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A mature TP environment heading in an uncertain direction

Though the regulations covering Mexican transfer pricing have been stable for several years, with no significant changes since 2006, many uncertainties remain for taxpayers. Simón Somohano and Jorge Mesta, of Deloitte, explore how more detailed guidance could take the Mexican transfer pricing environment to the next level.

From a legal standpoint, Mexican transfer pricing legislation and complementary regulations contemplate the obligation to comply with the arm's-length principle (as stated in the OECD's Transfer Pricing Guidelines) in transactions carried out with both foreign and domestic related parties. It also obliges taxpayers to maintain contemporaneous documentation for such transactions, considering for such purposes a separate transfer pricing analysis for each type of operation (for example, purchases of raw materials, royalties, management services, and so on). Reporting requirements include detailed transfer pricing information in the informative return and other tax information on intercompany transactions that is submitted along with the Statutory Tax Report (Dictamen Fiscal) by the independent auditors to the Mexican tax authorities.

Mexican tax law includes limitations on the tax deduction permitted for intercompany transactions, unless they comply with the arm's-length principle. As such, deductions for losses arising from derivative contracts or transactions carried out with low-tax jurisdictions may not be allowed. It also limits the deduction of interest arising from intercompany loans to a debt-to-equity ratio of 3 to 1, unless an advance pricing agreement (APA) can be obtained from the Mexican tax authorities whereby it is accepted that a higher level of leverage is arm's-length for a given industry. Compliance with the arm's-length principle in intercompany transactions is also required by the Business Flat Tax Law (IETU), an alternative minimum tax introduced in 2008.

A special transfer pricing regime exists for the maquiladora industry (in-bond manufacturing), whose main purpose is to allow the Mexican government to capture part of the value generated by assets located in Mexico and employed in the maquiladora operation, but which remain the property of a foreign related party.

Mexico also allows for APAs or Resoluciones de Precios de Transferencia on a bilateral or unilateral basis.

The current state of transfer pricing in Mexico

It is widely considered that transfer pricing is entering into a mature phase in Mexico. This means that a large majority of taxpayers pay due consideration to arm's-length pricing in their intercompany dealings and generally produce the corresponding supporting documentation. The level of maturity can also be assessed by the fact that transfer pricing examinations are regular events in the tax landscape and those examinations are conducted by tax officials knowledgeable of the subject and following well established procedures.

Past experience indicates that when a country enacts transfer pricing legislation, at first all participants (taxpayers, practitioners and tax authorities) ordinarily require extensive support from foreign individuals and organisations to develop technical expertise, internal standards and managerial procedures. In sharp contrast, the Mexican transfer pricing environment has evolved into a markedly domestic community. Even though multinational corporations (MNCs) generally handle their intercompany pricing policies on a global scale, besides the particularities of Mexican transfer pricing regulations, there is a substantial amount of practical knowledge at the local level that MNCs take into consideration. Practical knowledge can be understood in this context as knowledge related to the likely positions of the tax authorities with respect to certain transfer pricing issues or their expectations with regards to the type and level of documentation required for a certain type of transaction. It can also be understood in some cases that there is an informal consensus among the involved parties regarding issues not specified in the Mexican transfer pricing legislation, such as how to address the lack of adequate local comparable transactions or companies.

Although transfer pricing examinations are common, it is clear that such examinations generally do not have the same level of sophistication as those carried out by some of Mexico's main trade partners, such as the US, the UK or Germany. The tax authorities have developed a keen sense of the relevant issues but significant resources are still spent both by the taxpayer and the tax authorities to clarify situations that could be more easily understood through a greater accumulation of knowledge of the characteristics of any particular industry and its normal business practices. This relative lack of knowledge also leads to frequent and sometimes costly misunderstandings between the tax authorities and taxpayers regarding the type and nature of the documentation that should be prepared to demonstrate compliance with the arm's-length principle.

