Navigating Brazil's New Transfer Pricing Landscape: A Shift to OECD Standards

Episode Summary

Machado Meyer tax partner Fernando Colucci joins Skadden’s David Farhat, Loren Ponds, Eman Cuyler and Stefane Victor to explore Brazil’s historic shift from a 27-year formulaic transfer pricing system to full OECD compliance. As he explains, “We moved from a very strict, very formulaic approach to a simple, a direct import of the arm’s-length principle.” Tune in for his insights on dramatic changes facing multinational enterprises and Brazil’s notorious 75% penalty system that raises the stakes on compliance decisions.

• The Formula-to-Function Flip: Brazil abandoned 27 years of fixed profit margins in favor of the full OECD arm’s-length principle, requiring companies to conduct detailed functional analyses for the first time.
• All-or-Nothing Penalties: Brazil’s unique 75% penalty system creates stark choices: Accept the tax authority’s adjustment with no penalty or challenge it and face penalties on any sustained portion.
• Intangibles Enter the Game: Previously excluded from transfer pricing rules, intangible transactions are now subject to OECD guidelines, creating new compliance challenges.
• Limited Relief Mechanisms: While Brazil introduced its first APA program, it operates more like a written consultation process than traditional APAs, and the country has never executed a MAP case despite having treaty provisions.

Voiceover (00:03):
This is GILTI Conscience: Casual Discussions on Transfer Pricing, Tax Treaties and Related Topics. A podcast from Skadden that invites thought leaders and industry experts to discuss pressing transfer pricing issues, international tax reform efforts, and tax administration trends. We also dig into the innovative approaches companies are using to navigate the international tax environment and address the obligation everyone loves to hate.

(00:29):
Now your hosts, [00:00:30] Skadden partners David Farhat and Nate Carden.

Stefane Victor (00:36):
Hello, and welcome back to another episode of GILTI Conscience. My name is Stefane Victor, joined by David Farhat and Eman Cuyler. Today, we’re joined by one of our favorite guests who’s filling in for Nate Carden. She’s recently joined Skadden as a partner in the tax group. So happy to have you again, Loren Ponds. And we’re also joined by our guest, Fernando Colucci, who’s a specialist in providing [00:01:00] legal and tax assistance in M&A operations. And has expertise in commercial, corporate, and economic law, and has represented clients before a variety of administrative courts.

(01:11):
Today, we cover transfer pricing in Brazil. As of January 1st, 2024, Brazil has officially aligned its transfer pricing rules with the OECD transfer pricing guidelines, departing from its long-standing formula-based system. This shift marks a significant change in how multinational enterprises operating [00:01:30] in Brazil will need to assess, document, and defend their intercompany pricing. While the reform aims to reduce double taxation and improve alignment with international standards, it also introduces practical and interpretive challenges for both taxpayers and tax authorities.

(01:47):
Welcome. Thanks so much for joining us, Fernando.

David Farhat (01:50):
Yeah. Thanks, Fernando. And I’ll note that Stefane has never been that nice when introducing me, so Loren must be his favorites. And just to kind of echo Stefane, we’re super happy to have Loren as part of the firm now, and hopefully, a regular contributor/host to GILTI Conscience. And she’s sitting in today for Nate.

(02:10):
So Fernando, before we jump in, anything you’d like to say about yourself or your practice?

Fernando Colucci (02:14):
No. Just I want to thank you for the invite. It’s a pleasure to speak about Brazil, especially because as you know, Brazil has been historically seen as an outlier in terms of pricing matters. No one actually used to being interested in learning our rules, so I’m glad that things are changing and that people are willing to learn more about our rules.

David Farhat (02:34):
Yeah, that’s awesome, and thank you for joining us to talk about them. So, let’s just jump in and talk about some of the changes in the tax and transfer pricing landscape in Brazil as you migrate over to OECD. And give us an overview of some of the changes and what the landscape was like prior.

