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On June 29, 2022, the Brazilian Federal Revenue Service (RFB) and the Inter-American Development Bank (IDB) held a transfer pricing (TP) seminar to discuss in detail various topics related to the new Brazilian TP system proposal, which would implement the arm's-length principle (ALP) in Brazil.

Since the RFB and the Organisation for Economic Co-operation and Development (OECD) announced the new TP system proposal, in April of this year, the RFB has participated in several meetings, aimed at clarifying the provisions included in the proposed new system and allowed taxpayers to submit comments and feedback on the new TP rules. The seminar held on June 2h demonstrates the RFB's commitment to sharing advance parts of the proposal and listening to different perspectives on the matter.

The event was structured in blocks that addressed three of the main pillars of the proposal: (1) general TP rules; (2) specific aspects related to controlled transactions; and (3) simplification and legal certainty. Generally, the RFB shared the structure of the proposed law, presented details on the concept and implementation of the arm's-length principle for specific transactions, as well as confirmed some additional information and guidance that had been indicated in recent events and discussion groups in which the RFB had participated.

The RFB also highlighted its efforts in internal professionals' training, and in seeking consistency and uniformity in all areas involved within the TP system.

This Tax Alert covers some of the main points discussed during the seminar.

Intangibles

The RFB confirmed that the concept of intangible will align with the OECD Transfer Pricing Guidelines (OECD Guidelines).¹ This change is significant because the OECD Guidelines' definition of intangibles for TP purposes is quite broad and differs from the accounting concept adopted in Brazil. For example, under the new TP rules, intangibles not recorded in the books, but transferred within a multinational group, would be considered in a TP analysis.

Commodities

Transactions involving commodities have been one of the most discussed points during the events held with the RFB this year. Commodities play a significant role in the international trade carried out by Brazil.

At the seminar, the RFB addressed several points related to this topic, which are summarized below:

• Commodity concept: The new transfer pricing system would define commodity without taking into account the annexes of IN RFB 1.312/2012 (currently in force). Accordingly, the new TP system would define a commodity as follows: "a physical product will be understood as a commodity, including those in an intermediate stage and by-products (derived products), for which there is a quoted price that is used as a reference by unrelated parties in transactions carried out under comparable circumstances."
• Selection of the TP method: Under the new TP system, when comparable transaction price data are available, including quoted prices from exchanges or publications, CUP (Comparable Uncontrolled Price) would be considered the most appropriate method for determining commodity value for purposes of the TP analysis, as recommended by the OECD Guidelines. Taxpayers could apply other available methods, if it makes economic sense and obtains a better result in accordance with the ALP.
• Pricing date: A critical aspect of analyzing TP involving commodities is the pricing date and how that date is determined in different jurisdictions. The pricing date refers to the date on which the parties determine the price of commodity transactions. When the taxpayers can provide reliable evidence of the pricing date agreed by the related parties at the time the transaction was entered into (e.g., contracts) and this is consistent with the actual conduct of the parties, the date of the contracts would be the pricing date under the new TP system. To adopt this pricing criterion, taxpayers would have to register the contracts with the RFB. There are still no details on the form and procedures of this registration.
• Quoted prices: Quoted prices would be determined from (i) the commodity quotes obtained from internationally recognized commodity and futures exchanges; (ii) the indices and prices published by research agencies or government agencies; or (iii) other indices that are used as a reference by unrelated parties in comparable transactions.

TP adjustments

Under the new system, three types of TP adjustments would be possible: (i) primary; (ii) correspondent; and (iii) secondary. The primary adjustment would require the Brazilian corporate income tax (IRPJ) and social contribution on net income (CSLL) calculation bases and would have to be adjusted in cases of non-compliance with the ALP. The correspondent adjustment would arise as a consequence of the primary adjustment and would aim to avoid double taxation scenarios. Using a mutual agreement procedure (MAP), the Brazilian taxpayer, as well as the non-Brazilian taxpayer (nonresident), could correct in its jurisdiction the primary adjustment originally made by the counterparty. Finally, once a primary adjustment is determined, the secondary adjustment may be considered as a deemed loan to related parties involved in the controlled transaction that must be remunerated at an annual interest rate² and reimbursed to the Brazilian taxpayer.

While all three adjustments were discussed during the seminar, the RFB did not provide further details on how to calculate the primary adjustment or clarify how the secondary adjustment would be implemented.

