Brazil’s Administrative Council of Tax Appeals (CARF) overturned a tax assessment that used the ROACE (Return on Average Capital Employed) indicator to recalculate Transfer Pricing in international transactions, thereby nullifying the collection of Corporate Income Tax (IRPJ) and the Social Contribution on Net Income (CSLL) arising from adjustments made by the Federal Revenue Service. The ruling, issued by the 2nd Ordinary Panel of the 2nd Chamber of the 1st Section of CARF, pertains to the 2018 tax year and relates to oil rig charter contracts between a Brazilian company and related parties abroad.
The Origin of the Dispute
The tax audit contended that the company had incorrectly calculated the benchmark price when applying the Comparable Uncontrolled Price (CUP) method, as provided for in Brazilian Transfer Pricing legislation. According to the Federal Revenue Service, the contracts used as comparables had significantly shorter terms than those entered into by the taxpayer. To correct this discrepancy, the tax authority used the ROACE indicator to estimate a rate of return on investment and recalculate the price consistent with the arm’s-length principle. This adjustment reduced the costs considered deductible and resulted in the disallowance of tax losses and negative corporate income tax bases.
The CARF acknowledged the need for the adjustment but rejected the methodology
In analyzing the case, the panel agreed that the significant differences between the comparable contracts could justify comparability adjustments. However, it concluded that the methodology chosen by the Federal Revenue Service did not meet the technical requirements set forth in the regulations. The central rationale: the ROACE used was derived from the consolidated financial statements of large economic groups, which encompassed business activities other than the construction and chartering of the platforms under review—thereby compromising the reliability of the applied benchmark.
In the panel’s view, the use of consolidated financial indicators ultimately incorporates results from businesses unrelated to the transaction under audit, causing the index to fail to adequately represent the market conditions required by the arm’s-length principle. Although the audit sought to correct actual differences between the contracts, the mathematical model employed did not demonstrate sufficient technical precision to support the action.
The audit was canceled in its entirety
CARF rejected the company’s argument regarding formal nullity but upheld the appeal on the merits of the case. As a result, the previously disallowed tax losses, the CSLL tax loss carryforwards, and the costs originally claimed by the taxpayer were reinstated, thereby nullifying the assessment resulting from the Transfer Pricing adjustment.
What This Means for Companies
The decision does not amend Transfer Pricing legislation nor does it prevent tax authorities from making comparability adjustments. What it does reinforce is that these adjustments must be based on consistent parameters directly related to the transactions under review—not on generic or consolidated financial indicators that mix activities unrelated to the audited transaction. For companies with related-party transactions abroad, particularly in long-term contracts, the ruling confirms the importance of having technical documentation that rigorously supports the methodology applied in determining Transfer Pricing.
At TPC Group, we assist companies with long-term intercompany transactions in developing and documenting technically sound comparability adjustments that accurately reflect the specific transaction under analysis and avoid extraneous variables that could compromise their defense during a tax audit.
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