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Mexican controversies to rise as anti-abuse clause inserted into legislation

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On September 8 the Federal Executive Branch delivered its proposed tax package for 2014, which includes an important change in the Federal Tax Code (FTC) related to the substance over form concept, which derives from the proposed incorporation of an anti-abusive clause in article 5 of the FTC.

Existing law

Article 5 of the current FTC provides the option to apply a “strict application” to interpret any provision that refers to the subject, object, basis and rate of a tax.

In the proposed changes, the main argument to include an anti-abusive clause in the article referred to, is that some unfair taxpayer practices related to the tax legislation have been highlighted, which harm the proportionality standard provided in the Mexican Constitution. Therefore while some taxpayers are not paying taxes accordingly, this tax burden falls into the remaining taxpayers.

According to the OECD, the term tax evasion is generally used to mean illegal arrangements where liability to tax is hidden or ignored, that is, the taxpayer pays less tax than he is legally obligated to pay by hiding income or information from the tax authorities.

The modification proposed is to add two paragraphs in the aforementioned article which includes the anti-abusive clause.

During the process of a tax audit, the tax authorities may challenge either the formal aspect, such as whether tax returns are submitted on time, or the substantive aspect, such as supporting documentation, or both.

It is common for the tax authorities to challenge various deductions, arguing mostly that expenditures do not comply with the strictly indispensable standard, a concept which is not even defined by law.

Therefore, as the substance over form concept is very ambiguous, if the modification is approved to article 5 of the FTC, taxpayers shall enhance its supporting documentation of their records, not only taking into account the formal aspect, but also, by having sound evidence demonstrating subjective elements, such as a direct economic benefit.

For example, if an event took place to promote the company’s products, the taxpayer shall tie the amount of the expenses made in relation to the increase in the sales generated by the event, but generally, such increase in the sales cannot be measured accordingly, since, how can the branding exposure be measured accurately?

We are expecting an increase in tax controversies during tax audits due to the freedom that the tax authorities will have in regard to their criterion about the “substance over form” concept. The approval of the tax package is expected in mid November.

By principal Tax Disputes correspondents for Mexico, Fernando Lorenzo (fernando.lorenzo@mx.pwc.com) and Laura Enriquez (laura.enriquez@mx.pwc.com), of PwC.

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