Executive summary:
Brazil’s new transfer pricing regime calls for immediate action
The Brazilian taxing authorities have finalized the highly anticipated transfer pricing rules (TP) which aim to align Brazil’s existing TP law with Organisation for Economic Co-operation and Development (OECD) Guidelines. Taxpayers are required to adopt the new rules as of Jan. 1, 2024, but may choose to follow the new rules for 2023 through an irrevocable election. This early adoption election must be filed by Dec. 31, 2023 and applies retroactively as of Jan. 1, 2023.
Multinational corporations operating in Brazil must promptly reassess their existing TP policies to ensure alignment with the recently introduced regulations. The imminent deadline for early adoption necessitates swift action. Failing to comprehend the intricacies of Brazil’s updated TP regime and its influence on the dynamic international tax landscape may lead to tax inefficiencies and missed opportunities.
Transfer pricing rules in Brazil finalized
Key highlights
On Sept. 29, 2023, the Brazilian taxing authorities released updated regulations (Normative Instruction (NI) 2,161/23) to govern Law 14,596/23, published on June 15, 2023. These revised regulations provide comprehensive guidance on the implementation of the new TP framework in Brazil, adhering closely to the OECD Guidelines and the arm’s length principle.
The new Brazilian OECD-aligned TP rules aim to integrate Brazil into the global TP model and value chains; as well as enable a more efficient global operating model by introducing specific TP rules for intangibles, royalty transactions and business restructurings.
The timeline below outlines a summary of important dates and deadlines for taxpayers:
- Jan. 1, 2023: New TP rules take effect for taxpayers choosing to make the irrevocable election
- June 15, 2023: Publication of Law 14,596/23
- July 3, 2023: Publication of draft NI (Public Consultation 01/2023)
- Sept. 29, 2023: Publication of NI 2,161/23 regulating new Law 14,596/23
- Dec. 31, 2023: Deadline for taxpayers choosing to make the irrevocable election
- Jan. 1, 2024: New mandatory TP rules take effect
- Dec. 31, 2024: TP documentation is due for taxpayers choosing to make the irrevocable election
- Dec. 31, 2025: TP documentation is due for taxpayers not choosing to make the irrevocable election
The adoption of the arm’s length principle and broader the related-party concept
The new rules adopt the arm’s length principle aligning with Chapter V of the OECD Guidelines replacing the previous ’pre-fixed,’ granular transaction-based approach. The new rules require the outline of the intercompany transaction and the comparability analysis of the intercompany transaction to determine the terms and conditions of the intercompany transaction in accordance with the arm’s length principle. The taxpayer must provide an overview of the economic sector in which they operate, as well as the economic activities and the key external drivers that may affect the performance of their commercial operations.
Implementation of all TP methods according to the OECD Guidelines and the most appropriate method rule for intercompany transaction analysis
The new rules outline the most appropriate method which provides the most reliable determination of the terms and conditions that would be established between unrelated parties in a comparable transaction. The taxpayer must review the facts and circumstances surrounding the intercompany transaction, the availability and reliability of information on comparable transactions, and the degree of comparability and need to make comparability adjustments.
The most appropriate methods include the Comparable Independent Price (PIC), Resale Price, Cost Plus Profit, Transactional Net Margin, Profit Split and other methods provided that the alternative methodology provides a reliable result, i.e., an outcome similar to that arising from unrelated parties transacting in comparable transactions. Following the OECD Guidelines’ preference, the PIC is considered the most appropriate method when there is reliable data on the price or value of comparable third-party transactions.
Introduction of spontaneous, compensatory and primary adjustments
The new tax calculation adjustments should be based on the following provisions:
- Spontaneous adjustment: The taxpayer will make this adjustment directly to their income tax calculation and is required to accurately reflect intercompany transaction amounts in line with the arm’s length principle. The spontaneous adjustment is mandatory and must be completed by Dec. 31, 2023. There are certain exceptions for cases of incorporation, merger or closure of activities, in which the adjustment will be conducted on the date of the specific event.
- Compensatory adjustment: Parties involved in intercompany transactions must make this adjustment at the close of the calendar year to ensure the consideration of an arm's length amount in accordance with the arm’s length principle. Taxpayers opting for early adoption must decide on and finalize this adjustment by Dec. 31, 2023.
- Primary adjustment: The Brazilian federal tax authority (Receita Federal Brasileira (RFB)) will enforce this adjustment if the taxpayer fails to implement spontaneous and compensatory adjustments in order to align the taxpayer’s income tax calculation with arm's length results.
- The PIC Method is the preferred approach, and is considered the most suitable method, for cross-border commodities transactions with reliable comparables. However, taxpayers may employ alternative methods based on relevant facts and circumstances.
