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Mexico: Federal Tax Court position on re-characterisation of interest payments derived from back-to-back loans as dividends

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David Cuellar


Cesar Salagaray

It is well known by most Mexican taxpayers that Mexican Income Tax Law (MITL) provisions provide a disconcertingly wide definition of back-to-back loans. A clear understanding of when a finance scheme may fall under the scope of the back-to-back rules becomes crucial since interest derived from back-to-back loans are re-characterised as dividends and thus considered non-deductible for income tax purposes. According to the wording of the law, a back-to-back loan consists of "transactions whereby a person provides cash, assets or services to another which in turn provides cash, assets or services directly or indirectly to the former or to a other related party of the first one; and operations in which a person grants financing and the credit is guaranteed with cash, a cash deposit, shares or debt instruments of any nature of the creditor or a related party of the creditor".

Although under such definition there are many cases where taxpayers could not obtain certainty on whether a specific financing would fall under the scope of the anti-abuse rule, certain intercompany financing schemes have been implemented attending to business driven reasons and economical logic principles.

Nonetheless, the Mexican courts confirmed that having a business purpose is not a valid argument to circumvent the back-to-back limitation on interest since the rule does not establish that possibility.

Another example is a scheme under which a party (A) provided funds (cash or goods) as equity to another party (B), and the latter provided funds to another entity (C) related with the first as debt. These type of schemes are usually known as "equity blocker" structures.

Although there could be grounds to prevail on the argument that an equity blocker should not be considered as a back-to-back loan, a resolution from the Mexican Federal Tax Court has introduced even more uncertainty in this topic.

In this regard, the Federal Tax Court concluded that a transaction where entity A transfers its ownership in a company to another related party B, and subsequently B transfers the interest received to another related party C in exchange for a note and shares in C, fell under the scope of article 92 section V of the MITL, and thus, interest expenses derived from the note should be re-characterised as dividends, thus non deductible for C.

As can be seen, the wording of the above mentioned anti-abuse rules are so broad that there is not legal certainty on which transactions could qualify as back-to-back loans. On top of that, the tax authorities seem to be taking an aggressive approach that may jeopardise potential foreign investment in Mexico. As a consequence, a case-by-case analysis is highly advisable to determine whether a transaction falls under the back-to-back rules and which actions might be taken to mitigate a possible exposure.

David Cuellar (david.cuellar@mx.pwc.com) and Cesar Salagaray (cesar.salagaray@mx.pwc.com)

PwC

Tel: +52 55 5263 5816

Fax: +52 55 5263 6010

Website: www.pwc.com

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