Fernando Colucci (02:52):
So just so we understand, the Brazilian production rules is one of the hottest topics we have these days in Brazil in relation to corporate income taxation. We’ve been facing a very broad tax reform in Brazil, but in relation to income taxation, this is the most relevant change we recently had. To have an idea of the relevance to this changing paradigm, it’s important, really, to understand how were our previous rules before this change. The previous rules were in force since 1997, and they were fully based on a formulaic approach. So, we had only transactional methods. We had cap, resale price, and cost plus. And we had fixed profit margins that were imposed by law. So we had no profit-based methods, only transactional-based methods, and the profit margins were imposed by law.

(03:46):
So for instance, for the resale price method on imports, the profit margins ranged from 20 to 60%. Cost plus for exports had a fixed profit margin of 15%. And there was no function of analysis, so taxpayers had to comply with these markup margins regardless of their reality, regardless the risks taken, the functions developed by the relevant parties. But on the other hand, taxpayers were free to select the transitive pricing method that led to the lowest adjustment possible. So, our best method rule was not driven by the particularities of the transaction, but directly simply to let taxpayers select the method that would lead to a lowest [00:04:30] taxation. And the previous rules were not applicable to intangibles, and we all know how complex it is to test intangibles under the OECD models. So, the previous rules were very simple. They led to a very low level of controversy in Brazil, and you know that Brazil is known for its aggressive tax authorities for one of the highest levels of tax controversy.

(04:57):
But in relation to transfer pricing, the controversies [00:05:00] we had so far were very focused on the interpretation of certain specific topics of law. So, this simplicity made things somehow easier to taxpayers and also to tax authorities. But it’s said that it also led to a high level of low taxation in Brazil and to potential double taxation to legal entities abroad. So when the government proposed these new rules, they said that the past rules led to billions of dollars [00:05:30] in losses in collection of taxes in Brazil. And then after these 25 years dealing with these very specific and formulaic rules, in December 2022, the government proposed to the Congress the introduction of these new rules, which are fully based on the OECD model. So we move from a very strict, very formulaic approach to a simple, a direct import of the arm’s length principle.

(06:00):
[00:06:00] I like to say that not even the expression arm’s length was translated to Portuguese in the law. Of course, the law is written in Portuguese, but one of the sections make express reference to the arm’s length principle with no translation. So it says aplicacao do principio arm’s length.

Loren Ponds (06:21):
Really foreign concept. So before we get to the new rules, let’s go back. You mentioned that intangibles were carved out of the old [00:06:30] rules. How did that affect taxpayer behavior if you know that intangibles aren’t covered by the rules? What did that result in in terms of intangible transactions between Brazilian parties and their counterparts?

Fernando Colucci (06:44):
Yeah, they were not covered by the transfer pricing laws but they were covered by another set of rules that impose even more risk, strict limitations for deductibility. So, there was a limit of 5%. It was a very [00:07:00] problematic matter here in Brazil.

Eman Cuyler (07:03):
And sticking to the old rules, can you walk us through what triggered this change? Is it international pressure or other tax reforms within the country that made it such that this change made sense moving forward?

Fernando Colucci (07:18):
As I mentioned, this change was proposed by the government. So when the government sends this to the Congress, it sends a justification. And the justification presented [00:07:30] by the government was based mainly on the willingness of Brazil for joining OECD. That’s the main reason. But it’s interesting, especially because I’m talking to you in the US, because in addition to that, it was also expressly mentioned by the government that the former TP rules could have significant impacts to American companies investing in Brazil. Because they said that certain regulations proposed by the IRS in 2022, as far as I understand, [00:08:00] could raise concerns about the recognition of foreign tax credits from Brazil because the Brazilian transfer pricing rules were not aligned with the arm’s length principle, and that you could impose income taxation or something that is not actual income.

(08:15):
So basically, these two reasons led the change in the Brazilian transfer pricing rules. This is a very specific, a very technical matter, so the Congress didn’t actually review details and details it, but it accepted [00:08:30] the justification and the proposal became law.

