Since the enactment of Law 9430 in 1996, Brazil has encountered criticism over its TP legislation. The Brazilian standard is unique, which hinders the adoption of international pricing policies, restrains the incorporation of Brazilian entities into the value chains of multinational groups and imposes a significant tax burden on certain taxpayers involved in related-party transactions.
The intention to join the OECD, as documented by the Brazilian government in 2017, meant developing a work agenda between the Brazilian Federal Revenue Office (RFB) and the OECD. This gained momentum and notoriety after the enactment of US Treasury regulation (TD 9959), which limited tax credit claims on transactions conducted in Brazil because of the lack of TP rules aligned with the arm’s length principle (ALP). This resulted in the issuance of Provisional Measure (MP) 1152/22.
The MP addresses the determination of the corporate income tax (IRPJ) and social contribution on net income (CSLL) tax bases for legal entities domiciled in Brazil that engage in controlled transactions with foreign related parties. In the latter case, the terms and conditions governing a controlled transaction will be set out in conformity with those terms and conditions that would be established between unrelated parties in comparable transactions. As a result, the MP determines the ALP as the key underpinning of the TP rules in Brazil. The material effects of this are effective beginning January 1 2024 and adoption is optional for calendar year 2023.
Next, we describe the key provisions extracted from the MP, which, at time of writing, was approved by the national congress and sanctioned by the president, and renamed as ordinary law number 14,596/23. It is also worth mentioning that to date, no supplementary regulation was issued by the RFB, which would clarify how the new rules will be applied in practice.
Subjected transactions
Current TP legislation includes certain limitations on the type of transactions subject to an assessment of the deductibility thresholds of costs and expenses on import transactions. Besides recognising a minimum amount of export revenues, the Law 14.596/23 prescribes that controlled transactions comprise any business and financial relationships between two or more related parties, conducted either directly or indirectly, including only a single transaction or series of transactions.
Pursuant to Law 14.596/23, parties are ‘related’ when either are directly or indirectly influenced by another party, so that the terms and conditions governing their transactions may differ from those agreed upon between independent entities. This definition is broader than the former concept of relationship set out in Law 9430/96, and may include certain business arrangements even without the direct involvement of entities belonging to the same corporate group.
The new rules also apply to transactions carried out with any legal entity residing or domiciled in a country or jurisdiction with a favourable taxation or under privileged tax regime. This is defined as a country that does not tax income or taxes income at a maximum rate of 17%, or a country that does not tax income earned outside its territory or taxes income at a maximum rate of 17%, usually referred to as tax havens.
Application of the arm’s length principle
Under the provisions of Law 14.596/23, controlled transactions are assessed according to their terms and conditions, focusing on those that would be agreed upon between unrelated parties.
For such purposes, the rules require the application of the comparability analysis that can be performed from different standpoints, but essentially conducted to compare the terms and conditions of the controlled transaction with a transaction deemed as comparable. It encompasses, among other aspects:
The economically relevant characteristics;
The transaction date;
The availability of reliable information;
The selection of the most appropriate method;
The pricing uncertainties; and
The relevance of group synergy effects, if any.
Unlike old laws and regulations, Law 14.596/23 emphasises that the controlled transaction cannot be disregarded exclusively because no comparable transactions are identified, a wording absent in the current statute, which leaves uncertainty. Still, it is emphasised that if the unrelated parties would not have entered into the transaction or series of transactions, they may be disregarded.
Selection of the most appropriate method
The financial indicators examined using the most appropriate method include prices, profit margins, ratios, profit sharing or other information deemed relevant and consistency with the terms and conditions of controlled and comparable transactions. Taxpayers are required to identify the most appropriate method among the following:
Comparable uncontrolled price (PIC) consists of assessing the prices or amounts of the consideration from comparable transactions. This is the most appropriate method whenever reliable pricing or consideration valuation information is available for independent transactions;
Resale price less profit (PRL) consists of comparing the gross margin on the resale to unrelated parties with the gross margins obtained in comparable transactions;
Cost plus profit (MCL) consists of comparing the gross profit margin obtained on the supplier’s costs in a controlled transaction with the gross profit margins obtained on costs in comparable transactions;
Net transaction margin (MLT) consists of comparing the net margin of the controlled transaction with the net margins of comparable transactions carried out; and
Profit split (MDL) consists of dividing profits or losses in a controlled transaction in accordance with the terms and conditions that would be established between unrelated parties, considering the significant contributions provided in the form of duties performed, assets used and risks assumed by the parties to the underlying transaction.
Other methods are available, provided that the alternative methodology leads to outcomes that are consistent with those that would be achieved in comparable transactions – this can also be called the “sixth method”. The other method must also comprise the adoption of economically reasonable possibilities to price controlled transactions that cannot be properly evaluated by the other methods, whether due to the absence of comparable prices or the specificity of the transaction.
The Law 14.596/23 underlines transactions involving commodities, i.e., physical products for which quoted prices or reliable ratios are used as a benchmark by unrelated parties, determining the PIC method as the most appropriate option for those cases. Nonetheless, other methods may be applicable.
Range of comparable transactions and adjustments
Applying the most appropriate method may lead to a range of rates, margins or indexes arising from comparable transactions.
The new statute provides for the adoption of an interquartile range when there are uncertainties over the degree of comparability. It also provides a full range, when transactions between independent parties have an equivalent degree of comparability in relation to the controlled transaction.
In the event the financial indicator of a controlled transaction is within the appropriate range, no adjustments to the income tax and social contribution tax bases will be required. If not, the indicator adjustments will be applied in relation to the median amount.
