INSIGHT: Implementing the Transaction Net Margin Method for Transfer Pricing in Brazil (2023)

In February 2018, the Brazilian tax administration, Receita Federal do Brasil (RFB), began working with the Organization for Economic Cooperation and Development (OECD) to evaluate the similarities and differences between the two transfer pricing systems. As a result of this effort, known as the “Transfer Pricing in Brazil Project,” the OECD and RFB concluded that Brazil would need to make changes to its transfer pricing system to better align with the OECD Guidelines as a precursor to joining the OECD. On June 30, 2020, as part of the Transfer Pricing in Brazil Project, the OECD and RFB launched a survey to seek public input to inform the work related to the development of safe harbor provisions, use of available comparable company data, and sector-specific advance pricing agreements (APAs).

Now that RFB has significantly committed to the implementation of the OECD Guidelines, the country is faced with determining how to efficiently transition from its legacy transfer pricing regulations (1996 transfer pricing regulations), enacted in 1996 with the passage of Law 9430/1996 and amended by Law 12.715/2012, to adopting the arm’s-length standard, which is the guiding principle of the OECD Guidelines. Brazil’s 1996 transfer pricing regulations were primarily designed to price tangible goods transactions.

In 1996, intangible transactions, business restructurings, and the digital global economy were issues that did not have a material impact on the Brazilian economy. Updates to the 1996 transfer pricing regulations have focused on refining the current system while doing little to address the challenges associated with non-tangible transactions, including intangible transactions, business restructurings, and intercompany services. However, technological progress in Brazil and globally in the past 25 years has made non-tangible transactions as important if not more important than tangible goods transactions and has had a material impact on the Brazilian tax base.

As Brazil moves towards converging its transfer pricing regulations with those of the OECD Guidelines, RFB must determine which aspects of its current transfer pricing structure should be replaced with internationally accepted standards and which aspects should be maintained, albeit with certain modifications, to reflect what many Brazilian transfer pricing practitioners believe is the main strength of its current system: certainty.

There are many technical challenges in the implementation of an OECD system that has been developing for decades. It will take significant efforts by RFB, taxpayers, practitioners, and academia to change the Brazilian system. Based on our experience, we decided to focus this article on certain aspects of the adoption and application of the OECD’s transactional net margin method (TNMM) in Brazil, focusing on comparable company data, comparability adjustments and the possible use of safe harbors for functions traditionally tested with the TNMM.


The OECD Guidelines used to describe the TNMM as a method “of last resort” (Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, July 1995, paragraph 3.50), yet the TNMM became by far the most used method by tax authorities. For example, the TNMM has been relied upon in 80% of APAs with the Canada Revenue Agency (CRA), which is four times as often than all of the other transfer pricing methods prescribed in the OECD Guidelines combined (Advance Pricing Arrangement, 2017 CRA Program report, Table 4).

Similarly, the comparable profits method (CPM), which is a method that is analogous to the TNMM, has been relied upon in 86% of APAs by U.S. taxpayers and the Internal Revenue Service (IRS) for transfers of tangible and intangible property (Announcement and Report Concerning Advance Pricing Agreements, March 2019, p 9). Also, statistics gathered by the Inter-American Center of Tax Administrations (CIAT) conclude that as of 2019, the TNMM is the most used method in 15 countries in the Latin American region (CIAT Data 2019, Transfer Pricing Database, Section 1, Methods).

The TNMM determines an arm’s-length result for a controlled transaction by examining the profitability of independent enterprises engaging in activities similar to those of the “tested party” (generally the least complex entity involved in a controlled transaction) (OECD Guidelines, Paragraph 3.18) and operating under comparable circumstances (OECD Guidelines, Paragraph 2.64). Since the TNMM measures the total return on business activities, comparable companies need to be similar in their functions performed, assets employed, and risks assumed, but other types of comparability (for instance, comparability of products being manufactured or sold) are not as important. Usually, significant product diversity and some functional diversity between the tested party and the comparable companies are acceptable to determine comparability. A reasonable number of adjustments may be made to the comparable companies’ financials to improve consistency and to achieve greater similarity between comparable companies and the tested party.

