New transfer pricing rules affect Brazil’s oil and natural gas sectors

Published on December 29, 2022, Provisional Measure (MP) No. 1,152/2022 introduces new transfer pricing rules that aim to bring the Brazilian system closer to that of the OECD countries.

The MP is an important development for legal entities that calculate Corporate Income Tax (IRPJ) and Social Contribution on Net Income (CSLL) based on the actual profit regime and that have business connections or carry out transactions with related parties abroad – typical characteristics of companies in the oil and natural gas (O&G) sector.

One of the fundamental aspects of the MP is how it adopts the arm’s length principle in place of the previous fixed profitability margins system. In other words, the model now privileges the use of comparable market prices, considering each participant’s assets, risks and functions in a controlled transaction (the subject of analysis for transfer pricing purposes).

The most significant aspects of MP No. 1,152/2022 for O&G companies are outlined below:

Choice of transfer pricing method

Taxpayers are no longer able to choose the applicable transfer pricing method. Instead, they must follow the MP’s provisions, Brazilian Federal Revenue Service (RFB) regulations and the OECD guidelines to apply the ‘most suitable’ method – the one that provides the most accurate determination of the terms and conditions that would be established between unrelated parties in a comparable transaction.

Commodities

In the new model, there are no longer specific methods for commodities (PCI – Price Under Import Quotation and Pecex – Price Under Export Quotation), meaning that any of the methods listed in the MP can be applied to control the price of these products.

The MP broadly defines commodities as physical products or byproducts for which unrelated parties use ‘quote prices’ as a reference to establish prices in comparable transactions.

As such, the listing of goods classified as commodities that occurred in the PCI and Pecex methods no longer exists. Rather, the MP now recommends using the Comparable Independent Price (PIC) method to determine the value of a commodity transferred in a given controlled transaction.

Furthermore, the MP establishes that the RFB will regulate the tax treatment for commodities, and will even instruct on how to adopt parameter prices for uncontrolled transactions on commodity and futures exchanges, research agencies or government agencies – as should be the case with the ‘ANP price’ (National Petroleum Agency) that O&G companies frequently adopt for oil exports.

International cost-sharing

Commonplace in the O&G sector, international cost-sharing agreements were explicitly addressed in the new MP both in relation to sharing service costs and developing tangible or intangible goods.

With the MP now making rules related to international cost-sharing applicable in Brazil, it may lead to new developments in discussions on implementing tax-free international cost-sharing structures.

Specific situations

The MP also introduces specific rules for certain situations that companies in the O&G sector commonly face, such as:

• Intra-group services (outside the context of cost-sharing agreements);
• Using, transferring and enjoying intangible assets;
• Business restructuring – determining remuneration for the transfer of functions, risks and relevant assets;
• Granting intragroup loans and guarantees;
• Cash pooling;
• The end of non-deductibility of royalties paid to related parties abroad from IRPJ and CSLL calculations.

Indirect effects – US tax credits

In 2021, the US introduced new domestic rules (TD 9959 – FTC Regulations) for offsetting income tax paid abroad against US tax liabilities, which since then have provided for a new, source-based attribution requirement for recognizing foreign tax credits.

This new requirement imposed the need for a connecting link (or attribution) between the source country and the foreign country. Moreover, the taxpayers themselves must submit foreign taxes to the attribution test so that the tax paid in the source country is accepted in the US.

The original purpose of this rule was to deny credits for foreign taxes that did not conform to US tax standards. In its current form, the Brazilian tax system would not comply with such a connection nexus for reasons such as the following:

• It does not apply the arm’s length principle to transfer pricing;
• It provides for limits on the deductibility of royalty payments;
• It has not adopted a clear concept of permanent establishment (PE);
• It has other unilateral taxes on remittances beyond the PE concept, such as Cide and PIS-Cofins-Importation;
• It provides for withholding income tax on mere remittances/payments, rather than withholding based on the source of income.

In the event MP No. 1,152/2022 is converted into law, the first two characteristics would change, and Brazilian tax legislation would align with US legislation. This could contribute to the decision to allow IRPJ and CSLL tax credits paid in Brazil to offset US income tax.

Option for 2023

For taxpayers in general, the MP’s provisions will apply as of 2024, provided it is approved by the Brazilian Congress and converted into law. However, for taxpayers who wish to do so, the MP also guarantees the option of using the new transfer pricing model from January 1, 2023.

For more information on MP No. 1,115/2022 and the impacts of the new transfer pricing model on the O&G sector, please contact Mattos Filho’s Tax practice.