Loren Ponds (08:33):
That’s interesting. It’s certainly true. When the foreign tax credit regulations were proposed, that American multinationals saw immediate issues with operations in Brazil and creditability of taxes paid there on certain transactions. And it’s interesting to hear the characterization of why the rules changed from outside of the US because I think here, it was mostly recognized as part of the accession process. Accession [00:09:00] to the OECD process. And so that was kind of, yes, we’re going to get these rule changes, but it’s part of a bigger process of getting in line with OECD principles.

(09:09):
But it’s interesting to hear that US multinationals domestic tax issues were cited in the technical explanation for the rule change.

David Farhat (09:20):
Yeah. Unpacking that a little bit, were there any comments from the Brazilian tax authority about the changes or your equivalent of the Treasury? Were there any objections, [00:09:30] heartburn, anything like that around making those changes?

Fernando Colucci (09:33):
No, they were actually supporting this change. This is something that initiated in the Brazilian IRS. The Brazilian government via the Brazilian IRS have been discussing and aligning this with OECD authorities for, at least, 7 to 8 years before this change. So, Brazilian IRS actually was willing to have this change. Although it’ll make [00:10:00] their lives harder, we all know, but this is something that they supported.

Loren Ponds (10:05):
That was what I was going to ask. From the standpoint of the tax administration, it seems like a much heavier lift for the examiners and the technical folks at the Brazilian IRS. Were there any kind of technical assistance support that you got? Was there any technical assistance support from OECD or other stakeholders to get people up to speed on some of these concepts and applying these roles [00:10:30] in real life?

Fernando Colucci (10:31):
Yes. This is not actually public, but we all know that the Brazilian IRS has been sending auditors to take courses out of Brazil before OECD, to take master degrees out of Brazil. So although they don’t have a large number of specialists on this, what we know is that they have people that have been getting prepared for this change. Or at least, as I mentioned, 7 to 8 years.

(11:00):
[00:11:00] So actually, what seems to happen is that they actually have the government to draft these new rules. This is why I say that this is fully supported by the Brazilian IRS and they are prepared for this. I would say that even more prepared than the companies.

Stefane Victor (11:19):
You mentioned that Brazil is maybe an aggressive... Has an aggressive way about going things. Is that going to be affected by the new TP [00:11:30] rules, like a less formulaic approach is?

Fernando Colucci (11:32):
Mm-hmm.

Stefane Victor (11:33):
Is that going to yield in less controversy? More controversy?

Fernando Colucci (11:36):
Yeah.

David Farhat (11:38):
And to add onto that, it’s been about a year, right? Have you seen some of those changes in the tax authority?

Fernando Colucci (11:43):
Well, it’s about a year. But usually, things in Brazil, as they have a five-year statute of limitation term, I would expect that real litigation and audits would start within three years, for instance. We know that the tax authorities initiated [00:12:00] last year a specific route for reviewing the biggest taxpayers in Brazil. But for now, we don’t have any clue on the conclusions, or if this would lead actually to new tax assessments or not. But the point that you raised as novel aspect of these rules in Brazil is something important and somehow concerning for us that deal with tax authorities on a day-to-day basis because Brazil [00:12:30] has a civil law system that is highly founded on the principle of legality, on the rule of law. So, we don’t have previous experiences on rules similar to these transfer pricing rules. So, we have an idea... We don’t have, in Brazil, a general anti-avoidance rule. We don’t have any specific anti-avoidance rule.

(12:49):
But in these new transfer pricing rules, we do have some sections that grant powers to tax authorities simply disregard and recast transactions [00:13:00] if they understand that, and related parties would not set the same commercial standards. So, this is quite concerning for anyone that had dealt with the Brazilian tax authorities. We don’t know how things will happen, but if we take the past discussions that we had with tax authorities... At least, not the top of the IRS, I would say. But the ones that are on ground, the tax auditors that will actually perform the tax audits, they may have a [00:13:30] certain power that they are not used to have, and this could lead to bigger controversies.

David Farhat (13:36):
And what’s been the taxpayer response to some of these changes? I know in the past, there were some structures put in place to avoid the impact of the different transfer pricing rules between Brazil and, let’s say, the US. What’s been the response from taxpayers? Have you seen any restructuring? Have you seen any changes of how folks deal with Brazil given the new rules? Or are people still in more of a wait-and-see boat?

