In February 2018, the OECD and Brazil started a joint project to analyze the similarities and differences between Brazilian legislation and the transfer pricing (“TP”) frameworks to assess cross-border transactions between associated enterprises from a tax standpoint. This project is within the scope of Brazil’s initiative to engage with the OECD in tax-related projects, and, in a broader respects, consistent with Brazil’s interest in initiating the process to join the OECD.
Stages of the Project
The project had three stages:
- Stage 1: preliminary analysis of the legal and administrative framework of Brazil’s transfer pricing rules;
- Stage 2: assessment of the strengths and weaknesses of Brazil’s existing transfer pricing rules and administrative practices; and
- Stage 3: options for alignment with the OECD transfer pricing standard.
The study led to the identification of certain issues resulting from gaps and differences between the Brazilian and the OECD’s TP framework, which weaknesses resulted in BEPS and double-taxation issues. On the other hand, the study also identified some strengths of the Brazilian TP framework in relation to the facility of compliance for taxpayers and of administration by tax authorities. However, such strengths should not undermine the achievement of the dual purposes of the TP rules, i.e., secure the tax base in each jurisdiction and avoid double taxation. So, the objective would be to achieve the TP rules purposes consistent with the arm’s length principle and internationally accepted practice, which should be achieved with the implementation of a modern, simple and efficient TP system in line with the OECD standard.
Key Reasons for the Project
- Brazil’s TP regime (1996) was inspired by the work of the OECD (1979 Report) and, despite the significant revision in the OECD TP Guidelines (1995), including those derived from the BEPS Project – particularly BEPS Actions 8-10, Brazil’s system remains relatively unchanged;
- Brazil’s TP system contains a number of significant gaps and divergences from the OECD system, which reportedly led to double taxation and BEPS opportunities (impact on investment and revenue collection); and
- Some alignment with OECD TP framework is important for Brazil to join the OECD.
Assessment of Effectiveness and General Conclusions
- A large number of the gaps and divergences lead to instances of double taxation.
- A large number of the gaps create BEPS risks, leading to loss of tax revenue.
- The existing system favors some categories of taxpayers to the detriment of others and provides tax planning opportunities.
- Tax administration and tax compliance aspects of the Brazilian system are generally conducive to ease of tax administration and tax compliance.
- Tax certainty is generally provided but only from a domestic perspective; significant tax uncertainty is observed from an international perspective.
- Further tax uncertainty, even domestically, results from the absence of special considerations or very limited guidance for issues related to specific types of transactions, such as transactions with intangibles.
Source of the Main BEPS Risks
- Absence of adherence to the arm’s length principle;
- Different criterion for the selection of the method (freedom of choice rather than most appropriate method criterion);
- Absence of transactional profit methods (transactional net margin method and profit split method);
- Specific divergences in relation to performing a comparability analysis, including the absence of the notion of accurate delineation of the transaction, the limited
- comparability analysis (largely disregarding the functional and risk profile), and the strict use of comparable;
- Weaknesses in the safe harbor rules in place, which may provide further unintended tax benefits by deactivating the existing transfer pricing rules;
- Absence of special considerations for specific types of transactions, including those involving the use or transfer of intangibles, intra-group services, cost contribution arrangements, business restructurings, and financial transactions; and
- Issues in relation to the attribution of profits to permanent establishments.
Illustration of BEPS Risks
- Absence of accurate delineation of the actual transaction in identifying the commercial or financial relations: The concept of accurate delineation of the actual transaction set out in the OECD TP Guidelines is not reflected in the Brazilian TP framework, potentially leading to under-taxation and creating significant BEPS risks.
- Absence of profit split method: In some cases, the absence of the profit split method may jeopardize the proper allocation of income and limit the ability of the tax administration to allocate the appropriate tax base to the taxpayers in Brazil, thereby increasing the probability of BEPS risks.
- Absence of special considerations for business restructurings and intangibles: Combined with the absence of a complete comparability analysis, including a functional analysis and a risk analysis, the absence of guidance on TP aspects of business restructurings creates significant BEPS concerns and the transfer of profit potential out of Brazil including, importantly, transfers of valuable intangibles that may not always be duly recognized since the definition of intangibles contained in the current Brazilian rules may not be as broad as the one contained in the OECD TP Guidelines. As a consequence, such transfers or use of intangibles will also not be duly reflected in the Brazilian tax base.
From the technical analysis, two possible options for alignment were identified: (i) one contemplating an immediate alignment and (ii) other contemplating a gradual alignment process.
Full Alignment: Immediate vs Gradual
- Full and immediate alignment: the first option would seek to immediately align the Brazilian transfer pricing rules with the OECD standard, including the arm’s length principle and the guidance for its application contained in the OECD Transfer Pricing Guidelines and other relevant guidance and make the new rules and regulations applicable to all taxpayers immediately;
- Full and gradual alignment: the second option involves the same process, but this process is structured in stages over a longer period of time. This approach also offers the opportunity to prioritize the different needs with respect to the tax structure, administrative aspects, expertise of the workforce including the preparedness of the taxpayers, etc., as changes are progressively implemented. It appears that the most reasonable approach would be to set the conditions for a progressive transition of bringing the taxpayers represented by certain threshold (large MNE groups until smaller MNE groups), allowing the voluntary entry in the new regime. Gradually, by lowering the threshold as many times as deemed necessary (in the longer-term), all taxpayers will start applying the new regime. In the meantime, the necessary simplification measures will be developed to ensure continuous ease of tax compliance, efficiency of tax administration as well as tax certainty from both a domestic and international perspective.
- Partial alignment and/or dual system: A partial alignment in the form of allowing for the possibility of opting-out of the current regime to apply rules that follow the arm’s length principle would lead to transfer pricing “regime shopping,” and consequently to a loss of revenue. It would allow continued BEPS practices, as taxpayers would cherry-pick the regime they wish to apply with the motivation to pay less tax.
Benefits of Alignment with the OECD TP Guidelines
- Avoiding and eliminating double taxation, which results from the existing gaps and divergences;
- Preventing loss of revenue due to current BEPS practices, which also creates inequality within the current system, where some taxpayers are treated more favorably than others;
- Increasing tax certainty from an international perspective;
- Integrating Brazil in global value chains and fostering trade and investment in Brazil; and
- Facilitating Brazil’s accession to the OECD.