Specifics of the new transfer pricing legislation
A key feature of the new legislation is the application of the arm’s length principle—the foundation of the new system, in line with OECD standards, which treats both parties in the transaction as completely independent, with neither party influencing the decisions of the other. One of the most challenging issues was striking a compromise between the legal certainty concept inherent in Brazil’s constitution and the OECD’s principle-based system. The presentation includes a section that details different kinds of transaction and their recommended treatment.
A list of scenarios where the concept of related parties would apply, if established to provide additional legal certainty, was highlighted in the presentation. Legal certainty is supplied through explicit and direct definitions, which is entirely new ground for Brazilian legislation. Contractual terms, functions, assets, and risks, product or service characteristics, economic factors influencing the parties, and market and commercial plans are all to be taken into account.
While such lists are often exhaustive (i.e., if a circumstance isn’t mentioned, it won’t be considered) but, in this case, applying the arm’s length principle to a situation that isn’t listed may result in a related-party transaction. Many firms may need additional guidance here, though clarification could yet come. The courts may be utilized for this clarification, at least in the initial years of the legislation’s enforcement.
Transactional profit mechanisms, such as the TNMM and profit split, will be permitted. There will also be provision for the use of other approaches (for example, the presentation mentions valuation methods for intangibles). However, the “best practice” approach will be followed, as well as the determination of the tested party based on the material available.
It makes sense to include transactional profit techniques. Brazil was a strong supporter of the two-pillar solution that resulted in the global tax agreement (GloBE), but Pillar One could not be implemented in Brazil due to its current transactional legislation—which makes the division of profits into amounts A, B, and C impossible. The precaution for intangibles makes sense as well, because IP can still be transferred overseas using only the cost plus 15% method. The best practice approach is also worth highlighting, since taxpayers may choose the option that results in the smallest modification. Under the best practice approach, there would be a contradiction between constitutional rights and a technique “better suited” for the transaction.
A pillar of the new system is comparability
The new system will be built on the foundation of comparability, which should be clarified by the new legislation. In recent years, many issues have arisen from a disregard for documents presented by the taxpayers, resulting in a loss of confidence between the tax authorities and the taxpayers. It will be critical for the incoming regime to strengthen this connection.
Correlative adjustments, spontaneous adjustments, and conforming adjustments will all be available as new features (under a MAP, for instance), but also primary adjustments if the arm’s length principle is not used. This is significant. Brazil has never permitted such modifications and has always reserved the ability to exclude paragraph 2 of Article 9 of the OECD Model Tax Convention from its treaties.
Commodities transactions will also be subject to OECD scrutiny, with the goal of capturing the true market value of the item by expanding the comparability adjustments.
Another major source of concern is intangibles. There will be a DEMPE analysis (development, enhancement, maintenance, protection, exploitation) for revenue and expenditure allocation, a definition of intangible for transfer pricing purposes, valuation methodologies, and assistance on coping with uncertainties. Further, the present deductibility constraints will be examined, since they serve as an anti-abuse mechanism that interacts with the arm’s length principle.
Intragroup services are a major step forward
Intragroup services will also be examined, and they constitute a significant advancement in our perspective. The new legislation will look at when a service fee is appropriate and when it isn’t. Those that aren’t acceptable typically have to do with shareholder actions or a duplicate service (which is normally not deductible in Brazil, outside of the necessary expense concept). It is possible to employ direct or indirect allocation keys, though the safe harbor for low-value-added services must also be addressed (the 5% mark-up was not mentioned). Cost Contribution Agreements for research, development and services will also be given specific attention, with sufficient remuneration to be determined.
It’s important to note that every imported service is subject to a 40% tax assessment. Although not connected to transfer pricing, it is necessary to recognize intragroup collaboration (rather than servicing) in order to avoid this extra charge.
Regulations on business restructuring will be established, primarily to provide sufficient remuneration in the transfer of profit-generating operations.