As a natural consequence of the role of Mexico in the global economy and a reflection of the country's dependence on technology and capital from abroad, cross-border transfer pricing obligations in Mexico are borne mostly by the local subsidiaries of MNCs. That frequently derives in challenging circumstances both for taxpayers, practitioners and authorities, as all the parties involved more often than not do not have sufficient information available during the price-setting, documentation and audit phases of transfer pricing.

During the course of tax examinations, the tax authorities routinely determine the full disallowance of payments abroad to related parties, either as a bargaining chip in earlier phases of the examination process or as a conclusion in their final assessment. The tax authorities' repertoire of arguments for such disallowances is vast and in some cases remarkably creative. One of the most frequently used arguments employed in those cases is the lack of "proper" transfer pricing documentation. To any bystander it is perhaps not entirely surprising that a combination of lack of detailed guidance in Mexican tax law with respect to several aspects of the transfer pricing documentation and the inherent subjectivity of transfer pricing itself leads frequently to arbitrary conclusions with unreasonable penalties. This situation also diverts effort and attention from the evaluation of the substance of intercompany transactions to a discussion on formal compliance. This practice has been criticised by taxpayers, practitioners, and the OECD. Unfortunately, this issue downplays the expertise that the tax authorities have otherwise gained during the past decade and a half.

To be fair, it should also be pointed out that many times taxpayers also use arguments that are based solely on a legal interpretation of the formalities of the law as one of their main defence strategies. It is reasonable to conclude that for the Mexican transfer pricing audit process to be considered mature, taxpayers and tax authorities alike have to demonstrate their commitment to focusing the main discussion on the economics and business substance of the intercompany transactions. As in any mature and developed tax regime, a clear and decisive signal to this end should be given by the ultimate decision-maker: the tax courts.

There have been only a few transfer pricing cases discussed in a tax court, with only a couple of them already resolved. This facet of transfer pricing is still clearly in its beginning stages. Not only are there just a few cases that reach the litigation phase, but it is also clear there is a long road ahead before the courts' magistrates fully understand the peculiarities of transfer pricing that make it distinctively different from other tax fields.

Although Mexico allows for the use of APAs both on a unilateral and bilateral basis, their use has largely decreased from several hundred cases in 2003 (at which point an APA was mandatory for a maquiladora company to avoid the determination of a permanent establishment, with the only alternative being to apply safe harbour rules – generally more expensive from a tax liability perspective) to a handful of cases in 2013. Taxpayers often do not consider an APA as an attractive compliance alternative for transactions covered by the general transfer pricing regime or for thin capitalisation purposes. A likely explanation is the perceived complexity and length of the process, which makes it very similar to a transfer pricing audit even though it is supposed to be a friendly dialogue between the taxpayer and the tax authorities, as well as the perceived risk of triggering an audit if no agreement is reached, and the unwillingness of the tax authorities to concede a reimbursement of past taxes for all years before the agreement is reached. In addition, because of the slow pace of the negotiation process and the limitation to extend the terms of the ruling to cover up to three years after the year the APA request is filed, the perceived benefits of a unilateral APA for taxpayers are substantially diminished.

Given the size of trade and investment flows between Mexico and the US, the Mexican tax authorities have achieved a reasonable level of experience in competent authority procedures. In particular, the Mexican transfer pricing authorities have maintained for some time a high level of communication and exchange of information with their counterparts at the US Internal Revenue Service.

Areas that require attention

The Mexican transfer pricing environment described above has also shown recurrent situations faced by the tax authorities, practitioners and taxpayers alike that require more detailed guidance, including in some instances a change in the conduct of the parties, and more importantly, amendments to the existing transfer pricing regulations. Some of these changes are needed on a short term basis to avoid the Mexican transfer pricing environment transforming itself into a practice that deviates significantly from the goals and perspectives that are appropriate for transfer pricing purposes, as embodied in the OECD's Transfer Pricing Guidelines.

The OECD currently recognises that the Transfer Pricing Guidelines need to be modified to accommodate the experience acquired since they were issued (1995) as well as the pace of globalisation. This problem is exacerbated in Mexico by its own domestic legislation. Mexican transfer pricing legislation was enacted in 1997, the first of its kind in Latin America and one of the oldest worldwide. Although some amendments to the legislation have taken place, the regime has not changed substantially since then. The lack of a suitable transfer pricing regime is reflected in every single area of transfer pricing.

