Brazilian income tax legislation provides for specific rules on the taxation of revenues and expenses resulting from long-term agreements (agreements with a performance term longer than one year and with a pre-fixed price), according to which the company is permitted to account, on a monthly basis, for the corresponding costs and revenues based on the comparison between the incurred budgeted costs in relation to the total budgeted costs.
Thus, the rationale of tax ascertainment of long-term agreements involves the matching of revenues and expenses during the performance of the project, in which the amounts accounted for by the company in each period shall be proportional and related to the stage of the project. At the end of the agreement, the company shall perform adjustments resulting from any divergences between the estimated revenues and budgeted costs and the revenues and costs actually incurred. Therefore, such system does not result in any losses in tax collection.
However, we understand that Brazilian transfer pricing rules do not provide for the adoption of estimated costs and deemed net sales price for the purposes of calculating the benchmark under the Resale Price Less Profit (“PRL”) method.
In the PRL method, the calculation of the benchmark uses the average of the sales prices as well as the share of the cost of the imported items in the total cost of the products sold.
As the taxable basis of income tax on long-term agreements is founded on budgeted amounts (revenues and costs), the adoption of PRL in cases involving long-term agreements may result in distortions in the calculation of the benchmark as there is no transfer pricing provision allowing for the adjustment of the benchmark after the confirmation of costs incurred and revenues ascertained by the end of the project. Therefore, as transfer pricing rules assume the use of the actual costs and revenues, PRL should not be adopted until the variables used in its formula (costs and revenues) are effectively incurred and, thus, should not be calculated using estimated or deemed costs/revenues.
In addition, Brazilian transfer pricing rules also establish that, for the purposes of controlling and calculating the benchmark, the analysis shall be performed individually for each product, right or service transacted.
Recently, the Administrative Court of Tax Appeals (“CARF”) – second administrative instance – analysed a case involving a company focussing on vessels construction, in which the taxpayer defended the adoption of the PRL method only after the end of the contracted transactions. CARF, in turn, did not accept such argument, but the decision was favourable to the taxpayer as, upon tax inspection, the tax authorities made the transfer pricing calculations based on the vessels instead of the product imported on a case-by-case basis (Appellate Decision 1201-001.853 of 16 August 2017).
In view of the above and despite the fact that CARF understood in the aforementioned decision that the adoption of the PRL method should be made during the execution of the project, we understand that there are arguments to defend that the taxpayer may wait until the end of the project (when the costs and revenues effectively incurred will be ascertained) in order to perform the benchmark calculation of each good, right or service imported on transactions subject to transfer pricing controls and perform the corresponding transfer pricing adjustment, if any.
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