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Transfer pricing in Mexico: The upcoming challenges and opportunities

Andrés Manuel López Obrador_AMLO 600 x 375

Simon Somohano and Isaac Manuel Ramirez Obeso of Deloitte discuss the tax implications of the new government’s fiscal agenda as President-elect Andrés Manuel López Obrador (AMLO) prepares to take office in December.

AMLO, leader of the Movimiento de Regeneración Nacional party, won the July 1 2018 election by an unprecedented margin – around 53% of the total votes for the president. 

In the biggest election of the country's history measured by the number of both active and effective voters and the positions open, including for the president, governors, and members of Congress, AMLO and the nominated members of the cabinet are expected to continue the fiscal measures carried out by the existing administration. These involve strengthening tax collection measures, especially since AMLO's so-called 'fourth transformation plan' includes huge social programmes that will need a bigger inflow into the national treasury, among other resources. This new administration is therefore expected to continue to enforce the BEPS Action Plan.

The last couple of years have been highly dynamic in terms of transfer pricing (TP) regulations for the OECD/G20 members. Mexico, being an active member of both the OECD and the G20 and a leading country in Latin America, became one of the first countries to adopt the BEPS framework into its local laws. Besides implementing the three-tiered documentation requirements into the Mexican Income Tax Law (MITL), additional rules were recently issued with regards to the local file, Annex 9 of the multiple informative return (DIM), and the tax report certified by the independent auditor, among other things.

Based on Article 76-X and Article 110-X of the MITL, if taxpayers do not prepare and file the statutory tax report (dictamen fiscal) or the tax situation informative return (DISIF), then they must file Annex 9 of the DIM together with their annual tax return, for which the deadline is March 31 of the following year. The DISIF should also be filed no later than March 31, and the due dates for filing the dictamen fiscal were left unchanged (no later than July 30 or August 30 if all contributions were effectively paid by July 15 or August 15, respectively), allowing Annex 9 of the DIM to be filed together with such report for those taxpayers who opted to prepare the statutory tax report.

In April 2018, the Mexican tax authorities issued Rule 3.9.18 of the Miscellaneous Tax Rules stating that taxpayers who did not have their financial statements audited for tax purposes would be allowed to file Annex 9 of the DIM no later than June 30, as long as all the information included in it was consistent with that in the TP local file. In addition, the TP local file could be filed with the tax authorities along with Annex 9.

Although this new rule, together with the ones already in place, could be seen as an opportunity to provide certain flexibility to Mexican taxpayers for filing their tax obligations, it has caused confusion among taxpayers during the first year of implementation. It is noteworthy that Annex 9 of the DIM summarises much of the information included in the local file concerning transactions carried out with foreign related parties.

In June 2018, another major development with TP implications came into place under the Mexican Federal Tax Code – Article 69 B-Bis, which seeks to inhibit the improper transmission of tax losses. This rule lists six clear assumptions under which the authorities could disallow the tax losses, and three of them are closely related to TP:

  • A taxpayer incurs tax losses in any of the three fiscal years following the entity's incorporation, in an amount greater than the value of its assets and when more than half of its deductions derive from transactions with related parties;

  • A taxpayer incurs tax losses after the third fiscal year following the entity's incorporation, emanating from the fact that more than half of its deductions derive from transactions between related parties and where the deductions have increased by more than 50% compared with the previous year; and

  • When a taxpayer reduces by more than 50% its material capacity to carry out its preponderant business activity in fiscal years subsequent to that in which it declared the fiscal loss, as a result of the transfer of all or part of its assets through restructuring, splitting or a merger of companies, or because the assets were transferred to related parties.

While the thresholds established might appear arbitrary, the Mexican tax authorities have mentioned in different public forums that this was not the case. The limit on the timing of the tax losses and the amounts of deductions were defined based on data analytics using the authorities' information technology systems and databases, which found common ground among taxpayers considered to have improperly shifted tax losses.

