Mexico's Superior Chamber of the Federal Administrative Court published a decision in November 2017 in which it concluded that the tax authorities can take into account the fact that a transaction lacks a business purpose when determining whether a transaction has substance. The principles of the court's decision will apply in cases where the tax authorities discover during a tax audit that the transaction is not reflected in the taxpayer's accounting books.
The court stated that even though Mexican law does not define the term "business purpose", the concept is related to the profit earnings of an enterprise and, therefore, the absence of a business purpose for a particular transaction can be a factor that is relevant in determining whether a transaction is genuine and whether it lacks a real economic effect other than to create a tax advantage.
According to the Federal Administrative Court, the tax authorities can rely on the lack of business purpose provided other facts are present that corroborate that the transaction never took place, such as whether the transaction is unusual or exceptional, there is inconsistent data and documentation, there is an absence of infrastructure or personnel to carry out the transaction, a lack of cash flow, etc. In such cases, the burden then shifts to the taxpayer to demonstrate that the relevant transaction does have substance. Failure to do so can result in an assessment and potential criminal liability, depending on the circumstances. However, it appears that the lack of business substance on its own (i.e. without corroborating other factors), would not be sufficient to consider a transaction to be a sham transaction.
It should be noted that the tax authorities will be able to make the determination that a transaction is simulated without the involvement of a civil court. Under Mexican law, the tax authorities are required to provide a statement to the civil court in cases where they intend to make a sham transaction determination.
Taxpayers should be aware of this decision of the Federal Administrative Court and ensure that they maintain appropriate records of all documentation and other evidence that demonstrates a business purpose for their transactions.
Carlos Ramírez and Víctor Masón
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