Brazil issues further guidance on pricing of interest bearing transactions; taxpayerfavorable. Minus 60 case. Global Tax Alert

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1 8 August 2013 Global Tax Alert News from Transfer Pricing Americas Tax Center Ernst & Young s Americas Tax Center brings together the experience and perspectives of over 10,000 tax professionals across the region to help our clients address administrative, legislative and regulatory opportunities and challenges in the 33 countries that comprise the Americas region. Copy into your web browser: Services/Tax/Americas-Tax- Center---borderless-clientservice Brazil issues further guidance on pricing of interest bearing transactions; taxpayerfavorable decision in Resale Minus 60 case 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 /2012. Law , issued on 28 December 2012, provided significant changes to Brazilian transfer pricing rules for interest bearing transactions. Under Law , 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by an annual spread to be established by the Ministry of Finance based on a market average (the previous 3% limitation was revoked).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:

2 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. 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 60 1 (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 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 A Value Added on Brazil B 500 B 500 Total Cost C = A + B C = A + B Net Sales D D Participation Raw Material / Cost E = A / C 67% N/A Participation of Raw Material at Net Sales F = E * D N/A Gross Margin 60% Base N/A E = D - B Gross Margin 60% G = F * 60% F = E * 60% Parameter Price PRL 60% H = F - G 800 G = D - F Global Tax Alert Transfer pricing

3 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. Global Tax Alert Transfer pricing 3

4 For additional information with respect to this Alert, please contact the following: Ernst & Young Serviços Tributários S.S., São Paulo Werner Stuffer Demétrio Barbosa Janaína Costa Caio Albino de Souza Ernst & Young Serviços Tributários S.S., Transfer Pricing, Rio de Janeiro Marcio R. Oliveira Ernst & Young Serviços Tributários S.S., Transfer Pricing, Campinas Leandro Cassiano Ernst & Young Serviços Tributários S.S., Transfer Pricing, Porto Alegre Felipe Mauer Ernst & Young Serviços Tributários S.S., Transfer Pricing, Belo Horizonte Maira Costa Alves Ernst & Young Serviços Tributários S.S., Transfer Pricing, Curitiba Aline Weiss Ernst & Young LLP, Brazilian Tax Desk, New York Mariano Manente Ernst & Young LLP, Brazilian Tax Desk, London Ricardo Moura EY Transfer Pricing Global Transfer Pricing, Germany Thomas Borstell, Americas, United States Purvez Captain, EMEIA, Germany Oliver Wehnert, Japan, Tokyo Kai Hielscher, Global Markets, United Kingdom John Hobster, TESCM, Amsterdam Victor Bartels, Asia Pacific, Singapore Luis Coronado, Global Tax Alert Transfer pricing

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