Mexico: Moving forward along a different path

The arm's-length principle was included in article 215 of the Mexican Income Tax Law (MITL) since 1997. Under article 86, section XII of the MITL, each year, taxpayers have the obligation to prepare and maintain contemporaneous documentation proving that transactions carried out with related parties abroad or with companies in tax havens, comply with the arm's-length principle.

There are no penalties for not having a transfer pricing report; however, the possibility of reducing a penalty derived from an adjustment imposed by the tax administration service (SAT for its initials in Spanish) exists in case taxpayers have it. However, in practice, authorities had tried to reject deductions associated with payments performed to related parties abroad.

In addition, section XV of article 86 of the MITL establishes that companies conducting domestic related party transactions, must comply with the arm's-length principle by applying the corresponding transfer pricing method stated in article 216 of the MITL.

The failure to carry out intercompany transactions at arm's-length values, may derive on a possible adjustment by the tax authorities, together with the applicable fines. A penalty of 55% to 75% of the omitted tax may be imposed.

According to article 34-A of the Federal Fiscal Code (FFC), SAT may issue APAs at the request of taxpayers. Bilateral APAs with countries with which Mexico has signed international treaties are also available. The Mexican tax authorities have issued the highest number of APAs in Latin America; more than 1,388 APAs have been issued since the introduction of the respective rules. Also, APAs may be requested when attempting to sustain a higher debt-to-capital ratio than the 3:1 established in the Mexican regulations.

The Mexican authorities perform audit procedures very often, and some can last several years. Some pharmaceutical, automotive, financial industry companies, among others, have been audited. As of 2009, there are approximately 30 completed transfer pricing audits and 70 are still open. The types of transactions being reviewed are mainly the following: sales/purchases of tangible and intangible goods, services, reimbursements and interest payments. Nowadays, the SAT is paying special attention to financing and sales of stock transactions.

According to the OECD guidelines, when there are differences between situations being compared that could materially affect the comparison, comparability adjustments must be performed, where possible, to improve the reliability of the comparison. In this way, the MITL establishes the possibility of applying reasonable adjustments to eliminate comparability differences among the comparable transactions or the companies. As in other countries, adjustments must consider elements such as characteristics of goods and services; functions, assets and risks involved; contractual terms; economic circumstances and business strategies.

A common practice of the SAT is to accept asset intensity adjustments such as differences in accounts receivable, accounts payable, level of inventories and fixed assets. Regarding financing transactions, adjustments by country risk and, in general, the application of an adjustment will depend on the facts and circumstances of the transaction, every time that said adjustment may be demonstrated as applicable to the case.

According to the OECD, in practice it is observed that comparability analyses often place more emphasis on functional similarities than on product similarities and it may be acceptable to broaden the scope of the comparability analysis by including transactions involving products that are different, but functionally similar. In Mexico, according to article 215 of the MITL, taxpayers should consider the aforementioned comparability factors in determining comparability. Considering the limited amount of available information of Mexican comparable companies, a comparability of different products but similar functions is allowed and nowadays is very applicable.

In its revised version of its transfer prcing guidelines, the OECD establishes that the facts and circumstances of a particular case will determine whether differences in economic circumstances have a material effect on price and whether reasonably accurate adjustments can be made to eliminate the effects of such differences. In this sense, according to article 215 of the MITL, economic circumstances surrounding the analysed transaction are one of the elements that must be considered when determining if significant differences exist among a set of comparable transactions or companies. Therefore, economic circumstances must be considered when attempting to adjust the taxpayer's particular situation. SAT accepts the adjustment every time that the economic effect on the transaction may be demonstrated. In practice, SAT has rejected some similar arguments due to the fact that the support is referred to the occurred circumstance, and not to the documental support.

The OECD establishes that valuation methods for customs purposes may not be aligned with the OECD's recognised transfer pricing methods. The use of customs valuations to evaluate intercompany transactions is not expressly rejected in the MITL.

The Mexican authorities have already used custom values to determine transfer pricing adjustments for companies in the pharmaceutical industry that were importing generic active ingredients. This comparison has been made against secret comparables rejecting part of the taxpayer's deduction, without considering central aspects of the characteristics of the goods and services, nor of the commercial acceptance of the final products by end consumers, a situation that is considered defensible.

Regarding hierarchy of the transfer pricing methods, the OECD considers that a traditional transactional method is preferable to the transactional profit method. Moreover, the CUP method is to be preferred above all others.

In this same order of ideas, article 216 of the MITL establishes that taxpayers should give preference to the application of the CUP method in determining the arm's-length nature of intercompany transactions in accordance with the OECD transfer pricing guidelines. Moreover, taxpayers must show that the method used is the most appropriate or most reliable pursuant to all available information, giving primary preference to the resale price or cost plus method. With the new modifications applied to the OECD chapters, we expect that the Mexican legislation will be modified in order to allow the selection of the method according to comparability factors instead of the established order.

Considering that the arm's-length principle does not require the application of more than one method for a given transaction, the OECD guidelines do not require either the tax examiner or taxpayer to perform analyses under more than one method. In the same way, after the application of an initial method, Mexican legislation does not require the application of a corroborative method and most taxpayers only do so in situations in which said method provides additional support to the analysis.

These methods have been used in highly related transactions (mainly royalty payments), and a few unilateral and bilateral APAs. Nevertheless, considering the degree of interrelation of the profit to be split, the amount of information of the related parties involved in the transaction and the elements used to determine the profit, it is not usual to use them in regular transactions, such as in purchases, financing leasing and so on.

