Law No.9.430/96 and Normative Ruling No.1.312/2012
 See Article 24 of Law No.9.430/96 and note that this specific rule will need to be revisited by the legislators because the current tax reforms around the world have significantly reduced the income tax rate, and the 20 percent threshold might not be relevant to determine a “low tax jurisdiction.”
 Some critics considers the arm’s length standard as a fictional attempt to measure the value of the transaction ignoring certain efficiencies and economies of scale from operating related business that would not exist if the parties were not related
 However, the transfer pricing rules do not apply to royalties and technical, scientific, administrative, or other type of assistance, since these payments are subject to specific rules of deductibility
 Fixed market prices would violate the principle of free competition and equality of the market
 The taxpayer must provide the tax authorities all the documentation to show that he or she qualifies for the safe harbor (Normative Ruling 1312/2012 – Articles 48-49)