Mexico’s transfer pricing regime undergoes its most profound revision since its establishment
Background Information
One of the most important regimes that the country has at its disposal is the transfer pricing regime. This regime (in force in the country since 1997) seeks that the participants of an intercompany operation transact considering the terms that independent third parties would have observed in comparable operations, that is, based on the principle of assimilation to independent companies (arm’s length principle) proposed by the Organization for Economic Cooperation and Development in article 9 of its Model Tax Convention.
Unfortunately, since its establishment in Mexico, the taxpayers of the regime have overlooked essential aspects of it and have limited themselves to documenting for compliance purposes that their operations “are agreed at market value” – even if they lack economic substance or any valid economic reason-. This erroneous interpretation has led the tax authorities to implement an aggressive audit program that has resulted in heavy penalties for taxpayers and has even compromised their very operation. At this moment, more than one hundred conclusive agreements directly or indirectly related to the transfer pricing regime are open at the Procuraduría de Defensa del Contribuyente (PRODECON) – an independent public organism that functions as Mexico’s Taxpayer’s Ombudsman.
It is also important to emphasize that the regime is in addition under constant scrutiny at the international level. Civil Society Organizations, such as the Independent Commission on Tax Reform (ICRICT), the Tax Justice Network, Christian Aid, etc. have made severe criticisms of the way in which the transfer pricing regime has been implemented around the world, and have even pointed out “mispricing” practices, where the regime and its rules have been distorted by taxpayers and tax advisors even with the ultimate objective of eroding the tax base of taxpayers to the detriment of the national revenue of the country or countries involved.
Against this background, the tax reform proposal for fiscal year 2022 further tightens the screws on taxpayers by suggesting changes in the documentation practices of intercompany operations. The proposed changes seek to rethink the way in which the documentation of the operations is generated and even emphasize that the regime is not only for companies that carry out operations with foreign related parties, but also reaches taxpayers that carry out operations with their domestic related parties.
What do the major changes consist of?
Hand in hand with the recommendations made by the OECD in its action plan to combat tax evasion and profit shifting (the BEPS plan), in its actions 8-10 (alignment of transfer pricing with value creation), the Mexican government is rethinking the regime through the following measures:
National intercompany operations. In order to emphasize that the transfer pricing regime reaches even national groups, the wording of Article 76-IX of the Income Tax Law is revised to refer only to the documentation obligations of operations with related parties, thus generalizing the regime even to those who carry out operations with national related parties. Taxpayers in this case, must submit the informative declaration of operations with related parties no later than May 15 (according to section X of Article 76 of the LISR Mexican Income Tax Law) or even July 15 of this year in the cases provided for in Annex 19 of the Miscellaneous Tax Resolution for fiscal year 2022, dated December 27, 2021 and its transitory provisions (thirty-fourth and fifth) -taxpayers who have opted for the option to file a tax return or will file the local informative declaration-.
Crime of tax fraud in intercompany operations. The tax authorities, during the exercise of their verification powers, may determine the existence of tax simulation in intercompany operations (LISR 177, 42-B of the CFF– Federal Tax Code). Tax simulation is assimilated to the crime of tax fraud (CFF 109-IV) and punishable with imprisonment from three months to 9 years (CFF 108).
Standard for documentation of operations. A review of the documentation procedure for intercompany operations is made. Regarding the comparability analysis (the portrait of the attributes of the transaction under analysis that supports the search for comparables), it is requested to take into account not only the functions, assets and risks attributable to the entity under analysis but also those of the counterparty that transacts (LISR 76-IX). On the other hand, it is emphasized that the financial and business information of the transactions or comparable companies used for the construction of the reference intervals to justify the arm’s length condition of the operation (the ranges) be limited to one year, unless there is evidence that the taxpayer and its operations are linked to a broader business cycle (LISR 179).
Maquiladoras. The possibility for taxpayers of the regime to negotiate an Advanced Pricing Arrangement (APA) as an option to avoid setting up a permanent establishment is eliminated as option to avoid the permanent establishment configuration and restricts taxpayers to any of the safe harbor options: (6.9% on assets or 6.5% on total costs (LISR 182).
Indirect regulations. Various ordinances are modified to include concepts directly or indirectly related to the transfer pricing regime, namely: thin capitalization. Excluded from the exception rule are SOFOMES– Non-regulated Multiple Purpose Financial Companies and companies that are not assignees or contractors of the Mexican government for strategic areas or electric power generation (LISR 28-XXXVII). Business reason and market value are required in corporate restructurings (LISR 24,I,VII), backed loans (LISR 11-V) and sale of shares (LISR 161). Regarding the deduction of Services, technology transfer or royalties, they will only be deductible when rendered directly and not through a third party (LISR 27-X).
Changes in dates. As mentioned above, through the Miscellaneous Tax Resolution in its Annex 19 for 2022, transitory paragraphs thirty-fourth and fifth, the dates for filing the informative declaration of operations with related parties and the date for filing the local informative declaration of related parties have been modified. In view of these changes, the delivery schedule of the regime would be as follows:
Conclusions
As has already been pointed out, the changes analyzed here should lead taxpayers to review their documentation practices, prioritizing the confirmation of the economic substance of the transactions and the alignment with the standard required by the LISR– Mexican Income Tax Law according to the tax reform proposal. The “mechanical” execution of the transaction without due analysis should be cause for alert, because it can generate in taxpayers the false impression of complying with the regime, leaving loose ends that can later lead to costly sanctions that can go as far as the loss of the deduction of intercompany expenses and consequently the recalculation of the tax base, with the serious implications of the case, even compromising the smooth running of the business.