Mexican legislation does not provide a specific process to be applied in a comparability analysis; the MITL establishes the basic OECD elements of comparability and the use of the OECD guidelines to interpret the law, situation that provides clarity about the steps to follow.

The MITL does not address any restriction on whether the tested party must be the company resident in Mexico or the related party abroad. In certain cases we have found situations in which the SAT has required taxpayers to prove the application of the Mexican general accounting accepted principles over segmented accounting information of the tested party, situation that may be held as illegal every time that it might be considered as an extraterritorial application of the law and contrary to the goal of eliminating double taxation.

Considering that taxpayers do not always perform searches for comparables on a country-by-country basis, for example in cases where there are insufficient comparables available at the domestic level, and given the fact that there's not enough financial information available for local comparables in Mexico, the SAT allows taxpayers to use foreign comparable data.

In Mexico, under article 69 of the FFC, tax authorities may use confidential information obtained from third parties to determine the cumulative income and authorised deductions of taxpayers that have not conducted their transactions under the arm's-length principle. This has been and will continue to be used as a means of pressure towards taxpayers; the result of such a measure will be evaluated in the corresponding courts when solving related matters.

There are no actual business restructuring rules, nevertheless, general rules are applicable. Certain cases of companies that have been subject of a restructuring process have been audited by the SAT with a posture different to requiring a compensation payment. Authorities have rejected the new form of operation and have re-characterised transactions by determining unreported taxable income as if the Mexican company continued carrying out its initial activity before the restructuring.

Since 2008, article 213 of the MITL allows tax authorities to determine simulation for tax purposes without requiring a court finding of simulated acts, but the SAT may re-characterise transactions for tax purposes considering presumptive elements, only for related-party transactions.

According to article 217 of the MITL, the competent authority procedure involves exercising the right provided for in double-tax treaties between Mexico and the countries of residence of related parties with whom the transactions giving rise to the deficiency notice were carried out, in order to invoke the mechanism for negotiations between or among the tax authorities of the countries involved. The procedure has been used in cases involving Japan, the US, Switzerland and several others still pending.

List of Mexico's double taxation treaties in force
Argentina	Ecuador	Latvia*	Russia
Aruba*	Finland	Lebanon*	Samoa*
Australia	France	Liechtenstein*	Singapore
Austria	Germany	Lithuania*	Slovakia
Bahrain*	Gibraltar*	Luxembourg	Slovenia*
Barbados	Greece	Malaysia*	South Africa
Belgium	Guernsey	Marshall Island*	Spain
Bermuda	Hungary*	Monaco*	Sweden
Brazil	India	Morocco*	Switzerland
Canada	Indonesia	Netherlands	Thailand*
Cayman Islands*	Ireland	Netherlands Antilles*	Turks and Caicos*
Chile	Island	New Zealand	UK
China	Israel	Nicaragua*	Ukraine*
Colombia*	Italy	Norway	Uruguay
Cook Island*	Japan	Panama*	USA
Costa Rica*	Jersey Island*	Poland	Vanuatu*
Czech Republic	Korea	Portugal	Venezuela
Denmark	Kuwait*	Romania	Virgin Island*
*Being negotiated

Moisés Curiel
		Baker & McKenzie in Mexico Tel: +52 55 5279 2992 Email: moises.curiel@bakermckenzie.com Moisés Curiel is the Latin America transfer pricing director at Baker & McKenzie in Mexico. He earned his bachelors' degree in public accountancy from the Instituto de Estudios Contables with a specialisation in tax from the Universidad Panamericana, and a specialisation in intellectual property from the Instituto Tecnológico Autónomo de México (ITAM). He carried out the first transfer pricing audits in Mexico, which could be considered as the first in Latin America. Curiel participated in the drafting and implementation of various transfer pricing rules in the Mexican Income Tax Law, the Miscellaneous Resolution and the Federal Fiscal Code. He was a representative member of the Mexican government in the transfer pricing working group of the OECD. He is a member of the Mexican College of Public Accountants and of the Mexican Institute of Public Accountants. He has given courses in international tax at the Universidad Nacional Autónoma de México (UNAM), in the Escuela Bancaria y Comercial and in the Instituto Superior de Estudios Contables.

Carlos Linares
		Baker & McKenzie in Mexico Tel: +52 81 8399 1371 Email: carlos.linares-garcia@bakermckenzie.com Carlos Linares is a national partner at Baker & McKenzie in Mexico. He earned his bachelors'degree in economics from the Universidad Autónoma de Nuevo León (UANL), and holds a MA and a PhD in economics from Rice University in Houston Texas. Linares obtained a diploma in international tax from Harvard University and the Instituto Tecnológico Autónomo de México (ITAM). He is a professor of economics and public finance at the UANL and Tecnológico de Monterrey (ITESM). His experience includes working as a deputy director in the international tax area of the Mexican Ministry of Finance (Hacienda).

Emilio Angeles
		Baker & McKenzie in Mexico Tel: +52 55 5351 4148 Email: emilio.angeles-acosta@bakermckenzie.com Emilio Angeles is a national partner at Baker & McKenzie in Mexico. He is a certified public accountant, graduated from the Escuela Bancaria y Comercial with masters in economic and financial engineering from La Salle University. He has taken several courses in international treaties for avoiding double taxation and in transfer pricing. He has worked for more than 13 years in the tax arena, of which nine have been in international tax, particularly in transfer pricing. He has worked in various prestigious public accounting firms and was head of the department of transfer pricing and Title V in Income Policy in the Ministry of Finance and Public Credit from 1993 to 1996. He is a member of the Mexican national board of the maquiladora exportation industry. In addition, he has been a professor of international trade in various universities at a postgraduate level.