There are many aspects to be considered when discussing secondary adjustments. The RFB, however, has only mentioned that such adjustments will affect income that is not subject to the tax on financial operations (IOF). Other aspects that should be discussed include:

• The tax and accounting treatment of interest in the jurisdictions involved in the transaction
• The tax consequences of accrued interest
• Whether there will be a time limit for the related entity to reimburse or repatriate the adjustment amount to the Brazilian taxpayer

There also may be questions regarding profit and loss from foreign-exchange fluctuations.

These issues should be considered in the secondary adjustment regulations to avoid double taxation situations. Additionally, the possibility of using the MAP as an instrument to define the treatment of secondary adjustments in both jurisdictions should be considered.

Business restructuring

The new Brazilian TP rules are expected to incorporate the business restructuring analysis. The business restructuring concept differs from the corporate restructuring concept, which is currently covered by domestic legislation. According to the OECD TP Guidelines and the new TP system, changes in commercial or financial relationships between related parties, which result in the transfer of potential profit, in benefits or losses to any of the parties, must be remunerated according to ALP. These situations would include, for example, the potential transfer of functions, assets (tangible or intangible), risks and/or business opportunities between related parties. Taxpayers would need to map these situations to measure the effects that a transfer might have on the Brazilian tax base.

To provide greater legal certainty for this type of operation, domestic legislation should be considered to provide specific guidelines on how these transferred profits/losses should be calculated and treated from a local tax perspective, considering the deductions allowed by current tax legislation.

Documentation

In line with what was reported at an event in April, the RFB confirmed the implementation of three levels of documentation as provided in Action 13 of the Base Erosion and Profit Shifting (BEPS) project. Brazil currently requires the filing of the country-by-country (CbC) report locally but does not require the local file and master file. The RFB, however, did not provide details about how it would implement the local file and master file (e.g., which taxpayers must prepare the reports, whether the documents must be filled annually with the RFB or whether taxpayers must provide them to the RFB only upon request). Additionally, the RFB did not address the need to prepare an informative transfer pricing return, as required in several Latin American countries. Hence, several outstanding issues regarding local obligations for compliance purposes will need to be addressed through secondary legislation (local regulation).

Non-transparent contributors

If, at the time of preparing TP documentation, the taxpayer fails to deliver the documentation and information available for the accurate delineation of the controlled transaction, or if such information is not sufficient for an adequate comparability analysis, the new TP system would allow the tax authority to allocate to the Brazilian entity, the functions, risks and assets initially assigned to the controlled transaction counterparty. Additionally, given the existence of gaps in the functional analysis, the RFB may adopt reasonable estimates and assumptions to carry out or complete the transaction delineation between the Brazilian entity and counterparty and comparability analysis.

US tax credit (Foreign tax credit rule)

According to comments made by Mr. Joseph Dickson (American Treasury Attaché for South America), ALP adoption by Brazil as part of the new TP rules would lead to the removal of the main obstacle to claiming a foreign tax credit in the United States for the income taxes paid in Brazil. For this to happen, he stressed, the proposed legislation must in fact follow the OECD / international standards. In other words, the mere formal redesign of the Brazilian TP system would not be sufficient, because the ALP must be effectively applied.

Mr Dickson also emphasized that, despite some public pressure, the entry into force of the final regulations (TD 9959) should not be postponeed — i.e., the new US foreign tax credit rules are effective from 2022 onwards.

Additionally, the signing of an agreement to avoid double taxation (AADT) between Brazil and the United States is considered an effective tool to reduce double taxation, as well as double non-taxation in commercial relations between the two countries. However, Mr. Joseph Dickson made it clear that, if Brazil adopted the ALP and changed the royalty deductibility rules, an AADT would not be necessary for Brazilian tax credit recognition in the United States.

EY comments

In preparation for the new TP system, the RFB has made efforts in training its professionals and changing its relationship with taxpayers. The RFB has aimed to improve dialogue, which is helpful to taxpayers as Brazil adopts the new TP system. The expectation is that a bill will be proposed in the coming months for Congress's approval and subsequent implementation. The new TP system proposal represents an important step in adapting the Brazilian environment to the international taxation principles in line with OECD guidelines.

EY will continue to monitor the RFB's upcoming actions and share relevant updates regarding the process of local rule convergence to the international standard.

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ENDNOTES

¹ Any asset that is not considered a tangible or financial asset that may be held or controlled for commercial use activities and for which the use or transfer would be remunerated if the transaction took place between unrelated parties, regardless of whether the asset is subject to registration, legal protection or recognition as a tangible asset for accounting purposes.

² In accordance with the RFB's provisions, interest will be considered due from January of the year following the calculation period to which the (primary) adjustment refers and will be subject to taxation by the IRPJ and CSLL.