However, one cannot deny that tax losses have been on the agenda of the tax administrators around the globe for many decades, since such losses may be the result of what officials have considered as aggressive tax planning. Many tax agencies have refined their audit strategies towards corporate tax losses, giving more attention to businesses that report tax losses for several years.
In the context of the economic downturn, while facing increasing fiscal pressures, tax administrators face significant challenges in this field. In addition to growing compliance risks, loss-reporting businesses have increased substantially reaching historic levels, situation that has led to a relevant decrease in tax collection. On the other hand, businesses are struggling with severe economic stress.
In Mexico, the Tax Administration Service (TAS) has made administrative improvements to strengthen compliance and increase collection. One measure that has been implemented since 2010 has been what is known as profound surveillance program (PSP), under which businesses are selected on a routine basis, in cases indicia of potential non-compliance or aggressive tax planning exists (such as reporting losses year after year, substantial loss in a particular fiscal year).
Under this program, selected taxpayers are invited to informally explain particular issues and concerns and, as the case may be, to correct their tax situation; written responses to the specific questions normally are required by the tax authorities in this process. The PSP may give rise to a tax audit in some situations.
From a dispute resolution perspective, the PSP gives the opportunity for businesses to demonstrate bona fide loss claims and make adjustments where necessary, avoiding financial costs and risks that may result from an eventual and more extensive tax audit or review by TAS.
The issues that are given greater attention by TAS under PSP or a tax review are doubtful loss claims where large amounts are at stake, compliance of requirements applicable to the carry forward of losses, transfers of losses, as well as the potential manipulation of losses by groups of companies that consolidate for tax purposes.
Pursuant to the Mexican Income Tax Law (MITL), an operating loss declared for tax purposes can be carried forward and deducted from taxable profits of the 10 subsequent years. Operating loss carrying back is not allowed. Tax loss carry forward is a right of a specific taxpayer and cannot be transferred to another entity. In the case of mergers, operating loss carry forward of a merged entity is lost and in the case of a carry forward of the surviving entity certain limitations apply.
In the case of a spin-off, tax loss carry forward can be divided between the surviving entity and the spun-off entity or entities in proportion to: a) the inventories and accounts receivable transferred in the case of commercial entities; b) the fixed assets transferred, in all other cases.
In relation to tax consolidation, under the MITL certain holding companies are allowed to file a consolidated income tax return with their majority-owned subsidiaries. In general terms, this regime allows among other benefits the offsetting of losses incurred by one subsidiary against the profits of another.
It is important to mention that a 2010 tax reform introduced important modifications to the consolidation regime that limited to five years the benefits of the tax deferral. Also, transitional rules require the recapture of certain benefits from 2009 onwards. These provisions have generated controversies based on differences in interpretation of these rules by taxpayers and tax authorities and constitute an additional area of scrutiny by the Mexican tax authority. Another controversial issue is the case where at the level of the controlled companies, losses were diminished as a result of offsetting them against their accruable inventory, eliminating the recapture.
Further, attention is also given by the TAS to shifting offshore profits. An audit program on business restructuring that started some years ago continues to be in place. Additionally, shifting offshore losses or importation of losses is another area of concern for the Mexican tax authority, where intercompany charges continue to be closely reviewed.
Transfer pricing is still viewed by the Mexican tax authorities as a key risk area in the context of multinational companies that produce tax losses or have subsidiaries that generate tax losses. The shifting of risks and assets has been the focus of several tax reviews.
In the area of financial transactions the Mexican tax authority may challenge situations that appear to be implemented mainly to create artificial losses. In the field of derivatives, losses derived from speculative transactions have recently been considered as non-deductible items, based on a controversial interpretation of the MITL.
Under the situation described above, including the issuance of the Corporate Loss Report, it is expected that there will be a significant increase in the audits and reviews of corporate tax losses in Mexico and international cooperation with other tax administrations.
Controversies that involve corporate tax losses and its justification represent big challenges for taxpayers and should be solved under a holistic and global approach. In this context, defense files are highly advisable to provide evidence to tax authorities that transfer pricing and other tax rules have been duly met and that transactions respond to sound business and economic reasons. Proactive measures are more desirable than reactive measures to effectively avoid or minimise substantial tax risks. Competent authority processes, administrative appeals, as well as court proceedings, are expected to rise in number, in this area.
Additionally, concerning corporate tax losses, it may be expected that for 2012 the new government may introduce in the Mexican tax legislation more measures to counteract corporate loss utilisation that results from aggressive tax planning to facilitate the response of the tax administration following international trends. Hopefully, other tax rules are also put into place in favour of competitiveness and growth of the Mexican market which promote the creation of new jobs, such as reforms for groups that consolidate for tax purposes.
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