Mexico proposes new transfer pricing rules of the game

By Jesús Aldrin Rojas M., Managing Partner at QCG Transfer Pricing Practice, Mexico City

On September 8, Mexico’s Federal Executive presented a decree that would amend various tax laws, modifying the transfer pricing regime to enhance its effectiveness as a tax collection and audit instrument for the tax authorities.

The decree would provide new and aggressive rules of the game for taxpayers through changes amending, adding and repealing several provisions of the Federal Tax Code (CFF), Mexican Income Tax Law (LISR), the Value Added Tax Law (LIVA), and the Special Tax on Production and Services Law (LIESP).

Taxpayers with national intercompany operations

The tax reform proposal – in confirmation of the normative criteria 32/ISR/N, 34/ISR/N, 35/ISR/N and the Miscellaneous Tax Resolution in its rule 3.9.5 – emphasizes that the regime covers operations made between related parties residing in Mexico.

Consequently, Title VI, Chapter II of the Income Tax Law (LISR) would be amended to read as follows “of multinational enterprises and related party transactions.” Documentation obligations for operations with national and foreign related parties would be formalized (LISR 76-IX), and even domestic companies would be obliged to file an informative declaration of operations with related parties.

Such companies would need to disclose to the tax authorities the intercompany operations carried out, their amounts, the related parties with which the operation was carried out, and the transfer pricing method used. They would further have to disclose whether the transaction under analysis was conducted in arm’s length terms and, if applicable the adjustment to prices, consideration amounts or profit margins.

Criteria for the elaboration of transfer pricing analysis

To confirm the arm’s length condition of an operation (that is, to demonstrate that the intercompany transaction was conducted under the terms that would have been agreed with independent third parties), it is necessary to perform a comparability analysis.

The comparability analysis includes the relevant attributes of the intercompany operation – the characteristics of the operation, the asset functions and risks, the contractual terms and the economic circumstances, in the terms prescribed by chapter III of the OECD transfer pricing guidelines and article 179 of the Mexican Income Tax Law.

Until now, the comparability analysis was usually based on the entity analyzed for the confirmation of the arm’s length condition of the operation, but the proposed law reform would require that the perspective of the parties involved in the operation be considered (LISR 76-IX,b). The proposal would also restrict the period in which the price, amount of consideration or profit margins of the taxpayer must be evaluated, requiring a year-versus-year comparison, unless the taxpayer demonstrates the existence of a business cycle in the analyzed transaction (LISR 179). Furthermore, the proposal would also specify that when applying any of the transfer pricing methods prescribed by Article 180 of the Mexican Income Tax Law, the detail of the comparability adjustments implemented must be provided: accounting, capital and country risk (Income Tax Law 76-IX,d).

Finally, the result would have to be presented using the interquartile range, the method agreed upon in the framework of an amicable agreement procedure, or eventually, the method proposed by the tax authorities through the issuance of general rules (LISR 180).

Use of confidential taxpayer information for the construction of benchmarks (secret comparables)

One of the mechanisms available to the authority to confirm the arm’s length status of intercompany transactions of taxpayers is the use of information related to transactions carried out with or between independent third parties held by the tax authorities. The tax reform proposal reevaluates this provision by establishing that taxpayers could have access to this information by appointing two representatives, with the primary aim to eventually correct their situation, clarify omissions or challenge the tax credit imposed (CFF 46).

Deadline for filing transfer pricing information returns

The reform proposal would establish a new filing date for the informative returns declaration of operations with related parties (national and foreign). The new deadline would be May 15 – a date on which the financial information of public companies in relation to the immediately preceding fiscal year may not yet be fully available. On this same date the local file must also be presented for taxpayers who are obligated under the terms of articles 32-A, second paragraph and 32-H, sections II, III, and IV of the Federal Tax Code (LISR 76-X, 76-A).

The filing of the master transfer pricing informative return of the multinational corporate group and the country-by-country informative return will be made with a deadline date of December 31 of the fiscal year immediately following the one in which it is reported. (LISR 76-A).

Elimination of advance pricing agreements for companies in the maquiladora sector

One of the most evident changes is the elimination of the possibility of obtaining advance transfer pricing agreements (APAs) for taxpayers in the maquiladora sector. From the authorities’ point of view, the taxpayers of the regime had abused this option by assuming fiscally aggressive positions. Consequently, taxpayers of the regime, both maquiladoras and shelter companies, are limited to obtaining a safe harbor (6.9% on assets and expenses, 6.5% on costs) as options to avoid setting up a permanent establishment in Mexico, which would make the operation of many of the taxpayers of the regime more expensive.

It is also established that the omission to file the informative declaration of manufacturing, maquiladora and export services companies (DIEMSE) in the month of June of the year in question would lead to the configuration of a permanent establishment in the country. (LISR 182).

Crime of tax fraud in intercompany operations

Given that in operations with related parties there are no negotiation incentives that exist as between independent third parties, it is possible that taxpayers under the regime engage in transactions in which they operate in a manner different from the transaction’s real nature or, in the worst case, simulate an operation without it actually existing.

In response, the proposed amendment would incorporate into the Federal Tax Code the mechanism previously established in Article 177 of the Mexican Income Tax Law by means of which the tax authorities may determine the simulation of legal acts in intercompany transactions. If the taxpayers were in the corresponding legal or factual situation, they would be subject to the penalties established for the crime of tax fraud. (CFF 109,IV, CFF 42-B).

Other modifications impacting the transfer pricing regime

The federal government has also proposed amendments to provisions that, while not directly related to the transfer pricing regime, involve it. For example, interest deduction restrictions are imposed in default of the thin capitalization rules on taxpayers who, without being assignees or contractors, deduct interest derived from financing contracted for the construction, operation or maintenance of infrastructure “linked” to strategic areas for the country or for the generation of electricity.

In the same sense, the deduction of interest is also restricted to non-regulated multiple purpose financial companies (SOFOMES ENR), in those cases in which, in exception to the thin capitalization rules, “they carry out activities predominantly with national or foreign related parties”. That is, they contract intercompany debts, under the general argument (not necessarily correct) that the lender is frequently located in tax havens. (LISR 28-XXVII).

Finally, the transfer pricing regime would also be involved in the provisions that require the existence of a business reason in corporate restructurings (LISR 24, I, VII), supported credits (LISR 11, V, 5th paragraph), deduction of expenses for technical assistance, technology transfer or royalties, when these are provided through intermediaries (LISR 27-X), the regulations regarding the controlling beneficiary (according to the concept proposed by the Financial Action Task Force, FATF) (CFF 32-B ter, quater and quinquies), alienation of shares with source of wealth in national territory regarding the request for the inclusion of the transfer pricing study with which the market value of the alienation of shares or securities that represent the ownership of goods is demonstrated (LISR 24-161,VII) and even for the exclusion of the trust regime to taxpayers that maintain operations with related parties (LISR 206).

Conclusions

It is evident that the transfer pricing regime will be one of the mechanisms used by the tax authority to increase revenue collection in Mexico. The rethinking of the rules of the game, given the magnitude and depth of the proposed changes, will imply for taxpayers a structural review of their supporting documentation, which if they do not adapt to the new requirements will leave them exposed to onerous penalties, which may even lead to the loss of the deduction of intercompany expenses or to the recalculation of their taxable income. In soccer terms, the tax authorities, in addition to attacking, play offsides. It is the taxpayers’ job to act accordingly, promptly and responsibly.