Transfer Pricing in Brazil – Fixing double taxation with higher uncertainty?

3. Penalties for Non-Compliance

The RFB levies stringent penalties for non-compliance. If a taxpayer does not provide the required information for accurately delineating a controlled transaction or for conducting the comparability analysis, the RFB has the authority to take certain actions. It may attribute to the Brazilian entity any functions, risks, and assets that were initially assigned to another party in the controlled transaction if there is no reliable evidence to substantiate their actual involvement. Additionally, the tax authorities may use reasonable estimates and assumptions to outline the transaction and carry out the comparability analysis.

Taxpayers may also face fines for not presenting the Master and Local Files on time or for failing to meet the necessary requirements. Specifically, a fine of 0.2% per month may be imposed on the taxpayer’s gross revenue for the period to which the obligation pertains if the transfer pricing documentation is not submitted on time. If the documentation is submitted but does not meet the requirements, a fine of 3% of the taxpayer’s gross revenue for the relevant period may be levied.
 

Additionally, if the Master File is presented with inaccurate, incomplete, or omitted information, a fine of 0.2% may be charged on the MNE’s consolidated revenue from the previous year. Furthermore, a penalty amounting to 5% of the transaction’s value, as determined by the tax authority, may be imposed for failing to provide the necessary information or documentation in a timely manner during a tax audit, any preliminary audit actions, or for any conduct that obstructs the auditing process.
 

The new transfer pricing legislation stipulates a maximum value of BRL 5 million (approximately CHF 900 thousand) for infractions. The maximum penalty may be applied in cases such as failing to report the previous year’s consolidated revenue of the multinational group or if the provided information is not properly substantiated.
 

Brazil stands as one of the countries imposing some of the highest fines for tax infractions globally. At the federal level, the base penalty for failing to pay taxes is set at 75%, applied to the total amount or the difference in the taxes due. This figure can escalate to as high as 150% if the tax authorities determine any indications of fraudulent activity or if the taxpayer is found to be uncooperative with the investigation.
 

4. Navigating Risk in Brazil 

The transition to the OECD framework in Brazil means revisiting existing transfer pricing policies. MNEs must ensure that their transfer prices reflect the arm’s length standard, supported by robust documentation and thorough economic analyses. This may involve reevaluating contractual arrangements, reassessing the allocation of profits to the Brazilian entity, and potentially restructuring business operations in Brazil to align with the new regulatory requirements.
 

The increased emphasis on documentation under the OECD Guidelines necessitates a comprehensive approach to record-keeping. MNEs are expected to maintain detailed transactional records, including the nature of goods and services exchanged, contractual terms, and the economic rationale behind pricing decisions. The Master File and Local File approach, coupled with country-by-country reporting, provides tax authorities with a holistic view of an MNE’s global operations, requiring a consistent and transparent transfer pricing policy.
 

Tax litigation and contentious disputes represent a significant challenge for MNEs operating within Brazil. Brazilian tax authorities are often known for being aggressive in their interpretation of tax legislation, especially in matters of international tax practices. This frequently gives rise to a high number of contentious tax issues, often leading to protracted legal battles. These disputes can be incredibly costly in financial terms and also require considerable time and administrative effort. Additionally, the outcomes of such litigation are often unpredictable, which adds an element of risk for MNEs. This prolonged uncertainty can hinder business planning and operations.
 

Proactive engagement with tax authorities could help clarify expectations and reduce the likelihood of contentious audits. Understanding the available dispute resolution mechanisms under the new legislation, such as APAs and MAPs, is crucial for addressing any disagreements that may arise, potentially avoiding costly and time-consuming litigations.
 

In that sense, Brazil has already experience in applying its regulations on MAPs, which the Brazilian tax authorities have now indicated should support bilateral APA requests. The authorities are also working on strengthening the structure of personnel required to receive and process MAP and APA requests, having recently requested taxpayers and scholars to contribute with suggestions to APA regulations. They have, in general, been quite open to sit at the table with taxpayers to understand their cases and discuss preparatory steps for the filing of APAs.

