On 3 April 2012, the Brazilian Federal Government enacted Provisional Measure n. 563 (published in the official gazette of 4 April 2012 – "MP 563") which, among other provisions, introduced changes in the Brazilian transfer pricing rules. In general terms, transfer pricing rules aim at avoiding undervaluation of export prices or overvaluation of import prices in transactions with related parties abroad (or non-related parties located in low-tax jurisdictions or subject to privileged tax regimes) as a way to transfer non-taxed profits from Brazil to other countries.
Some changes introduced by MP 563 originated from recurrent disputes between the Brazilian tax authorities and taxpayers and aim at reducing the potential for future litigation. Some of the changes introduced by MP 563 had been previously considered by provisional measure n. 478/2009, but it was not converted into law by the Brazilian National Congress.
We comment below on some of the most relevant changes in the Brazilian transfer pricing rules introduced by MP 563.
1. Amendments to the Resale Price Method – PRL
1.1. Calculation Method
MP 563 modified the calculation of the reference price for purposes of transfer pricing adjustments under the PRL method, making it very similar to the calculation method established by Normative Instruction n. 243/2002 ("IN 243" – the normative instruction enacted by the Brazilian Revenue Services which regulates the Brazilian transfer pricing rules).
There are several tax litigation cases at the judicial and administrative levels regarding the calculation of reference prices under the PRL method as, in the view of the taxpayers, the calculation method set forth by IN 243 is illegal and not consistent with the one provided by Law n. 9,430/1996. MP 563 tends to eliminate similar discussions in relation to future periods.
1.2. Profit Margins
MP 563 also amended the profit margins for purposes of application of the PRL method. Traditionally, under the PRL method, imports of goods to be simply resold by the Brazilian importer were subject to a 20% profit margin, while the import of goods subject to industrialization in Brazil were subject to a 60% profit margin (the application of the 20% profit margin generally allows higher deductible costs for Brazilian importers). The 60% profit margin has always been considered by taxpayers as too high and disconnected with market conditions.
According to MP 563 the profit margins for pure resale and industrialization operations performed by the Brazilian importer should be the same. Such profit margins are of 40%, 30% or 20% depending on the economy sector of the importer, as follows:
40% for the following sectors:
(i) manufacture of pharmaceutical and pharm-chemical products;
(ii) manufacture of tobacco products;
(iii) manufacture of optical, photographic and cinematographic equipment and devices;
(iv) sales of medical and odontology machines, equipment and devices;
(v) exploitation of oil and natural gas; and
(vi) manufacture of petroleum products
30% for the following sectors:
(i) manufacture of chemical products;
(ii) manufacture of glass and glass products;
(iii) manufacture of cellulose, paper and paper products; and
(iv) metallurgic sector
20% for all other sectors
The Ministry of Finance, under grounded circumstances, may change such profit margins.
In case the taxpayer carries out activities that fall within more than one economy sector, the profit margin should be the one applicable to the specific sector which the tested product relates to. Notwithstanding, in case a given imported product is resold and used for the manufacturing of one or more products, or in case the imported goods are used in different manufacturing processes in Brazil, the final reference price shall be equal to the weighted average of the prices calculated under the PRL method, in accordance with the respective economy sector.
1.3. Freight, insurance, import taxes and customs expenses
MP 563 also clarified that the amount of freight and insurance borne by the importer should not be included in the calculation of the reference price, whenever the freight and insurance are paid to non-related parties not resident in tax havens and that do not benefit from any privileged tax regime. Before the enactment of MP 563 there were discussions in court on this matter. Furthermore, MP 563 clarified that the import taxes and expenses related to customs clearance of imported goods should not be considered for purposes of calculating the reference price. The non-inclusion of such amounts generally allow higher deductible costs for the Brazilian importer.
The wording of MP 563, with regard to the exclusion of the expenses above (freight, insurance, import taxes and customs expenses), may create doubts in its application given that it is not clear whether such expenses may also be excluded from the price practiced in the transaction or only in the computation of the reference price. When analyzing the conversion of MP 563 into law, the Brazilian National Congress should aim at clarifying the wording of the provisions in order to avoid future disputes between taxpayers and the tax authorities.
2. Amendments to the Comparable Uncontrolled Price Method - PIC
MP 583 also introduced new provisions related to the PIC method in order to clearly establish the operations/transactions that may be considered for purposes of determining the "arm's length/ uncontrolled" price used for purposes of application of this method.
Transactions utilized to calculate the transfer pricing adjustments under the PIC shall now (i) represent at least 5% of the import price of the transactions subject to transfer pricing rules performed by the relevant taxpayer, in the respective computation period, in connection with the type of imported good, right or service, in case the taxpayer uses its own transactions to support the calculation of the reference price (instead of using transactions practiced by other taxpayers); and (ii) correspond to independent prices practiced in the same calendar year of the respective import transactions subject to transfer pricing rules. With regard to item (ii), in case there are no independent prices practiced within the same calendar year, the taxpayer may use independent prices practiced in the year immediately preceding the relevant year, adjusted by the exchange variations incurred in the period.