The TNMM is best applied to intercompany transactions in which one of the parties involved performs relatively routine functions and does not make significant non-routine contributions (for instance, through the ownership and exploitation of important intangibles) when performing the function. When this is the case, the tested party’s appropriate profit expectations can often be benchmarked using comparable company data. Functions commonly benchmarked using the TNMM include distribution, manufacturing, and the provision of services.

Data Availability and Country Risk Adjustments

For developing countries, one of the main difficulties in applying the TNMM is the lack of local data of independent companies that are reasonably comparable to the taxpayers that operate in their countries. Capital markets in many of these countries provide a minimal pool of potentially comparable public companies, the primary source of global comparables given their publicly available financial information. For example, the number of Brazilian public companies that exist within Bureau van Dijk’s (BvD’s) TP Catalyst database, as of June 2020, was only 358, while other countries in the region like Mexico and Argentina only had 130 and 97 public companies respectively. This database is often used in transfer pricing analyses by both taxpayers and tax authorities alike.

With regard to potentially comparable private companies, reliable data available in the region is also scarce due to limited nature of local filing requirements of qualitative and quantitative data. Finally, in many industries, such as the automobile or pharmaceutical industry, local entities may be part of another multinational group, which means they lack independence and are, therefore, not reliable for use as comparables (even if standalone data were available). All the above represent some of the challenges developing countries face when applying the TNMM to calculate a reliable arm’s-length range of results.

To address the data availability issue, would RFB, like other Latin American tax authorities, accept benchmarking completed with regional or global public comparable companies? According to statistics from the Inter-American Center of Tax Administrations as of September 2018, out of 18 countries with transfer pricing regulations in Central America, South America, and the Caribbean, 17 of those tax authorities disclosed they accept comparable companies from geographic markets other than their own.

If RFB chooses to adopt this approach, should regional comparable companies be adjusted to account for country risk differences? Other regional tax authorities, like the SAT in Mexico (known as Servicio de Administración Tributaria (SAT) in Spanish), have discussed this issue at length, and in Annex A of this article, we list the approach taken by a select group of countries. However, there is currently no broadly accepted method to adjust for differences between country conditions. This is a significant challenge facing transfer pricing practitioners regionally and will affect Brazil as well.

To account for country risk differences, RFB could allow adding a country risk premium (or discount) to the identified arm’s-length profitability in the application of the TNMM. Country risk involves the risk of operating a business in a specific location and is not related to the nature of the business activity. Country risk encompasses differences in political instability, inflation, sovereign debt burden, currency fluctuations, and government regulations.

If taxpayers experience difficulties in identifying publicly available financials for Brazilian comparables to implement a TNMM analysis, a country risk premium could be factored into the profit level indicator (PLI) of foreign comparable companies. Another option for addressing country risk would be to adjust the interest rates used in the capital adjustments (discussed in the following section) to account for the differences in the local interest rates of the comparable companies’ countries and the country’s interest rates of the tested party. In any case, it is essential to consider that operating subsidiaries located in higher-risk countries do not necessarily generate higher actual profits and could experience losses.

Other Comparability Adjustments

When conducting a transfer pricing analysis using the TNMM, it is essential to consider if there are material differences in the conditions of the potentially comparable transactions relative to the controlled transaction. In some instances, adjustments can be made to control for the impact of such differences and improve the reliability of the comparison.

Adjustments may be made to the comparable companies’ financial statements and to the observed profitability of the comparables to eliminate differences in accounting practices between comparable companies and improve consistency across those comparables and the tested party. These adjustments increase the reliability of the comparable companies’ results and the transfer pricing analysis. The most widely used comparability adjustments include accounting adjustments, working capital adjustments, and country risk adjustments (discussed above).

Accounting adjustments are usually focused on amortization of intangibles, and on differences in inventory accounting (accounting for inventory on a LIFO vs FIFO basis). Working capital adjustments can be used to adjust for differences in opportunity costs related to differing levels of inventory and of trade receivables and payables.

Also, there are other mechanisms that are be employed to increase the reliability of the comparison between the profitability of tested party and the identified comparables. This includes the use of multiple year financial information of comparable companies and the tested party, the use of an interquartile range (IQR), the frequency of comparable companies’ financial information updates, the method to average the PLI results, and other considerations. In Annex A, we present different benchmarking requirements by a selected group of countries we considered most relevant to Brazil’s economy.

