Provisional Measure establishes new transfer pricing rules

On December 29, 2022, the highly expected Provisional Measure No. 1,152 of December 28, 2022 (“MP 1,152”) was published, amending the Brazilian transfer pricing rules (“TP”) for purposes of calculating Corporate Income Tax (“IRPJ”) and Social Contribution on Net Income (“CSLL”). As Provisional Measure, the MP must be converted into Law by Brazilian Congress within 120 days, or it will lose its effects.

TP rules seek to protect the tax base of countries on international transactions. To this end, minimum amounts of taxable income and maximum amounts of deductible expenses (“Benchmark”) are established for purposes of calculating corporate income taxes in relations between related parties and parties that benefit from more beneficial tax treatment.

The Brazilian TP legislation in force until December 29, 2022 – Law No. 9,430/1996 – is not fully compliant with the suggestions of the Organization for Economic Cooperation and Development (OECD) for calculating TP Benchmarks, as it considers predetermined methods with fixed margins. This system is widely criticized for diverging from the international practices adopted by many countries and has even generated numerous discussions in the United States (USA) since American rules now prohibit the offsetting of taxes paid in Brazil since Brazilian TP legislation does not follow the “arm’s length” principle.

MP 1,152 was published in this context, and its application is mandatory as of 2024 and optional as of 2023. The new rules amend the current system, 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.

In this regard, it is worth mentioning that the 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, there was an expansion in the definition of related parties to also incorporate a subjective criterion that refers to all parties whose relationship of influence, direct or indirect, may impact the transaction prices. The legislation continues to establish a list of people presumed to be related to the Brazilian taxpayer, as with controlled and controlling companies.

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

The assessment of the controlled operation will be based on the facts and circumstances of the transaction and evidence of the effective conduct of the parties, to identify the commercial and financial relationships and the economically relevant characteristics associated with these relationships. During this process, the options realistically available to the parties will be considered to assess other possibilities that could have been adopted if unrelated parties had carried out the transaction. The new rule allows for the disregard or replacement of the controlled transaction when it is concluded that unrelated parties, acting under comparable circumstances, 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, considering a series of factors, including the economically relevant characteristics of the transactions and the applicable method and financial indicators. The following methods should be considered:

The new rule offers a new model to the methods used to reach the Benchmark. In this regard, the preferred and recommended method is the application of the PIC, which considers comparable prices in transactions between unrelated parties, is preferred and recommended. Such method is also applicable for commodities. In addition, other methods now follow the OECD guidelines and are based on a comparability analysis, abandoning the fixed margins of the current system. There is even a provision for the use of other methods, which is not allowed in the current system. 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” standard.

If the comparability analysis results in the need for adjustment, MP 1,152 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 may establish a different adjustment in the calculation of IRPJ and CSLL (“Primary Adjustment”).

The new rules provide that, in Spontaneous or Primary Adjustments (both exclusively in the assessment of IRPJ and CSLL and not in the taxpayer’s profit and loss), a Secondary Adjustment may be carried out, whereby the Brazilian party shall be reimbursed at the adjustment amount. The adjusted amount will be considered a credit granted to related parties, bearing interest at the rate of 12% per year. The interest rate is reduced to zero if the amount is fully reimbursed within 90 days.

Still, we highlight other relevant points:

• Intangible assets: are now expressly subject to transfer pricing controls;

• Special Rules: the rules provide specific guidelines for transactions involving:

(i) intragroup services;
(ii) cost-sharing agreements;
(iii) business restructuring;
(iv) financial operations, 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. It is discussed whether this could result in applying fixed margins if the taxpayer so desires;

• Procedures: the new rules also bring the possibility of filing ruling requests, in addition to mutual procedure agreements with other countries; and

• Royalties and payments for technical assistance: previous deduction limits on royalties were repealed. The new rules prohibit the deduction of royalties and fees for technical, scientific, administrative, or similar assistance to:

(i) parties residing in low-tax jurisdictions or that benefit from preferential tax systems; and
(ii) when the deduction results in double non-taxation.

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