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International inter-company charges proves to be controversial issue in Mexico

Karina Perez and Manuel Llaca of PricewaterhouseCoopers in Mexico believe that multinational companies should have a dispute resolution policy in place that will withstand challenges from the authorities over international inter-company charges.

In the context of the global economy, multinational enterprises (MNEs) follow different business models which involve centralising their functions, assets and risks to obtain competitive positioning, and thereby producing benefits for several members of the organisation situated in different jurisdictions.

As a result of this, a member of a group may provide a number of services for the whole group such as administrative, technical, financial, and marketing. These services typically generate significant economic benefits for the recipients through economies of scale and synergies.

The costs incurred by a group service centre normally must be re-charged among those group members who have benefited from those services. The arm's-length standard and OECD transfer pricing guidelines generally apply under the tax legislation of most countries and compliance with these standards would generally make these countries treat these costs as a deductible expense for income tax purposes.

Though direct charge methods may be used to determine the arm's-length charge, it has been recognised that in some cases it is justifiable to apply indirect charge methods to distribute the costs between those members who have benefited from the services.

In this situation, though difficulties may arise in the application of the arm's-length principle and the identification of the benefit being provided, many countries accept this type of charge as a deductible expense if international transfer pricing principles and other domestic requirements are met.

In this regard, even though intragroup services are now part of a business and economic reality around the world, the Mexican Income Tax Law is inconsistent compared with other laws. Under this law, pro rata expenses made abroad with non-residents are non-deductible and the law contains no guidance or definition of what should be understood as pro rata expenses. Furthermore, the law establishes general requirements applicable to all expenses, including formal ones, which should be met to deduct the intragroup charges.

Considering the above, in light of internationally accepted transfer pricing principles and treaties, a substance over form approach would be desirable in applying the provision that disallows the deduction of pro rata expenses made abroad (Article 32-XXVIII of the Income Tax Law).

However, since Mexico is a civil law country, the tax authorities have interpreted this rule following form over substance in the course of their audits.In some instances, tax authorities have challenged the deduction of intragroup charges on the mere basis that they are considered pro rata expenses. In other cases, the authorities have challenged such deductions with additional arguments, including an assertion that the transactions are not arm's length, and or have not satisfactorily complied with the "strictly indispensable" standard for deducting trade or business expenses. It should be noted that this standard is one of the main requirements that intragroup charges should meet in order to be considered a deductible item in Mexico (similar to the US "ordinary and necessary").

Recently, by applying this standard tax authorities have been challenging significant amounts of intragroup charges, arguing that companies have not provided enough evidence to demonstrate that a service was provided or a benefit was obtained. The process of supporting these two circumstances can be a burden since it is more difficult to obtain records for up to five years before the audit is initiated, and many times those services are provided in other countries. Moreover, employee turnover can slow down the process of obtaining support.

Furthermore, based on the recognition of the existing pressure on the group service centres to allocate expenses abroad and perception that abuse may exist in some circumstances, the Mexican tax authorities have been carrying on an extensive audit programme in this regard on MNEs operating in Mexico in sectors, such as oil and gas, consumer and industrial products and services, financial services, technology, communications.

Although treaty protection may seem available in some instances (article 9 and the Discrimination Article) for application of article 32-XVIII, if certain domestic requirements are not duly met, the issue may be considered to be domestic by the Mexican Tax Administration and important tax contingencies may result for businesses, such as double taxation, penalties and surcharges.

The statutory tax audit reports of MNEs that operate in Mexico as of fiscal year 2009, must disclose whether they are making pro rata charges and whether they have been treated as a deductible expense or cost. This increases the exposure of an audit and tax assessments by the tax authorities.

In light of the above, considering the significant amounts that may be at stake in a controversy with the Mexican tax administration in this area, it is important that MNEs with business in Mexico reconsider their positions and risks concerning the deduction of intercompany charges.

Some taxpayers have elected not to deduct those charges; others have decided to implement international best practices that provide them with high standards of support and compliance in sustaining their deduction in Mexico, either under an audit process, a competent authority procedure, an administrative appeal or before the courts.

A timely design and implementation of a dispute resolution strategy should be considered to ensure a positive outcome during an audit. However, a globally consistent solution, as well as a proactive rather than reactive approach, is highly advisable to address this important issue.

Litigation in this area may not be desirable for many reasons: the uncertainty that arises from the law, the fact that Mexican tribunals follow a form over substance approach and the trend of the courts to rule in favour of the tax administration. Public statements from the Tax Administration Service put at 56% the number of tax cases filed before the courts that the Mexican Tax Administration wins.

Of course, litigation may be used as the last resort if the dispute persists and has to be evaluated on a case by case basis.

Karina Perez (; and
Manuel Llaca (

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