This new rule shows tangible proof of how TP is now being applied outside the legal frame of the direct TP compliance obligations. Actually, TP audits are being carried out by multidisciplinary teams from the Mexican tax authorities, meaning the audit process involves different implications besides TP for income tax purposes, including customs or value added tax. Having strong contemporaneous TP documentation in place takes on greater relevance when falling into this particular situation, since taxpayers will need to respond to the first notification issued by the tax authorities within the 20 days following the issuing of the notification.

The documentation to be provided within this short time frame also includes, but is not limited to, the books for the previous 10 years of the company under review, together with technical and legal arguments explaining the fiscal and legal origin and application of the tax losses.

On July 11 2018, the second resolution of modifications to the Miscellaneous Tax Rules for fiscal year 2018 was issued by the Mexican Servicio de Administración Tributaria, introducing Rule, for TP adjustments. The rule begins by providing a definition and by classifying the different types of TP adjustment. First, such adjustments can be either real – when they impact both taxes and the books of the taxpayer, or virtual – when the impact is only on taxes.

The second tier of definitions consisting of the different types of virtual and real TP adjustments is provided:

  • Voluntary or compensatory – refers to adjustments filed by the taxpayer itself to compensate the difference between the controlled transfer price and an arm's-length price. This would need to be filed before the annual tax return of the fiscal year to which the adjustment was made.

  • Primary – results from a tax assessment from the competent authorities and for tax purposes only. The primary adjustment will create a correlative adjustment with either a domestic (for Mexican TP purposes, domestic transactions are also required to be arm's length) or a foreign related party.

  • Domestic correlative adjustment – results from a primary adjustment for a transaction carried out with a domestic related party.

  • Foreign correlative adjustment – results from a primary adjustment performed for the foreign related party and based on a friendly resolution defined in an international tax treaty and that was previously accepted by the Mexican tax authorities.

  • Secondary – results from the application of an assessment by the Mexican tax authorities involving a TP adjustment to certain transactions characterised as deemed dividends, e.g., interest expenses and non-deductible payments with a direct benefit to local or foreign shareholders.

Based on the definitions previously listed, the rule states that taxpayers that register voluntary TP adjustments should consider adding a nominal income/increase in deductible expenses or a decrease in deductible expenses, as applicable, for the monthly provisional tax calculations. The related withholding amount for income tax purposes should be paid, provisions of international tax treaties would be applicable, and the related rules for VAT and special tax on products and services (IEPS) would also be applicable.

In addition to the documentation already required for considering voluntary TP adjustments deductible for tax purposes, among other requirements, taxpayers:

  • Need to have filed their annual tax returns, DISIF, DIM, local file, master file and the country-by-country report (these last if applicable) in a timely fashion. The TP reports should include the TP adjustments applied in the fiscal year in question and would also need to be noted in the tax returns;

  • Should have a documentation report for determining the TP adjustment properly signed by the TP expert who prepared the document;

  • Should have an electronic invoice with the applicable requirements; and

  • Should have the documentation to prove that the applicable payments of VAT and IEPS have been made.

TP adjustments are a common practice within multinational companies since many charges, specifically service charges, are initially made based on a budget, and at a certain point of the year in progress an adjustment is made to the TP in order to be at arm's length or to be aligned with the TP policies of the local or multinational groups. This new set of rules means taxpayers are meant to apply TP adjustments only in extraordinary situations and not as commonly as in the past. The exhaustive and long list of requirements and documentation to be provided to the Mexican tax authorities eliminates the flexibility of constantly changing transfer prices.

In relation to Actions 8 to 10 of the BEPS Action Plan, on July 3 2018 the OECD released a discussion draft on the TP aspects of financial transactions. The final guidance will provide worldwide taxpayers and tax administrations with guidance and principles for financial transactions. This is of great relevance to Mexico, since TP has moved from a fiscal application, and to the grounds and legal frameworks of other regulatory agencies for the local financial and economic system, such as: Banco de Mexico (Mexico's central bank), Comisión Nacional Bancaria y de Valores (regulatory agency of the Mexican securities exchange), Comisión Nacional de Seguros y Fianzas (regulatory agency for insurance and sureties entities) and Comisión Nacional del Sistema de Ahorro para el Retiro (regulatory agency for the pension systems).