Comparability adjustments have been discussed at length in OECD literature and go beyond the scope of this analysis. Our objective is to highlight the challenges RFB and Brazilian taxpayers will face regarding comparability adjustments. There is no universal method for applying comparability adjustments, nor is there a consensus among tax administrations regarding the reliability of these adjustments. To mirror some of the simplicity of the current transfer pricing system, RFB could take a simplified approach to comparable adjustments while reserving the right to apply them when considered material to the reliability of the analysis.


Considering the prescriptive nature of the existing Brazilian transfer pricing regulations, which favor predictability, the adoption of the OECD Guidelines will present new complexities and ambiguities to RFB and Brazilian transfer pricing practitioners as they begin conducting formal comparability analyses to determine an arm’s-length range of profitability. Given Brazil’s current use of safe harbors, RFB has expressed interest in developing new safe harbors that are more aligned with the use of the arm’s-length standard in the OECD Guidelines. Such safe harbors could significantly ease the burden of conducting the economic analyses associated with OECD-compliant comparability analyses.

The latest version of the OECD Guidelines discusses safe harbors at length, including possible benefits, concerns, and recommendations (OECD Guidelines, Chapter IV, Section E). The OECD Guidelines deliberate a safe harbor system when talking about the application of a simplified charge mechanism for low value-adding intra-group services (OECD Guidelines, Chapter VII, Section D). However, empirical evidence regarding the use of safe harbors based on the TNMM is sparse.

To inform the development of safe harbor measures that would provide simplicity and tax certainty for Brazilian taxpayers, the OECD and RFB issued an open invitation to interested stakeholders to provide comments on the development of safe harbor provisions and other simplification measures for Brazil. Below, a description of three safe harbor mechanisms currently in place in India, Mexico, and the U.S. is provided.

Indian Industry Safe Harbors

India is one of the only countries to have attempted the use of safe harbors on a broad scale for limited-risk subsidiaries operating in the country. The safe harbor rules cover:

  • Software development and information technology (IT) services: the safe harbor is a 17% return on total operating costs (i.e., ROTOC, calculated as operating margin divided by total operating costs) for transaction volumes up to 1 billion Indian rupees (approximately 70 million Brazilian reals or $13.6 million). The ROTOC increases to 18% for transaction volumes above 1 billion rupees and up to 2 billion rupees (approximately 140 million reals or $27.2 million).
  • Knowledge process outsourcing: for transactions up to 2 billion rupees, the safe harbor is an 18% ROTOC if employee salary costs to total operating costs ratio (employee cost ratio) is 40% or less. The safe harbor increases to 21% ROTOC if employee ratio is between 40% and 60%, and to 24% ROTOC if the employee ratio is greater than or equal to 60%.
  • Contract R&D related to pharmaceutical drugs or software development: the safe harbor is a 24% ROTOC for transactions up to 2 billion rupees.
  • Automotive parts manufacturing: there is no transaction threshold for this function. The safe harbor is 8.5% ROTOC for non-core auto components and 12% ROTOC for core auto components.
  • Corporate services: the safe harbor is a 5% ROTOC or less for transactions up to 100 million rupees.

These industries create a significant portion of the Indian Tax Authority’s tax base and are therefore protected by the higher safe harbor operating margins. However, the operating margins in the Indian safe harbor provisions are perceived by taxpayers to be unreasonably high. In addition to the excessive margins, in our experience, Indian taxpayers have chosen not to avail of the Safe Harbor provisions, because:

  • given the transaction-oriented thresholds are set relatively low, large corporations are disqualified from applying the safe harbors;
  • there is low awareness amongst small and middle-sized corporations about the safe-harbor provisions; and
  • there are significant documentation requirements to support intercompany transactions even if the Indian taxpayer avails of the safe harbor provision.

Therefore, few taxpayers choose to take advantage of the safe harbor regime in India and instead perform their own benchmarking analysis to support their transfer pricing policy, even if it necessitates defending their transfer pricing policies against the Indian Tax Authority.

