Key Points in this Article
- Effective January 1, a “Provisional Measure” was published which significantly changes Brazil’s transfer pricing legislation by aligning it closely to the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (“the OECD Guidelines”).The Provisional Measure has up to 120 days to obtain approval for it to become law, i.e., a deadline of April 28, 2023. The recent elections in Brazil, which saw a change in presidential administrations, casts some doubt on the Provisional Measure’s prospect of adoption.
- If the measure passes before this deadline, the new transfer pricing rules will be elective for FY 2023 (i.e., taxpayers can choose whether to adopt them or continue with the former Brazilian transfer pricing rules). The new rules would become mandatory as of January 1, 2024
- We highly encourage taxpayers with operations in Brazil to consider the impacts of the prospective change on their local and global transfer pricing models to prepare themselves for the challenges of implementation, as well as to consider the risks and opportunities the new rules may present.
Introduction
In keeping with a unique Brazilian political tradition, in the final days of the year the Provisional Measure No. 1,152 (“MP No. 1,152/22”) was published on December 29, 2022. which stipulates amendments to the Brazilian legislation on transfer pricing. This change had been previously delayed from prior deadlines of August 31, September 30, October 31, and November 30, 2022, but it was not until the last day of the year that outgoing president Jair Bolsonaro signed out the document in one of his last acts as president.
Background
Brazil’s first serious opportunity to join the Organisation for Economic Co-operation and Development (OECD) came in 2009, when the former OECD Secretary Angel Gurría, who was visiting Brasília to present an analysis on the Brazilian economy, noted that “the possibility of Brazil becoming a formal partner of the OECD is up to the Brazilians; our doors are open to Brazil.” This invitation was evaluated by Guido Mantega, the former Brazilian Finance Minister, who was from PT, a left-center wing party. However, at the time, Mantega expressed a lack of interest in the invitation, largely because the BRICS Forum was the more pressing focus of the government. Consequently, that opportunity to join the OECD was missed.
In May 2017, Brazil changed course and submitted a formal request to join the OECD. The Brazilian government believed that becoming an OECD member would help attract foreign investment into the economy.
Following Brazil’s application for OECD membership in 2017, which was supported by former president Michel Temer, the Brazilian authorities made several lobbying attempts to expedite the process.
At the beginning of 2018, Henrique Meirelles, the then Finance Minister, along with Angel Gurría, the OECD Secretary-General, and Jorge António Rachid, the Secretary of the local tax authority, launched an OECD-Brazil work program to start making local transfer pricing (“TP”) rules more compatible with the OECD TP guidelines. This program seeks to align Brazil’s rules and unique characteristics with internationally accepted standards and practices.
However, it is important to note that Brazil has just finished its election process, won by former president Lula da Silva. This adds complexity to the situation because the efforts to align the Brazilian TP rules and join OECD was a Bolsonaro government plan; the Bolsonaro government pushed through the Provisional Measure 1.152/22 was published on December 29th.
Outcomes of the Alignment Project
The 15-month project conducted by OECD and Receita Federal aimed to align the Brazilian transfer pricing rules to OECD. The first outcome was a useful document outlining the gaps that should be corrected in order to avoid doble taxation and non-taxation, the main disadvantages of contemporary Brazilian TP rules. This document was in turn the basis for a conclusion: Brazil would need a full alignment with OECD to produce the desired effects of the reform.
The Provisional Measure 1.152/22 represents a significant departure from the old Brazilian transfer pricing model. As expected, the new rules entail a full alignment with OECD standards: for example, by introducing to Brazilian TP legislation the arm’s length principle, and adopting the OECD Guidelines’ approach to royalties and intangible transactions – thereby addressing a problem that has endured for more than six decades: the limitation of deductions for payments relating to intercompany royalties and intangibles assets for Brazilian taxpayers.
Provisional Measure 1.152/22 Explained
In Brazilian legislation, a Provisional Measure is an instrument for urgent matters, and the trigger for this Provision Measure was the change to USA tax rules which eliminated the foreign tax credit for taxes paid in Brazil due to deviations in the latter’s transfer pricing legislation relating to the arm’s length principle.
The urgency was also justified in view of the tax collection losses that Brazil experiences year after year due to the various deficiencies inherent in Brazilian legislation, which allow the erosion of the taxable base and the shifting of taxable profits (as described under the OECD’s BEPS initiative).
The Provisional Measure has 40 articles, divided in six chapters with constituent sections and subsections as follows:
Below is a summary of the main changes to Brazilian TP legislation:
Arm’s length – The arm’s length principle will be observed in all controlled transactions, based on the terms and conditions of operations carried out between independent parties in the open market.
Extension of applicability – It also considers commercial and financial relationships between domestic related parties, in addition to entities located in tax havens.