Fernando Colucci (14:00):
[00:14:00] No. I do see a large number of activities. US companies, for instance, and all other companies connected to Brazil, what I see is that they’re certainly re-evaluating their structures, engaging more with the Brazilian IRS. As I mentioned, it was simpler before. Now, companies need to do comparability studies, benchmark transactions, prepared detailed documentation. So, this is a whole new paradigm that involves actions [00:14:30] that were not needed before. Actions like delineating transactions, interviewing local staff to understand functions and risks, setting comparables. These were not actions needed under the previous rules.

(14:44):
What we hear is that people, for instance, consulting firms are seeing an increase in questions from clients about restructuring plans, TP documentation. We do see this at the firm. I’ve personally seen companies revisiting their transfer pricing paradigms, converting, [00:15:00] for instance, from limited-risk to full-risk distributors after a deeper functional analysis. So, most of companies are not simply waiting and seeing. They’re actually taking actions to review their structures and see how they could actually improve their systems because as you know, some of the companies had double taxation, and they simply had to accept it.

Eman Cuyler (15:24):
Are there certain industries that seem to be more impacted that seem to be asking these questions? So for example, [00:15:30] pharma commodities or any specific sectors that seem to be a little bit more alert than others?

Fernando Colucci (15:36):
Yeah. I see, in my experience, pharma is one of them because pharma... I mentioned that we had very few controversies under the previous rules, but pharma was one sector that had these discussions because on their way, tax authorities understood the resale price method should be applied and the way taxpayers understood it. So pharma, tech, and [00:16:00] agribusiness, I would say that are very active in reviewing their supply chains.

(16:06):
And the penalty is a big motivator too, because in Brazil, non-compliance can lead to penalties of 75% of the unpaid taxes.

David Farhat (16:17):
Yeah, let’s talk about the audit process in Brazil because that’s... But yeah, I think you see Eman’s reaction there. So, let’s talk about the penalty system and the audit practice because I think a lot of folks in the US now are feeling [00:16:30] the pain of penalties and penalty assertion, but I think this is a different animal based on some of what we’ve been talking about.

(16:36):
So, walk us through the audit process and how the penalty applies in Brazil.

Fernando Colucci (16:45):
Let’s start with the audit. So in Brazil, a typical audit would start with the tax authorities conducting, initially, a factual review of the situation. They reviewed the relevant documentation, books, agreements, all the transactions that are especially relevant in this case for transfer pricing. So, [00:17:00] this first stage is performed to understand the facts. And after they review the facts, they will actually try to apply the tax law to those facts. It’s a very, let’s say, methodological process. They are trained to separate the factual review from the legal analysis.

(17:21):
And one thing that is interesting and important, and sometimes challenging from the Brazilian side is that there is no really room [00:17:30] for negotiation with the auditors. So if you don’t agree with their factual review, their factual conclusions or their legal interpretation, they’re not empowered to settle. So if the auditor concludes that there’s a problem, they’ll simply issue a formal tax assessment. And when we have these formal tax assessment, there is an automatic penalty, 75% fine on the amount assessed in addition to the tax itself. So, this is the standard [00:18:00] penalty under the Brazilian law. And for most tax assessments, it’s imposed immediately. Basically, it’s the default approach, unless you can challenge the assessment and you win.

(18:12):
Specifically, just one point in relation to this because this is a deviation specific to transfer pricing, is new rules state that taxpayers may decide to accept the transfer pricing adjustments proposed by the auditor at the end of audit without the application of penalties.

David Farhat (18:30):

[00:18:30]
Oh, wow. Okay.

Fernando Colucci (18:32):
So if after an audit, the authority understands that there should be an adjustment, the company may accept it, make the adjustments, make the collections with no penalties. This is not possible in any other matters. So in a regular income tax audit, if you decide to accept the adjustment after an audit, you still will be subject to the 75% penalty. But for transfer pricing, you are allowed to accept it without a [00:19:00] penalty. But it’s a zero or a hundred.

