On April 3 2012 Provisional Measure 563 was altered, with several modifications made to the transfer pricing rules. One modification alters the way in which the Brazilian equivalent to the comparable independent price (CIP) method(1) is calculated.
The CIP method uses third-party and unrelated-party transactions to determine the acceptable transfer pricing for imported goods, services and rights.(2) Before the new rule was enacted, the CIP method under Brazilian transfer pricing rules employed the arithmetic average of identical or similar products sold or purchased under similar conditions. The new rule uses a weighted arithmetic average of identical or similar items sold or purchased by the taxpayer or by third parties under similar conditions.(3)
The new method requires that the weighted average be used when determining transfer pricing. The example below illustrates how the difference between an arithmetic average and a weighted arithmetic average affects the transfer price.
Product A is imported by Brazilian Company X from British Company Y. The buyer (importer) and seller (exporter) are related parties.(4) Product B is a similar product. Suppose that 20 unrelated Product A transactions and 30 unrelated Product B transactions are used for comparison. All 50 transactions are appropriate for calculating transfer pricing. The prices of the 50 transactions (as measured in a hypothetical currency unit) are as follows:
- Product A prices - 62, 67, 71, 74, 76, 77, 78, 79, 79, 80, 80, 81, 81, 82, 83, 84, 86, 89, 93 and 98; and
- Product B prices - 81, 82, 83, 84, 85, 86, 87, 87, 88, 88, 89, 89, 89, 90, 90, 90, 90, 91, 91, 91, 92, 92, 93, 93, 94, 95, 96, 97, 98 and 99.
The average value for Product A is a sum of the transaction values divided by the number of transactions, as follows:
The average value for Product B is also a sum of the transaction values divided by the number of transactions, as follows:
The arithmetic average (ie, the previous method) of Product A and Product B is the sum of the average value for Product A and the average value of Product B, divided by two:
Thus, when the arithmetic average is employed, the value used in evaluating transactions for Product A between related parties (ie, Company X and Company Y) is 85.
However, the arithmetic average does not account for the fact that there were more Product B transactions than Product A transactions. Thus, a transfer price of 85 does not reflect the average price of identical and similar products.
The weighted average (ie, the new method) price of identical and similar products is the sum of all the transaction values divided by the total number of transactions:
The weighted average price can also be determined by weighting the product value averages by the number of transactions for each product:
Here, the weighted average makes it possible to find the acceptable transfer price for cases where only the average price for each product and the number of transactions for each product are available.
If the price associated with related party import transactions exceeds the transfer price, the taxpayer must add this difference to its net profit when calculating Brazilian income tax and social contribution liabilities (collectively, corporate income tax).
For example, if the actual pricing practised between the related parties is 95, it would be greater than the transfer price determined under the weighted average method, which is 86. Thus, when determining the basis for calculating Brazilian corporate income tax, the taxpayer must disregard the practised cost/price of 95 and use 86, the value determined by the transfer pricing rules.
For further information on this topic please contact Ricardo Ciconelo, Lucas Kurtz, Daniel Takaki or Elisa Sielski at Manhães Moreira Advogados Associados by telephone (+55 11 3145 9555) or email ([email protected], [email protected], [email protected] or [email protected]).
(1) The CIP is one of the methods accepted by the Brazilian transfer pricing legislation.
(2) Transfer pricing attempts to regulate cross-border sales transactions between related parties by requiring that sales prices are the same as they would be in an arm's length transaction (ie, a transaction between unrelated parties).
(3) 'Similar goods' are defined as those that have:
- the same nature and function;
- mutual replacement; and
- equivalent specifications.
(4) In addition to regulating entities under common control, transactions with exclusive distributors are included in the definition of related parties.