TP challenges facing the Mexican tax reform for 2023 and beyond
As Mexican taxpayers face an increased set of TP requirements, Simón Somohano and Selene Rangel of Deloitte Mexico offer a guide through the new complexities.
Mexico’s 2022 tax reform included significant amendments to the Mexican Income Tax Law (MITL) and the Federal Tax Code (FTC), among other regulations. These new regulations became effective on January 1, 2022 and are also applicable for fiscal year 2023 and beyond.
Taxpayers have been facing a series of difficulties in complying with the requisites established in the MITL from a practical perspective. This article looks at selected TP provisions according to major topics and summarises the challenges it represents to be fully compliant with such reform.
Detailed information requested in the local files and TP documentation
The related party concept established in the MITL is broad and extensive. Two or more persons are considered related parties when one of them participates, directly or indirectly, in the administration, control or equity of the other, or when a person or group participates, directly or indirectly, in the administration, control, or equity of such persons. Members of partnerships or joint ventures (asociación en participación) are also considered to be related, as are the persons who are considered related parties of such members. Similarly, the head office or other permanent establishments thereof are considered related parties of a permanent establishment in Mexico, as are the persons indicated in the preceding paragraph and the permanent establishments thereof.
The local file included in the Mexican rules requests taxpayers to gather information from all the related parties with whom they completed transactions. Taxpayers often do not have control over the administration of their counterparties, and this results in significant efforts to obtain such information, ending usually in a negative answer from some related counterparties to share it.
In line with the above, the amended article 76 section IX requests a functional analysis of the taxpayer and its related parties by each type of transaction. This also creates an important burden for taxpayers, as there are certain cases where transactions are not relevant for the counterparty and the Mexican taxpayer does not have access to enough detail or it is difficult to obtain. Also, the miscellaneous tax rules regarding the local file request financial and tax information of the counterparties of the Mexican taxpayers regardless of the size or materiality of the transaction. In some cases, this information is even considered confidential, restricted to a few individuals within the respective multinational organisations, and the affiliates are not willing to disclose such information even internally with other group members.
On the other hand, the tax reform impacted taxpayers obliged to submit their local files. With the amended article 76-A of the MITL, many taxpayers who did not exceed the revenue threshold established in article 32-H of the FTC, but are related parties of those taxpayers subject to file a statutory tax report (also known as SIPRED), are required to submit their local file. This is regardless of the size of their operations, per the amendment to the provisions of article 32-A of the FTC.
This amendment represents an important challenge, especially to business groups that have many subsidiaries or affiliates with a large number of routine intercompany transactions. Usually, these entities have a relatively small income, unlike those originally subject to the local file submission obligation. This fact, combined with the anticipated deadline to submit the local file being May 15th instead of December 31st each year, loads additional pressure to such business groups to submit in time and in a proper manner, while considering the 2022 regulatory changes. This is notwithstanding that such compliance implies additional costs that usually do not entail added value to their operation.
Increasing information to be disclosed via informative returns
The tax reform also included the requirement to submit the informative return incorporated in Annex 9 of the Multiple Informative Return about domestic related party transactions, both for corporations and individuals.
On the other hand, the Tax Situation Informative Return (DISIF, in Spanish) contains questions related to compliance in the presentation of Annex 9 for legal entities, however, the DISIF due date is on March 31st and MITL indicates that the deadline to submit Annex 9 is May 15th. Nevertheless, at that time of submitting the DISIF, no clear guidelines from the Mexican tax authorities were available on how to respond to these questions, so taxpayers faced uncertainty around how to address this issue. Similarly, Annex 9’s template has not been updated, so taxpayers are required to fill data for their intra-Mexico related party transactions using the fields corresponding to foreign related party operations. While this may not represent a significant additional burden to taxpayers, it does indicate the lack of preparedness of the tax authorities to implement the reporting requirements of the tax reform.
Availability of financial information from comparable companies used in economic analyses
The MITL establishes that the economic analyses must consider information from comparable operations corresponding to the year subject to analysis. Only when the business cycles or commercial acceptance of a taxpayer product cover more than one year, information from comparable operations corresponding to two or more years may be considered. This represents a challenge because the comparable companies generally report their public information as of March or April of the following year, which leaves a very limited period for taxpayers to prepare the TP economic analyses and comply with the obligation as of May 15th. In other countries where similar provisions apply, the deadline to comply with the TP documentation considers this situation and due dates are later in the year.
There are industries where the business cycles clearly exceed one year, for instance automotive or infrastructure. The MITL specifies that only when the business cycles or commercial acceptance of a taxpayer's product cover more than one year, information from comparable operations corresponding to two or more years may be considered. However, in TP audit experiences, the Mexican Tax Authority usually does not accept the taxpayers’ arguments and concludes with information from comparable companies for only the year subject to analysis to evaluate compliance with the TP provisions.
However, for practical purposes, when there is no financial information available corresponding to the year under analysis, the approach has been to consider the latest financial information available for the comparable companies. For example, in case of fiscal year 2022, the approach would be to take 2021 financial information.
The global economic situation has presented a series of disruptions that complicates the plan to transfer prices at a business or multinational group level. For instance, the COVID-19 pandemic, shortage of raw materials, high level of prices and inflation, exchange rate fluctuations, logistical problems, etc. Therefore using a benchmark for a single year does not give room for anticipate fluctuations that occur from one year to the next.
In 2022, many industries experienced a drop in demand, pressure on the cost of inputs or a combination of the above effects, a situation that is not reflected in the financial information of the comparable companies in 2021. This has led to complications in meeting the margin that taxpayers obtained in 2022, compared to the margins reflected in the interquartile range obtained from the set that is used as comparable with information from 2021. Averaging multiple years of financial data for comparable transactions or companies should have allowed taxpayers to have a broader spectrum to properly plan their intercompany pricing policies. As a result of the amendments to the MITL, more volatile ranges would be expected from one year to another, which would in turn introduce additional challenges to taxpayers to properly plan ahead their TP policies.
Finally, the MITL amendment to article 180 established that the interquartile range is mandatory to test the intercompany transactions, previously this statistical method was optional and was referenced in the rules for the MITL. This change might impact certain transactions where MNEs catalogued them as residual or insignificant, so the practical approach taken was to test them with another statistical method e.g., a minimum and maximum.
Best practices to face the increase in disclosed information in TP documentation
The main recommendations to face these challenges could be summarised as follows:
Create defence files for significant operations that merit the use of periods greater than one year for purposes of the economic analysis;
Update the functional analyses in the second half of the year that is subject to analysis;
Perform preliminary analyses of at least the most significant transactions for the group’s subsidiaries resident in Mexico, and track deviations from the current year vs. last year to try to identify potential adjustments;
Anticipate any deviations of taxpayers’ forecasted results before year’s end (December 31st);
At the beginning of the next year, send information requests to have the financial and fiscal information available of the counterparties that entered into operations with the taxpayer; and
Use automated tools to gather and disclose the information requested in the different informative returns the taxpayer is subject to.