Methods – Adds transfer pricing methods available under the OECD Guidelines where the most appropriated method must be selected, including:
- Comparable Independent Price – PIC (comparison with transactions carried out between independent parties);
- Resale Price Minus Profit – PRL (based on the comparison of margins applied in resales, and no longer on the simple application of a fixed margin);
- Cost plus Profit – MCL (based on comparing profit margin over cost);
- Net Transaction Margin – MLT or TNMM (comparing the net margin of the controlled transaction with the net margins of comparable transactions carried out between unrelated parties, both calculated based on an appropriate net prift indicator);
- Profit Sharing – MDL or PSM (sharing profits or losses, or part thereof, in a controlled transaction in accordance with what would be established between unrelated parties in a comparable transaction, considering the relevant contributions provided in the form of functions performed, assets used and risks assumed by the parties involved in the transaction).
Commodities – The previously applicable PCI and PECEX methods are no longer valid, suggesting (but not requiring) the application of the PIC method.
Financial and other transactions – New transactions will now be subject to transfer pricing reviews: cost-sharing agreements, cash pooling, business restructuring, insurance contracts and guarantees.
Intangibles – The new guidelines indicate the need for TP analyses for intangible transactions such as licenses and royalties.
Adjustments – Four adjustment models were presented: Spontaneous, Compensatory, Primary and Secondary:
- spontaneous adjustment – carried out by the legal entity itself;
- compensatory adjustment – carried out by the parties to the controlled transaction;
- primary adjustment – carried out by the tax authority; and
- secondary adjustment – made as a result of previous adjustments.
Validity – The new rules are mandatory from 2024, but taxpayers may elect to adopt them from 2023.
BaseFirma Comments
According to the Brazilian constitution, Provisional Measures (“PMs”) are rules with the force of law, sent by the President of the Republic for analysis by the National Congress. The rule is that the PM can be edited in situations of relevance and urgency. As soon as it is edited, the PM takes immediate legal effect. But, to become a law, it needs to be approved by the Chamber of Deputies and the Senate.
The term of validity of the PM is 60 days, automatically extended for an equal period if the vote in Congress has not been concluded (a total of 120 days of potential validity). If the PM is not approved within 45 days, starting from the date of its publication, it enters an emergency regime, with the suspension of the processing of all other legislative deliberations. We note that, based on historical precedent, it is common for the PM’s approval to occur only in the last days of validity.
Not all PMs will necessarily become law. They can expire due to the lapse of time, be overturned in plenary or even revoked by later PMs.
The figure below shows the percentage of success of the past 20 years’ PMs; we note that Jair Bolsonaro has by far the lowest percentage of conversion compared to other presidents:
https://espacodemocratico.org.br/artigos/um-balanco-de-duas-decadas-de-medidas-provisorias/
Brazil has only recently concluded of the most controversial political election periods in 20 years; the election process, which finished in October 2022, saw significant changes to the composition of the parliament, as well as a hotly-contested presidential race which resulted in the victory of Lula over the incumbent Bolsonaro. Importantly, Lula is a left-leaning political and ideological rival of the right-wing Bolsonaro and is expected to challenge much of his predecessor’s legacy while in office.
It is difficult to predict how the Provisional Measure 1.152/22 will be received and analyzed by the new government. On one hand, the new TP rule is robust and well-designed; but on the other, it represents a significant piece of legislation promoted by the former Bolsonaro government that the Lula administration may seek to unwind (a capability made possible by the Bolsonaro administration’s failure to pass the legislation earlier in his term).
While taxpayers await official decisions on the PM’s fate, we highly recommend that they use the coming months to prepare for the potential changes. In particular, taxpayers can begin the process of considering how the new rules would fit into their local and global transfer pricing models (i.e., transactional flows, markup policies, etc.), modeling effective tax rate impacts, and initiating discussions with key stakeholders (i.e., finance, IT, and accounting departments, among others). This will help inform key decisions, such as whether to adopt the model during the elective period of FY 2023 or defer until the changes become mandatory in FY 2024 (assuming passage of the PM). If fully adopted, the alignment measures could present meaningful and enduring opportunities for many multinational taxpayers; in particular, those who have been incurring double taxation due to partial or full nondeducibility of certain intercompany transactions, as well as those who have been maintaining a TP model for Brazil separate from their global policy.
BaseFirma will be following the developments in Brasilia closely and will publish additional information as it becomes available. Furthermore, we have also prepared a high-level “roadmap” outlining the key dates and activities taxpayers should undertake during FY 2023 in preparation for the potential changes.
For further information, please do not hesitate to contact:
Davi Santana de Jesus davi.santana@basefirma.com (Partner, BaseFirma Brazil)
Chad Martin chad.martin@basefirma.com (Denver Office Lead, BaseFirma USA)