As a result, current Mexican transfer pricing legislation is based on a framework that is founded more on high-level concepts than on actual practice. It is also highly ambiguous and in many instances requires legal interpretation. Amendments and criteria issued by the tax authorities have been limited. Although the position of the tax authorities is known for a broad array of specific issues, they are not binding on the tax authorities nor can the taxpayer defend himself using a position taken by the tax authorities that is widely known in other audits or stated in public forums. As Mexican tax law is based on Roman law, all these uncertainties can be solved only to a limited extent through the resolution of court cases, as opposed to the common law practiced in Anglo-Saxon countries, where they can play a significant role in providing precedents that can be applied to situations that are unforeseen or too specific to be included in the tax statute.

On the most basic level, more guidance is required on the selection and adjustment of comparable transactions or companies. It is clear that the Mexican economy in some aspects is significantly different from a developed economy, but the norm in Mexican transfer pricing practice is the lack of public information regarding local comparable transactions. This situation is known by everyone, leading to the widespread use of foreign comparable transactions or companies with some sort of domestic "adjustment"; however, more guidance on the subject would clearly be to the advantage of all the parties involved.

An offshoot of this discussion is the need to have a broader conception of "comparable". Taken literally, it would not be possible to apply a transfer pricing method in accordance with Mexican tax law for certain types of transactions, such as the sale of intangibles or shares. In most cases an analysis of these transactions would require the application of discounted cash flow models, which result in the construction of a "comparable" (market) price which is not an observable, third party comparable transaction per se. The Mexican tax authorities have said they consider that the construction of a price does not lead to a valid comparable transaction and hence does not provide for valid transfer pricing documentation. For the aforementioned cases this would lead to absurd conclusions in most circumstances as it would not be possible for the taxpayer to comply with transfer pricing regulations via the application of any available method. More guidance, making it explicit that under some circumstances constructing prices are valid alternatives to direct comparable transactions, would be helpful.

Another area that clearly requires attention, either by the issuance of criteria by the SAT or through an amendment to the tax law, is the minimum content required for documentation purposes. The ambiguity of this point is one of the main factors used by the Mexican tax authorities for the disallowance of deductions. More guidance on this issue would clearly benefit everyone, as leaving the determination of the proper level of documentation to a tax court is clearly a lengthy process that involves uncertainty for the parties involved and also implies an increase in compliance and collection costs for taxpayers and the tax authorities, respectively. This ambiguity clearly extends to the concept of having a different level of documentation for the purposes of the tax return (for normal tax compliance purposes) and the documentation which is reasonable for the tax authorities to require during the course of an audit, once they have determined that a transfer pricing risk exists, as made explicit in the guidelines and the White Paper on Transfer Pricing Documentation published by the OECD last July.

Intangible property is another area that clearly requires attention. It is clear that this is an area of high controversy on a global scale, as can be seen in the second draft of the paper on transfer pricing considerations for intangibles issued by the OECD that is expected to substitute the current chapter on intangibles included on the Transfer Pricing Guidelines. In the context of Mexico, the level of controversy is heightened by the positions taken by the Mexican tax authorities, which in many respects can be summarised as a high level of scepticism of the role, extent and value of intangible property in the operations of a company. Such skepticism is also shown in other areas, such as the IETU tax, which disallows the deduction of royalties when paid to related parties. It doesn't help that the tax authorities frequently base their assessments on benchmarks which use as a reference Mexican intellectual property or civil law. As Mexican laws in general reflect an outdated economic environment regarding the role of intangible property, when brought forward in tax discussions, they can have an unfavourable effect for the taxpayer. The recent Revised Discussion Draft on Transfer Pricing Aspects of Intangibles issued by the OECD, if incorporated into the guidelines, would doubtless provide (to some extent) this much-needed guidance on the transfer pricing aspects of intangibles.

