Why is Brazil adapting its transfer pricing rules to OECD standards?

An important and critical step in Brazil’s integration into the OECD (Organization for Economic Cooperation and Development) has been the publication of its new rules on transfer pricing, but what is the purpose of its integration, the reason for the modification of its rules and the economic impact for the country?

Transfer pricing is the most controversial and complex issue in international taxation, and it also corresponds to the mechanism most used by multinational companies to move their profits from one jurisdiction to another.

Transfer pricing rules arise with the main purpose of protecting the tax base of countries in international operations, seeking that these transactions obey as much as possible the reality of the markets. These rules are based on the assumption that companies or related parties benefit from a more advantageous tax treatment using strategies to transfer their profits to jurisdictions with lower tax rates. In other words, the expectation is that, through a properly implemented transfer pricing practice, transactions between related parties will be carried out at market values thus avoiding profit shifting or tax evasion.

Now, why should such rules be aligned with OECD standards?

The OECD is an organization of 38 member countries, whose purpose is to establish international standards and propose solutions to various social, economic and environmental challenges. The Organization provides a forum for Governments to compare policy experiences, seek answers to common problems and identify good practices, seeking to promote prosperity and combat poverty through economic growth and financial stability.

Currently in Latin America, 4 countries are part of the Organization: Chile, Costa Rica, Colombia and Mexico, the latter being a member since 1994. Brazil is currently in accession talks with the OECD Council, as are Argentina and Peru.

On December 29, 2022, the Ministry of Economy of Brazil took a decisive step in the process that the country is going through to enter the OECD, through the publication of the new transfer pricing rules, contained in Provisional Measure No. 1,152 (“MP 1,152”).

The current Brazilian transfer pricing legislation, included in Law No. 9,430/1996, does not fully align with the OECD’s suggestions, as it considers certain predetermined methods with fixed margins. In other words, Brazil’s transfer pricing system does not follow the “arm’s length” principle, which has been widely criticized and questioned for differing from the international practice adopted by many countries, and has even caused economic damage to the country.

The new transfer pricing rules seek to correct existing gaps and weaknesses in the current system and problems resulting from the mismatch with the standard established by the OECD, since these divergences deteriorate the international business relationship, the insertion of the country in global value chains and the collection of tax revenues.

The federal government claims that the implementation of this measure is urgent due to a recent change in U.S. fiscal policy, which no longer recognizes or allows the tax credit for taxes paid in Brazil, due to deviations or gaps in the Brazilian transfer pricing system.

Another reason is due to the collection losses that Brazil experiences year after year, due to the various deficiencies in Brazilian legislation, which allow the erosion of the tax base and transfer of profits.

In this regard, if immediate legislative measures are not taken, the country could experience a significant reduction in current investment and lose competitiveness in attracting new capital, negatively impacting employment levels and the national economy.

From the implementation of this new framework, despite having as a counterpart the loss of simplicity and practicality of the current model, it is expected to allow a greater integration of the Brazilian economy in the international market, eliminating barriers that hinder and harm trade and foreign investment derived from the existing risk of double taxation.

It is important to mention that the new legislation has 40 articles, while the current legislation has only six articles. This legislative change stems from a project initiated more than four years ago, under the collaboration of the OECD with the Brazilian Federal Revenue Secretariat (Receita Federal do Brasil or “RFB”), which produced a detailed report on the Brazilian transfer pricing methodology and its transition to OECD rules (Convergence Report). Building on the findings of this assessment, the project explored Brazil’s potential to approach the OECD transfer pricing standard, which is a critical reference for OECD member countries, and followed by most countries in the world.

While the new rules will only take effect in 2024, there is an option to join such standards in 2023. Regardless of the case, Brazilian companies, as well as the entities that enter into transactions with them, must take into account that there is still much to regulate, business arrangements to analyze and modify to allow a convergence or approximation to the required standards and an infinity of administrative processes as a consequence.

Technically, the content of MP 1.152 is broadly descriptive and provides the necessary elements for the intended alignment with OECD standards. There are also subsections with special treatment for commodities (which still depend on more specific regulation), and more complex issues such as the application of transfer pricing adjustments and their interrelation with double taxation agreements.

Specifically, Chapter 3 deals with specific provisions and contains six sections that cover more specialized topics: transactions with intangibles, intangibles that are difficult to value, intra-group services, cost-sharing contracts, corporate restructuring, and financial transactions.

The current legislation, due to its limited scope and practicality, is not very demanding in terms of documentation, without a specific sanctioning regime, so Chapter 4 of MP 1.152 establishes the required documentation and the applicable sanctions.

On the other hand, although the new transfer pricing framework bets on objectivity and almost completely eliminates certain existing gaps, there are still certain aspects that can give rise to endless controversies or questions.

Considering the high degree of subjectivity of the practice of transfer pricing, one of the most relevant aspects in the implementation of the new system would be the questioning of the interpretative weight of the OECD Transfer Pricing normative guidelines and/or the UN Manual for resolving regulatory conflicts.

As an example, in Mexico, the Income Tax Law (“LISR”) establishes that for the interpretation of the provisions of said law, the Transfer Pricing Guides for Multinational Companies and Tax Administrations, approved by the OECD Council, which currently contains more than 650 pages, will be applicable. In this sense, by taking as a reference what is indicated by the OECD guidelines, endless disputes are avoided by subjectivity and / or interpretation of the current law.

Finally, it is worth remembering that transfer pricing is not an exact science but that it does require the exercise of judgment by the tax administration, as well as by the taxpayer. In this sense, it is expected that in the regulation and implementation phase of the new Brazilian regulatory framework, public consultations and greater debates will be held to provide clear answers in order to avoid disputes and controversies for taxpayers.

By Jáuregui y Del Valle, S.C., Mexico, a Transatlantic Law International Affiliated Firm. 

For further information or for any assistance please contact mexico@transatlanticlaw.com

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