The Chamber of Deputies approved, on March 30, the conversion project of Provisional Presidential Decree 1,152/22 (“MP 1,152/22”), which introduced the new Brazilian transfer pricing policy. Among the innovations in the conversion process, the following stand out:
- the expansion of the criteria used in the case of commodities (Article 13 of the MP),[1] which now admit the use of prices charged between unrelated parties and public prices, in addition to the quotation prices already provided for in the original wording;
- the exclusion of the secondary adjustment (Articles 17, IV, and 19 of the MP),[2]-[3] since it would "encourage taxpayer to seek the compensatory adjustment [...], adjusting not only the tax base [...], but also the negotiated prices";[4] and
- the exclusion of the prohibition on the deductibility of royalty and technical assistance payments involving parties residing in favorable tax jurisdiction or entitled to privileged tax regimes (Article 45, I, of the MP),[5] "because the mere fact that the entity [...] is located in a tax haven does not mean that the deduction is not due".[6]
The conversion project was sent to the Senate, which is expected to analyze and approve it in the coming days. The conversion of MP 1,152/22 shall be completed by June 1 to maintain its efficacy.
For a better understanding of the subject, we examine, in this Article, the normative grounds that justify the new Brazilian transfer pricing policy.
The arm's length principle
According to Article 2 of the MP, the new Brazilian transfer pricing policy is guided by the arm's length principle, which determines that the "tax base [of the corporate income tax (IRPJ) and the social contribution/tax on net income (CSLL) shall observe] [...] the terms and conditions [...] that would be established between unrelated parties in comparable transactions."
Next, Article 3 describes transactions that are controlled and therefore subject to the transfer pricing policy, as all "commercial or financial relationships between two or more related parties, established or carried out directly or indirectly, including contracts or arrangements in any form and series of transactions."
Article 4 adds that the "parties are related when at least one of them is subject to the influence, exercised directly or indirectly by another [...], which may lead to the establishment of terms and conditions in their transactions that differ from those that would be established between unrelated parties [...]". The hypotheses are exemplified in § 1.
The English expression adopted by Brazilian legislation, arm's length, literally means the distance of an arm. Given that the corporate or personal proximity between the contracting parties can influence the business conditions, the law uses this metaphor to require that a distance between related parties must be considered. With this, it is possible to analyze the transaction as if it had been concluded between independent parties under similar business conditions.
For example, imagine that the parents decide to sell something to their children. The conditions of this contract – price, terms and forms of payment, and guarantee – are generally different from those applied when the contract involves unrelated parties. That is, the family relationship and the consequent proximity between the contract parties influence and allow the business conditions to differ from those applied in the market, creating benefits and losses that ordinarily would not exist.
Nevertheless, the proximity between contract parties does not constitute abuse or refer to an unlawful act. Economic science even explains the impact of this phenomenon with the transaction costs theory of Ronald Coase[7] – Nobel Prize in Economics.
According to him, there are costs intrinsic to contracting in the market – such as costs to negotiate, draft contracts, and ensure the execution of these. The market is itself costly and imperfect. Coordination between economic agents, in turn, makes it possible to reduce this cost. This shows the intrinsic synergy between the related parties, since the corporate and personal relationships between them reduce the costs.
On the other hand, the presence of these more beneficial or harmful terms and conditions constitutes an instrument for related parties to transfer or maintain income in jurisdictions with lower tax burden, intending to reduce the overall tax burden. This fact causes the progressive erosion of the tax bases of the states.
To this macro perspective is added the tax equality, considering that other taxpayers, who follow market conditions, should bear a greater tax burden.
In a competitive scenario with the absence of transfer pricing rules, a tax advantage is created, in addition to the existing economic one, which can violate the freedom of competition and the principle of tax neutrality.
A mechanism to correct tax treatment
In this sense, the transfer pricing policy constitutes a mechanism for correcting the tax treatment to determine the tax base consistently with the market income.[8]
It is not, therefore, a question of nullifying the synergy between related parties, but of correcting the tax treatment and preventing it from being an additional disturbance to competition, beyond the already existing economic advantage.
For this reason, when it is held that there should be adjustments in the tax base, the underlying private relationship is not altered. It is only recognized that, for tax purposes only, the price of the transaction, for example, shall be a different one from the real one.