Prorated expenses are another area of controversy. In accordance with Mexican tax law, they are non-deductible when arising from transactions involving related parties that are not subject to income tax (including foreign related parties). The definition of what constitutes a prorated expense is subject to debate; it is even more difficult to identify whether a particular case qualifies as a prorated expense or not and, as a consequence, there are no sufficiently reliable compliance alternatives or, if one can be found, it tends to increase the administrative burden of the taxpayer significantly. On its most basic level, a prorated expense can be understood as a cost-allocated expense. One of the main advantages of a multinational is its ability to perform centralised activities that are carried out in a different country from where the rest of the company's economic activities are taking place, hence benefiting from economies of scale and favourable cost location savings. Disallowing or increasing the compliance costs for prorated expenses is in essence a form of increasing the cost of doing business in Mexico. It also shifts the discussion from the main point of the argument (whether the cost allocated is at arm's-length) to a discussion of formal compliance with tax requirements, which does not discriminate between expenses that are necessary for business activities versus those that are not.

It is not uncommon for a Mexican practitioner to be asked about the reason for having domestic transfer pricing regulations, as there is only one federal income tax with a single tax rate that applies uniformly across the country for all types of taxpayers (notwithstanding some special tax regimes). Taxpayers often say they do not understand the purpose of domestic transfer pricing if in any case the tax that is not paid in one of the Mexican companies is paid by its counterpart in the transaction. These positions may oversimplify the issue, as it is clear that domestic transfer pricing is a valid source of concern for the Mexican tax authorities, but it should be recognised that Mexican tax legislation does not discriminate between situations where there is a risk of reduced tax collection from others where there is no such risk.

All the issues mentioned could be clarified with more guidance either in the form of regulations or amendments to existing tax laws. All of them at some point imply the risk of not being able to properly estimate the appropriate taxable income.

Mexican documentation requirements also impose other problems that may be unfavourable to all parties involved. After reading the White Paper on Transfer Pricing Documentation published by the OECD last July, one feels that many issues pointed out in the diagnosis of that document clearly apply to Mexico.

Within the scope of large taxpayers, only a handful are exempted for documentation purposes. If obliged, the lack of material criteria for the transactions to be covered under documentation requirements obliges taxpayers to document each type of intercompany transaction, no matter how small it may be. Although transfer pricing documentation does not need to be submitted to the tax authorities, it should be delivered to an independent auditor for a limited review, who in turn discloses the compliance status in the statutory tax report submitted to the tax authorities. Hence, every single year all taxpayers must invest significant resources to comply with transfer pricing requirements which, as mentioned before, are sometimes not relevant from a materiality perspective. As resources are limited (starting with the capacity of the taxpayer's information systems to process all the information needed for each type of transaction), the trend is to have mass processes in the elaboration of transfer pricing documentation that increasingly deviates from an analysis based on specific facts and circumstances, as required by the arm's-length principle. In the end, this also affects the tax authorities as the quality of information received is perceived to be insufficient for the evaluation of transfer pricing risks.

Enhancing maturity

Let's consider the following as desirable standards of a mature transfer pricing regime: (1) It puts a low compliance cost on a taxpayer that engages in low risk transactions and that, with the use of high-level data, shows that it is paying a reasonable amount of taxes; (2)It provides clear guidance about how to comply; (3) It provides the tax authorities with sufficient tools for conducting a precise and targeted examination; (4) It does not allow for assessments based on ambiguous laws or laws that are insufficiently founded in economic reasoning or business practices; and, at its most basic level, (5) It does not leave room for arbitrary conclusions or the imposition of penalties disproportionate to the faults involved. Taking these standards, it could be argued that the Mexican transfer pricing environment is leaving the implementation and developmental phases and entering into a more mature stage, with better risk assessment tools, stable compliance costs and more legal certainty, but it runs the risk of heading in the wrong direction unless actions are taken to correct the deficiencies in the regulatory framework. A long awaited comprehensive tax reform, presumably to be discussed in the Mexican Congress this autumn in order to be implemented in 2014, would provide a unique opportunity to implement the changes needed to take the Mexican transfer pricing environment to the next level.

