Brazil to adopt arm’s-length transfer pricing standard

Sowmya Varadharajan
| 6/8/2023
Brazil to adopt arm’s-length transfer pricing standard
In summary
  • Brazil’s transfer pricing rules will align with broader global transfer pricing approaches.
  • Further guidance is anticipated on how the new rules will be implemented.
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On May 10, the Brazilian Senate approved Provisional Measure 1.152/22 (PM 1.152/22) without significant changes to the original proposal, which was issued on Dec. 29, 2022. This is a welcome outcome as it will align Brazilian transfer pricing rules with broader global transfer pricing approaches and methodologies required by other jurisdictions.

Further guidance on how Brazil will implement PM 1.152/22 is expected once the measure is enacted. In the meantime, here are five things for taxpayers to consider as they navigate what is expected to be Brazil’s new transfer pricing landscape.

1. Conformity with global transfer pricing principles

PM 1.152/22 conforms with the following general global transfer pricing principles:

  • Use of arm’s-length principles
  • Transaction-based and profit-based transfer pricing methods in accordance with the Organization for Economic Cooperation and Development (OECD) transfer pricing guidelines
  • Selection of the most appropriate transfer pricing methodology for the related-party transaction under review
  • Adoption of a functional analysis process to delineate a transaction based on functions performed, assets employed, and risks borne by the parties to the transaction
  • Selection of the tested party if an applicable arm’s-length method is applied
  • Preparation of transfer pricing documentation in accordance with the OECD transfer pricing guidelines, to support the arm’s-length nature of related-party transactions

Crowe observation

By conforming their transfer pricing rules with the transfer pricing principles used by most jurisdictions, multinational corporations should be able to include Brazil in their overall global transfer pricing model rather than having to prepare separate documentation using unique standards.

2. Definition of related party

Brazil’s current law does not include a definition of related party. PM 1.152/22 provides a principles-based definition of related party and provides a list of specific cases where parties are treated as related, including controlling and controlled entities; business units (including the head office and its branches); entities included in the consolidated financial statements; entities under common control; entities that have the same partner (or partners that are family members) who owns at least 20% of the capital of the entity; and spouses or close relatives of a board member, director, or controlling partner of an entity.

3. Effect of adoption of arm’s-length principles

Under current law, Brazil’s transfer pricing rules mostly are based on the application of fixed margins predetermined by law. The arm’s-length principles could significantly change the results of the transfer pricing analysis, requiring taxpayers to reevaluate their transfer pricing models and profit allocations among jurisdictions. For instance, losses recorded using a fixed margin could be replaced by profits under an arm’s-length analysis. Therefore, it would be prudent for taxpayers to start modeling their tax and transfer pricing outcomes now to determine whether there should be changes in setting and monitoring transfer prices.

Crowe observation

Although there has not been much guidance in this area, companies also should consider how changes in tax and transfer pricing under the new provisions will affect Brazilian customs duties.

PM 1.152/22 also makes it easier for companies to meet arm’s-length standards in other jurisdictions in related-party transactions involving intangibles by revoking prior law limits on the deductibility of royalty payments by Brazilian companies, provided the payments are treated as income by the beneficial owner of the property. Brazil’s limit on the deductibility of royalty payments was the subject of litigation under U.S. transfer pricing rules in 3M Company v. Commissioner. In that case, the U.S. Tax Court narrowly sided with the taxpayer, holding that the taxpayer met the requirements under the so-called blocked income regulations under Treasury Regulation Section 1.482-1(h)(2) and therefore could take into account foreign legal restrictions in Brazil on the deductibility of royalties for purposes of determining the arm’s-length amount in a transaction between controlled taxpayers. With the changes in PM 1.152/22, U.S. taxpayers will no longer need to meet the requirements in Treasury Regulation Section 1.482-1(h)(2) to support their transactions with Brazil.

4. Application of PM 1.152/22 to all related-party transactions

Historically, Brazilian transfer pricing rules primarily applied to import and export transactions. However, PM 1.152/22 applies to all related-party transactions, including transactions involving intangibles, services, intercompany financing, cost sharing arrangements, and business restructuring transactions. Furthermore, PM 1.152/22 provides guidance on how these transactions should be evaluated for purposes of Brazilian transfer pricing. It also should be noted that such guidance is broadly consistent with the OECD transfer pricing guidelines.

5. Impact on the U.S. foreign tax credit regime

PM 1.152/22’s adoption of arm’s-length principles also has the potential to remove a barrier to claiming U.S. foreign tax credits on taxes paid to Brazil. Under recent changes to the U.S. foreign tax credit regulations, a foreign tax will be creditable in the U.S. only if, among other requirements, the foreign country’s transfer pricing rules follow the arm’s-length principles. Once the law adopting arm’s-length principles is signed into law, taxes paid to Brazil should be eligible for the U.S. foreign tax credit if other requirements for claiming the foreign tax credit are satisfied. Clarifying IRS guidance would be helpful on this issue.

Looking ahead

Brazil’s new transfer pricing rules will be effective beginning in January 2024, but taxpayers are permitted to use the new rules in 2023 if they file an electronic application by Sept. 30, 2023. Accordingly, multinational companies with business in Brazil should evaluate their transactions under Brazil’s new and prior laws to determine whether to adopt the arm’s-length approach for 2023. Even if a company does not intend to adopt an arm’s-length approach for Brazil for 2023, this evaluation can be used to prepare for the January 2024 effective date.

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Sowmya Varadharajan
Sowmya Varadharajan
Principal, Tax