Loren Ponds (19:03):
Right. It’s taken over you.

Fernando Colucci (19:03):
So, you cannot-

(19:05):
Yes, you cannot-

Stefane Victor (19:07):
That’s a Brazilian negotiation style. Take it or leave it.

David Farhat (19:09):
Yeah.

Fernando Colucci (19:11):
Yeah, take it or leave it.

David Farhat (19:11):
It’s called baseball style negotiation.

Stefane Victor (19:15):
We can make that painful or more painful.

David Farhat (19:18):
But to go back to the process a little bit, I know you mentioned that the exam team, they don’t have the power to settle. But is there any way to influence their finding of fact or their [00:19:30] legal reasoning at all? Is there a back and forth, or is it just they go away and they come back with something?

Fernando Colucci (19:35):
No. Usually, it’s a back and forth. The best way, in certain situations especially in relation to transfer pricing audits, we have the opportunity to chat with the auditor to present your case, present your documents, present your reasoning. But of course, you need to present all these in written. So the way you present the documentation, your reasoning to them either in a conversation or in written, is important to try to drive them the route you want them to drive.

Stefane Victor (20:06):
Is there a chance as this continues to get ramped up, that the taxpayers are better at answering these questions or coming to the right answer than the Brazilian tax authority as they’re dealing with this model, like the arm’s length standard, for the first time?

David Farhat (20:24):
Ah, I see what you’re saying. Given that the taxpayers may have a bit more experience with the OECD rules, [00:20:30] how would that influence. Yeah, I see the question.

Fernando Colucci (20:32):
I don’t see that because, of course, we’re talking about multinational companies. The ones that are not in Brazil, for sure, are used to the OECD method there. They know the rules. But the ones that will be dealing with the tax auditors here in Brazil are the locals. And in my experience, although they know the OECD model, my feeling and my experience shows that in certain situations, tax authorities are actually more prepared [00:21:00] than them. So, it’s the other way around usually.

Stefane Victor (21:03):
So, can you explain just how the 75% penalty comes into play? Does it come into play only after someone chooses not to accept the re-determination and take it to trial?

Fernando Colucci (21:17):
Yes. So, you have the full audit. At the end, tax auditor says that you should make a transfer pricing adjustment and that you should collect corporate income taxes. You can accept it [00:21:30] and pay the tax liabilities without any penalty, or you can challenge it. If you don’t accept it, you decide to challenge it, you can file an administrative appeal but the penalty will be there. And then you have a whole administrative discussion, a whole administrative litigation. At the end, if you have the tax assessment maintained, the penalty will usually be maintained. If you have it partially maintained, the penalty will still apply for [00:22:00] the portion maintained.

(22:01):
So once you decide to challenge it, unless you win, you need to pay the penalties as a rule. We have specificities. I can talk on the administrative discussion a little bit because in certain situations, you may have the tax assessment maintained without any penalty, especially when there is a certain level of doubt. Which party’s the right one, the taxpayer or the tax authorities? That’s the rationale behind it.

Eman Cuyler (22:27):
Is that amount a little bit lower [00:22:30] under certain circumstances? So let’s say that a multinational comes forward and says, “Hey, I made this mistake. I should have actually paid X. So, could we amend this and pay the proper amount?” Would the penalty still be 75% or is there option?

Fernando Colucci (22:47):
No. We do have a voluntary disclosure proceeding. So if you take this movement, as you mentioned before, any tax audit, you would be performing a voluntary disclosure. And in this situation, you can pay the taxes [00:23:00] with the interest without any penalty. But once you have the tax audit initiated, you cannot do the voluntary disclosure anymore. And in all other cases, except transfer pricing, once you have a final assessment from tax authorities, you have the 75%. But in transfer pricing, if you’re accepted, you may pay without any penalties.

Loren Ponds (23:23):
And is that a permanent rule or is that a transition?

Fernando Colucci (23:26):
No, it’s a permanent rule that is applicable to all [00:23:30] federal tax assessments, to all federal taxes.

