How Will BEPS Change Brazil’s Tax Practices?

Fabio Gaspar, Upstream Tax Manager of Shell in Brazil, discusses the challenges of being a non-OECD country in a time of BEPS implementation.

How do you think the BEPS initiative will affect Brazil?

I think the whole world really wants to understand the impact of the BEPS project so far. You’ll find that many countries – including Brazil – are still trying to figure out how applicable these recommendations will be for their particular domestic legislation.

In Brazil, we do have additional challenges. We’re having to match BEPS recommendations with our domestic legislation, which is completely different from the legislation in an OECD environment. In a post-BEPS world it means we need to navigate these outcomes – made for an OECD environment – and apply it specifically for our methods, which are not meant for an arm’s length standard.

Could you tell what the Brazilian approach to transfer pricing is like? How is it different to the OECD’s approaches?

Regardless of the BEPS projects, over the past few years we’ve seen Brazil evolving towards an environment that is more friendly to the arm’s length standard. That being said, if we look even further back (say three or four years) we have seen incredibly important changes for Brazil. Brazil is known for its fixed margins, but gradually we’ve seen our legislation evolve to allow independent comparables more in line with the OECD’s arm’s length standard.

Brazilian transfer pricing rules were only enacted into law in 1996, which is not too long ago considering other international implementation. By the time policy makers decided to bring transfer pricing rules into Brazil, they faced a decision as to whether or not OECD standards should be followed.

OECD standards are, of course, based on risks and functions and the arm’s length standard is the guiding principle to materialise these. In Brazil, policy makers ended up adapting fixed margins. It is believed that Congress ultimately opted for fixed margins because of the certainty that fixed margins provides.

You’ve spoken briefly about fixed margins. What are the strengths of this method?

Brazil is a huge country with a lot of gaps between its regions. Therefore, inspecting transfer pricing based on the risks and functions of the arm’s length method would cause very different outcomes depending on the level of knowledge of the tax inspectors, taxpayers, and tax courts.

We find that fixed margins provide a level of certainty to the results of an inspection, which simply assessing risks and functions would not. In essence, fixed margins are easier to follow, regulate and inspect.

Brazil is one of the top ten economies in the world, and around 90% of its GDP is located in the South-East region. The huge size of the country and the differences between regions would ensure that the inspection of transfer pricing would be challenging. It would be likely that we would have very different outcomes in the event we chose not to follow a fixed margin, mathematical, objective method. As a result, the challenges of inspecting transfer pricing using the OECD guidelines is speculated as to why BRICS regions are so careful when adopting the arm’s length standard.

The adoption of fixed margins seemed to make sense at the time the law was enacted, and it shouldn’t change too drastically in the coming years. In spite of this, we’ve been seeing some radical changes taking place recently. One very good example of this is the Pecex, which now ensures that Brazil has specific methods based on independent comparables.

The most pressing issue for MNCs doing transfer pricing in Brazil is the gap between OECD guidelines and our domestic methods. The differences between fixed margins and the arm’s length method then becomes the biggest challenge for those companies, and reconciling both methods may be rather challenging.

Despite the fact that fixed margins should be simpler to apply, this is not always true. Gaps in the legislation cause taxpayers to have a lot of doubts when applying the method, generating a lack of certainty as to how to operate. In that sense, different interpretations may be given by taxpayers or tax authorities. Therefore, having very specialised personnel for transfer pricing is highly advisable. Preparing well, and in advance, then becomes crucial in order to succeed.

MNEs can come up against double taxation. Do you have any words of wisdom for them?

When it comes to preventing double taxation, the best position for the taxpayer to be in is to have considered the transaction in advance. Having a strong internal process for analysing risks and functions is the key to success.

It is important to bear in mind that taxpayers in Brazil can generally choose between different methods of operation. By comparing the different methods available in Brazil, you can more adequately match one of them to the transaction at hand. It is worth mentioning that transfer pricing demands the employment of professionals within different areas of the company, so ensuring that these departments work in co-ordination with specific accountability and responsibility is key. These internal professionals should be in touch from planning in advance, all the way through to preparing the documentation for file.

In recent years, a new ruling issued by the Internal Revenue Service has allowed independent auditors to audit transfer pricing documentation and files in advance, so that in the event of a tax audit the report can be presented quickly.

Further to this, a lot of countries use advanced pricing agreements (APAs) or double taxation treaties to deal with transfer pricing and avoid double taxation. Those tools – although very useful – are not very present in Brazil yet. Double taxation treaties usually apply for documentation only in the exchange of information, and APAs are not allowed in Brazil.

With an increasing number of challenges in the transfer pricing industry, do you think most work should be undertaken in-house?

Tax payers are definitely more concerned with tax audits in recent years. We’ve been seeing a lot of audits taking place, and it’s very important to ensure you have the best professionals at hand.

These can be in-house professionals (such as lawyers and accountants), or this can mean you have external help. Outsourcing a portion of the transfer pricing work may be very beneficial, especially for compliance.

I do think that it’s preferable to have in-house personnel for planning, preparing and understanding the transactions that relate to transfer pricing. This is because in-house employees get used to the way the business operates. On the other hand, a lot of outsourced professionals carry a lot of experience in terms of compliance.

All in all, a balanced mix between in-house professionals and outsourcing seems like the way to go for MNEs to be successful in transfer pricing.

What does the future look like for tax in Brazil?

Regardless of the outcome of the BEPS project, it is my opinion that Brazil – the tax authorities in Brazil, to be more specific – will not likely give up the control and simplicity provided by the fixed margins methods.

That said, I do believe that authorities will keep enhancing current legislation and I think that, in the long run, we will see fixed margins coming closer to the arm’s length standard.

I believe that, only through these kinds of conversations, will we be able to build a more equitable tax environment around the world. I hope that we can help with that in Brazil as well.