Brazilian transfer pricing rules

Brazilian transfer pricing rules determine the maximum deductible price on imports and the minimum taxable price on exports for income tax purposes, which are imposed in Brazil at a combined rate of 34%. If the actual price of a given import is considered not to satisfy transfer pricing rules, a portion of it is considered non-deductible and a positive primary adjustment is made for income tax purposes. In turn, a minimum taxable revenue should be booked if the actual price of a given export does not satisfy the transfer pricing rules.

Nonetheless, it is important to bear in mind that the Brazilian transfer pricing system is absolutely unique, differing enormously from the rules found in the majority of the developed countries and even from the OECD guidelines. In this sense, Brazilian transfer pricing rules are usually better understood if their differences are explained from the start. Accordingly, this introductory topic aims at presenting some of the unique features of the Brazilian rules before addressing them in more detail.

The biggest difference between the Brazilian rules and the reality worldwide is found in the fact that Brazil does not adopt the arm's-length standard (ALS) to calculate transfer prices. Brazil adopts a formulary apportionment system of transfer pricing, meaning that a given company's worldwide net income before taxes is calculated and apportioned between different countries based on pre-established arithmetic formulas. It is worth pointing out that several Brazilian scholars and some international professors affirm that the formulary apportionment system does represent a form of achieving the arm's-length price.

Another important difference is that Brazil does not adopt what is internationally known as the best method rule. In the majority of jurisdictions, taxpayers should adopt the methodology that provides the most reliable measure of an arm's-length result. In Brazil, taxpayers are entitled to freely choose any of the existing methods. Certain scholars even defend that, should a tax inspection on transfer pricing be initiated, tax authorities are required to choose the methodology that offers the best result for the taxpayer (the less burdensome methodology).

In Brazil, transfer pricing rules only apply to international transactions. Local transactions are subject to an even less sophisticated system known as the improper allocation of profits (distribuição disfarçada de lucros), which has the same underlying rationale.

Transactions entered into with companies located in low tax jurisdictions are immediately subject to transfer pricing rules regardless of the existence of any corporate or business relationship connecting the parties. The low tax jurisdictions are blacklisted by Normative Instruction No. 1,037/2010. Rumour has it that a new blacklist will be released in the near future.

Another unique feature of the Brazilian transfer pricing system is that royalties paid in consideration for the licensing of intangibles are not subject to transfer pricing rules (although certain restrictions for deducting expenses with royalties are found in ordinary legislation).

It is also worth mentioning that the statutory language of Law No. 9,430 only establishes that transfer pricing rules should apply for imports and exports. However, Brazil being a civil law country, where the law expressly defines the meaning of imports and exports, certain transactions may not fall within such concepts (contracts, certain intangibles, corporate reorganisations, etcetera). This creates practical problems about whether certain transactions should, or should not, be subject to transfer pricing control. A recent change in the legislation was made whereby it was expressly defined that back-to-back transactions are also subject to transfer pricing control.

Another consequence of using the formulary apportionment system refers to advance pricing agreements (APA). Although Brazilian companies are entitled to enter into an APA with the IRS, practically speaking such instrument only makes sense if a company does not comply with any of the methodologies set forth in the legislation. In turn, the Brazilian IRS tends to be extremely conservative when approving anything that could lead to a reduction of the taxes to be paid by companies. Consequently, APAs are rarely used in Brazil.

Finally, Brazilian legislation only provides for primary transfer pricing adjustments. On the other hand, Brazilian transfer pricing rules provide for neither correlative nor confirming adjustments (which may lead to double taxation).

With the main differences of the Brazilian system having been outlined, there follows below a summary of the Brazilian transfer pricing rules. Before addressing the methodologies in more detail, it is worth keeping in mind that Brazilian transfer pricing rules are relatively new when compared with those of other countries. Several situations therefore still remain unclear. Additionally, case law has still not yet been consolidated and the existing precedents mainly refer to imports. This is one of the reasons the recent changes in the transfer pricing legislation mainly refer to imports rather than exports.

It is also worth pointing out that transfer pricing primary adjustments should be informed to the IRS by means of the income tax return named a "DIPJ", which is usually submitted once a year (May or June). As part of this tax return, companies should also state the transfer pricing method they have adopted regardless of the existence of any primary adjustment.

As previously mentioned, imports from related parties and/or from entities located in tax havens are subject to transfer pricing control. If the actual price of a given import is considered not to satisfy transfer pricing rules, a portion of it is considered non-deductible and a positive adjustment is made for income tax purposes.

Given that Brazil adopts the formulary apportionment system to calculate transfer prices, the following methods are available for calculating transfer prices on imports of goods, services and transfers of rights: (i) comparable uncontrolled price method; (ii) resale price method; and (iii) cost plus method. More recently, a fourth method was created to address the import of commodities: the commodity exchange import price.

An arm's-length price under the CUP method is the average price of the same or similar goods, services or rights under the same contractual conditions in Brazil or abroad in the same fiscal year. The Brazilian IRS provides that comparability adjustments should be made whenever necessary to minimise the differences between the prices to be confronted (for example, payment terms, negotiated quantities, liability for freight and insurance). If it is impossible to identify comparables in the same period, the Brazilian IRS allows the use of comparables identified in the previous year, to the extent that currency exchange adjustments be made.

It is worth mentioning that multinationals generally do not adopt this method since the universe of comparables to be analysed is still not clear. In addition, the Brazilian IRS has access to information concerning all imports and exports of goods in and out of Brazil; multinationals do not, meaning the position of the tax authorities in a dispute would be stronger.

