Over the past decades, Brazilian transfer pricing rules (Brazilian TP rules) have been severely criticised by tax practitioners, multinational enterprises (MNEs) and foreign governments because of its singular approach, leading to double or no taxation in many different instances given the lack of symmetry between the TP regulations adopted by the vast majority of jurisdictions (i.e., OECD Transfer Pricing Guidelines – OECD TPG) and the Brazilian formulary approach.
The effects on the lack of harmonisation between the Brazilian TP rules and the OECD TPG are hard to measure. But, it is tangible within the business community that the deviation of the Brazilian TP rules has caused an impact on the transfer of new businesses to Brazilian subsidiaries of MNEs, taking them away from the possibility of being part of the global supply chain, for instance.
Furthermore, the deviation of the Brazilian TP rules has exposed MNEs to the wildness of the Brazilian tax environment as it has caused a massive volume of tax litigation against tax assessments deriving from TP adjustments. In many cases, the most significant tax exposure of MNEs in their global organisation comes out of TP disputes in Brazil. This issue by itself turns out to be a compelling business driver for MNEs not to invest more in their Brazilian subsidiaries.
Given that, a pathway for improvement and alignment of the Brazilian TP rules to the OECD TPG has been discussed and recently became more prominent since Brazil formally requested its accession to the OECD on May 2017. By the end of 2019, a comprehensive report named “Transfer Pricing in Brazil: Towards Convergence with the OECD Standard” was jointly released by the Brazilian government and the OECD, assessing the convergent points and mismatches between the Brazilian TP rules and the OECD TPG, and potential alternatives for alignment and measures to tackle discrepancies (Assessment).
Upon the release of the Assessment, the Brazilian government has unofficially but very vocally, communicated to the business community that Brazil should adhere to the OECD TPG, possibly as soon as from 2021 or 2022. The decision of the Brazilian government to achieve an alignment with OECD TPG is a historical milestone, since, not long ago, it refused to accept the embracement of such guidelines.
The Assessment revealed a large number of inconsistencies of Brazilian TP rules that would increase the risk of double taxation, discouraging international trade and foreign investment. Likewise, a significant amount of gaps identified would create BEPS risks and loss of taxable revenue, remarkably due to the lack of special provisions for more complex transactions, such as the ones involving intangibles, financial instruments, intragroup service, and business restructurings.
The positive aspects found by the Assessment on Brazilian TP rules primarily refer to the general simplicity of tax compliance and ease of tax administration. Tax certainty also plays a factor in this field; however, it is restricted to the domestic level and only to a limited extent as such certainty does not exist for more complex transactions that lack special provisions.
In this context, although historically most of the tax practitioners and business community have positioned themselves in favor of a TP harmonisation, more recently, dissonant voices have been raised doubting on the benefits of reaching alignment with the OECD TPG. The main arguments are that Brazilian TP rules are not necessarily inconsistent with the arm’s-length principle; tax compliance simplicity and ease of tax administration would be missed; the absence of the best method rule; tax controversy would increase, and a formulary approach would still be a better option for developing countries despite its inconsistencies.
However, it can also be argued that the Brazilian TP rules’ formulary profit margins generate an unfair tax treatment among taxpayers by providing a more flexible environment to individual taxpayers or industries relatively to others. Rarely, the economic reality of the transaction matches the rigid approach of local TP rules, especially considering the fast-paced and continuous developments of the global economy.
The so-called simplicity and easy TP documentation is not always transposed when actually
putting the arms around the actual documentation process (e.g., massive data volume, need to document on a product-by-product basis, inconsistency on the application of TP method, etc.).
Another argument in support of the existing Brazilian TP rules is the absence of best method rule, which would provide flexibility to taxpayers to switch back and forth between TP methods to avoid any adjustment upon taxpayers’ convenience. In practice, the reality is much harder as the majority of taxpayers are stuck with the resale minus method. This applies because of many limitations on the application of the Brazilian version of the uncontrolled comparable prices, cost-plus method and absence of non-traditional TP methods, not to mention the reluctance of Brazilian tax authorities to accept how to apply such methods in an audit process.
By accepting that there is no perfect model to address the deficiencies and vulnerabilities of the existing system fully, the complete alignment to the OECD TPG seems to present relatively more upsides than downsides. For now, a partial alignment is apparently out of the question as it was disregarded by the Assessment reasoning that it would not eliminate the main flaws identified – even though it is expected that the Brazilian government may customise the OECD TPG to our economic reality, which is a recurrent procedure when adopting international norms and standards.
Also, alignment to the OECD TPG should not be perceived as a path to immediate and entirely solve Brazilian TP and surrounding issues. Instead, the alignment to the OECD TPG undoubtedly will estimulate Brazilian economy, international attractiveness, and, ultimately, will promote Brazil’s taxation rights and preserve Brazil’s taxation basis.
The mitigation of potential drawbacks arising from the alignment may be achieved by implementing some mechanisms, especially related to documentation, audit process and introduction of reasonable transition rules to facilitate the conversion to the OECD TPG. The increase in tax litigation could also be curtailed by a joint effort of administration and taxpayers though transparency and information on reliable database for assessing comparability.
As a conclusion, the alignment of the Brazilian TP rules to the OECD TPG is a long-term endeavor, that will demand a costly workload, administration resources, and shall require a continuous improvement in the following years. However, as this measure tends to foster the inflow of investment in Brazil, enhance competitiveness of Brazilian economy in a global context, and promote the integration of Brazil in global value chains, benefits prove to surpass disadvantages.
Gil F. Mendes
T: +55 11 3147 4632
E: gil.mendes@mattosfilho.com.br
Ivanise Filatow
T: +55 11 3147 8604
E: ivanise.filatow@mattosfilho.com.br
