Law establishes new transfer pricing rules

On June 15, 2023, the highly expected Law No. 14,596 of June 14, 2023 (“Law No. 14,596/23”) was published, amending the Brazilian transfer pricing (“TP”) rules for purposes of calculating the Corporate Income Tax (“IRPJ”) and Social Contribution on Net Income (“CSLL”).

Law No. 14,596 resulted from the conversion into law of Provisional Measure No. 1,152/2022, enacted in late 2022, and will enter into force on January 01, 2024, or, optionally, as of 2023.

TP rules establish minimum amounts of taxable income and maximum amounts of deductible expenses (“Benchmark”) to calculate IRPJ/CSLL in transactions between related parties and parties that benefit from a more advantageous tax treatment.

The Brazilian TP rules currently in force – Law No. 9,430/1996 – were widely criticized for diverging from the international practices adopted by many countries. This legislation even caused several discussions in the United States (USA) regarding the recovery of income taxes paid in Brazil.

The new rules amend the current system by replacing fixed margins with comparability tests that best enforce the “arm’s length” principle. This principle establishes that the Benchmark calculation must consider the relationships carried out between independent parties in comparable transactions.

The new TP rules still apply to transactions with related parties, parties residing in countries that do not tax income or levy taxes at a maximum rate lower than 17%, or parties that benefit from preferential tax systems. However, the definition of “related parties” was expanded to include all parties whose relationship of influence can, directly or indirectly, impact the transaction prices. The legislation also establishes a list of people presumed to be related to the Brazilian taxpayer, as in the case of controlled and controlling companies.

In terms of application, the rules still require the establishment of the controlled transaction and its comparison with the Benchmark, in order to identify the need for adjustment in calculating IRPJ/CSLL.

The assessment of the controlled transaction will be based on the facts and circumstances of the transaction and evidence of the parties’ effective conduct. The new rule even allows for the disregard or replacement of the controlled transaction when it is concluded that unrelated parties would not have carried out the controlled transaction as established.

The comparability test will be carried out to compare the terms and conditions of the controlled transaction with those established between unrelated parties. It will consider a series of factors, including the economic characteristics of the transactions and the applicable method and financial indicators. The following methods should be considered:

The new rule offers a new model for the methods used to establish the Benchmark. The preferred and recommended method is the application of the CUP, which considers comparable prices in transactions between unrelated parties.

In addition, the other methods are now based on a comparability analysis, abandoning the current system’s fixed margins. In fact, there is a provision for the use of other methods, which is not currently permitted. Another change is that the taxpayer no longer has the option of choosing the more favorable method and must use the most appropriate method to reach the result set by the “arm’s length” principle.

If the comparability analysis results in the need for adjustment, Law No. 14,596/23 now expressly provides taxpayers with two alternatives:

(a) to directly adjust their calculation of IRPJ and CSLL (“Spontaneous Adjustment”); or

(b) to adjust the amount of the transactions until the end of the fiscal year (“Compensating Adjustment”).

In case of divergencies, tax authorities can establish a different adjustment in the calculation of IRPJ and CSLL (“Primary Adjustment”). The new rules did not include the secondary adjustment initially included in Provisional Measure No. 1,152/2022.

In addition, we highlight other important points:

• Intangible assets: are now expressly subject to transfer pricing control;
• Special Rules: the rules provide specific guidelines for transactions involving:
  • intragroup services;
  • cost-sharing agreements;
  • business restructuring;
  • financial transactions, including debt and treasury transactions, as well as insurance and liens.

The rules can impact current structures for apportionment or sharing expenses, warranties, and other intragroup liens.

• Documentation and penalties: tax authorities will determine how the information and other supporting documents will be provided. In the event of non-compliance, a fine (minimum of BRL 20,000 and maximum of BRL 5 million) will be applicable, which does not exclude the Primary Adjustment made by the authority. If the tax authority disagrees with the adjustments indicated by the taxpayer in his income tax return, the option for amending the calculations remains in force with no penalties;
• Safe Harbors: tax authorities will regulate the applicable safe harbors and other measures to facilitate the application of the rules. Whether this could result in applying fixed margins if the taxpayer so desires is under discussion;
• Procedures: the new rules also bring the possibility of filing ruling requests, in addition to mutual procedure agreements with other countries;
• Royalties and payments for technical assistance: previous deduction limits on royalties were revoked. The new rules prohibit the deduction of royalties and fees for technical, scientific, administrative, or similar assistance paid to related parties if it results in double non-taxation.

Demarest’s tax team is available to provide any further clarifications on the matter that may be necessary.