The transfer pricing rules are not intended to question the legitimacy of the transaction and its prices, that is, one should not talk about fraudulent overpricing or under invoicing, since the parties effectively contract the prices in a real way. The tax law is limited to comparing these prices with those that would be obtained under market conditions (at arm's length) and adjusts them to calculate the tax bases.
Hence, there is a difficulty that is intrinsic to the application of transfer pricing rules: how to identify market conditions?
In most cases, there is no single price, form, and contractual conditions. In fact, it is difficult to define market conditions, because of the range of options available.
It is noticed, therefore, that this construction impacts the control by the tax authorities, since, under the principle of arm's length, it must turn to the hypotheses in which there is a substantial deviation of market behavior and conditions.
The application of the new Brazilian transfer pricing policy, consequently, will reveal to what extent tax authorities are attending to these fundamentals, and this may result in the litigation regarding the subject.
[1] Conversion project of MP 1,152/22: "Article 13. Where there is reliable information on comparable independent prices for the traded commodity, including quotation prices or prices charged between unrelated parties (internal comparables), the PIC method shall be considered the most appropriate for determining the value of the commodity transferred in the controlled transaction, unless it can be established in accordance with the facts and circumstances of the transaction and other elements of Article 11, including the assets, functions, and risks of each entity in the value chain, that another method is more appropriate to observe the principle outlined in Article 2.
[...]
- 2 The adjustments provided for in § 1 shall not be made if the comparability adjustments affect the reliability of the PIC method and justify the consideration of other transfer pricing methods, in accordance with Article 11.
[...]
- 5 - The public prices shall be used for the control of transfer pricing in the same way as they would be used by unrelated parties in comparable transactions.
- 6 - In extraordinary cases, the use of public prices shall not be appropriate for the control of transfer pricing if it leads to a result incompatible with the principle provided for in Article 2. [...]
[2] MP 1,152/22: "Article 17. For the purposes of this Provisional Presidential Decree, it is considered:
[...]
IV - secondary adjustment - that used as a result of the adjustments provided for in items I or III of the caput."
Conversion project of MP 1,152/22: Excluded item IV of Article 17 of MP 1,152/22.
[3] MP 1,152/22: "Article 19. If the spontaneous adjustment or the primary adjustment referred to in items I and III of the caput of Article 17 are made, the secondary adjustment shall also be made, which shall be determined based on the following criteria:
I - the adjusted amount will be considered as credit granted to the related parties involved in the controlled transaction, remunerated at the interest rate of twelve percent per year;
II - the interest provided for in item I shall be considered due from January 1 of the year following the period of calculation until the date on which the amount considered as credit is fully reimbursed to the legal entity resident in Brazil and shall be subject to taxation of the IRPJ and CSLL;
III - the interest rate will be reduced to zero if the amount considered as credit is fully reimbursed to the taxpayer in Brazil within ninety days, counted from:
(a) January 1st of the year following the calculation period that caused the spontaneous adjustment; or
(b) the date of the notification of the tax notice regarding the primary adjustment."
Conversion project of MP 1,152/22: Excluded Article 19 of MP 1,152/22.
[4]Office of the Deputy Da Vitória - PP / ES, opinion of the Joint Committee on the Provisional Presidential Decree 1.152/22, p. 35.
[5] MP 1,152/22: "Article 45. In determining the actual profit and the tax base of IRPJ and CSLL, the amounts paid, credited, delivered, employed, or remitted as royalties and technical, scientific, administrative, or similar assistance are not deductible:
I - entities resident or domiciled in favorable tax jurisdiction or entitled to privileged tax regimes, as referred to in Articles 24 and 24-A of Law No. 9,430 of 1996; or [...]"
Conversion project of MP 1,152/22: Excluded item I of Article 45 of MP 1,152/22.
[6] Office of the Deputy Da Vitória – PP/ES, Opinion of the Joint Committee on Provisional Presidential Decree 1.152/22, p. 34.
[7] R. H. Coase, The firm, the market and the law, University of Chicago Press, 1988.
[8] Paul Kirchhoff, Tributação no Estado Constitucional, São Paulo: Quartier Latin, 2016, p. 105.
