Parenting Styles and Family Relationships
This is a good opportunity to teach your child that every family is different, with different rules and different ways of doing things. This is an important concept for her to begin to grasp now in this situation, and when she's older and telling you all the things that other parents let their kids do.
You could make a request to your brother that the spankings not be conducted in front of your daughter. Let him know that it upsets her, and ask him to honor that, as you will honor his right to his parenting style.
Empathize with your daughter's distress by reflecting back her feelings: "I know you don't like seeing your cousin spanked. I know it makes you feel sad and mad. We don't spank at our house, but not all families are the same. Other families do things that we don't do." She is actually learning a good lesson here: It's possible to love people and maintain family relationships even when they don't behave as we do.