TP audit risk escalates in Mexico
Jesús Aldrin Rojas of QCG Transfer Pricing Practice warns taxpayers to properly comply with the obligations of the transfer pricing regime in Mexico.
The transfer pricing (TP) regime in Mexico is of particular importance given the number of multinational companies operating in the country, more than 60,000 Mexican companies with foreign investment according to the Ministry of Economy.
The Mexican government began its TP audit programme in 1999 and has gradually increased the frequency and tone of its inspections.
The Tax Administration Service (SAT) reviews have been aimed at detecting deviations from the arm's-length condition of high-risk transactions (intangible assets, services, financial operations), they have focused on specific aspects (for example, risk sharing between related parties) and have even approached taxpayers on a sectorial basis, prioritising reviews in sectors such as automotive, mining, pharmaceutical or finance.
Even so, relatively few cases have been resolved in court (where the SAT has had a notable success rate) and most of the audits have been mediated by the Mexican Taxpayer's Defense Attorney's Office (PRODECON). At the end of President Peña Nieto's six-year term, there were more than 100 conclusive agreements directly or indirectly related to inter-company operations of taxpayers.
The current administration of President López Obrador signalled its interest in the regime by publishing in fiscal year 2020 the list of reportable schemes in which it included those related to TP, specifically:
Transfer of intangible assets that are difficult to value;
Business restructurings in which the structure of functions, assets or risks has been modified without the payment of a consideration or in which operating income has been reduced by more than 20%;
Transfer or concession of the temporary use or enjoyment of goods or rights without consideration, or the rendering of unremunerated services or functions;
Absence of comparables due to the contribution of the taxpayer of unique and valuable intangibles to the multinational's business; and even when,
The counterpart of the intercompany transaction is the beneficiary of a unilateral protection regime.
Already during the pandemic, the SAT began an aggressive campaign of auditing multinational groups in which it has sought to eliminate the intermediation of tax advisors and has even threatened companies with charges of tax fraud.
In these terms, a significant number of taxpayers have adjusted their results and taxable bases and have even had to publish public apologies in the national media.
The latest measure has been the addition of Article 33, first paragraph, section I, subsection i) to the Tax Code for fiscal year 2021, which resulted in the publication of pre-established margins by industry, including a calculation of an ‘effective tax rate’, where the taxpayers of the forementioned industries are expected to reach the profitability or tax burden parameters suggested by the SAT.
It should be mentioned that the ‘effective tax rates’ do not take into account the taxpayer's strategy, business model and organisation, but are generic benchmarks to inform the authority's collection expectation.
Given the above scenario, what situations can trigger TP reviews? It is necessary to consider that in many cases, taxpayers in fact (at least in appearance) comply with their obligations in terms of documentation, but this compliance is affected by various analysis errors.
Typically these errors originate from a lack of knowledge of the multinational group’s business context, which leads to inadequate characterisation of operations, selection of wrong contractual vehicles, deficiencies in the implementation of the comparability analysis, inadequate application of adjustments, construction of wrong reference intervals (ranges), and even lack of interpretation of BEPS criteria in its Actions 8–10 and 13.
Such errors are magnified and reproduced year after year, especially when there is no independence between the TP advisor and the auditor for tax purposes, even giving rise to mispricing practices, where inter-company, comparable and interval operations are adjusted to aggressive tax planning schemes.
Given the financial needs of the Mexican government, what seems imminent is an increase in audits and the establishment of tax credits related to the TP regime (which historically have been in the multi-millions and have even compromised the very operation of the taxpayers under review).
When in doubt about the proper compliance with the obligations of the regime, it is important to carry out preventive reviews, risk detection, preparation of defense files for specific operations and even correction of taxable bases taking into account the new BEPS environment and the national interpretation criteria.
Jesús Aldrin Rojas
Managing partner, QCG Transfer Pricing Practice