The outcome of Brazil's general election might affect TP regulations

The timing of Brazil's OECD compliance, according to tax directors from three MNEs, including JTI, is dependent on the impending presidential election results.

Brazil's presidential battle, which concludes on October 30, is likely to determine whether the nation follows the planned path toward OECD transfer pricing norms.

Pedro Lima, senior tax manager of tobacco manufacturer JTI in Santa Cruz do Sul, asserts that the elections will have an effect. "If the current president [Jair Bolsonaro] is re-elected, there is a great chance that Brazil will adopt the OECD guidelines."

"The tax authorities have mentioned that they want to adopt the rules regardless of elections. They are running against time to have everything ready for next year. It will happen sooner or later, [but] for 2023 – that remains to be seen," says Lima, referring to the projected deadline of the following year.

Lima claims that Luiz Inácio Lula da Silva, often known as Lula, an opponent of Bolsonaro and a former president, has not consistently demonstrated a desire to advance Brazil's OECD membership.

He claims that it is not one of his priorities.

On October 2, the first round of the general elections was place. Lula barely defeated Bolsonaro with 48.4% of the vote. On October 30, the second round will take place.

According to recent surveys, Lula is expected to maintain his lead in the election, but Lima warns that nothing is guaranteed.

It is unclear whether Lula will continue to press for Brazil to follow OECD and TP guidelines, but the country has demonstrated a stronger desire to harmonize its tax laws with global norms.

Brazil has historically improved its relationship with the OECD through a number of initiatives.

The Brazilian government is still seeking to join the OECD despite efforts to achieve full membership, which also entails implementing the global norms in its TP system.

Since they were established in 1996, the current TP rules have not altered. They do not adhere to the arm's-length principle (ALP), instead using exact calculating techniques with predetermined margins.

Especially under Bolsonaro, Leonardo Meller, head of tax at food maker Puratos in So Paulo, is optimistic about Brazil's desire to join the OECD.

I believe it will join, but I don’t know when, due to the elections. If Bolsonaro continues, this rule is just a matter of time," he claims.

Since it was introduced and Bolsonaro was elected in 2018, Meller continues, "there has been a movement of no turning back."

The timing of the implementation of the OECD TP regulations would depend on the election outcomes, according to Daniel Cordeiro, tax manager of the global aircraft giant Embraer in So Paulo.

"The results of the election will be key as to whether it will come into place next year. It will have to go through both houses of Congress," he says.

The implementation of the TP principles, according to certain tax directors, must continue to be Brazil's top priority, especially given that the country's present tax system provides few options for taxpayers.

"It’s not a great model. Society wants change," Meller stated.

By being more flexible and equitable, the OECD standards would enable Brazilian firms to prioritize comparability analyses, he continues.

Brazil's TP system may be "unique," as Cordeiro claims, but considering the range of businesses operating today, the restrictions are excessively rigid.

He claims that despite the tax authorities accepting some variations in the fixed margin strategy, the present norms make it impossible for particular companies. Brazilian TP regulations do not rely on the use of ranges, although they can accept a variance of 5% for all transactions and 3% for those involving commodities.

"It will be ideal to have more flexibility. If you prove that the [fixed] margins aren’t applicable, then you can have a specific margin allowed. That’s one of the key issues," according to Cordeiro.

"The standard could be that you have a margin or range of margin and if you have your own benchmark, you can show that the range does not apply to your specific case. This would work," he claims.

Even with the leeway provided by the deviation, another drawback of Brazil's TP regulations is that they emphasize mathematical issues in transactions. The transfer prices are computed via the formulary apportionment technique.

According to Cordeiro, the ALP's incorporation in the legislation would foster a more commercial perspective on TP and introduce economic reasoning into debates between taxpayers and authorities.

The administration also needs to implement international norms in other areas.

For instance, according to Itamar da Cunha, senior tax planning manager at cereal maker Kellogg's in So Paulo, the laws governing withholding tax credits that Brazil now has with the US continue to be a significant issue.

Brazilian taxes would become creditable in the US under the rules governing international tax credits if Brazil joined the OECD.

"They are denying the credit of the income tax. The issue is the standardisation," claims da Cunha.

"Our difference with other countries is creating that type of situation. We should seek these types of benefits," he continues.

Da Cunha and Dante Zanotti, a tax lawyer at the So Paulo law firm Lefosse, concur that it is imperative to revise the TP rules given the way that US firms with Brazilian subsidiaries are already being impacted by changes to the US foreign tax credit system.

"Under these [OECD] regulations, one of the important aspects is to have TP guidelines aligned with the US. Brazil currently does not," according to Zanotti.

The prospective use of OECD TP principles is anticipated to increase the jurisdiction's foreign investment as well as tax certainty.

According to Lima, "The biggest difficulty is to explain local rules to foreign investors. We have our set of rules that create additional controls and obligations."

Despite Brazil being a sizable market for multinationals, investors are less keen to invest there because of the mismatch with foreign legislation. Following OECD guidelines might make the nation a more desirable economic hub.

Da Cunha contends that it is crucial for Brazil to embrace the OECD regulations as much as feasible.

"However, Brazil has had a different approach to TP for many years, and that is something that must be considered. If Brazil adopts the ALP, it must be done in a gradual way," he continues.

It would be expensive for small-to-medium-sized businesses (SMEs) in particular to abandon the present TP system.

The tax authorities and the government would have to take into account the various sorts of firms or income while carrying out the transition because SMEs would not have the same resources as multinationals.

According to Zanotti, adopting OECD principles would have an impact on all types of Brazilian firms.

The majority of inter-company transactions now carried out by businesses with Brazilian firms would be impacted, according to him.

The most significant effects could be seen in inter-company transactions involving services, intangibles, and financial transactions because the present TP standards tend to concentrate on transactions involving things.

Zanotti cautions that applying OECD criteria to these transactions will cause significant changes.

The possibility that Brazil would become "more expensive" before the adoption process was fully completed, according to Lima, means that shareholders would need to finance the higher cost of implementation.

"The issue we need to take care of is the transitional rules. Will there be transitional rules or will they [corporations] switch straight away?" asks Lima.

More information about Brazil's future tax policy will become available after the projected election results at the end of the month. The 2023 date appears a bit ambitious in the meantime, especially if a transition phase is chosen.

Overall, it appears that the future president already has a heavy workload. Directors of TP eagerly anticipate the findings.

By fLEXI tEAM