President Andrés Manuel López Obrador (AMLO)'s administration reached its first six months in mid-2019. It finds itself in the middle of a rapidly changing domestic and international economic and political order that has already directly impacted Mexico. Several trade disputes have arisen in the past few months, particularly between the US and China, and Mexico has been part of these disputes (although arguably for other than purely commercial reasons).
In May 2019, US President Donald Trump's administration threatened to impose tariffs on Mexican imports, starting at 5% and reaching a maximum of 25%, if AMLO's government failed to prevent Central American migrant flows from reaching the US-Mexico border (subsequent actions from AMLO's government achieved a reduction in migrant flows that seem to subdue the risk of implementation of such tariffs). The new trade deal, known as the United States-Mexico-Canada Agreement (USMCA), which will replace NAFTA has not been yet been ratified by the three member countries, creating uncertainty for investors and risk to the Mexican economy, which has been projected to grow below 1% in 2019 by the International Monetary Fund. Finally, international credit rating agencies have downgraded the country's rating, although it still continues to be regarded as investment grade.
Under such economic strains, fiscal policy has been a key concern for Mexican citizens, international markets and investors. The budget announced by AMLO includes heavy spending on social programmes that were part of the promises made during the presidential campaign and huge support to Petróleos Mexicanos (Pemex), the world's most indebted and financially troubled state-owned oil company. In an anticipated move, credit rating agencies also recently downgraded Pemex's credit rating to speculative from investment grade. Tax collection is therefore crucial to avoid a widening fiscal deficit and the risk of further downgrades to both Pemex bonds and sovereign bonds.
At the beginning of June 2019, Mexico's tax authority – Servicio de Administración Tributaria (SAT) – announced a surprising increase in the tax take from large taxpayers, with new technology playing a big part in the SAT's ability to achieve such a goal. Transfer pricing audits have substantially increased in Mexico and now multi-disciplinary reviews are executed by the SAT in which, for example, an international tax or a customs specialist leads an examination and routinely involves transfer pricing specialists to review the related aspects as part of a single assessment.
Mexico became one of the first OECD member countries to adopt the BEPS-related guidelines into its local legal framework. Since then, additional rules have been issued that make clear that transfer pricing will continue to be one of the main aspects tax authorities will focus on.
New non-binding transfer pricing criteria
On November 2018, Mexico's SAT published two non-binding criteria related to transfer pricing in the Official Gazette. The first criterion is referred to as 40/ISR/NV "Modifications to the value of transactions with related parties within the interquartile range". Tax authorities consider it an improper tax practice for taxpayers to:
I. Make any changes to the prices, amounts of consideration or profit margins corresponding to transactions entered into by the taxpayer with related parties, when these are already within the adjusted range using the interquartile method corresponding to comparable transactions. That is, when they are between the lower and upper limits of the range, since said modification is not intended to comply with the applicable tax provisions, but to obtain an undue benefit by increasing deductions or decreasing the taxpayer's income, and
II. Advise, provide services or to participate in the implementation of the practice described before.
The SAT's arguments are built around the fact that a transfer pricing adjustment is made in order to compensate for taxpayers not having proper arm's-length pricing with related parties and when such pricing results in prices, amounts of considerations or profit margins outside the adjusted interquartile range defined as comparable. It is therefore not appropriate for taxpayers to perform transfer pricing adjustments when the transaction is already within range and at arm's length, leading to a decrease in the taxable base.
The non-binding criteria also stipulate that an adjustment to the transfer prices referred to in rule 18.104.22.168. of the 2018 Miscellaneous Tax Resolutions is only applicable when the prices, considerations or profit margins already adjusted by applying a statistical method are: outside the range referred to in Article 180's second paragraph of the Income Tax Law; or outside the lower and upper limit referred to by the interquartile range method.
The adjustment of transfer prices is also considered appropriate when it is recognised by the tax authorities as the result of a consultation regarding the methodology used in the determination of the prices or amounts of the considerations in transactions with related parties or agreements between competent authorities under the framework of applicable international treaties, that is, in terms of particular resolutions.
The second criterion is referred to as 39/ISR/NV "Recognition of unique and valuable contributions". Tax authorities consider an improper tax practice when taxpayers:
- Do not recognise the unique and valuable contributions of their own and of the selected comparable companies for the purposes of demonstrating that their controlled transactions were at arm's length;
- Consider transactions or comparable companies when there are significant differences between the transaction or the analysed party and the potential transactions or companies proposed as comparable that are determined or generated from unique and valuable contributions; and
- Advise, provide services or participate in the implementation of the practices described above. Valuable contributions are defined as those conditions or attributes of the business that generate value in a significant manner and that involve the expectation of generating greater future economic benefits than would be expected in their absence, such as intangibles, created or used, or factors of comparability that define some competitive advantage of the business. These latter include the activities of development, improvement, maintenance, projection and/or exploitation of intangibles.
The new tax authority criteria also assign responsibility to transfer pricing advisors in cases where such tax practices are implemented by a taxpayer. Transfer pricing advisors (or any other individuals) that advise or participate in the elaboration of transfer pricing documentation that may lead to improper tax practices, may be subject to penalties, which are detailed in Article 89-I of the Federal Fiscal Code. They will be liable if they have advised or provided services that aim to totally or partially avoid the payment of any taxes in contravention of tax regulations, except where the advisor clearly states in the transfer pricing report or written tax opinion that the practice contravenes the tax authorities' criteria or states in writing to the taxpayer that the tax advice may contravene the interpretation of the tax authorities.
Moreover, the Federal Fiscal Code also imposes an obligation on external certified public accountants to disclose whether a taxpayer has applied any of the SAT's non-binding income tax criteria when issuing and filing the taxpayer's annual tax report (dictamen fiscal), thus adding another responsible party to the disclosing requirements.
