Not All Transfer-Pricing Rules Are Created Equal

Historically, by adopting Sec. 482, the U.S. has prevented multinational companies’ (MNCs’) transfer-pricing (TP) attempts. This provision authorizes the IRS to allocate gross income, deductions and credits between related parties, to avoid eroding the U.S. tax base and clearly reflect the income earned by each taxpayer in each transaction. In this way, the U.S. follows the internationally accepted arm’s-length principle, which aims to treat all transactions as if they were between unrelated parties, for economic and tax purposes. Unfortunately, Brazilian TP methods do not follow general internationally accepted guidelines, which can frustrate those doing business with that country.

U.S. Methods

Under Regs. Sec. 1.482-3(a), the most commonly accepted methods for obtaining an arm’s-length price are the: (1) comparable uncontrolled price (CUP) method; (2) resale price (RP) method; (3) cost plus (CP) method; (4) comparable profits method; and (5) profit split (PS) method. These form the basis for the preparation and/or procurement of complex economic TP studies by U.S. MNCs, to establish global TP policies for U.S. tax purposes.

A TP study must be supported by contemporaneous documentation and updated on a periodic basis. In addition, through a binding agreement between the IRS and an MNC, called an Advanced Pricing Agreement (APA), the IRS ensures compliance and offers taxpayers some degree of certainty in planning their business activities, by applying a pre-determined agreed-on TP method to specific transactions between the MNC and related parties.

OECD Guidelines

Following in the U.S.’s footsteps, other countries, such as Canada, Germany, France, the U.K., Japan and Australia, have also created TP legislation affecting MNCs, to protect against the erosion of their respective tax bases. The TP rules adopted by these countries generally follow the Organization for Economic Cooperation and Development’s (OECD’s) 1979 guidelines. The U.S. is one of the major OECD countries; even though Sec. 482 differs from the OECD’s guidelines, it follows the guidelines’ arm’s-length principles.

The OECD guidelines were also closely followed by non-OECD countries, such as Argentina, Colombia, Ecuador, India, South Africa and Venezuela, in implementing their TP rules. These countries have strictly followed OECD guidelines and methods, by including the CUP, RP, CP and PS methods and/or similar calculation methods and APA-like procedures in their regulations.

As a result, when dealing with TP issues, a somewhat homogenous “playing field” for OECD and non-OECD countries has been created. Normally, an MNC’s TP study prepared in the U.S. can be used as the basis for subsequent studies required in other OECD guideline-compliant jurisdictions.

Additionally, the vast U.S. tax treaty network allows some relief when TP-rule overlap may cause double taxation of a U.S. MNC’s income. Such tax treaties usually provide an opportunity for taxpayers burdened by simultaneous TP rules to force their taxing authorities to agree on the terms of a secondary adjustment. Due to the common trait of the OECD guidelines, the U.S. TP study and another country’s study are important tools in resolving the discussion between taxing authorities.

The definition of acceptable prices between related parties for U.S. tax purposes is a highly technical discussion and relies heavily on in-depth economic analyses and valuations. Whenever the discussion involves an OECD country, or one that adopts the OECD’s TP guidelines and/or has a tax treaty with the U.S., the debate tends to revolve around known variables contained in the OECD guidelines, documented (or to be documented) in some version of a TP study.

Brazil

Unfortunately, this commonalty is not present when the TP discussion involves Brazil. Brazil implemented international TP controls, for the first time, under Law nr. 9.430, on Dec. 27, 1996. The Brazilian regulations can be misleading. Even though Brazil’s TP control mechanisms are based on transactional price and cost, they go far beyond economic reality and deviate from the basic OECD and U.S. guidelines.

For those well versed in TP, the Brazilian approach comes as a surprise, because it fails to adopt the arm’s-length principle and instead promotes a “cookie-cutter” approach. This can be seen in the RP and CP methods (for import and export), as well as in the calculation of interest on loans (not registered with the Central Bank of Brazil), which are all based on arbitrary and governmental pre-determined profit margins (which may or may not be the same as the profit margins established between unrelated parties).

Because Brazil and the U.S. do not yet have a tax treaty in force, U.S. MNCs cannot rely on U.S. government publications or reports or on a statement from the U.S. Federal taxing authorities for CUP method purposes.

Unfortunately, in deviating from proven OECD and U.S. practices, Brazilian TP methods: (1) only rely on “gray area” market research, performed by an officially recognized institution, company or technical publication that specifies the industry sector, period and companies researched, as well as the profit margins and data collected; and (2) do not provide for a feasible APA or similar procedure.

More importantly, the taxing authorities will not accept a TP study as an economically independent TP appraisal to prove compliance with Brazilian TP rules. In its place, a U.S. MNC must maintain extensive contemporaneous documentation controls, to demonstrate compliance with the Brazilian methods and avoid successful challenges by Brazilian taxing authorities.

Conclusion

For the above reasons, when dealing with cross-border TP issues in Brazil, U.S. MNCs should:

1. Not rely on their global TP study;

2. Take into account the differences between the U.S. and Brazilian TP systems (i.e., the method and arm’s-length ranges); and

3. Implement more tailor-made TP documentation procedures for Brazil.

From Lionel Bonner Nobre, J.D., LL.M., CFP, Miami, FL