3. Introduction of transfer pricing methods for the import and export of commodities
MP 563 created new transfer pricing methods for the import and export of commodities, namely, the "Listed Price in Imports Method" (Método do Preço sob Cotação na Importação – "PCI") and the "Listed Price in Exports Method" (Método do Preço sob Cotação na Exportação – "PECEX"). As from 2013 these will be the only applicable transfer pricing methods for the import and export of commodities (that is, the taxpayers will not be entitled to adopt any other transfer pricing methods established in legislation when importing or exporting commodities from related parties or parties located in a low tax regime or subject to a privileged tax regime).
PCI is defined as the average daily prices of the listing of goods or rights subject to public prices in internationally recognized Brazilian mercantile and future stocks. The price of goods which are imported and informed by Brazilian importers shall be compared with the listing prices of such goods in internationally recognized Brazilian mercantile and future stocks, adjusted for more or less of the average market premium, on the transaction date, in case of imports from: (i) related individuals or entities; (ii) residents in tax havens or tax privileged regimes; or (iii) individuals or entities which benefit from any type of privileged tax regimes. If there is no listing available for the transaction date, the taxpayer shall use the last available listing. In case it is not possible to identify the transaction date, conversion will be made taking into consideration the date of registry of the import declaration of the good.
In turn, PECEX is defined as the average daily prices of the listing of goods or rights subject to public prices in internationally recognized Brazilian mercantile and future stocks. The price of goods which are exported and informed by Brazilian exporters shall be compared with the listing prices of such goods in internationally recognized Brazilian mercantile and future stocks, adjusted for more or less of the average market premium, on the transaction date, in case of exports to: (i) related individuals or entities; (ii) residents in tax havens or tax privileged regimes; or (iii) individuals or entities which benefit from any type of privileged tax regimes. If there is no listing available for the transaction date, the taxpayer shall use the last available listing. In case it is not possible to identify the transaction date, conversion will be made taking into consideration the date of shipment of the exported goods.
The mandatory application of the PECEX method could be disadvantageous to Brazilian exporters of commodities, many of which have been using the CAP method (i.e. production cost plus a fixed profit margin) in their export transactions.
The tax authorities shall enact regulations to further detail the application of PCI and PECEX.
4. Changes in the transfer pricing rules applicable to cross-border loans between related parties
MP 563 also introduced changes in the transfer pricing rules applicable to cross-border loans between related parties. Until the enactment of MP 563, transfer pricing rules only applied to cross-border loans in case the respective loan agreements were not registered before the Central Bank of Brazil. Such rules established that interest paid to related parties were deductible up to the amount that did not exceed the amount calculated based on Libor rate plus an annual spread of 3%.
With the enactment of MP 563 transfer pricing rules will apply to any cross-border loans between related parties (and not only to those whose respective loan agreements are not registered before the Central Bank of Brazil) and the interest will still be calculated according to the Libor rate but the spread margin will be fixed in an annual basis by the Ministry of Finance (instead of the pre-determined 3% annual spread margin).
5. Option for the methods
As from 2012 taxpayers will have to expressly make the option for one of the transfer pricing methods set forth in the legislation (the tax authorities will enact rulings governing the term and procedure for the option for one of the transfer pricing methods). The option will be mandatory/irreversible if the tax authorities commence a tax audit against the taxpayer, except when, during the tax audit, the tax authorities disqualify the method adopted by the taxpayer, case in which it will be required to present, within 30 days, new transfer pricing calculations based on a different method. MP 563 establishes that the tax authorities should justify the disqualification of the method applied by the taxpayer.
According to MP 563, the tax authorities are authorized to determine/arbitrate the reference price based on the documents they are provided with and apply one of the transfer pricing methods set forth in legislation if the taxpayer, after the completion of the 30-day term previously commented: (i) does not present the documentation that supported the determination of the price practiced and the calculation record for determination of the reference price under the chosen method; (ii) presents useless or insufficient documents to evidence the correctness of the calculation of the reference price according to the chosen method; or (iii) does not present any useful element for the verification of the calculations of the reference price, under the chosen method when requested by the tax authorities.
6. Effectiveness of the changes introduced by MP 563
The new rules commented in 1 to 4 will be in force as from 1st January 2013, pursuant to Articles 53 and 54 of MP 563.
The Brazilian National Congress will have 60 days, extendable for an additional 60-day period, counted as from the publication of MP 563, to convert it into law, otherwise the changes introduced by MP 563 will not be effective. When converting MP 563 into law, the National Congress may change the wording of MP 563.
According to the Brazilian Federal Constitution, the new rules established by MP 563 will become effective in 2013 for purposes of the corporate income tax (imposto de renda da pessoa jurídica – IRPJ) only if MP 563 is converted into law in 2012 (otherwise the new rules would only be effective for purposes of the IRPJ in 2014). Taking into consideration the terms involved and the date when MP 563 was published, the National Congress will most likely be able to convert MP 563 into law in 2012.
In addition, taxpayers, at their own discretion, may make use of the new rules in 2012, case in which the option will be mandatory for the whole fiscal year and will be applicable for all changes introduced by MP 563 regarding the Brazilian transfer pricing rules. The potential advantage of using the new rules should be analyzed on a case-by-case basis, depending on the specific situation of each taxpayer and on the transfer pricing methods it utilizes.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.