Amendments to the Transfer Pricing Regulations
The Transfer Pricing methods are extremely significant to determine whether the conditions established in the commercial or financial relations among related companies comply with the Arm’s Length Principle incorporated in the new Brazilian regulations. This article explains the main aspects of the Transfer Pricing methodology in Brazil.
In order to determine whether the prices of controlled transactions are at the Arm’s Length Principle, the Organization for Economic Co-operation and Development (OECD) guidelines provide for “traditional transaction-based methods” and “transaction-based methods” for the analysis. Likewise, they state that the most appropriate method for the specific circumstances under analysis should be the one selected.
Accordingly, Brazil recently stated in Law No. 14,596 on Transfer Pricing that the most appropriate method provides the most reliable determination of the terms and conditions to be established among unrelated parties in a comparable transaction, considering three aspects:
- The facts and circumstances of the controlled transaction and the appropriateness of the method regarding the nature of the transaction must be determined through a functional analysis.
- The availability of reliable information on unrelated party transactions.
- The degree of comparability between the controlled transaction and unrelated party transactions, including the reliability of comparability adjustments necessary to remove differences among compared transactions.
According to this concept and the OECD guidelines, the Brazilian regulations issued Normative Instruction No. 2161, which states in Section III Methods, the following methods:
Comparable Uncontrolled Price
The Comparable Uncontrolled Price (CUP) method compares the price or consideration of the controlled transaction with those of comparable unrelated party transactions.
In addition, Article 37 of the aforementioned instructions states that if there is reliable information on comparable independent prices of the merchandise subject to the transaction, including quoted prices or prices performed with unrelated parties (“internal comparables”), the CUP method will be considered the most appropriate to determine the value of the merchandise transferred in the controlled transaction.
Resale Price
The Resale Price (RP) method compares the gross margin earned by a purchaser of a controlled transaction on the subsequent resale to unrelated parties with the gross margins earned on comparable unrelated party transactions.
The RP method is generally more appropriate for commercial transactions and, in general, its reliability will decrease as the reseller adds value to the object of resale by performing additional functions, including processing, or when the reseller is involved in the performance, maintenance, or use of intangibles associated with the product held by a related party.
Cost Plus
The Cost Plus (CP) method compares the gross profit margin obtained on the supplier’s costs in a controlled transaction with the gross profit margins obtained on the costs in comparable unrelated party transactions.
This method is normally employed for controlled transactions supplying semi-finished products or rendering services.
Transactional Net Margin
The Transactional Net Margin (TNM) method compares the net margin of the controlled transaction with the net margins of comparable unrelated party transactions, both calculated based on an appropriate profitability indicator.
This method is the ratio between the operating profit of the controlled transaction and a denominator reflecting an appropriate profitability indicator, thus considering the following criteria:
- Operating items must be calculated which directly or indirectly relate to the related transaction.
- Items unrelated to the related transaction that materially affect comparability should be excluded.
- Non-operating or financial income and expenses, in general, as well as expenses or provisions for income taxes, should not be calculated.
Profit Split
The Profit Split (PS) method splits earnings or losses, or part thereof, in a controlled transaction as unrelated parties do in a comparable transaction, considering the relevant contributions provided for in the form of the functions performed, the assets used, and the risks assumed by the parties involved in the transaction.
The profit split may be performed in the following cases:
- Contribution analysis
- Residual analysisl
Other Methods
These may be implemented as long as the alternative methodology adopted produces results consistent with those obtained in comparable unrelated party transactions.
In conclusion, the recent Brazilian Transfer Pricing regulations consider it feasible to employ the methods accepted in the OECD guidelines. These regulations require taxpayers to employ the most appropriate method to determine the market value of transactions. In addition, the law guides the implementation of these methods to ensure proper application.