The non-binding criteria also pose a challenge to external certified public accountants. The review of the transfer pricing analysis and contemporaneous documentation (to identify whether a taxpayer has applied any of the non-binding criteria) require an expertise in transfer pricing that is not typically possessed by a certified public accountant and may require the participation of a certified public accountant's own transfer pricing specialist.
Transfer pricing is highly subjective and the SAT has been looking to reduce uncertainty by issuing laws, rules and non-binding criteria. However, many taxpayers and practitioners consider the rules and criteria to be aggressive, adding unnecessary complexity and cost to the transfer pricing and general tax compliance process. The Mexican Chartered Accountants Institute (IMCP), the profession's governing body, issued a public letter to the senior management at the SAT requesting a deferral in the enforcement of criteria 39/ISR/NV and 40/ISR/NV until a thorough technical review was completed and agreed between the SAT and the IMCP. At the time of writing, the SAT had not accepted a deferral in the enforcement of the non-binding criteria, but it had expressed its openness to continue discussions on the matter.
Transfer pricing adjustment rules
The SAT introduced a series of rules in 2018 in an attempt to define and clarify the application of transfer pricing adjustments (see 'Transfer pricing in Mexico: The upcoming challenges and opportunities', Latin America Transfer Pricing Focus, 15th edition, International Tax Review).
Rules 22.214.171.124. through 126.96.36.199 also caused controversy once taxpayers started implementing them based on their 2018 transfer pricing results. Some taxpayers interpret the rules as an excessive burden aimed at discouraging the application of transfer pricing adjustments that reduce the taxable income of Mexican taxpayers, despite the fact that the adjustments are required to obtain an arm's-length result if all documentation requirements are met.
One year has passed since the rules for transfer pricing adjustments were issued and it has represented a challenge for taxpayers on the basis that multinational enterprises are required to maintain a certain level of flexibility in order to adapt to the dynamics of today's markets. Consumers are evolving faster than they used to and technology is exacerbating. Flexibility comes with the ability to adjust final pricing. Such moves will have a direct impact to transactions among the members of a business group located across geographies around the globe and so rules, such as the ones discussed above, will avoid uncertainty and provide guidelines for multinational companies adjusting their inter-company pricing. However, complying with the rules in a timely manner will require additional resources and planning.
Typical challenges encountered by taxpayers when implementing the transfer pricing adjustment rules, include: the complexities of amending the value declared at customs in import documentation (pedimentos), when as a result of an adjustment there is an increase in the value of tangible products imported by the taxpayer from a related supplier based abroad; obtaining an affidavit from the related counterparty in the inter-company transaction stating that the conforming adjustment was made in the same fiscal year; and the timely issuance and booking of electronic invoices reflecting the credit note corresponding to the adjustment, among others.
Simón Somohano is a tax partner based in Tijuana and responsible for Deloitte's transfer pricing practice in Latin America and the Spanish-speaking Caribbean. He has more than 29 years of experience in the application of tax, economic and financial criteria in transfer pricing valuation analysis of intangibles, double tax issues, planning, business model optimisation, structuring and economic consulting.
Under his leadership, Deloitte's regional TP practice has been consistently recognised as one of the leading practices in Latin America. The team won Americas Tax Awards-Mexico Transfer Pricing Firm of the Year for a second consecutive year and Simón has consistently been named one of the 'world's leading transfer pricing advisors' by the prestigious Legal Media/Euromoney Magazine.
His clients include several Fortune 500 multinational companies doing business in Mexico. He has extensive experience and a successful record leading on Mexican negotiations for advanced pricing agreements (APA); mutual agreement procedures (MAP); and TP examinations with Mexican and foreign authorities, teaming with colleagues in Deloitte's global TP network.
Simón advises across a variety of industry sectors, with a focus on automotive and manufacturing, maquiladoras, retail and consumer goods, real estate and the energy and resources market. Simón is a frequent guest speaker in international tax and business forums in Mexico and abroad. He has authored several articles on transfer pricing and is a co-author of the 'Transfer Pricing International Handbook'; the 'A Country-by-Country Guide', published by the International Tax Institute; and 'Transfer Pricing: A Theoretical, Legal and Practice Framework', published by the Institute of Chartered Accountants (Mexico).
|José Eduardo Campos Martínez|
Eduardo Campos is a transfer pricing partner in Deloitte Mexico, based in Mexico City. As of June 2019, he is the TP lead partner for Mexico and Central America, coordinating a group of 25 partners in the region.
He has more than 16 years of experience assisting multinational companies in transfer pricing matters including valuation analysis of intangibles, structuring new business models, acquisitions, business valuations and portfolio valuations among other topics.
His clients include several Fortune 500 clients with subsidiaries in Mexico and multinational Mexican companies with a presence in more than 30 different countries, according to the last data published by Forbes Mexico. He has successfully represented different clients in TP audits performed by the Mexican tax authorities and over the past three years negotiated advance pricing agreements (APA) and mutual agreement procedures.
He has specialised in transfer pricing topics for the finance and automotive industries, assisting important multinational enterprises with the implementation of inter-company pricing policies. He has worked with two of the largest commercial banks in Mexico, following new TP documentation requirements set up by Mexico's Central Bank and National Banking and Securities Commission.
Eduardo holds a bachelor's degree in economics from the Instituto Teconológico y de Estudios Superiores de Monterrey (ITESM), where he specialised in corporate finance and financial markets. He has participated in different tax seminars in Mexico and as a speaker guest speaker for the China Chamber of Commerce in Mexico and speaker at the Universidad La Salle and ITESM for different financing topics. He has authored several articles on transfer pricing in specialised journals, such as the International Tax Review.
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