Transfer Pricing in emerging countries and UN manual

The UN has updated its Transfer Pricing Manual

The United Nations has updated its Practical Manual on Transfer Pricing. In particular, it contains a chapter drafted by the Brazilian tax administration providing an update on its specific transfer pricing legislation.

The UN Manual

The 2021 version of the United Nations Practical Manual on Transfer Pricing for Developing Countries was published in April. This is the third edition of the Manual, prepared by the UN Committee of Experts. This Committee comprises 25 experts proposed by governments and selected by the UN Secretary General. It includes representatives appointed by member States and independent experts.

The purpose of the Manual is to provide practical guidance to governments, tax administrations and taxpayers that address the concerns of developing countries. The manual’s stated objective is to contribute to a common understanding of how the arm’s length principle should be applied in order to avoid double taxation and prevent or resolve transfer pricing disputes. Although consistency with the OECD principles is desirable, it remains non-systematic since the manual aims to address the concerns and specificities of non-OECD countries.

This new very dense version (570 pages) includes several sections, along with country sheets produced by representatives of the tax administration in the countries concerned:

Part A is an overall summary of transfer pricing issues.

Part B deals with the arm’s length principle, analysis of comparables and transfer pricing methods. It also contains guidance on intra-group services, including a chapter on centralised purchasing functions (paragraphs 5.6 et seq.). It also contains new guidance (Chapter 9) on intra-group financial transactions and application of the arm’s length principle to intra-group loans.

Part C deals with the development of transfer pricing legislation, documentary obligations, transfer pricing control and amicable procedures.

Finally, Part D contains country sheets including Brazil, China, South Africa, India, Mexico and a new country, Kenya.

Focus on Brazil

Brazil is the most “original” of emerging countries because it has very specific transfer pricing legislation: while applying traditional transfer pricing methods (CUP, Cost Plus and Resale Minus) Brazilian legislation requires a fixed margin rate ranging between 15% and 40%. Brazilian legislation therefore diverges not only from the OECD principles but also from the principles set out in the UN Manual.

Under current Brazilian legislation, the notion of market price is not a relevant concept.

Nor is there any choice of “best method”. The taxpayer may use one or more of these three methods and choose one that will not result in any adjustment or the lowest possible adjustment

A ceiling price for imports

Brazilian law sets a ceiling price which can be determined according to three methods.

• Comparable market price method: this is the arithmetic average of the sales prices of similar or comparable products or services with independent third parties on the Brazilian market or in a foreign market with the same financial conditions.
• Resale price method: this is the arithmetic average of the resale price of identical or similar goods with independent third parties, reduced by rebates, export taxes, commissions and a fixed margin. There are three levels of margins depending on the business sector. The standard rate is set at 20% and will apply to all sectors not listed for the other two rates. A 30% rate applies to the chemicals, paper, metallurgy and glass industries. Finally, a 40% rate applies to the pharmaceuticals, tobacco, equipment, oil and gas sectors. Only sales made on the Brazilian domestic market can be used as a benchmark. However, the adjustment will be made across all goods sold on the internal and external market.
• Cost plus method: this is the average cost of production of a similar or identical good or service in the country of production, plus export taxes and a margin of 20%. The cost of production is defined in a relatively precise manner by the normative instruction.

The Brazilian tax administration gives an opinion that the resale price method is more advisable in the case of an import, because the cost plus method involves having access to the costs of the foreign company, which is not always easy or desirable for the foreign company. That being said, in the case of invoicing for services, the opinion of the Brazilian tax administration seems difficult to follow in practice, since this is the classical method recommended by the OECD.

A floor price for exports

For exports, the reasoning is the opposite to imports. The Brazilian company must record a minimum taxable income when it sells goods or provides services to related companies domiciled abroad. It should be noted that if export sale prices are identical to those on the domestic free market for comparable products, they need not be justified by the methods below.

• Export sale price: this is the arithmetic average of the export prices charged by the company to independent companies or the prices charged by other Brazilian companies in their sale to third parties for a comparable product or service. This is therefore a comparable market price method.
• Wholesale price less: this is the arithmetic average of wholesale prices in the country to which the export takes place between independent companies, less consumer taxes and a margin of 15% of that price.
• Retail price less: this is the arithmetic average of retail prices in the country to which the export takes place between independent companies, less consumer taxes and a margin of 30% of that price.
• Cost Plus: this is the average production or purchase price plus applicable taxes and a mark-up of 15% of that cost.

As with imports, the Brazilian tax administration is of the opinion that the Cost Plus method is the most suitable for exports, insofar as all data is in the hands of the Brazilian company to justify prices.

In addition, specific rules exist for setting interest rates and royalties for trademarks, patents: again, these are rates or margins laid down by Brazilian law, that are required without the possibility of adapting them.

Finally, with regard to the transfer pricing documentation, it should be noted that Brazil is also atypical, in that there is no filing of documentation (central file, local file). On the other hand, Brazil has adopted the country-by-country report format.

Legislation defended by the Brazilian tax administration

In the country sheet drafted by a representative of the Brazilian tax administration, there is an obvious desire to justify the merits of applying these fixed margins.

The benefits expected from the use of fixed margins include:

• ease of application and lower cost: transfer pricing can be determined without the use of very technical knowledge;
• legal certainty: it is easy to anticipate what transfer prices will be with the group companies. Moreover, according to the Brazilian tax administration, there is no distortion of competition since all companies in a sector are subject to the same tax burden in their intra-group relationships.

Nevertheless, the report recognises some weaknesses, which are not insignificant in our view:

• the risk of double taxation in cases where there is no recourse to the amicable procedure; however, it must be noted that despite the adoption of an order in 2018, it does not seem that in practice the amicable procedure works with Brazil;
• a discrepancy between actual profitability and the tax base.

Despite this, the representative of the Brazilian tax administration made recommendations to countries that would consider adopting the fixed margins method, suggesting the use of margin ranges resulting from data statistics on independent companies.

Brazil has applied for OECD membership, which would involve a drastic change in its transfer pricing legislation. However, the process is far from complete, meaning that French companies should continue to adapt their policies to the specificities of that country.

Article published in Option Finance on 25/10/2021.