Stefane Victor (23:34):
So, circle back. The question posed during the appeal process is not as simple. Do you sustain the adjustment or not? It’s more granular on each of the sub-points.

Fernando Colucci (23:46):
So once you have a tax assessment, you can file an administrative appeal. It goes through, initially, to a first-level review, which is carried by a panel of five judges. [00:24:00] All of them are former tax auditors from the Brazilian IRS. So they are, let’s say, seasoned professionals often with decades of experience. They will review both facts and law. Not only to check the numbers are correct, this is important, but also to confirm if the legal reasoning is correct it sound. Of course, as they are former tax auditors, usually, taxpayers don’t win at this level. So [00:24:30] usually, you need to file another appeal to what we call CARF, which is our higher tax court administrative council of tax appeals. In this case, the appeal is heard by a panel of six judges, and the composition is very specific. I think it is, as I hear, very unique to Brazil.

(24:52):
Three of the judges are also former IRS officials, so we say that they are representing tax [00:25:00] authorities. The three other are lawyers usually, so they are not IRS-related. And we say that they are taxpayer representatives. So in the second level, you have this 50/50 split, which theoretically gives you a more fair hearing. But there’s an important aspect because if there is a tie... You have six judges. You may have a tie. So if the vote ends 3 to 3, and this [00:25:30] happens a lot, tax authorities have the tie-breaking vote. So, the tax assessment is sustained when you have a 3, 2, 3.

(25:38):
The Brazilian law has been amended a few years ago, and now in these cases when you have a tie, the penalty is waived. So this is why I said that usually when you lose, the penalty will be maintained. But when you lose because of a tie, in this case, the penalty will be waived. But the principal tax, [00:26:00] of course, still hold. So this is called in Brazil, voto de qualidade. It’s a hot topic between taxpayers and tax authorities because tax authorities absolutely don’t agree with this, but this is how things are going for the last three years, let’s say.

David Farhat (26:17):
So, are there any other penalties specific to transfer pricing around documentation and things of that nature?

Fernando Colucci (26:23):
Yes, we do have specific penalties. They go up to 5% of the transactions, [00:26:30] so it may go very high amounts. And the wording of the law for imposing those kind of penalties is very broad, so this is an important aspect as well. Because if they say that you have presented your documentation but the documentation is not precise, is leading to misleading, they may assess you based on these rules. So in addition to the tax liability itself, you can have this specific documentation penalties as [00:27:00] well. And in the administrative discussion, differently from the alternative you have at the end of the audit, it’s not a question of yes or no. The court will not say, “Do we uphold the adjustment or not?” They can go very deep. They can get very granular. So, they may agree with tax authorities only in part accepting some arguments, but none others. Accepting the adjustment [00:27:30] in relation to certain transactions, but not in relation to others. So you may have a partial victory, for instance. And in a portion that is maintained, unless it’s maintained under a tie, you have to pay the tax liability plus the penalty.

Stefane Victor (27:47):
So, there might be some serious calculus on which direction to go. And I imagine from the taxpayer’s point of view, there’s an added level of uncertainty because you [00:28:00] may win on some points, lose on some points, but still end up in a worse position because of the large penalty that comes along with the new assessment.

Fernando Colucci (28:11):
Yeah. There is a provision saying that the 75% penalty will be reduced to 50%. So, to 37.5% if you pay the tax liability within 30 days of issuance of the tax assessment. So in certain situations, [inaudible 00:28:31] [00:28:30] you may end up accepting, for instance. You may accept, for instance, the adjustments in relation to a portion that you don’t believe you win, without penalties if you accept. If you are able to separate things, you may accept in relation to a portion, you may decide to challenge the other portion. So, this is something that we usually analyze with clients before actually presenting the appeal.

Stefane Victor (28:59):
I was thinking [00:29:00] that’s a little bit different than actually litigating all the points. If a taxpayer feels that they are justified on all of their points and they get... Let’s say half of them accepted, half of them rejected. They would have to pay the penalty on the 75%. But what you’re describing an opportunity to not have to pay the 75% is by accepting a re-determination on a portion of the arguments. Right?

