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  • Writer's pictureTulio Lira

Let's Talk About Transfer Pricing?

(This article is originally published in Portuguese)

Starting with the basics, let's first go to the epicenter of the foundation of modern intelligence: Wikipedia.

"Transfer pricing means the amount charged by a company on the sale or transfer of goods, services, or intangible property, to a company related to it. Since these are prices that have not been negotiated in a free and open market, they may deviate [sic.] from those that would have been agreed upon between unrelated business partners in comparable transactions under the same circumstances." [1]

Excellent! It would be difficult to summarize in fewer words (maybe it has to do with the fact that the bibliography on the page points to Schoueri). This paragraph can even be broken down into smaller parts from where we would extract some of the fundamental concepts of transfer pricing rules, such as (i) international transactions, (ii) related parties, and the famous (iii) Arm's Length principle - but this can get tiresome, tedious, and is probably already better explained in several other places on the internet. What is important to know for now is that this is an internationalized concept focused on the correct division of profit taxation between jurisdictions.

This way, when company X (resident in a tax haven that does not tax income) overcharges its invoices for services to its sister Y in Belgium (with tax of up to 31.75%), these expenses will not be deductible in the country of the beers, due to transfer pricing rules. This prevents the escape of taxable income.

By the way, when dealing with issues between nations, I think it is valid to discuss with the terminology in "lingua franca" (English - as far as I could follow). Thus, 'transfer pricing' will be 'transfer pricing' ("TP") and 'Arm's Length principle' will continue to be 'arm's length principle'. Other nomenclatures may appear along the way.

Well then. Why TP?

As seen in the example above, transfer pricing rules are rooted in the conceptual basis of what could be conceived as tax justice in international taxation. The basic idea of "justice" easily populates our minds, but it can hardly be translated objectively - especially when it comes to taxation. The German philosopher Immanuel Kant and his Categorical Imperative took the first bite at the subject by tackling the materialization of justice. Kant believed that there could be a formal test/method to validate moral principles and actions as 'justifiable' when universally applicable: what is right or wrong for one, must also be for another, when faced with a similar situation. Wonderful, isn't it? The question here is: how to transfer this to the cordless telephone that is international tax law?

The OECD already gives the complete package: TP Rules + BEPS + AEoI (CRS / CbCR etc)[2]

These acronyms have certainly echoed in Brazilian ears at some point. Without going into the merits of each one, let's understand that the solution proposed by the OECD is: a single rule + open communication. If everyone follows the same book and knows everything at the same time, there is no confusion. Simple? No. There are a number of legal issues involved here, including information disclosure, data privacy, and the various adaptations in the legal system to receive changes made by the "supranational" body that is the OECD.

I started with the answer, didn't I?

Allow me to relocate the issue. One of the biggest issues around TP is to align the whirlwind of each country's rules and interpretations with (i) the reality of the facts and (ii) the corresponding tax adjustments of the other country, especially allowing the profit already taxed by one jurisdiction not to be reached by the other. The first point is a more conceptual question of the effectiveness of the tax rules themselves: "are they sufficient to ensure the fair division of taxable income between the jurisdictions involved?" The second point concerns the protection of the taxpayer, who (ideally) should not see his profit subjected to double taxation.

At that point, it is normal to think, "but we have the double taxation treaties exactly for that (!), to address among other things transfer pricing adjustments. Right?"

É. For all the easy relationships where both countries use the same rulers, squares and measures.... and currencies. The two points are somewhat related and will give much to write about. Let us now look at Brazil in the midst of this sea of uncertainty.

The TP rules in Brazil were conceptually introduced in 1996 by Law n. 9,430/96 (the "BR TP Law") and are based on (i) fixed safe harbor margins and (ii) freedom of method selection. Thus, in Brazil, the control of over- or under-invoicing is done by determining maximum comparison prices for imports and minimum prices for exports. These are the so-called "price parameters", which are then compared with the prices charged by the taxpayer. This means that as long as the company can demonstrate that (by the method it chose) it remained within (with a delta of up to 5%) the parameters pre-set by the Brazilian government, everything is fine[3].

