Brazil’s 5 Fixed-Margins Method

Brazil enacted its transfer pricing rules in 1996 (Federal Law No.

9,430/96) and they entered into force on January 1, 1997. With these rules, Brazil simplified the traditional methodology to make it more practical. This chapter discusses only the ‘fixed-margins’ methodology.

An exhaustive discussion of Brazil’s transfer pricing rules can be found in the UN Manual (2017: Chapter 10.1).

The majority of the methods included in the OECD’s guidelines involve identifying a comparable for the profit rate of a related-party transaction. As the name suggests, the fixed-margins approach instead uses pre-established profit margins to indicate the level of profit that can be acceptable in the arm’s length price (also called the parameter price). As a result, the tax administration does not need to perform complex comparability analyses. The profit margins are determined by taking into account the economic sector, line of business or, even more specifically, according to the kind of goods or services dealt with (UN Manual, 2017: 372). Current legislation sets forth different fixed mar-gins per economic sector.⁶

Benefits of the Fixed-Margins Approach for Developing Countries Researchers have noted the benefits of Brazil’s fixed-margins approach, which are listed below:

transfer pricing rules | 43 Simplicity: Determining the arm’s length price through the fixed-margins approach is a much more manageable task than performing resource-intensive and expensive case-by-case comparability analy-ses. This approach is easy for both taxpayers and tax authorities to use (Valadao and Lopes, 2013). It requires less technical skill than performing a traditional comparability analysis. It also eliminates the need for the tax authority to access expensive databases, lessening their financial burden.

This does not mean, however, that calculating the transfer price under the fixed-margins method is a straightforward task. The costs to which the fixed margins are applied must still be determined by the tax authorities. This requires data from the other related parties, its provid-ers, third parties, and in some instances from MNCs that may have similar transactions in a public database. However, this process is still simpler than the conventional comparability analysis.

Predictability: Under the fixed-margins method, the rules for determin-ing the transfer price are clear to both taxpayers and the tax authorities, and thus, predictable.

Transparency: The process is also transparent, which is a key element for promoting investment in developing countries. In situations where there is weak tax administration there is a greater need for clear and transparent rules, such as fixed margins, in order to leave no room for corruption. Sundaram has stated that, ‘as long as fixed margins are transparent and “scientific” in their formulation and operation, and genuinely seek to determine prevailing market margins, they provide a more flexible, real world response to what constitutes an arm’s-length price’ (Sundaram, 2015: 17).

Certainty: Evidence has shown that, in sharp contrast with the tradi-tional approach, Brazil’s fixed-margins approach results in very few legal disputes between taxpayers and the tax authorities, thereby remov-ing the need for expert staff applyremov-ing subjective judgments susceptible to corruption (Picciotto, 2017: 11). As a result, this approach provides certainty to both taxpayers and the tax authorities.

Tax collection: Experts believe that Brazil’s fixed-margins approach is helping to protect the Brazilian tax base (Schoueri and Galendi Júnior, 2017: 193). Ilarraz has said that it could strengthen the taxing rights of

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developing countries (Ilarraz, 2014: 218). A criticism of the approach, however, is that it focuses primarily on minimum taxable profit (Lang et al., 2008: 111 spéc. p. 128). This could be considered a disadvantage of the approach since only a minimum of tax revenue would be col-lected. However, ensuring a guaranteed minimum of tax revenue is a realistic goal for developing countries that have limited capacity and resources with which to perform transfer pricing audits. According to Valadao and Lopes (2013: 40), the approach is also low cost, which is a benefit for tax administrations that cannot afford to run audits under the conventional framework.

Difficulties in Its Application and Other Criticisms of Brazil’s Fixed-Margins Approach

Other research has identified certain criticisms of Brazil’s fixed- margins approach, which are listed below.

Lack of justification and transparency in setting the margins: Setting the profit margins for prices requires information on how MNCs oper-ate and on market conditions. Brazilian law provides for discussion between the taxpayers and the tax administration on the applicable rates for each specific industry. However, details on the preliminary steps or studies that Brazil undertook in determining their fixed-margin rates are not publicly known. The United Nations Practical Manual can be useful here as it provides general guidance for coun-tries considering adopting the fixed-margins approach, including pricing research from existing public databases (UN Manual 2017:

D.1.9. at 543–545).

Rigidity of the fixed margins: Another difficulty may arise in a situation where an MNC engages in activities in more than one of the cat-egories specified by the law. Brazilian legislation emphasizes that the applicable margins are those corresponding to the activity sector in which the imported goods are intended for use. However, an MNC’s operations may be complex. This poses a challenge for tax authori-ties determining the real use of the goods within the structure of the MNC. Use of an incorrect margin may constitute a new means of profit shifting. For example, a company importing pharmaceutical chemicals can charge a 40 percent margin, and another company importing chemical products can charge a 30 percent margin; in such

transfer pricing rules | 45 a situation a company may have an incentive to use a lower margin to reduce its tax obligation.

Risk of double taxation: Another criticism of the fixed-margins app-roach is that it was adopted somewhat unilaterally without adequate consultation with other countries in which Brazilian subsidiaries might have had business activities. As a result, MNC profits could be taxed twice, if, for example, the other country refused to make the correlative adjustment. For this reason, introducing this approach unilaterally may raise issues as it may make the country appear less attractive for foreign investment. Where multiple jurisdictions are concerned, coordination between countries would be judicious in order to balance the need to attract investment and collect tax revenue. Weak tax administrations may consider adopting the fixed-margin approach on a multilateral or bilateral basis if it is feasible.

Brazil’s Accession to the OECD and the End of the Fixed-Margins Approach

By way of Decree No. 9,920, of July 18, 2019, the Brazilian gov-ernment announced its intention to join the OECD. In this respect, the OECD and the Brazilian Tax Administration issued a statement deciding that the Brazilian transfer pricing rules would be fully aligned with the OECD transfer pricing rules (OECD and RFB, 2019). This decision will override some of the positive features of the Brazilian transfer pricing approach (Schoueri, 2019). Going forward, the fixed-margin approach may be less attractive for developing countries that aspire to join the OECD but may still have merit as a methodology.