David Farhat (29:25):
Yeah. So, it’s not all or nothing. You can...

Loren Ponds (29:27):
Mm-hmm.

Stefane Victor (29:28):
Yeah, but you can’t disagree, but pay in advance and hope that you don’t get paid the 75%. Basically saying, just hold this money just in case you guys win on these arguments. That’s not...

Loren Ponds (29:43):
It’s so good.

David Farhat (29:45):
Went prepared.

Stefane Victor (29:46):
Yeah, exactly.

Fernando Colucci (29:50):
No, you do can if you pursue the judicial route in advance. But when I say all or nothing, let’s say that tax authorities decide that you should charge a 5% mark and you understand you should charge 3%, but in reality, you charged 1% let’s say. You cannot negotiate and say, “Okay, I’ll not pay 3 or not pay 5. I’ll pay 4.” No. Either you accept a five or you decide to challenge it. This is why I say that it’s all or nothing.

(30:21):
And this is not actually written in the law, but this is my view. If you are able to separate things, then you can decide to accept a portion of... In relation, for instance, to financial transactions. And you can charge in relation to other transactions. This is not written in the law, but this should be, in my view, the best way to interpret it.

David Farhat (30:44):
To mitigate some of those penalties that could come from the challenge. That makes a lot of sense. Another thing to think about with transfer pricing, we always have to worry about double tax. What are the mechanisms in Brazil currently to deal with some of that? What’s the treaty network like? Is there an APA program? Is there a competent authority working on MAP cases? What’s the plan for that?

Fernando Colucci (31:05):
The previous rules didn’t provide any APA rules. These new rules, they do bring APA provisions. So this is the first time we have APA rules in Brazil. Of course, we are eager to see how they will be implemented by the Brazilian IRS. It’s still a very specific APA system because it’ll only involve unilateral [00:31:30] APAs. What we see from law, because we still don’t have it in practice, but it seems that we would not have an open dialogue between taxpayers and tax authorities as it is expected in an APA. We have something here in Brazil that is called a consultation. So, this is related to all federal taxes. So if you have any doubts in relation to a given law or a given tax, you may [00:32:00] file a consultation before tax authorities, they will review it and reply in written. This is basically the way our APA was structured.

(32:10):
So based on the wording of the law, taxpayers will submit their claims via an administrative proceeding and we receive answers from tax authorities in written. There may be a back and forth between the beginning and the end, but it doesn’t seem to be a very open dialogue. So it may be a step forward, [00:32:30] but not as forward as we wanted. As to MAPs, we’ll need to and see how IRS will be willing to apply it, because we do have MAP provisions in the double tax treaties executed in Brazil, but we don’t have information of any MAP executed by Brazil so far. So although it is there, we don’t have it in practice.

(32:53):
And as to the treaty network, Brazil has, today, 34 double tax treaties [00:33:00] in force. What is a low treaty network? If I’m not mistaken, the US has almost 70 treaties, so it would be twice the number of treaties that Brazil has. But especially in relation to transfer pricing, we need to wait and see how MAP provisions might be applied by tax authorities.

David Farhat (33:18):
Is there an effort to increase the treaty network ongoing since the change of the rules, or is that something that still hasn’t started?

Fernando Colucci (33:26):
No, there is an ongoing willingness to increase [00:33:30] that. I wouldn’t say this has changed because of these new rules. We have-

David Farhat (33:36):
Got you.

Fernando Colucci (33:37):
I would say that we have, at least, five treaties being discussed by the Brazilian tax authorities. It always takes a long time not only to negotiate, but also to bring them into force under our rules because it needs to be approved by the Congress as well. So it’s increasing but it’s a very slow path, let’s say.

Loren Ponds (34:00):
[00:34:00] Yeah. I was going to ask, is it similar to our practice where Congress has to get on board? And that can significantly delay ratification.

