By Fernando Matos, Carlos Ayub, Alexandro Tinoco and Daniel Macedo

As part of a long-awaited initiative to stimulate domestic growth, the Brazilian government on 3 April published Provisional Measure (MP) 563/2012, which includes significant changes to the country's transfer pricing rules. MP 563/2012 amends the rules applicable to imports of goods, sets profit margins for certain sectors, and creates two new transfer pricing methodologies.

The MP still must be enacted into law, which is expected to take place within 60 days following publication. Although the changes made by MP 563/2012 will apply to fiscal years starting on or after 1 January 2013, taxpayers can opt to apply the rules from fiscal year 2012.

Highlights of MP 563/2012 include the following:

• Changes to the resale price minus profit method (PRL): The PRL historically has been the most frequently used method to determine the reasonableness of the price paid by a Brazilian taxpayer in inbound intercompany transactions. The PRL method takes into account certain statutory gross profit margins, which vary depending on the use of the imported products, services, or rights. The statutory gross profit margins currently are 60 percent for imported items used by the importer in the production process and 20 percent in all other cases in which the imported items are not used in the production process, regardless of the industry of the taxpayer.
  
  MP 563/2012 introduces the following changes to the application of the PRL method:
  
  
  • New gross profit margins: New gross profit margins will apply, depending on the taxpayer's sector or the activities for which the imported products, services, or rights are used. These are summarized below:
    
    

  Gross profit margin	Sector or activity
  40%	Manufacturing of pharma-chemicals and pharmaceuticals Manufacturing of tobacco-related products Manufacturing of optics, photography and cinematographic equipment and instruments Sale of medical and dentistry-related machinery and equipment Extraction of oil and natural gas Manufacturing of petroleum by-products
  30%	Manufacturing of chemical products Manufacturing of glass and glass-related products Manufacturing of cellulose, paper and paper products Metallurgy
  20%	All other sectors

  
  
  • Freight and insurance and import tax costs: One of the most controversial issues raised with regard to import transactions is the treatment of freight and insurance costs and its impact on the Brazilian import tax cost for purposes of comparison with the price calculated using the PRL method. From an economic perspective, payments to third parties do not generate a transfer of profits to related parties and, therefore, should not be subject to the transfer pricing rules. MP 563/2012 now provides that, unless paid to related parties, freight and insurance expenses, as well as the import tax and other customs costs incurred by the local importer, should not be taken into account when determining the price that is subject to assessment under the Brazilian transfer pricing rules.
    
    
  • PRL calculation formula: MP 563/2012 also introduces changes to the PRL formula. The parameter price, which continues to have as its starting point a sale transaction entered into by the Brazilian taxpayer, must take into account the ratio of the products, services, or rights imported from related parties to the total costs of the products, services, or rights sold by the Brazilian taxpayer. For practical purposes, this change expands the approach the Brazilian tax authorities have been requiring taxpayers to apply when applying the "PRL 60" method.
    
    
• Changes to the comparable uncontrolled price method (PIC): The PIC is defined as the weighted average of the uncontrolled prices of similar goods, services, or rights as calculated in the Brazilian market or in other countries, for purchase or sales transactions carried out under similar circumstances. MP 563/2012 provides that the application of the PIC method in cases in which the taxpayer applies the method based on uncontrolled import transactions should take into account similar uncontrolled transactions with a volume representing at least 5 percent of the total import amount from related parties. The MP does not set a threshold where the PIC method is applied solely based on comparable transactions entered by parties other than the Brazilian importer. MP 563/2012 also provides that the PIC method should be applied based on transactions entered during the same fiscal year as that under analysis. When transactions entered during the same period are not available, the taxpayer can rely on transactions entered into in the prior year, as long as it makes adjustments to the price of such transactions to account for foreign exchange rate fluctuations.
  
  
• New transfer pricing methods for commodities: MP 563/2012 introduces two additional transfer pricing methods to the existing Brazilian methods: the stock exchange import price (PCI) and stock exchange export price (PECEX) for inbound and outbound transactions in commodities, respectively. Under the additional methods, the basis for comparison is the average stock exchange price for the relevant items adjusted for any applicable upward or downward spreads. The stock price that should be used corresponds to the average price on the date of the transaction. In cases in which no stock price exists for the relevant date, the analysis should be based on the average stock price for the most recent date before the transaction date.
  
  
• Inbound and outbound loan transactions: Taxpayers have long argued that interest paid on intercompany loan transactions is not subject to the Brazilian transfer pricing legislation if the loans are registered with the Brazilian central bank (BACEN). MP 563/2012 specifically provides that interest expense paid to related parties will not be deductible if above the six-month London Interbank Offered Rate (LIBOR) plus a spread (to be determined by the Brazilian tax authorities). In practical terms, the new provision indicates that interest expense above such a threshold will be taxed at the applicable corporate income tax rate.
  
  
• Limitation on ability to change transfer pricing methodology: Brazil requires domestic companies to conduct an annual transfer pricing analysis and include the results on specific forms filed with the Brazilian income tax return. Effective from fiscal year 2012, a taxpayer cannot take the initiative to change the transfer pricing method originally selected to analyze and substantiate its intercompany transactions once the Brazilian tax authorities initiate an audit. If the authorities conclude that the method originally chosen by the taxpayer should be disqualified, the taxpayer will be granted an additional 30-day period to prepare a new transfer pricing analysis that can be based on any of the available methods.

Brazil's transfer pricing rules have been a source of controversy since they came into effect. Unfortunately, the changes introduced by MP 563/2012 do little to align Brazilian transfer pricing legislation with the international norm. They continue to lack the economic rationale provided under the U.S. transfer pricing regulations and the OECD transfer pricing guidelines. Nevertheless, the changes are significant and will impact the transfer pricing tax burden of all multinational companies in Brazil.