Mexican VAT from transactions without effective cashflow deemed as not deductible
Ángel Escalante-Carpio and Gabriel Rojas Izquierdo of Escalante & Asociados discuss the binding precedent in which it was concluded that VAT charged must be paid through cash flow to be deductible.
Following the most common international standards, under the Mexican Value Added Tax Law (VATL), VAT is an indirect tax (charged at 16% of the final price) which is collected via a system of partial payments whereby taxable persons deduct from the VAT collected the amount of tax paid to other taxable persons on purchases for business activities.
VAT is paid at each stage of commercial activity, and the registered businesses must show the VAT charged to customers on invoices, allowing them to know how much has been paid on the product or service (deductible if they are also taxable persons). One of the main requirements for VAT to be deducted is that the price (including the amount charged on concept of VAT) is effectively paid in each period (i.e., month).
On August 12 2022, a jurisprudence was issued by the Plenary of the Sixteenth Circuit (Aguascalientes) in Tax Matters (PC.XVI.A. J/4 A (11a.)), when solving a criterion contradiction between two Collegiate Courts of the circuit, where it was concluded that the amount charged by VAT to them by other taxable persons, on purchases, must be paid through cashflow, in order to be deductible from VAT collected.
This implies that if the amount charged in concept of VAT payment obligation is removed by the taxpayer through other means (e.g. set-off or netting) the amount charged to the taxpayer will not be deductible.
This jurisprudence derives from the analysis of resolutions which denied the refund of favourable VAT to taxpayers, arising from transactions which price (including the VAT) was paid through a centralised treasury (including services of cash polling and netting). The binding precedents concluded that set-off or netting is not allowed as a valid payment method for deductibility of the VAT charged to taxpayers.
The precedent is based upon the consideration that, on the one hand, the VATL deems the price for commercial activities as effectively paid when the obligation is removed through a method (different to the cashflow) allowed under civil law, but, on the other hand, the VATL requires that the VAT charged to the taxpayer must be paid through cash flow, in order to be deductible.
This means that VAT paid will only be deductible for tax purposes when it is through cashflow (regardless if the price payment obligation was removed via another form). Establishing a different method of payment for the price of the purchases and VAT, notwithstanding that according to VATL, the VAT must be included in the price and charged alongside it.
In our opinion, the criterion is incorrect and ignores the VAT mechanics of deductions as well as the way the ordinary operations between groups (such as multinational enterprises) are carried out. However, this precedent is highly relevant, since it implies a significant risk for transactions (mainly between related parties or intra-group) in which there is no cashflow or, in the corresponding period, the agreed prices arising from the daily operations of the companies are not made. In such cases, companies will not be allowed to deduct the VAT charged to them resulting in a double taxation.
This precedent is against the international standard of neutrality of the VAT mechanism, which aims for tax to be neutral regardless of how many transactions are involved. Therefore, this precedent implies a VAT double taxation, contrary to the main tax target, which is that it shall be borne ultimately by the final consumer, and not be a charge to businesses.
In addition, the jurisprudence is incompatible with the guidance issued by the Mexican tax authority regarding the issuance of invoices, which in Mexico must be done through the tax authorities systems and allows representing netting as a valid means of payment.
It is important to mention that the referred jurisprudence is only binding for the authorities of that specific Judicial Circuit (Aguascalientes). It is not binding in the rest of the circuits or the Mexican Supreme Court of Justice. In addition, according to available information, this precedent has not yet been implemented in tax audits.
The analysed precedent undoubtedly represents a structural change regarding the mechanics of VAT and the way in which it can be deducted, and clearly steers away from international standards. It is expected that the Mexican Supreme Court of Justice will pronounce over this matter and issue a final precedent which will be binding in Mexico.