International Tax Review (ITR): What advice would you give to companies about how to reduce the risk of becoming involved in a dispute with the Mexican tax authorities?
Luis Carbajo-Martinez (LCM) (pictured): Mexico is a formalistic country and its tax authorities are very active in auditing taxpayers. There are commonly as many as 90,000 tax audits in a fiscal year.
Audits on customs matters increased from 2,400 in 2009 to 6,800 in 2011 and this tendency is expected to increase in the coming years on customs and other tax matters such as transfer pricing.
The tax authorities are becoming more specialised in litigating cases and increasing revenue from tax assessments.
It is important to get sound tax and legal advice at the planning stage, but also that companies continue receiving consistent advice once the strategy is being implemented or at the time the structure is fully operational.
In many cases, advice given at the planning or implementation stages is not fully or adequately applied in the long-run, and thus, because of errors in the implementation, or even worse, because formal requirements of specific tax laws are not fully met, a good and solid planning strategy may not have the desired tax effects.
Companies without complete knowledge of the auditing trends should ask their tax advisers to determine whether they have any activity likely to become subject to the scrutiny of the tax administrations and then consider possible options to correct what has been done or to prepare in case the authorities audit the company.
A tax litigator should assess the taxpayer’s chances of prevailing based on judicial precedents and determine a potential strategy based on any formal mistakes made by the tax authorities which could result in the entire tax assessment being declared null and void by a court of law.
ITR: What options do Mexican taxpayers have to resolve disputes with the authorities other than litigation? What are the positives and negatives of these options?
LCM: Taxpayers have the legal right to request a self-correction, which involves filing a supplementary tax return to amend the original return and paying the omitted taxes.
Then, taxpayers have to notify the tax authority about the self-correction procedure and the authority may accept or reject the amounts paid via this procedure.
However, a self-correction procedure will involve a fine equivalent to 20% of the paid omitted taxes, if the self-correction is conducted before the final audit minutes are issued.
If the self-correction is conducted after issuance of the final audit minutes, but before notice of the formal assessment, the fine is equivalent to 30% of the tax liability.
Although the self-correction procedure is convenient and gives legal certainty, each specific case has different particularities which have to be analysed by tax practitioners and tax attorneys together to assess the appropriate strategy.
Once a tax assessment is notified, taxpayers may either file an administrative appeal or challenge the assessment in court.
In the international arena it is also common for non-residents to file for mutual agreement procedures (MAP) whenever the Mexican tax administration takes a position which contradicts tax treaty law by re-characterising certain income.
The MAP suspends the terms for the taxpayer to file for a litigation appeal. This alternative has the advantage that both tax administrations participating in the MAP would have to work out a solution to avoid any double taxation.
However, in most of Mexico’s tax treaties reaching a final settlement is not mandatory so there is no certainty that a given issue will be solved through a mutual agreement by the tax administrations.
ITR: Are you seeing any trends in the types of dispute cases the Mexican tax authorities are taking up, and those where they are succeeding in the courts?
LCM: The Mexican tax administration is auditing the main sectors of the economy: maquiladoras (manufacturing in free trade zones), pharmaceutical companies, electronics and telecommunication, hotels, and oil and gas companies.
The areas being scrutinised are also very broad.
I have seen a particular trend whereby the Mexican tax administration is scrutinising whether taxpayers comply with the domestic deduction requirements on payments abroad.
Specifically, the authorities are ensuring that payments abroad do not lack substance; that they are connected to the business-producing activity; that the compensation has been calculated at arm's-length; that the corresponding taxes are correctly withheld and that the pertaining invoices are secured from the service providers.
Although the tax authority attempts to reject an entire deduction based on different allegations – including for alleged lack of compliance with the arm’s-length principle – we have secured court resolutions confirming that the tax authority should not reject the entire deduction and should make adjustments.
Another issue being scrutinised is supply-chain restructurings in which no compensation is being calculated for the Mexican entity losing revenue as a consequence of the restructuring (as an exit payment).
Taxpayers must analyse the need for compensation. If no compensation is paid, documentation relating to the restructuring should analyse the economic and financial rationale leading to that decision in detail as it may be contended at audit.
Transfer pricing disputes are also increasing in the courts, but no significant final resolutions yet exist. For transfer pricing, taxpayers must include consistent financial information in the economic analysis.
ITR: What do you think multinationals in Mexico can expect from the Mexican tax authorities in the future?
LCM: Mexico will continue to be very active in auditing taxpayers once the new administration takes office on December 1 2012.
We are generally seeing audit activity increase for companies with international or inter-company transactions.
Whether an audit is triggered by the reduction of taxable income, increase of refund requests, negative opinions on audited financial reports, or because of a whistleblower, once an audit is open the tax authority will concentrate first on formalistic inconsistencies and then it will move to matters of substance.
The main focuses include: permanent establishment, withholdings, pro-rata expenses, thin capitalisation, interests, business restructurings, migration of intangibles and reimbursements.
I have also seen a dramatic increase in the auditing activity of the Mexican customs authorities during the last year.
The Mexican tax administration recently announced the creation of a new branch that will specifically audit customs and foreign trade issues. Thus, we should expect even more audits in future.
A recent court precedent may change the litigation environment. In the past, it was possible to file additional evidence that was not submitted at the auditing stages.
However, there is a new court resolution stating that additional evidence cannot be filed to rebut the finding of the tax authority once an audit has been closed and a tax assessment has been issued.
In our view, this lacks legal merits and violates certain constitutional rights. However, I advise taxpayers to involve their litigation advisers as soon as the audit procedure commences to avoid compromising the eventual litigation strategy of the company.Luis Carbajo-Martinez (firstname.lastname@example.org) of Baker & McKenzie.