Adjustments are expressly prohibited from inflating the corporate income tax loss or diminishing the tax calculation base. However, an exception is granted for compensatory adjustments or outcomes mutually agreed upon in dispute resolutions outlined in international agreements or conventions aimed at eliminating double taxation where Brazil is a signatory.
Introduction of low value-added services
The new rules introduce the OECD-based concept of low value-added services for intercompany transactions for which the taxpayer can opt for a simplified approach when pricing them. The gross margin on the direct and indirect costs on low value-added services will be at least 5% if the service provider is a Brazilian taxpayer and a maximum of 5% if the service provider is a non-Brazilian taxpayer.
Addition of all cross-border financial transactions such as guarantees, cash pooling, centralized treasury functions, insurance transactions, intercompany loans, and risk management
Financial transactions were not previously subject to TP analysis in Brazil. The new rules require a specific economic analysis for any intercompany transaction involving financial resources and that are considered as debt transactions.
Introduction of cost contribution arrangements (CCAs)
The new rules establish general guidance for the usage of CCAs for two or more related companies to share the benefits and risks of ‘valuable contributions.’
The RFB is expected to issue regulations for CCAs as there are no specific rules for such transactions in Brazil.
Introduction of advance pricing agreements (APAs) and mutual agreements procedures (MAPs) to mitigate uncertainty and double taxation
The new rules introduce the possibility of APAs aligning with the OECD Guidelines. In addition, they cover the usage of MAPs although Brazil had previous guidance in place since 2016. The RFB is expected to issue additional regulations for APAs and MAPs providing specific guidance.
Elimination of the royalty deductibility limitation and inclusion of royalty transaction analysis from a TP perspective
The new rules remove the royalty deductibility limitation and now require a transaction analysis for all royalty payments between related parties.
Royalties (including technical, scientific, administrative assistance or similar amounts) are to be considered non-deductible when paid, credited, delivered, employed or remitted to related parties, when such deduction results in double non-taxation, in the following scenarios:
- The same amount is already considered a deductible expense by a related party;
- The amount deducted is not treated as taxable income of the beneficiary in accordance with the legislation of its jurisdiction; or
- The amounts are intended for financial, directly, or expressly, deductible expenses of related parties, which include the scenarios referenced above.
This replacement of the strict deductibility restrictions on royalties (i.e., payment of royalties abroad had its deductibility limited to 1% to 5% of the total income) and technical assistance payments with such general anti-abuse provisions (royalties not deductible if paid to tax havens) and a switching clause (if deductions lead to double non-taxation) benefits mostly tech companies with valuable intangibles.
The new rules offer the possibility of multinationals to implement other types of royalties in Brazil, which had been previously unnoticed as well as extending the royalty payment deductibility in Brazil because it will be tested based on the arm’s length principle.
New TP Documentation Requirements
The new TP rules introduce a three-tier documentation framework, encompassing: 1) Country-by-Country report (already implemented in Brazil since 2013), 2) the Master File (Arquivo Global), and 3) Local File (Arquivo Local)). This structure aligns with the OECD Guidelines and serves to furnish comprehensive details on global revenue distribution, global operations and activities, and intercompany pricing. Furthermore, certain information will be integrated into taxpayers’ corporate tax return (Escrituração Contábil Fiscal (ECF)).
Full TP documentation will require in-depth functional and economic analyses, alongside a thorough evaluation of a comparable range (interquartile or complete) when considering profit-level indicators. The TP analysis conducted on a transaction-by-transaction basis requires careful consideration of the functions undertaken, contractual terms, economic circumstances of both involved parties, business strategies, and risks assumed by each party. Additionally, a comprehensive economic analysis is indispensable to identify the tested party(ies) for each intercompany transaction.
The new rules introduce three categories for documentation requirements:
- Full Master File and Local File (broadly aligned with the OECD Guidelines’ requirements) for Brazilian taxpayers with intercompany transactions exceeding R$500 million (approximately US$100 million currently) in the previous year;
- Simplified information on intercompany pricing for taxpayers with intercompany transactions between R$15million (approximately US$3 million currently) and R$500 million; and
- Exempt documentation for taxpayers with intercompany transactions not exceeding R$15 million (intercompany pricing still must follow the arm’s length principle).
The taxpayer will submit the Master File and the Local File through the the RFB’s official digital portal (e-CAC). The RFB will accept the documentation in Portuguese, English or Spanish and will require all reports written in languages other than Portuguese to be accompanied by a simple Portuguese translated report. A request for translation may be required during an audit process, if necessary.
