MP on taxation of multinationals awaits sanction – 06/05/2023 – What tax is this

Recently approved by the Federal Senate and still awaiting presidential sanction, provisional measure nº 1152/2022 on transfer pricing, in addition to revoking the fixed margin regime, determines the adoption in international operations between related parties of the so-called “arm’s length” regime, proclaimed by OECD as a necessary condition to avoid double or non-taxation, as well as damage to a global environment of free competition.

According to the “arm’s length” regime, the price practiced in an operation between related parties —companies of the same group, for example— must be compared to the price that would be practiced in equivalent situations, established between independent parties. Thus, the profit earned in these operations must be allocated to each of the contracting parties based on an analysis of risks and functions, and taxed, based on this allocation, by the jurisdictions of their respective residences.

For example, if a Brazilian company exports a certain product to its parent company in the United States, which in turn resells this product in the domestic market or re-exports it to third parties, the lower the price practiced in exports from Brazil, the greater the profit of the American parent company. . And vice versa, since the price charged for resale to third parties will necessarily be the market price, over which there is no control.

Adopting the “arm’s length” for defining the price of the operation, the distribution of the taxable profit will be based on a comparative analysis with the prices practiced in the market, leaving each jurisdiction with the portion of profit that would be rigorously defined in a free market competition. So far everything is fair!

Challenges arise in determining and allocating the profit earned in the controlled transaction. The choice of the most appropriate method and the analyzes based on which not only the outline of the operation is carried out, but also the allocation of profit itself is a process made up of relative judgments, conducive to divergences between the taxpayer and the tax authorities, and between the tax authorities jurisdictions in which taxpayers reside.

For example, if a Brazilian taxpayer produces a product based on technology developed by its parent company based in another jurisdiction, the tax authorities of that jurisdiction may understand that the amount of royalties paid by the Brazilian company is below the amount that would be charged to unrelated third parties. In this case, part of the Brazilian company’s profit should be allocated to the foreign parent company. An adjustment to increase the parent company’s income tax calculation base should then correspond to a reducing adjustment of the Brazilian company’s calculation base, under penalty of double taxation of the economic group. The reverse hypothesis is also possible. The Brazilian tax authorities may understand that the Brazilian taxpayer has a relevant role in valuing the intangible, in such a way that services should be charged by the Brazilian tax authorities.

In line with the OECD, the new transfer pricing rule brings instruments to rule out the occurrence of costly litigation for all those involved in this dispute over taxable income. However, all require a flexible posture on the part of the farm administration. This will be the secret to the success of the new rules, as the Brazilian taxpayer, over the years, considering the volume of tax disputes existing in Brazil, has shown itself to be living up to the national anthem —”if you raise a strong club from justice, you will see that your son doesn’t run away from the fight”. A study by the National Council of Justice reveals that in 2020 there were about 77 million active lawsuits in the Judiciary, approximately 40% of which were of a tax nature.

In order to reduce points of friction, the new law foresees the possibility of establishing a specific consultative process in terms of transfer pricing, which assures the taxpayer, among others, the selection criteria for the most appropriate method, the choice of comparable and comparability adjustments, which in fact may bring some security in the determination of transfer prices.

However, it should be noted that this is not a conciliatory procedure for reaching an agreement on these issues, which would avoid contestation by the taxpayer. To this end, along these lines, what the OECD recommends in its directives is the adoption by states of rules that make the so-called Advance Price Agreements (APA) feasible, which should be achieved through cooperation between tax authorities and taxpayers and , preferably from all jurisdictions involved.

The recommendation focuses on bilateral or multilateral APAs. The consultation process in the new Brazilian rule is very far from all this interaction and the network of double taxation agreements in Brazil is very timid, which significantly reduces the efficiency of the procedure, which may even be subject to judicialization if the taxpayer comes to deviate from the answer given to you.

As long as there is a double taxation agreement, the new rule also provides for the possibility for the taxpayer to request the establishment of a friendly procedure (MAP) to review ex-officio adjustments determined by the tax authorities. Once again, this is a procedure with minimal interaction on the part of the taxpayer, limited to the request for the initiation of negotiations between the contracting states, and which will be at the discretion of the Brazilian tax authorities, which conditions the effectiveness of the instrument to the sensitivity of the tax authorities regarding the claims of the contributor.

If the Brazilian tax authorities remain focused on immediate collection objectives, the taxpayer’s reaction will certainly be to knock on the doors of the Judiciary. Furthermore, as there is no obligation for the Brazilian tax authorities to enter into an agreement to resolve the conflict with the other contracting state and as the conventions entered into by Brazil do not provide for the possibility of arbitration, there will be no pressure for the contracting states to seek a consensual solution . Hence, once again, a flexible stance on the part of the Brazilian tax authorities will be decisive.

All this, however, does not invalidate the recognition that the new rules put Brazil in line with the OECD. However, its efficiency will depend on flexible behavior on the part of the Brazilian tax authorities, which will avoid us entering an era of complex conflicts. On the other hand, the adoption of a conciliatory posture, as also recommended by the OECD, offers foreign investors a more reliable and favorable environment for new investments that will actually place us in global value chains.

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