5.  Practical Examples

Taxpayers should review their transfer pricing system and, where warranted, adjust to meet the arm’s length principle and mitigate double taxation. Below are a few examples that may arise under the new legislation.
 

Example 1: Royalties from Intercompany License Agreements

Previously, Brazil had fixed deductibility limits for royalties related to intercompany license agreements. These limits were based on a percentage of net sales and varied depending on the industry and type of licensed intangible, and were between 1% and 5% of net sales.
 

Under the old rules, if a foreign related party charged royalties to its Brazilian subsidiary, the deductibility of these royalties for Brazilian tax purposes would be capped at the prescribed limits. Any royalty payments exceeding these limits would not be deductible for the Brazilian entity, potentially leading to a higher taxable income in Brazil and to a double taxation issue.
 

Going forward, the Brazilian entity will need to present a comparability analysis to determine an arm’s length range for royalty rates. This analysis needs to consider factors such as the nature of the licensed intangible, the industry sector, the economic benefits expected from the use of the intangible, and comparable license agreements between independent parties.
 

For purpose of this example, a MNE has intercompany license arrangements involving multiple entities and jurisdictions. The license rate worldwide is 8% of turnover. The MNE has also a subsidiary in Brazil, with a comparable license agreement but a royalty rate of 3% to comply with old rules. The difference (8% - 3% = 5%) was already subject of discussion with tax authorities in the jurisdiction of the licensor.
 

The new rules offer an opportunity to align the rates with the worldwide model. It includes the ability to set royalty rates based on a comparability analysis rather than fixed limits, which can lead to more flexible and economically justified royalty structures. Royalties can, or should, be set in a way that better reflects the value contribution of intangibles. It should be noted that changes of historical arrangements could attract increased scrutiny under audit. APAs could be particularly helpful to manage risks in this regard.
 

Example 2: Interest from Intercompany Loans

Interest payments on intercompany loans were also subject to specific rules under the previous Brazilian transfer pricing regime. The Brazilian tax authorities established fixed interest rates for some loans, known as the “presumed interest rates”, or some predetermined reference rates for other loans. These rates were often not aligned with the economic reality or market rates and did not consider important elements such as credit rating. Terms of the loan were also not always taken into consideration.
 

If a foreign related party charged interest to its Brazilian subsidiary under an intercompany loan, the interest rate would need to adhere to the prescribed presumed rates to comply with the previous Brazilian transfer pricing regulations. Under the new transfer pricing rules, an arm’s length interest rate must be determined based on a comparability analysis, taking into account factors such as the accurate delineation of the transaction as debt or equity, the credit rating, and the impact of any financial guarantees.

6. Take Aways

The alignment of Brazil’s transfer pricing system with the OECD Guidelines is a fundamental step to harmonize local rules with international principles and reduce double taxation.
 

The new rules abolish the formulaic approach with fixed margins. They introduce the arm’s length as guiding principle for transfer prices. The application of the arm’s length principle can be subjective, and there is little guidance of how the RFB will do so. Taxpayers can no longer rely on safe harbors. The subjectivity in applying the arm’s length principle increases uncertainty going forward. Transfer pricing controversy could grow significantly in Brazil.
 

Tax penalties can be severe ranging up to 150% of taxes underreported. Applying the new rules and submitting complete documentation on a timely manner to the tax authorities is essential to avoid additional burden.
 

MNEs with operations in Brazil are encouraged to review the current transfer pricing model to ensure it aligns with the new requirements. Opportunities may also arise. Furthermore, MNEs are strongly encouraged to establish robust processes for the collection, analysis and reporting of all data required for compliance and audit defense purposes. Finally, companies should consider bilateral APAs as a powerful tool to manage risks, uncertainty, and protect themselves against hefty penalties.