Historically speaking, the resale price method (locally known as PRL) has always been the methodology most frequently used by Brazilian taxpayers. Under PRL, an arm's-length price represents the average price of goods, services or rights sold/resold minus unconditional discounts, turnover taxes, commissions, and a presumed profit margin over the sale/resale price (less unconditional discounts) in the same fiscal year. Such presumed profit margin may vary from 20% up to 40% depending on the activity conducted by the company, as listed in Table 1.

Table 1
Gross profit margin	Sector/activity
40%	Pharmachemical and pharmaceutical products
	Tobacco-related products
	Optics, photography and cinematographic equipment and instruments
	Medical and dentistry-related machinery/equipment
	Extraction of oil and natural gas
30%	Chemical products
	Glass and glass-related products
	Cellulose, paper and paper products
	Metallurgy
20%	All other sectors

The price of goods resold is the effective price (wholesale or retail) used by the company with independent customers. In the transfer pricing regulations, the Brazilian IRS clarifies that this method is destined for both sale and resale of goods, services or rights, with or without addition of any value by the Brazilian company.

A recent change in the transfer pricing legislation modified how the PRL is calculated. Such change aimed at adapting the PRL to those transactions in which the imported product would not be resold, but rather be subject to a manufacturing process. According to the new legislation, although the calculation would still be based on the liquid sales' price, the ratio between products, services or rights purchased from a foreign related party and the final cost of the product, service or right sold to third parties, should also be taken into account.

The cost plus method provides that an arm's-length price is the average cost incurred abroad in a fiscal year to produce goods, services and rights, with the addition of taxes imposed by the other state on exports, plus a 20% margin applied exclusively on the cost.

To apply this method, the Brazilian company may use information provided by the related party that incurred costs abroad. Additionally, the Brazilian company may obtain information from third parties located in the same country of the related company that bore the cost.

Under PCI, transfer prices are defined based on the average commodity exchange price for the concerned item on the date of the transaction. Positive and negative adjustments can be implemented based on the premium paid in respect to such item. For those products not negotiated in commodity exchanges, Brazilian legislation authorises the use of prices obtained from reputable institutions.

The methods established by Brazilian legislation to calculate transfer prices on the export of goods, services or rights between related parties are: (i) export sales price method; (ii) wholesale price in country of destination less profit method; (iii) retail price in country of destination less profit method; and (iv) acquisition or production cost plus taxes and profit method. The only recent change in respect to exports refers to the creation of a fifth method, which is destined to calculate transfer prices connected with the export of commodities: commodity exchange export price.

It is worth mentioning that companies falling within the safe harbour set forth in the applicable legislation are not required to prepare a study to demonstrate the legality of their transfer prices. If a given company has registered more than 10% of the export revenue in the transactions with related parties as profit, it is entitled to demonstrate the correctness of its transfer pricing control based solely on the transaction's documentation (this percentage used to be 5%). However, please note that such safe harbour only applies if the net export revenue derived from transactions with related parties represents up to 20% of the total net export revenues.

Under PVEx, transfer prices correspond to the average of the export sales price charged by the company to other customers or other national exporters of identical or similar goods, services or rights during the same tax year using similar payment terms.

This is defined as the average wholesale price of identical or similar goods, services or rights in the country of destination under similar payment terms, reduced by the taxes included in the price imposed by that country and a profit margin of 15% of the wholesale price.

This is defined as the average retail price of identical or similar goods, services or rights in the country of destination under similar payment terms, reduced by the taxes included in the price imposed by that country and a profit margin of 30% of the resale price.

This is defined as the average cost of acquisition or production of exported goods, services, increased by taxes and duties imposed by Brazil, plus a profit margin of 15% including exchange gain variation, calculated based on the sum of the cost and taxes.

Similar to PCI, transfer prices under PECEX are defined based on the average commodity exchange price for the concerned item on the date of the transaction. Positive and negative adjustments can be implemented based on the premium paid with respect to such item. For those products not negotiated in commodity exchanges, Brazilian legislation authorises the use of prices obtained from reputable institutions.

For many years, interest practiced in cross-border loans between related companies was only subject to transfer pricing rules when such loans were not registered with the Central Bank of Brazil. For these cases, interest should not exceed the Libor rate for six-month US dollar deposits plus a spread of 3%, otherwise the excess was not deductible by the Brazilian borrower. On the other hand, the same amount should be accounted as taxable income by the Brazilian lender.

As of January 2013, all intercompany loans are subject to transfer pricing control, including the loans signed before such date. The definition of a maximum interest expense for Brazilian borrowers or a minimal interest income for Brazilian borrowers is now defined based on the following rules:

• Transactions in US Dollars (USD) at a fixed rate: the transfer pricing rate shall correspond to the market rate of those Brazilian sovereign bonds indexed in USD issued by the government on the external market;

• Transactions in Brazilian Reais (BRL) at a fixed rate: the transfer pricing rate shall correspond to the market rate of those Brazilian sovereign bonds indexed in BRL issued by the government on the external market; and

• Other cases: the transfer pricing rate shall correspond to the LIBOR for six-month deposits.

On top of such rate, a spread rate will be added to determine the interest rate for transfer pricing purposes. The Treasury will define such spread rate periodically. In 2013, the IRS defined a spread rate of 3.5% for regular transactions and 2.5% for transactions entered into with residents in low tax jurisdictions.

Thiago Medaglia
		Felsberg Advogados Tel: +55 (11) 3141 3660 Fax: +55 (11) 3141 9150 thiagomedaglia@felsberg.com.br www.felsberg.com.br Thiago Medaglia heads the tax practice of Felsberg Advogados, one of the most prestigious Brazilian law firms. He holds a LL.M. degree in domestic taxation from the Catholic University of São Paulo. He also holds another LL.M. degree in international taxation from Georgetown University Law Center, where he was designated graduate tax scholar and awarded with a full tuition scholarship.