Fernando Colucci (34:09):
There is an interesting discussion now in relation to Ireland because for instance, most of airplanes that are used here in Brazil, they are leased from Irish companies. And Ireland is blacklisted today. So, there’s this discussion for having a treaty [00:34:30] between Brazil and Ireland to bring a relief to the Brazilian airline companies.

Loren Ponds (34:35):
And it’s blacklisted. Can you talk more about that? Why is Ireland blacklisted?

Fernando Colucci (34:41):
Because the rule here in Brazil is we do have a blacklist, so we need to be in that blacklist to be considered blacklisted. And the consequence is you’ll be subject to transfer pricing, either if you’re not related party. You have a more strict, I think cap rules, and you have a higher withholding income tax. [00:35:00] But the rule that brings you into that list is the countries that have income taxation lower than 17%.

Stefane Victor (35:09):
Wow.

Loren Ponds (35:09):
Okay. So, it’s been with the haven because of the corporate income tax rate is below. But 17 seems to be... You might think that now, in a world with a minimum tax of 15%, 17 is outmoded in terms of what.

Fernando Colucci (35:26):
Yeah, I was about to say that. It used to be 20. A few years ago, it went down to 17. Don’t know why. But actually, it should be at least 15 because of Pillar 2, and we now have Pillar 2 rules in Brazil as well. So, things are not matching.

Loren Ponds (35:45):
Right.

David Farhat (35:46):
Well, growing pains, right, as you move from the old system to the new.

Fernando Colucci (35:50):
Yeah.

David Farhat (35:50):
But Fernando, as we get towards the end of this conversation, I think one last question from me would be as a multinational either currently operating in Brazil or looking to operate in Brazil, with the new transfer pricing rules and the new legislation, what would be some things they should definitely do? Things they should look out for? And things maybe they should just wait and see before doing anything?

Fernando Colucci (36:15):
My recommendation here is to start with a thorough risk assessment. So, understand your intercompany transactions, identify potential areas of concern. Getting prepared, that’s the motive. So investing good benchmarking, transfer pricing software. As you know, in most of cases, it’s worth the investment. Of course, engage skilled advisors who understand the Brazilian system and they always see the guidelines. Because in Brazil, being proactive is key. Companies should wait and follow for updates from, I say, the [inaudible 00:36:51], the Brazilian IRS. They need to stay informed about new interpretations. It’s very often that Brazilian IRS presents these answers to consultations the rulings, and these rulings are binding to tax authorities. So in certain situations, you may be having a consultation issued by tax authorities that will give you more certainty without needing to you be the one that goes before tax authorities. So staying informed about this new interpretations, about this new guidance, and of course by decisions issued by courts. Because in Brazil...

(37:31):
We didn’t reach that in our discussions, but in Brazil, virtually all tax controversies and in courts, and most of them are resolved by the Supreme Court. This is totally different from the US as I understand, because we have a very thorough and large Constitution. And virtually, all tax controversies you can say that’s conflicting with constitutional principles and then you bring it to Supreme Court. [00:38:00] And of course, it takes years and years, sometimes decades, to reach a final decision. But even in certain situations, you may have a decision issued by Supreme Court that is not particularly related to transfer pricing but it may impact the way you interpret, in our case here, the transfer pricing.

(38:18):
So, Brazil is complex. I’m sure we have one of the craziest tax systems in the globe. But I would say that with the right approach, companies can navigate these changes and that system successfully.

David Farhat (38:32):
We really appreciate the time, Fernando. I think the biggest takeaway is complexity, craziness, and be prepared.

Fernando Colucci (38:40):
And keep cash in your purse.

David Farhat (38:41):
Yeah, exactly. That 75% penalty is tough. But again, Fernando, we really, really appreciate the time. And to the listeners, once again, this has been GILTI Conscience. Thank you so much.

Voiceover (38:58):
Thank you for joining us for today’s episode of GILTI Conscience. If you like what you’re hearing, be sure to subscribe in your favorite podcast app so you don’t miss any future conversations. Skadden’s tax team is recognized globally for providing clients with creative and innovative solutions to their most pressing transactional planning and controversy challenges. Additional information about Skadden can be found at skadden.com.