Global Tax Alert (News from Transfer Pricing) | 8 August 2013

Brazil issues further guidance on pricing of interest bearing transactions; taxpayer-favorable decision in Resale Minus 60 case

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On 2 August 2013, the Brazilian Ministry of Finance issued ordinance 427/2013, which finally provides the interest rate spread that was mentioned but not specified in Law 12.766/2012.

Law 12.766, issued on 28 December 2012, provided significant changes to Brazilian transfer pricing rules for interest bearing transactions.

Under Law 12.766, the calculation of the maximum amount of deductible expenses and minimal revenue arising from interest subject to transfer pricing regulations should observe the following:

  • For transactions in US dollars (USD) at a fixed rate, the parameter rate is the market rate of the sovereign bonds issued by the Brazilian government on the external market, indexed in USD.
  • For transactions in Brazilian real (BRL) at a fixed rate, the parameter rate is the market rate of the sovereign bonds issued by the Brazilian government on the external market, indexed in BRL.
  • For transactions concluded abroad in BRL at a floating rate, the Ministry of Finance will determine the parameter rate; and for all other cases, the parameter rate is the London Interbank Offered Rate (LIBOR).

The subsequently obtained parameter rate can still be increased by an annual spread to be established by the Ministry of Finance based on a market average (the previous 3% limitation was revoked). Ordinance 427/2013 now provides the annual spread depending on the Brazilian taxpayer’s position on the loan as follows:

  • Brazilian entity as the borrower – Starting on 1 January 2013, the (statutory) spread should be no more than to 3.5%.
  • Brazilian entity as the lender – From 1 January 2013 to 1 August 2013, no interest rate spread is required on the transaction. Starting on 2 August 2013, the spread is required to be no less than 2.5%.

As specified in IN 1.322/13, (please see Global Tax Alert, Brazil issues new Normative Instructions that clarify the application of safe harbor provisions and interest rate pricing on intercompany financing transactions, dated 1 February 2013) intercompany agreements entered into as of 1 January 2013 or after will be subject to the new Law 12.766/12. Whereas, agreements previously entered into and registered with the Brazilian Central Bank will be grandfathered by the previous rules and will not be subject to the new requirements. Please note, that the renewal or re-negotiation of existing agreements should be considered as a new transaction, and therefore, subject to the new regulations.

Resale minus 60% normative instructions vs. law

The recent judicial hearing, Eli Lilly v Fazenda Nacional, decided in the Brazilian administrative council of tax appeals (CARF) brings about another taxpayer favorable ruling on the highly controversial topic regarding the application of the Brazilian transfer pricing method for imported materials that are subject to further industrialization in Brazil, Resale Minus 601 (PRL 60).

Since the issuance of Brazilian transfer pricing regulations in 1996, no other topic has been more controversial. The controversy stems from differing interpretations among Brazilian taxpayers and the tax authorities on the legal basis of IRS Normative Instruction # 243/02 (IN 243/02), issued in 2002.

Brazil’s Federal Revenue Department prepares its interpretations of issued law through the issuance of normative instructions. Brazilian taxpayers have argued that IN 243 oversteps its bounds and provides for a differing calculation scheme as proscribed by Law 9.430/96 (as amended by Law 9.959/00). In contrast, Brazil’s Federal Revenue Department contends that their interpretation is legally permissible and provides guidance for the application of Law 9.430/96.

The two differing interpretations of IN 243/02 lead to significant differences in the calculation of taxable income. A comparative example of each calculation methodology is shown below:

Description

IN 243/02

Law 9.430/96

Cost (CIF+II)

A

1.000

A

1.000

Value Added on Brazil

B

500

B

500

Total Cost

C = A + B

1.500

C = A + B

1.500

Net Sales

D

3.000

D

3.000

Participation Raw Material / Cost

E = A / C

67%

N/A

Participation of Raw Material at Net Sales

F = E * D

2.000

N/A

Gross Margin 60% Base

N/A

E = D - B

2.500

Gross Margin 60%

G = F * 60%

1.200

F = E * 60%

1.500

Parameter Price PRL 60%

H = F - G

800

G = D - F

1.500

Because of the money at stake, numerous taxpayers have taken this issue to CARF to provide a decision on the interpretation of IN 243/02. Although the rulings have been mixed between the taxpayer and the Federal Revenue Department, the most recent judicial hearing was ruled in favor of the taxpayer. The court’s opinion sided with the taxpayer concluding that Brazil’s Federal Revenue Department overreached its authority in the issuance of IN 243/02; consequently, the taxpayer’s use of Law 9.430/96’s calculation methodology was legally permissible.

Unfortunately, this recent ruling does not put to rest the controversy of IN 243/02. At the time of this publication, no cases regarding IN 243/02 have reached Brazil’s Superior Tribunal de Justiça, which would could provide an ultimate ruling on this subject, and reconcile all previous decisions. Until then, taxpayers will continue to face uncertainty regarding the interpretation of IN 243/02.

Endnote

1. The PRL 60 method requires a 60-percent profit margin on goods or parts used in the production process.

For additional information with respect to this Alert, please contact the following:

Ernst & Young Serviços Tributários S.S., São Paulo
  • Werner Stuffer
    +55 11 2573 3902
    werner.stuffer@br.ey.com
  • Demétrio Barbosa
    +55 11 2573 3486
    demetrio.g.barbosa@br.ey.com
  • Janaína Costa
    +55 11 2573 3734
    janaina.costa@br.ey.com
  • Caio Albino de Souza
    +55 11 2573 3301
    caio.albino@br.ey.com
Ernst & Young Serviços Tributários S.S., Transfer Pricing, Rio de Janeiro
  • Marcio R. Oliveira
    +55 21 3263 7225
    marcio.r.oliveira@br.ey.com
Ernst & Young Serviços Tributários S.S., Transfer Pricing, Campinas
  • Leandro Cassiano
    +55 19 3322 0556
    leandro.cassiano@br.ey.com
Ernst & Young Serviços Tributários S.S., Transfer Pricing, Porto Alegre
  • Felipe Mauer
    +55 51 3204 5574
    felipe.mauer@br.ey.com
Ernst & Young Serviços Tributários S.S., Transfer Pricing, Belo Horizonte
  • Maira Costa Alves
    +55 31 3232 2114
    maira.costa@br.ey.com
Ernst & Young Serviços Tributários S.S., Transfer Pricing, Curitiba
  • Aline Weiss
    +55 41 3593 0770
    aline.weiss@br.ey.com
Ernst & Young LLP, Brazilian Tax Desk, New York
  • Mariano Manente
    +1 212 773 2744
    mariano.manente@ey.com
Ernst & Young LLP, Brazilian Tax Desk, London
  • Ricardo Moura
    +44 20 7951 6907
    rmoura@uk.ey.com

EYG no. CM3714