The alignment of Brazil to the transfer pricing standard of the Organization for Economic Cooperation and Development (OECD) will prevent the country from facing revenue losses totaling billions of reais per year, Pascal Saint-Amans, director of the Center for Tax Policy and Administration at the OECD, told Valor.

Brazilian authorities and Mr. Saint-Amans will detail the new Brazilian system on Tuesday in Brasília, the result of convergence between the OECD and the Secretariat of Federal Revenue. According to him, the final phase of the studies started in February 2018 found a surprising extent of losses for Brazil because of the current system.

“If we say that Brazil loses revenue today, and that by changing the rules it will lose less, it means that companies will pay more tax,” Mr. Saint-Amans said. “Someone can argue that this is not good for investments. In reality, since the situation is complex, it is not incompatible with an improvement of the corporate tax regime in Brazil.”

Transfer pricing is an issue that all multinationals face. It can be used to move profits from one country to another. It concerns the amount charged when goods or services are sold between two companies in the same group in different countries. It can allow them to legally reduce their tax liability, for example, by accounting for low or overpriced transactions or by moving profits to low-tax jurisdictions such as tax havens. For some transactions, it may be relatively easy to set transfer prices and for tax authorities to control them. But there are more complex transactions, involving, for example, intangible assets and certain financial transactions, which are more challenging for tax authorities to control.

The Brazilian system, with a fixed margin, was originally designed to be simple and easy. But the OECD assessment is that it is detached from commercial reality and has resulted in multi-billion revenue losses and double taxation problems.

To join the OECD, Brazil will adopt a new system fully aligned to the organization’s standard, which seeks to determine the appropriate market price in the transaction. At the same time, simplification measures will be developed to achieve the objectives of the old system, but based on economic reality. Brazilian authorities are to determine when a bill will be presented to Congress and how the system will be gradually put into practice.

Mr. Saint-Amans is one of the world’s leading experts on taxation. He is at the center of the fight against tax evasion. And he was a key player in the creation of the global minimum tax of 15% on multinationals, the biggest overhaul of the international tax system in decades. Read below excerpts from the interview before his trip to Brasília:

Valor: Does the Brazilian transfer pricing system pose detrimental effects on Brazil?

Pascal Saint-Amans: Yes, it does. We identified quite a while ago that the Brazilian transfer pricing policy was atypical, very different and not in line with the OECD standard. To facilitate a change, we decided with the Ministry of Economy and the Secretariat of Federal Revenue to do an analysis. This work is now being finished and has led to some very surprising findings. We thought that the Brazilian system was quite different but a very robust one, which protected Brazil’s tax base. The reputation of Brazil was of a “tough guy,” very strict. The study showed that the Brazilian system had many flaws and led to many revenue losses. The main lesson of this work is that, in a constructive, relaxed way, we were able to make a common analysis of the situation between the OECD, on one hand, and the Federal Revenue, on the other, and realize the deficiencies and some advantages, but that are limited, in order to reach these common findings that will facilitate Brazil’s approximation and alignment to international standards.

Valor: How does this loss of revenue by Brazil happen, in practice?

Mr. Saint-Amans: Multinationals are currently able to legally transfer profits generated by operations in Brazil to low or no tax foreign jurisdictions by exploiting some of the divergences between the Brazilian transfer pricing structure compared to the international standard. A concrete example is the case of a company with high-value products that benefit from cheap production factors. Due to the Brazilian system of fixed margins, the company can legally leave only a small amount of profit in Brazil, say 15% of the production cost, while the real added value is close to 100%! The product will be sold to another company in the group in a low tax country and resold from there to other countries. Because of the fixed margin, the profit will have been transferred out of Brazil. This is just one example. Many other situations arise in relation to other transactions that affect all sectors of the Brazilian economy, including transfers of valuable assets, including intangible assets, as well as financial transactions.

Valor: How much tax revenue does Brazil lose per year in this case?

Mr. Saint-Amans: I don’t have precise figures, but we are talking about quite large amounts, billions of reais, no doubt. This study is based on the country-by-country reporting adopted in the BEPS (Base Erosion and Profit Shifting) case. Examining this study, Brazil realized that a good part of the tax base that should have remained in the country was transferred to countries that offered advantages. The Brazilian transfer pricing, which gave the impression of being solid, with a fixed price in the transaction depending on the activity, in practice was easily circumvented or even used to transfer profits abroad. The system favors transfer abroad, with loss of revenue, as it is also rigid in some fields, which is an obstacle to better integration of Brazil in the value chains.

Valor: How much would Brazil lose, then?

Mr. Saint-Amans: These are large amounts, not secondary values on a company.

Valor: Many multinationals use this practice, of avoiding paying taxes in Brazil?

Mr. Saint-Amans: The answer is yes. It is something that is systematically used, which is logical. There is a tax system with its advantages and its disadvantages, and companies deal with it. The advantage of this system, and this is why we wanted to build a common answer with the Federal Revenue, is that it is simple to handle. It doesn’t need many tax auditors or many controls, because there is a fixed margin determined beforehand and companies have no choice. With the OECD transfer pricing, on the other hand, you have to examine it transaction by transaction. We acknowledge that it is complicated, sophisticated and needs more resources in tax administration. That said, we try to understand how the OECD itself could simplify things. Brazil is going to align itself with the OECD rules, and in turn the OECD moves in the direction a little on the positive side of the Brazilian system.