The Maquiladora Safe Harbor in Mexico

Maquiladoras are foreign-owned factories operating in Mexico that import manufacturing components from their foreign principal for processing into finished products for export, derive revenue solely from manufacturing activities, and that employ machinery and equipment which are property of the foreign principal. Mexico’s maquiladora program dates back to 1964 as part of an effort to industrialize the country, increase foreign investment, and boost employment. It has expanded significantly since the enactment of the North American Free Trade Agreement (NAFTA) in 1994. Maquiladoras are an important part of U.S.-Mexico trade and have historically received tax benefits such as permanent establish protection for the foreign principal, reduced tax rates, and simplified transfer pricing through the availability of a safe harbor regime.

The current safe harbor regime for maquiladoras was introduced in Article 182 of the 2014 Mexican Income Tax Law. Under the 2014 law, taxpayers are required to apply a safe harbor return to their maquiladora operations or have an APA in place with SAT. The safe harbor requires that maquiladoras report a minimum taxable profit for the provision of manufacturing services as the greater of the following: 6.5% ROTOC or 6.9% return on total operating assets (i.e., machinery, equipment, buildings, inventories, etc. that are owned by both the Maquiladora and the foreign principal).

Notably, the 2014 tax reform eliminated two options that had previously been available to maquiladoras to comply with the arm’s-length principle, namely: (1) a transfer pricing study using methodologies described in the Mexican Income Tax Law; and (2) a transfer pricing study using the TNMM which considered profitability relative to the foreign-owned assets employed in the maquiladora’s operations (International Tax Review, Mexico’s transfer pricing update—A rapidly changing post BEPS environment).

The margins under Mexico’s safe harbor provisions for maquiladoras are perceived by taxpayers to be significantly high. Therefore, since 2014, many taxpayers have opted to apply for APAs with the SAT to support their transfer pricing policy. To address the growing demand for bilateral APAs between the U.S. and Mexico, the IRS and SAT implemented a “fast track” transfer pricing methodology to allow qualifying maquiladoras owned by U.S. companies to apply a formulary apportionment return based on their industry, expenses, and assets.

After the fast track option was announced in October 2016, the SAT notified eligible taxpayers with pending APAs about the option to apply the methodology. When the fast track method was announced, it was available for the 2014 to 2017 tax years; however, the IRS and SAT have not issued further guidance regarding the availability of this method for taxpayers requesting APAs beyond the tax year 2018.

The Services Cost Method in the U.S.

The U.S.’s services cost method (SCM) is described at length in the U.S. Treasury Regulation Section 1.482-9 and is a specified transfer pricing method for which “covered services” can be charged out at cost, without applying a markup. Accordingly, the SCM provides taxpayers an effective safe harbor and also relieves the IRS from having to audit qualifying service transactions enabling them to focus on riskier transactions. The SCM is an elective method, and taxpayers are permitted to utilize other methods under the regulations to determine the arm’s-length compensation for these covered services. First, taxpayers must apply the “business judgment rule,” which states that for a service to be eligible under the SCM, the service must not significantly contribute to key competitive advantages, core capabilities, or fundamental risk of success or failure in the business. Then the service must be considered a covered service, as defined in the regulations. A covered service falls into one of the following two categories: (1) specified covered services; or (2) low margin covered services.

Specified covered services are defined as controlled services transactions that are specified in Revenue Procedure 2007-13. These services have been indicated to be support services common among taxpayers across industry sectors at a high level. Rev. Proc. 2007-13 describes 101 different services that consist of various types of payroll, accounting, administrative, coordination, tax, treasury, staffing, recruiting, training, information technology, and legal services, among others. Low margin covered services are defined as controlled services transactions for which the median comparable markup on total service costs is less than or equal to 7%. The Treasury Regulations also specifically exclude the following services from the application of the SCM: manufacturing, production, extraction, construction, distribution, research and development, engineering, financial transactions, and insurance. The IRS has deemed these services as value-added services and expect U.S. taxpayers to demonstrate that their transfer pricing policy follows the arm’s-length standard.

The Path Forward

The implementation of safe harbors could provide Brazil an alternative to the TNMM and would be broader than Brazil’s current fixed-margin method. Safe harbors may be a viable option for Brazil to enforce reasonable profit margins for limited-risk distribution, manufacturing, and service functions while easing the compliance burden on the taxpayer’s side and providing them with certainty. Under this approach, safe harbors could be developed for specific functions and sectors that are considered significant to Brazil’s economy, maintaining a simple documentation alternative mirroring one of the main advantages perceived by the Brazilian transfer pricing practitioners of the current system.

