Transfer Pricing alert: 13-001
Brazil Amends Transfer Pricing Rules on Financial Transactions
By Marcelo Natale, Carlos Ayub, Fernando Matos, and Alexandro Tinoco (São Paulo)
The Brazilian government on December 28, 2012, published new transfer pricing rules on financial transactions. Law 12,766/2012 amends Law 12,715, approved approximately 90 days before, which introduced new transfer pricing rules on intercompany loan transactions by expanding the scope of the rules to include all financial transactions involving interest payments. In practice, the provisions related to interest included in Law 12,715 did not have any effect, because they were scheduled to enter into effect on January 1, 2013. New Law 12,766 supersedes those provisions.
The Brazilian revenue services on December 31 published Normative Ruling 1,312 to regulate the application of the new transfer pricing rules enacted by Law 12,715. However, the language in the ruling is not consistent with Law 12,766. The Brazilian revenue services will likely issue an additional ruling addressing the new transfer pricing rules on financial transactions soon.
The new transfer pricing provisions on financial transactions are applicable to new contracts starting on or after January 1, 2013. The new rules grandfather financial transactions entered into before January 1, 2013, as long as they are not renegotiated or amended in tax periods after the new transfer pricing provisions become effective.
Historical treatment of intercompany financial transactions
When the Brazilian transfer pricing rules were originally enacted through Law 9,430/1996, they specifically indicated that financial transactions registered with the Brazilian Central Bank (BACEN) were outside the scope of the new rules. Otherwise, the reasonableness of interest expense or revenue associated with the transactions had to be consistent with the six-month London Interbank Offered Rate (Libor) for U.S. dollar deposits, increased by an annual spread of 3 percent on a pro rata basis. In practice, despite some debate regarding the concept of “registered” transactions, virtually all inbound contracts were registered with BACEN after the introduction of the web-based system RDE-ROF in 2001.
Back in 1996, BACEN’s technicians would review, approve, or reject all contracts involving inbound and outbound financial transactions. It was a bureaucratic process whereby taxpayers had to submit the proposed contract to BACEN and await a response. At that time, it made sense to allow financial transactions registered with BACEN to remain outside the scope of the transfer pricing rules, under the rationale that if BACEN approved a given transaction, the interest expense or revenue associated therewith must be adequate, and analyzing those from a transfer pricing perspective would erode BACEN’s authority.
In 2001, BACEN established an electronic process for taxpayers to report their financial transactions. Although draft contracts were no longer reviewed by a technician, BACEN could still challenge the transactions if they were considered inadequate.
Taxpayers have long argued that the process of informing BACEN of their intercompany financial transactions was sufficient to allow those transactions to fall outside the scope of the transfer pricing rules. Until recently, the Brazilian tax authorities seemed comfortable with that assumption, and taxpayers were rarely challenged on the matter.
Law 12,715/2012, published in September 2012, made significant changes to the Brazilian transfer pricing rules. The new transfer pricing rules specifically provided that interest associated with intercompany loan transactions would not be deductible if it was not consistent with the six-month LIBOR plus 3 percent annual spread, regardless of registration with BACEN. This change would introduce a flat criterion applicable to all old and new contracts.
It is important to point out that Law 9,430/1996 dealt with financial transactions not registered with BACEN, whereas Law 12,715/2012 deals with intercompany loan transactions. Based on the language of Law 12,715/2012, taxpayers and tax practitioners wondered whether any other interest-bearing financial transactions would fall outside the transfer pricing spectrum as long as they were registered with BACEN. The new Law 12,766 represents a quick fix to address the uncertainty associated with Law 12,715 from September 2012, even before the older law became effective.
Highlights of new rules
The basic rule is that the “limit” (maximum for inflows and minimum for outflows) is a combination of a “rate” plus a “margin” (spread). Different rates are provided, depending on the type of transaction, the currency used, and other factors. The margin will be determined by the minister of finance, but it is unclear at this point if there will be different spreads for each type of transaction or just one fixed margin as in the past (when a flat spread of 3 percent provided a safe harbor). Also, it is not clear when and how often this spread will be published, a fact that brings some uncertainty to the analysis. The only information provided is that the spread will be a “market average,” without clarification as to which market and what type of average will be adopted.
The rates are defined as follows:
|USD||Foreign||Fixed rate, predetermined||Market rate of sovereign bonds of Federative Republic of Brazil, issued in USD, in foreign markets|
|Real||Foreign||Fixed rate, predetermined||Market rate of sovereign bonds of Federative Republic of Brazil, issued in Reais, in foreign markets|
|Any (a)||Any (a)||Any (a)||Libor for six months for the respective currency adopted (b)|
|Real||Foreign||Variable||May be determined by the Minister of Finance|
(a) The LIBOR limit considers the adoption of any currency, market, and type resulting in different combinations other than those specified for other rate limits.
(b) If there is no specific LIBOR for the currency adopted, six-month LIBOR in U.S. dollars should be used.
A very important factor introduced by Law 12,766 is the concept of the “verification moment,” that is, the point in time when a taxpayer should test the transaction for transfer pricing purposes. New paragraph 9 of article 22 establishes that this verification should be done “on the contract date of the transaction” and not on a periodical way, as previously stated by Law 12,715.
Law 12,766 introduces significant changes to the Brazilian transfer pricing rules on financial transactions, which had previously not been well regulated. The new rules represent a significant advance to align the Brazilian transfer pricing rules on these transactions with the international standards by avoiding the adoption of fixed flat rates. Taxpayers should consider carefully the appropriate limit at the time of the contract date and avoid closing contracts until further clarification regarding the spread/margin and official source of information for the rates to be used.