The new version of the OECD transfer pricing guidelines for multinational enterprises and tax administrations was published in July 2017 (OECD TP guidelines). The OECD TP guidelines incorporate the recommendations of the OECD´s BEPS action plan. Some of the main changes or clarifications to the OECD TP guidelines are as follows:
Further provisions on the application of the arm’s-length principle (comparability analysis);
Transactions involving commodities;
Provisions on safe harbours;
Transfer pricing documentation;
Intangible assets and cost sharing agreements; and
Restructures.
The aforementioned is relevant for Mexican tax purposes as the Mexican Income Tax Law (MITL) provides that for the interpretation of Mexican transfer pricing provisions, the OECD TP guidelines are applicable. The reason behind this reference in the MITL is that it includes limited transfer pricing provisions.
Derived from these changes to the OECD TP guidelines, Mexican taxpayers that carry out transactions with Mexican and foreign-based related parties, should verify if the terms and conditions established for those transactions and the transfer pricing analyses supporting them are still in line with these new provisions.
The current transfer pricing environment in Mexico
Mexican tax authorities have transfer pricing matters high on the agenda to prevent tax profits obtained by taxpayers being shifted abroad to related parties through intercompany transactions in which the amounts of consideration are not in line with market conditions.
In this regard, Mexican tax authorities have been very active auditing related party transactions, assessing significant tax credits. The approach that they take throughout audit processes, which is in line with the OECD, goes beyond the mere review of formalistic requirements of the transfer pricing studies and supporting documentation and the application of a transfer pricing method. Tax authorities are making integral reviews to make sure that each of the parties involved in the transactions are obtaining consistent profits with the assets, functions and risks incurred.
In certain cases, tax authorities are not only relying on the application of one transfer pricing method, but rather analysing the profitability of the counterparty to verify that all parties are compensated adequately.
Common mistakes found in TP documentation throughout audit processes in Mexico are: tax and financial information mismatches in the studies and the tax returns, poor functional analyses to determine assets, functions and risks; incorrect analyses to determine the most appropriate transfer pricing method to evaluate the transaction (in many cases companies apply the most favourable instead of the most accurate); inappropriate comparable companies or transactions; incorrect internal financial information (i.e. segmented information); inapplicable adjustments; among others.
It should be noted that the Mexican tax authorities are very advanced in the implementation of electronic systems to detect taxpayers’ risks. Nowadays, Mexican tax authorities are obtaining electronic accounting, electronic tax returns, tax reports, electronic invoices, among other documentation directly from taxpayers. This information is analysed by powerful data analytic programs developed internally.
On related party transactions, Mexican tax authorities would have at hand very detailed information due to the new informative returns (i.e. local, master file and a country-by-country report). Information for tax year 2016 has to be filed before December 31 2017.
If Mexican taxpayers have inconsistencies between tax and accounting documentation filed in regards to related party transactions, it would automatically raise a red flag. Mexican tax authorities are sending “invitation letters” to taxpayers to clarify inconsistencies detected. If they do not clarify the situation in a limited period of time, Mexican tax authorities are carrying out effective audits based on the fact that they are already starting with detected tax inconsistencies.
Thus, it is important that Mexican taxpayers make sure that all the documentation is consistent and that all informative returns are properly filed to avoid unnecessary “invitations” or audits by tax authorities.
Furthermore, notwithstanding that the transfer pricing documentation is in compliance with tax provisions from a substance and formalistic perspective, and that the tax and accounting information is filed correctly, taxpayers should consider that there are many other requirements to deduct expenses related to intercompany transactions. Taxpayers should demonstrate that the expenses incurred were strictly necessary to carry out their business activities, that the transactions effectively took place by providing supporting documentation (i.e. deliverables of the services), have proper invoices, among others.
Compared to what happens in other jurisdictions, Mexico continues being a very formalistic country in regards to taxes, thus even though the intercompany transactions have substance and are at arm’s length it does not necessarily mean that they are deductible items.
Advance transfer pricing agreements
A mechanism that may be recommendable in certain cases for Mexican taxpayers to have more certainty and reduce transfer pricing controversy risks in Mexico is the request of advance pricing agreements (APAs) (unilateral or multilateral), as provided in the Federal Fiscal Code and the OECD TP guidelines as tax authorities may validate the intercompany transaction in advance.
APAs in Mexico are applicable for five years. The year in which it is filed, the previous one and the subsequent three.
Mexican tax authorities have also been active involved in these kinds of procedures and have incentivised taxpayers to enter into them so as to avoid risks.
However, Mexican companies that pursue an APA should consider that they would still be required to comply with transfer pricing requirements regardless the fact that Mexican tax authorities agreed on the methodology.
Santiago Llano Zapatero (sllano@ritch.com.mx)
Ritch, Mueller, Heather y Nicolau, S.C.