Valor: For example?

Mr. Saint Amans: What we have done in recent years at the OECD is to modify the transfer pricing standard. In the BEPS project, we have three measures on transfer pricing. First, we say that if [the company] wants to locate intellectual property in a country it has to have substance. Second, we can simplify the benchmarks for the price of raw materials, such as oil, and look at the market price as Brazil and Argentina do. So we acknowledge that this so-called “sixth method” is not incompatible with the OECD standard. We also developed the global agreement announced in October 2021 with two pillars: Pillar 2 introduces a minimum global tax of 15% on multinationals – and Brazil should ask itself if it will put this tax in place; we will work closely with Brazil to see if it is possible. And Pillar 1 includes two things: the biggest multinationals – notably U.S. and European ones, with a combined profit of $700 billion a year – will leave a 25% share of profits in the countries of markets according to some criteria when this political agreement is legally in place, whether the company has a physical presence in the country or not. We will have $125 billion to $ 200 billion a year redirected to these markets. Brazil is a big market. Therefore, it is a fundamental change. In addition, when a company has distribution activity in a country, which is underpaid, we will also simplify rules, as Brazil does, for the company and the country to have more legal security. It will be an approach that respects the principle of full competition, only more simplified. Brazil has two reasons to align itself with the OECD rules: they are more robust, and the Brazilian rules are quite fragile.

Valor: What legal changes will Brazil have to make, then, to align itself with the OECD system?

Mr. Saint Amans: Brazil needs to pass a law that will call into question its fixed margin principles and acknowledge the relevance of a transactional approach. I understand that this bill is well advanced, but the political question now, which does not belong to us, is about the timing for this legislative change. We understand that Brazil will hold elections this year. But these are technical and bipartisan works. We are confident that this work will result in a possible majority in Brazil after the elections.

Valor: In other words, will Brazil need to join the Arm’s Length Principle at the heart of the OECD standard?

Mr. Saint Amans: Yes. This means we should transact as if we were not in a family. In family, we embrace each other. When we are foreigners, we are at arm’s length. The principle forces a company, when doing internal transactions, to put the market price, which would be as with an independent entity and not as with someone in the family. It is a rule that dates back to 1928. Every internal transaction must be done at market price. This system has its weaknesses, because in an open world, with tax havens, companies are interested in locating their profits in countries where there is little taxation. That is why we introduced the BEPS.

Valor: With the change in transfer pricing in Brazil, will the multinationals pay more taxes?

Mr. Saint Amans: Yes, If we say that Brazil loses revenue today, and that by changing the rules it will lose less, it means that companies will pay more tax. Someone can argue that this is not good for investments. In reality, since the situation is complex, it is not incompatible with an improvement of the corporate tax regime in Brazil. It is just that the current system has many drawbacks. I am not saying that Brazil was very bad and the rest of the world was very good, no. But the simplicity of the Brazilian system runs into the problem of double taxation.

Valor: The OECD says that the change will help Brazil in global value chains. How?

Mr. Saint Amans: It has to do with what we just talked about. Brazil has its own rules, which fundamentally integrate poorly with the rest of the world. We found that companies were not necessarily making all the investments that they could make in Brazil. We think that it is not only the fiscal obstacle, but there is a fiscal obstacle that is substantial. And if it is solved, it could facilitate better integration.

Valor: Is the transfer pricing change key for Brazil to join the OECD?

Mr. Saint Amans: Of course. To join the OECD, Brazil needs to be in compliance with OECD standards.

Valor: In other words, the country must do this in two, three years?

Mr. Saint Amans: It has to do this before it can join the OECD. There is a tight schedule. It depends on how fast Brazil wants to get in, but clearly it is one of the important points of the country’s accession to the OECD. But, I insist, it is not a pressure imposed by the OECD, we built this together.

Valor: Economy Minister Paulo Guedes recently went to the OECD and talked to you about a tax overhaul in Brazil. Is this a factor for accession?

Mr. Saint Amans: The question of tax policy in general is not a matter of accession. We have standards like tax information exchange with Brazil, the country applies BEPS and has engaged in providing reliable information for our statistics. In contrast, the OECD has recommendations in this field, which countries are not obliged to apply. What we see from Brazil is that its tax burden is high (33.9% of GDP in 2021) and with a VAT (value-added tax) system that is not good, because of the federal structure and the way it is shared between the federal government and the states. The work that has begun on simplifying and improving the effectiveness of VAT is very important, and ensures revenue without economic distortion. VAT is a very good tax that can be a little regressive, and we need to pay attention to this. And in Brazil it is not so effective.

Valor: In Brazil, do you pay a lot of tax?

Mr. Saint Amans: The VAT in Brazil is not effective, it generates income but also causes obstacles to the fluidity of exchanges, it makes life more complicated. In corporate tax, the revenue could be even higher while making life easier for companies. An OECD recommendation could make tax overhaul to be more effective, less penalizing for the fluidity of business. Today, the Brazilian system compared to other Latin American countries has a level of mandatory taxation that is higher, but it goes with a level of state development that is higher than other countries in the region.

Source: Valor International

https://valorinternational.globo.com