Brazil’s new proposed transfer pricing rules to impact U.S. taxpayers

Late last year, Brazil published draft legislation bringing its transfer pricing requirements in theoretical alignment with the United States and Organization for Economic Cooperation and Development (OECD) rules. In particular, the new legislation would for the first time establish an arm’s-length requirement governing Brazilian transfer pricing. This could have a significant tax impact on U.S. companies with entities in Brazil.

The legislation

Provisional Measure No. 1.152/2022 mirrors the OECD transfer pricing guidelines and brings an arm’s-length principle concept to Brazil’s transfer pricing regime. The legislation also provides guidance on the identification of intercompany transactions and the methodologies available to demonstrate compliance with the arm’s-length principle. Additionally, like most OECD member states, a penalty regime was created with a transfer pricing documentation requirement to achieve penalty protection.

The provisional rules will need to be enacted into law in Brazil within 120 days. Although enactment is expected, the country has a lot at stake in its quest to generally align itself more closely with the OECD. Additionally, it is anticipated the new rules will have the net benefit of increasing tax revenues in Brazil, a further impetus for making the change. If passed in its current form, Brazilian taxpayers would have the option to implement in 2023, but will be required to do so in 2024.

The impact to U.S. taxpayers

For U.S. companies with entities in Brazil, the obvious impact is that there will be new requirements to be met, with additional compliance and possibly additional tax due. The lack of cohesion between U.S. transfer pricing requirements and current Brazilian requirements has caused many U.S. companies to put structures in place that will be either untenable under the new rules or possibly tax inefficient.

Potentially the most consequential impact will be to the foreign tax credit (FTC) recognized by U.S. companies with Brazilian entities. New FTC regulations issued in late 2021 provided limitations to whether a foreign tax is creditable in the U.S. based in part on whether the jurisdiction’s profit allocation rules are consistent with the arm’s-length principle. This requirement has been a headache for many U.S. taxpayers, with Brazilian income tax potentially not getting the benefit of a credit against U.S. tax. While the U.S. Department of Treasury has yet to release guidance on whether these changes will be enough to fulfill this requirement and, if so, which year the change would become effective, clearly this would be a step in the right direction toward solidifying the case for an FTC.

What now?

U.S. taxpayers with Brazilian entities should begin to look at the potential impact of the new legislation to make an informed decision about the best path forward, leaving enough time to implement in 2023 if the changes are net favorable. This may not be a simple or straightforward exercise, especially in the instance where taxable income (and resulting tax) increases in Brazil, but the ability to use that tax as a credit against U.S. tax also increases.

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