The deadline for submission of the documentation for years 2023 (early adoption) and 2024 will be the last business day of the following year, and for following years, it will be within three months after the submission of the corporate tax return (for the corresponding year).
Penalties for not having proper TP documentation range from R$20 thousand to R$5 million (approximately US$4 thousand to US$1 million currently).
Early adoption
The updated regulations extend the deadline for the irrevocable election from Sept. 30, 2023, to Dec. 31, 2023, granting taxpayers an additional three months for thoughtful analysis before making this election. The irrevocable election for early adoption can be executed through the e-CAC until Dec. 31, 2023, and applies retroactively from Jan. 1, 2023. Otherwise, the new TP regime becomes mandatory starting Jan. 1, 2024.
Multinationals are advised to initiate an assessment of how the new TP rules will impact their existing TP policies, along with estimating the overall tax implications resulting from the newly mandated revenue allocations in Brazil. The TP analysis is required for all intercompany financial, tangibles, intangibles, restructuring and services transactions.
In the process of adjusting current TP policies, multinationals must revise or create new intercompany agreements to align with their updated TP policies. Specifically, new agreements are essential for transactions falling within the purview of the new TP rules, including royalties, which were previously excluded under the prior Brazilian TP regulations.
U.S. foreign tax credit requirements
A major goal of the new TP framework is to alleviate double taxation (and double nontaxation) scenarios. Namely, the new rules attempt to eliminate one of the main obstacles associated with the new foreign tax credit (FTC) rules in the United States.
The 2022 U.S. Final Regulations introduced an attribution requirement as a new element to the net gain requirement. The attribution requirement is intended to allow a FTC only if the country imposing the tax has sufficient nexus to the taxpayer’s activities or investment of capital that generates the income included in the tax base. For resident taxpayers, the attribution requirement will be satisfied if the foreign tax base is determined using arm's length principles (i.e., no destination-based criteria). For non-resident taxpayers, the attribution requirement will be satisfied if the foreign base meets one of the following tests: activities, source or property (e.g., situs).
The complexity, application and timing of these new rules has sparked harsh criticism by taxpayers and tax professionals alike. In response, the IRS and Treasury have granted taxpayers temporary relief (the relief) under sections 901 and 903 in determining whether a foreign tax qualifies as a creditable tax for purposes of the FTC. Notice 2023-55, issued July 21, 2023, gives taxpayers the option to temporarily apply:
- Former section 1.901-2(a) and (b) (i.e., before T.D. 9959), for the definition of a foreign net income tax and for purposes of satisfying the net gain requirement, but subject to a modified non-confiscatory gross basis tax rule; and
- Existing section 1.903-1 without the jurisdiction to tax excluded income and attribution requirements.
The relief applies to tax years beginning on or after Dec. 28, 2021, and ending on or before Dec. 31, 2023 (e.g., 2022 and 2023 calendar years). U.S. taxpayers must analyze 1) whether they satisfy certain criteria to be able to rely on this relief and 2) whether they should rely on this relief. Taxpayers who fail to satisfy the relief criteria, along with taxpayers that choose not to rely on the relief, will be required to comply with T.D. 9959 in its entirety and instead analyze the creditability of Brazilian taxes.
For resident taxpayers, the regulations are clear on the attribution requirement. A fixed-margin TP system violates international norms, resulting in disqualification of the foreign tax entirely from creditability. Now that Brazil has adopted the arm’s length principle and OECD norms, U.S. multinationals will need to analyze:
- Whether an election to early adopt may be viewed by the IRS as a noncompulsory payment, even when relying on the temporary FTC relief; and
- Whether the remaining elements of the net gain requirement are satisfied should a taxpayer fail to satisfy the temporary FTC relief criteria.
Next Steps
Both the RFB and taxpayers face significant challenges ahead. The RFB is tasked with administering and enforcing these new regulations, and it is probable that they will issue additional guidance, such as regulations, to provide clarity for taxpayers regarding the new the TP procedures necessary for commodities, intangibles, financials operations, CCAs, business restructuring, MAP and APA, among other matters. Taxpayers may find themselves needing to overhaul their entire TP framework, demanding extensive global coordination, meticulous planning, and allocation of resources.
Final reminders
The deadline for early adoption is rapidly approaching and the effective date of the new regulations is imminent. Taxpayers are strongly encouraged to reach out to their advisors promptly to gain a thorough understanding of how the latest guidance will impact their tax obligations and reporting requirements. Key considerations include:
- Early adoption election for 2023;
- Implementation of the new methodology and documentation requirements; and
- Adjustment of intercompany agreements to align with the adoption of the new TP arrangements.