With a safe harbor in place, taxpayers are assured that if their operating margins are at least as high as the safe-harbor level, then the tax authority will not subject them to a transfer pricing examination. Safe harbors need not be binding to taxpayers. Suppose the economic facts and circumstances are in place to argue for a lower operating margin than the one offered by the safe harbor. In that case, the taxpayer should be able to choose to use a lower operating margin while assuming the risk and uncertainty of potentially undergoing a transfer pricing audit.

Another challenge for Brazil in implementing safe harbors would be the lack of reliable publicly-available data of comparable companies, as previously discussed, which would be needed to compute the safe-harbor ranges of required profitability. Additionally, such safe harbor provisions would be more useful for routine functions rather than more complex transactions, such as those involving intangible goods or business restructurings.

Finally, RFB should consider performing an analysis to determine how different safe harbor thresholds may impact their tax revenue base. There is tension over threshold levels given that a lower threshold could erode tax revenue and higher thresholds may disincentivize taxpayers from using safe harbors leading to greater uncertainty. An ideal threshold would be low enough that taxpayers would elect to apply the safe harbor to reduce their compliance burden but high enough for the Brazilian government to maintain or even increase their tax revenue.


We attempted to cover critical issues that we commonly face as transfer pricing practitioners when applying the TNMM to determine if intercompany transactions follow the arm’s-length principle. Brazil faces a similar dilemma as other developing countries on determining an appropriate pool of comparable companies to benchmark arm’s-length returns. In our experience, and after evaluating public information available, the more localized comparable sets become, the less likely those comparable sets will reflect industrial and functional comparability with the Brazilian taxpayer.

However, regional comparable sets may necessitate quantitative adjustments to account for additional country risks if they operate outside of Brazil. RFB will need to weigh the availability of comparable companies against the reliability of applying country risk adjustments to determine which pool of comparable companies will provide the most accurate reflection of an arm’s-length return while at the same time making it efficient for Brazilian transfer pricing practitioners to identify and evaluate comparable sets.

We have extended our analysis of the TNMM to identify best practices from foreign tax authorities in designing a safe harbor regime. The ultimate goals of a successful safe harbor regime are audit certainty, simplified administration, and protection of the tax revenue base. A successful safe harbor regime should aim to cover most small and less-risky intercompany transactions by applying reasonable margins or levying reasonable taxation. This will reduce Brazilian taxpayer’s effort in complying with transfer pricing regulations and will free the RFB to concentrate their resources on auditing more complex intercompany transactions. There are best practices and obstacles from foreign tax authorities that can be implemented or amended to achieve RFB’s objectives in its alignment with the OECD Guidelines.

We believe a successful implementation of the TNMM and the safe harbor regime that respects the arm’s-length standard will ultimately provide certainty, fairness, and simplicity to both RFB and Brazilian taxpayers.

Annex A

Benchmarking requirements for a selected sample of countries in the application of the TNMM

INSIGHT: Implementing the Transaction Net Margin Method for Transfer Pricing in Brazil (1)

Duff & Phelps

*Russia’s net assets criteria requires that taxpayers’ net assets should not have a negative value as of December 31st of the last three-year period prior to the reporting period. Russia’s losses criteria requires that taxpayers should not have reported losses in more than one year during the three-year period prior to the reporting year. Russia’s independence criteria requires that potentially comparable companies are eliminated as dependent if they own subsidiaries where direct, indirect, or total participation is greater than 25%, or have a shareholder in the form of a legal entity that reported direct, indirect or total participation in excess of 25% in any year during the review period. The independence threshold may be raised to 50% if less than four comparable companies are identified after the application of the net assets, losses, and independence screens.

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This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Fabian Alfonso is a Managing Director, Transfer Pricing, Duff & Phelps
Salim Vagh, Director, Transfer Pricing, Duff & Phelps
Jaime Marie Sepulveda, Transfer Pricing, Duff & Phelps
Igor Scarano, Partner, Transfer Pricing LAB

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