Based in Mexico City and Tijuana, Simón Somohano ( is Deloitte's lead transfer pricing partner for Latin America and the Caribbean Region. Jorge Mesta ( is a transfer pricing partner based in Mexico City.




Simón Somohano

Lead partner

Transfer pricing services

Latin America & the Caribbean Region


Galaz, Yamazaki, Ruiz Urquiza, S.C.

Paseo de la Reforma 489, Piso 6

Colonia Cuauhtémoc

06500 Mexico, D.F.


Tel: +52 (664) 622-7872


Simón Somohano is a tax partner based in Tijuana and Mexico City responsible for Deloitte's Transfer Pricing practice in Latin America and the Caribbean Region.

He has more than 20 years of experience in the application of tax, economic and financial criteria in transfer pricing, anti-dumping/subsidy investigations, valuation analysis of intangibles, double tax treaty issues, tax planning, business model optimisation, structuring and economic consulting.

He has been named as one of the World's Leading Transfer Pricing Advisors by the prestigious Legal Media/Euromoney Magazine.

His clients include several Fortune 500 multinational companies doing business in Mexico. He has represented numerous companies in the negotiation of Advance Pricing Agreements (APAs) and transfer pricing examinations with Mexican and foreign authorities.

Simon is a frequent guest speaker in international business forums in Mexico and abroad. He has authored various articles on transfer pricing. He is also a co-author of Transfer Pricing International Handbook. A Country-by-Country Guide published by the International Tax Institute and Transfer Pricing; A Theoretical, Legal and Practice Framework, published by the Institute of Chartered Accountants (Mexico).

He is a board member of the Transfer Pricing Committee of the Institute of Chartered Accountants (Mexico) and has advised on tax issues to the National Export Maquiladora Council. He has participated as a board member of the Tax Institute at the University of San Diego's School of Law.

He holds an M.Sc. degree in Economics and Finance from Warwick University's Business School in the UK and a

B.Sc. in Economics from Universidad Panamericana in Mexico City. He is also a Certified Financial Consultant from Mexico's Securities and Banking Commission.




Jorge Mesta Espinosa


Transfer pricing services


Galaz, Yamazaki, Ruiz Urquiza, S.C.

Paseo de la Reforma 489 Piso 6

Del. Cuauhtemoc

Mexico, D.F., 06500

Tel: +52 (55) 5080-7059

Fax: +52 (55) 5080-6001


Jorge Mesta is a transfer pricing partner based in Mexico City. Jorge has experience in a diverse range of industries, with an emphasis on real estate, infrastructure and consumer products. He is currently the tax leader for the real estate, construction and hotel industries for all Tax & Legal services of Deloitte Mexico.

He joined the transfer pricing practice of Deloitte Mexico in May 2001. He has been involved in solving business problems related to different areas of his clients' day-to-day business activities, such as the sourcing of materials, logistics, information technologies, financial planning, production, marketing and sales, financial operations and the management of intangible property.

As a transfer pricing professional, Jorge has participated in tax consulting projects related to the restructuring and set up of new operations, tax defence and the elaboration of documentation and APAs. His trajectory has allowed him to be involved in projects which require the integration of different tax disciplines, as well as coordinating activities in different Latin American jurisdictions subject to transfer pricing regulations

He has authored several articles which have been published in International Tax Review, Tax Management International Journal, Puntos Finos and Ejecutivos de Finanzas.

Before joining Deloitte, Jorge worked as department chief in Mexico's General Directorate of Tax Policy and Fiscal Coordination of the Ministry of Finance, where he carried out economic analysis for the evaluation and proposal of reforms to the Mexican tax system.

Jorge holds a B.A. degree in economics at the Instituto Tecnológico Autonomo de México (ITAM). He took courses in advanced econometrics at ITAM and in the economics and legal framework of international commerce at the London School of Economics and Political Science. He has also participated in seminars on international taxation in Mexico sponsored by the OECD and the taxation of intellectual property rights in New York.

Jorge is currently a member of the International Fiscal Association's Transfer Pricing Committee (Mexican Group) and the Mexican Institute of Finance Executives (IMEF).

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