All of the financial regulatory agencies that have adopted TP rules in their legal frameworks mention that the valid OECD guidelines will provide a set of rules to establish arm's-length prices among controlled transactions and entities. That said, entities that are engaged in the financial services industry involve pricing of products that can sometimes be of great complexity and that therefore involve guidance that cannot be found in the existing OECD guidelines. The Mexican tax authorities do have a special team focused on reviewing, not only the financial services industry, but also certain financial transactions carried out by multinational groups, such as hedging, cash pooling, treasury structures, intra-group loans, and guarantee fees.

In June 2018, the Mexican government approved a convention to standardise the tax treatment of income obtained by pension funds. The main objective of such conventions is to strengthen the Latin American integrated market, which is composed of the stock exchanges of Mexico, Chile, Peru and Colombia, as part of the accords to avoid double taxation under the Pacific Alliance framework agreement. The convention establishes new limits for the member parties for taxing income and capital gains for pension funds established in the member jurisdictions and dictates that those funds will have access to the benefits provided by the agreements to avoid double taxation.

Transfer pricing has also been implemented in another local strategic economic sector – the energy sector. During the first half of Enrique Peña Nieto's (incumbent president of Mexico) term, the authorities designed and implemented a historic pack of reforms. Of those reforms, the reform of the energy sector was one that would provide Mexico with a new legal framework to enable it to become once again an energy powerhouse within the global economy. The reforms attracted foreign investment into the blocks that were awarded by the government and into the retail power market and new petrol stations.

Within the complex new set of laws and rules for the energy sector, TP regulations were also implemented in the Hydrocarbons Revenues Law. Contractors performing transactions with related parties (e.g., the sale or marketing of hydrocarbons, procurement of supplies, materials or services) must establish their prices according to the TP rules established in the MITL, which makes reference also to the OECD guidelines for further interpretation. In addition to the provisions mentioned above, the new contract models for exploration and production activities (e.g., licensing contracts, production-sharing contracts, profit-sharing contracts and service contracts) include additional considerations regarding transactions carried out with related parties. One of the annexes of the model agreements defines accounting procedures for costs, expenses and investments. However, some specific requirements for TP purposes include:

  • When a controlled transaction exceeds $5 million, the operator must submit information, documentation, and evidence of the application of a TP method for determining an arm's-length price for the transaction;

  • Each year, each participating company must submit its externally audited financial statements, and if related party transactions have been carried out during the year, the TP report must also be submitted; and

  • All costs that are not arm's length will be rejected.

The Ministry of Finance is a competent authority for energy regulatory purposes and therefore is the entity empowered to request information and documentation from independent and related parties, regarding the transactions carried out by the contractor. The model agreement for shared production activities includes similar requirements but the threshold for preparing and submitting a documentation report for TP purposes under the Hydrocarbons Revenues Law has been raised to $20 million.

President-elect Andrés Manuel López Obrador himself and his team of advisors has announced that all bids around the energy sector will be put on hold to initiate a deep and thorough review of the contracts awarded to the private sector to ensure the correct application of the law. While it is uncertain what changes will be made to the regulation, the industry expects to have tighter rules in terms of compliance and transparency.

All the TP and tax regulations previously described demonstrate the clear commitment of the Mexican state to the international community with regards to fighting BEPS, and also to implementing TP as a requirement for transparency and best practice for companies doing business in certain strategic sectors of the Mexican market. Although the objectives of all these new rules are clear, many of them require adjustments as witnessed by both local and multinational companies that have recently been experiencing added complexity in relation to both their compliance activities and their daily operations. In the meantime, we can continue to expect more adjustments to be issued, stronger enforcement by the tax authorities with regards to TP compliance, and the dynamic environment of a new era in international taxation.

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