Shifting the focus now to Europe, we see that the application of the TP rules requires much more caution and substance when compared to Brazil. As a rule, a true market study of margins and comparable companies / groups is required before defining how operations by associated companies should proceed. It is not up to the government to tell how the market works; it is up to the market. Everything begins with an analysis of the product and the company in question, and then the search for comparables - which is normally done by the common nomenclature of the product or the activity of the company (when we are talking about manufacturing or commerce) or by the parameters of the royalty/interest contract (when it is a financial analysis). Once the companies and operations are found, we look at the numbers, expenses, margins, and everything else to achieve an acceptable margin range... for that year.

Although longer, more expensive, and painful, this transfer pricing analysis is the surest method to ensure the application of the Arm's Length principle as advocated by the OECD. And why is that? Well, in the first place, because it is what most other countries do out there, and this parity of methods brings more legal certainty and breaks some of the telephone-wire between two different methods (it is hard to disregard the value of parity of conduct). Secondly, because of the general merit of the Brazilian method. For example, the odd period of the pandemic required extraordinary negotiations at extraordinary prices and margins - something difficult to fit into the Brazilian plastered margins.

And now?

In 2018, OECD experts and RFB representatives initiated a collaborative study on the BR TP Rules entitled "Transfer Pricing in Brazil: Convergence to the OECD Standard"[4]. The objective was to analyze the effectiveness of the BR TP rules and develop an alignment strategy for Brazil before the country could officially join the OECD. The results of this study reveal that, although simple, the imprecise nature of the BR TP Rules creates a risk of base erosion and profit shifting (BEPS). Ipsis litteris:

"Transfer pricing analysis in Brazil is not based on a thorough comparability analysis, which includes the proper identification of the business or financial relationships and careful consideration of the economically relevant circumstances of the taxpayer, the functions performed, the assets used and risks assumed, and other comparability factors. The concept of precise transaction delineation set forth in the OECD Transfer Pricing Guidelines is also not found in Brazil's transfer pricing framework, potentially leading to under-taxation and creating significant BEPS risks."[5]

In the report, the OECD more descriptively highlights the points of contrast between the Brazilian approach and the international standards to which it would need to conform in order to officially join the "club" of economic cooperation and development (OECD) - today, Brazil is simply an 'interested observer'.

It is curious to remember that although Brazil is not yet a member of the OECD, the BR TP Law was inspired by the OECD guidelines; those that were in force at the time the BR TP Law was adopted (as noted in the BR TP Law's explanatory memorandum). However, contrary to its inspiration, the BR TP legislation has evolved little since its introduction and the simplicity of the Brazilian transfer pricing system is often counterbalanced by its vagueness which can sometimes culminate in a loss of tax revenue. These weaknesses are mainly due to the absence of special considerations for more complex transactions (e.g. transactions involving the use or transfer of intangibles, intra-group service transactions, and transactions that include business restructuring, among others).

As Brazil gains ground on the international stage, it is important that its tax framework is mature enough to accommodate the increased complexity required by the transactions it wants to attract. Isn't it?

Article available on the website Juridicamente.

[1] Available at: Accessed in 30 de Oct 2021. [2] The meaning of the abbreviations: Base Erosion And Profit Shifting + Automatic Exchange of Information (Common Reporting Standard + Country-by-Country Report etc). [3] To be sufficiently rigorous, one must recognize that there are formal transfer pricing methods in Brazil that go beyond mere fixed margins. CPL - Production Cost Plus Profit Method: based on the production cost of the good in its origin (abroad) and PVEx - Export Sales Price Method: based on the comparison of independent prices (export to third parties) are two examples that require the taxpayer to look at third party companies and groups and compare the prices practiced. However, these methods (i) are not used in practice, (ii) the RFB is not prepared to verify the veracity of the information shared because it does not yet have access to international databases, (iii) nor does the taxpayer.

[4] Available at: Accessed in 29 Oct 2021. [5] OCDE. Preços de Transferência No Brasil: Rumo à Convergência para o Padrão OCDE. Pag. 15. Disponível online em: Accessed in 29 Oct 2021.

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