TP adjustments may be made through the following:
Spontaneous adjustments refer to adjustments made by a legal entity domiciled in Brazil directly to the calculation of tax bases (based on a taxpayer’s analysis carried out after the fiscal year end);
Compensatory adjustments refer to adjustments made by the parties to the controlled transaction until the end of the calendar year in which the transaction was carried out (based on a taxpayer’s analysis carried out before the fiscal year end that cannot be aimed at reducing the tax bases or increasing accumulated losses, unless in accordance with certain provisions issued by the RFB); or
Primary adjustments refer to adjustments made by tax authorities with a view to adding to the tax bases (analysis conducted by tax authorities after the fiscal year end).
Transactions involving intangible assets
Intangible assets represent assets that, other than tangible or financial assets, are likely to be held or controlled for use in business activities and for which use or transfer would be interest-bearing should the transaction be conducted between unrelated parties.
The development, enhancement, maintenance, protection and exploitation analysis should be adopted for assessing the duties, risks and assets related to the intangible assets. This requires determining the parties involved and engaged in performing activities in connection with the development, enhancement, maintenance, protection and exploitation of intangible assets. Therefore, the delineation of transactions must also designate the parties performing the duties, using assets and assuming the economically significant risks, focusing on the parties that exercise control over and have the financial capacity to assume them.
The Law 14.596/23 revokes certain articles from the income tax legislation that address the limits and requirements for the deductibility of royalties and technical, scientific and administrative assistance or similar services.
Intragroup services
The provision of services comprises any activity performed by a party, including the use or provision, by the service provider, of tangible or intangible assets or other resources entailing benefits for one or more parties.
The performed activity entails benefits if it provides a reasonable estimate of the economic or business value to the other party to the controlled transaction. This is to enhance or maintain its business position so that unrelated parties, under comparable circumstances, would be willing to pay for the activity or perform it on their own account.
One may consider that the performed activity does not entail benefits if:
The activity is characterised as a partner activity; and
The activity represents the duplication of a service already provided to the taxpayer or that has the capacity to perform—except in cases where the duplicated activity results in additional benefits for the service taker.
Cost contribution agreements
Cost contribution agreements comprise any agreements under which two or more related parties agree to share the contributions and risks underlying the acquisition, production or joint development of services, intangible assets or tangible assets based on the share of the benefits that each party expects to be entitled.
Business restructuring
Business restructuring comprises changes to business or financial relationships between related parties leading to potential profit shifting associated with the transfer of duties, assets, risks, or business opportunities. The compensation for the transfer of potential profit will comprise the joint amount of transferred items.
Financial transactions
The Law 14.596/23 defines the following as financial transactions and, therefore, subject to assessment from a TP standpoint:
Loan transactions: if a controlled transaction involves the provision of funds and is documented as a “loan transaction”, the provisions set forth in the Law 14.596/23 will apply. This will determine whether the transaction will be either fully or partially delineated as a loan transaction or capital transaction. The terms and conditions of a controlled transaction that are delineated as a debt transaction will be established in accordance with the ALP.
Intragroup guarantees: whenever a controlled transaction involves the granting of guarantees in the form of a legally binding commitment of the related party in the event of debtor’s default, one should determine whether the granted collaterals will be delineated. This applies whether fully or partially, as: services (in which case compensation will be due to the guarantor), partner activity or capital contribution (in which case no compensation will be due).
Centralised cash management agreements: the terms and conditions of a controlled transaction defined as a “centralisation transaction of cash balances” (also characterised as cash pooling) of related parties arising from an agreement with the objective of managing short-term liquidity will be established from the ALP.
Insurance contracts: the terms and conditions of a controlled transaction involving an insurance transaction between related parties, and which is delineated as a service, will be established from the ALP. The terms and conditions of a controlled transaction involving insurance contracts between related parties, which is delineated as provision of services, will be established according to the ALP.
Documentation
Taxpayers are required to provide the supporting documentation for their TP analyses and to substantiate that the transactions conducted with foreign parties are consistent with the ALP. For reporting purposes, taxpayers should provide every and any information used as a basis for the delineation of transactions, comparability analysis, controlled transactions and in the identification of the parties to the controlled transactions. It is worth noting that this documentation and provided evidence are similar to the ‘local file’ and ‘master file’ document from Action 13 of the OECD BEPS project. Additionally, a TP declaration (specific return) shall be provided by the taxpayer on a format to be defined by tax authorities.
The RFB will determine the appropriate way information should be provided as regards the filing or submission of documents, reports and tax filings. This is in addition to assessing the materiality of the transactions subject to the submission of documents and related deadlines, considering the possibility of granting additional periods in the first year.
Out-of-court settlement procedures
As for outcomes agreed upon through dispute resolution, the tax authorities are required to assess whether the tax assessment issued conforms with the provisions of the international agreements or conventions to eliminate double taxation to which Brazil is a signatory.
Regulatory instruction 2132/23
Regulatory instruction (IN) 2132, enacted on February 24 2023, the first documentation about the MP, rules that taxpayers who are assessing the early adoption of the rules presented in the MP for calendar year 2023 will have to finalise their option between September 1-30, 2023.
The IN also states that spontaneous and compensatory adjustments will only occur when noncompliance with the ALP results in an IRPJ and CSLL tax base lower than the tax base that would be calculated if said principle had been observed. In other words, the mentioned adjustments could only be made if they increase the IRPJ and CSLL tax base or reduce the tax loss carryforwards.
Given the conversion of the MP into the Law 14.596/23, the IN shall be adjusted to reflect the updated text. At this opportunity the RFB may consider reviewing the possibility of the compensatory adjustment also with the purpose of reducing the IRPJ and CSLL tax base.
