Brazil’s New Transfer Pricing Rules Make Detailed Records a Must

Multinational enterprises generally have welcomed the introduction of OECD-based transfer pricing regulations in Brazil. But given the particularities of the new system, taxpayers face challenges aligning existing transfer pricing policies and procedures with the new law for their Brazilian operations, which opens the door for tax controversies.

One challenge stems from new regulations requiring the use of comparable domestic transactions to test compliance with the arm’s-length principle under profit-based methods. This is standard practice across Latin America. But unlike other Latin American jurisdictions, Brazil has a large and mature stock market exchange that hosts more than 400 publicly traded companies—the most in the region.

As a result, global or regional data sets used by multinationals might need amending to cover Brazilian publicly traded companies that satisfy comparability factors under the new regulations. This could lead to inconsistent transfer pricing approaches for the same functions and risks, depending on where the related party is located—increasing the potential for controversy.

Another challenge that might give rise to controversy is applying a risk adjustment to profits of comparable transactions when using profit-based methods. Risk adjustment aims to account for differences in the economic circumstances of the market or country in which the tested party and comparable companies operate.

The effect generally will be to increase the arm’s-length range and expected level of profitability (and taxable income) of the Brazilian taxpayer as tested party. Multinationals might encounter this if they carry out baseline wholesale distribution activities in Brazil that are in scope of Amount B, a critical part of Pillar One of the global tax treaty.

Brazil is considered a qualifying jurisdiction for Amount B and has expressed interest to apply Amount B, which could end in double taxation, specifically for transactions with a US-related party. The US so far has been reluctant to apply Amount B, and there is no double tax treaty between the US and Brazil at the moment. Multinationals might want to model out an Amount B result, see how it compares with the current transfer pricing approach, and explore available options to mitigate any potential risk.

Another challenge for Brazilian taxpayers, specifically those importing raw material and tangible goods for resale, is how to align the new transfer pricing rules with customs valuation legislation.

The Brazilian transfer pricing rules provide for different types of taxpayer-initiated adjustments. One is a general tax adjustment, which is only permissible to increase the Brazilian taxable income. Another is a compensatory adjustment, which may be upward or downward and requires the related counterparty to make the same change.

While the compensatory adjustment may help Brazilian taxpayers reduce their taxable profit for income tax purposes, it’s unclear if and how the same affects other taxes. Where raw material and tangible goods are imported, a downward compensatory adjustment likely will be reflected in higher prices of the imports, which in turn might affect customs valuation and other taxes.

Those up- and downward adjustments won’t automatically impact the tax basis of other taxes, but there is no guidance on how to interpret the term “automatically.” Therefore, taxpayer must perform a case-by-case analysis to assess other potential tax implications before making an adjustment.

Brazil’s introduction of an OECD-compliant transfer pricing framework has opened up previously unavailable planning opportunities, such as using cost-sharing agreements to develop intangibles. However, the new rules also introduced business restructuring provisions with a potential exit tax.

Neither cost-sharing agreements for developing intangibles nor business restructuring are concepts previously known to Brazilian tax authorities and bear significant risk for controversy. If multinationals wish to change their Brazilian operations, they should consider the business restructuring rules, anticipate potential challenges by Brazilian tax authorities, and address those challenges in transfer pricing documentation.

Multinational taxpayers will have to help Brazilian tax authorities navigate the new environment. Thoughtful transfer pricing documentation is an important method for doing so and can mitigate future controversy.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Imke Gerdes is partner at Baker McKenzie in New York, focusing on international tax law and transfer pricing. She is admitted to the New York State bar, the German bar, and is a registered Austrian tax adviser.

Clarissa Giannetti Machado is partner at Trench Rossi Watanabe and head of its tax practice group in Brazil.

Carlos Linares-Garcia is a tax partner based in Mexico, the managing partner of the firm’s Monterrey office, and the head of Baker McKenzie’s North America and Latin America transfer pricing and economics practices.

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