Mexico's Proposed Tax Reform Affects Transfer Pricing
09 October 2013
Posted by: Author: Ernst & Young
Author: Ernst & Young
The tax reform presented by President Peña Nieto to the Mexican Congress would affect Mexico’s current transfer pricing regime. The tax reform is expected to be debated and voted on by the Mexican Congress and a final package is expected to be approved by 31 October 2013.1 The proposals in the tax reform affecting transfer pricing are described below.
Non-deductibility of certain intercompany payments
The proposal attempts to address issues identified in the Base Erosion and Profit Shifting’s (BEPS) action plan, and proposes making payments made by a Mexican resident to related parties (both domestic and foreign) non-deductible when the counterpart is not taxed on the corresponding revenue at a rate that is greater than the Mexican tax haven rate (75% of the rate paid by Mexican residents). In making this determination, the tax rate presumably would be the effective tax rate, rather than the nominal corporate tax rate of 30%. This proposed provision seems to be designed to discourage the use of transfer pricing to effectively use a corporate group´s tax attributes even for local (domestic) transactions and would require more detailed regulations and further clarification. It is not clear if this determination would be made based on gross income or net taxable income.
The proposal also would make non-deductible those expenses that are in turn deducted by another related party. This provision would apply to all payments that may be deducted by another related party.
New export requirements for maquiladoras
In an effort to limit the benefits granted to export manufacturers (IMMEX), a new definition of what constitutes a maquiladora is proposed. Under the proposal, a maquiladora would be a manufacturing entity that derives at least 90% of its revenues from export activities, compared to 10% required currently. The proposal would eliminate current presidential decree benefits.
Maquiladora definition is incorporated within the text of the MITL
The proposal would incorporate a new maquiladora definition into Article 175 of the new Mexican Income Tax Law (MITL) (previously stated in the IMMEX Presidential Decree). The new definition would require four conditions to be met. First, inventories imported temporarily must be subject to a transformation or refurbishing process, and must be returned abroad. Second, if domestic or foreign inventories are added to the manufacturing process, these materials have to be exported with the temporarily imported inventories. Third, transformation or refurbishing processes must be performed with machinery and equipment on consignment, and these assets must not have been property of the maquiladora or any other domestic related party in Mexico. Fourth, assets owned by foreign non-related entities can be used, as long as this entity and the maquiladora’s principal: (1) can demonstrate they have a business relationship; (2) there is a legal agreement in place between the principal and the maquiladora; and (3) the assets are provided due to the business relationship between the non-related entity and the maquiladora’s principal. This new definition attempts to limit potential tax structures or maquila conversions.
Creation of transition regime for shelter maquiladoras
The proposal would provide a transition regime that would allow maquiladoras operating under a shelter program for three consecutive years to leave the shelter program, and if convenient for such taxpayers, to compute taxes as a routine maquiladora once the transition regime has elapsed. This proposed change is based on the argument that the shelter program is not creating permanent investments, but only allowing nonresidents to minimize the tax burden (previously allowed through temporary rulings). Under the proposed new rule, it would be very important for shelter maquiladoras to review the related party and permanent establishment definitions of the new law and evaluate the implications for routine maquiladoras.
Transfer pricing option eliminated for maquiladoras
Transfer pricing compliance options for maquiladoras would be limited under the proposed law to the safe harbor rules or an Advanced Pricing Agreement (APA) if the maquiladora would be reporting taxable income different than that established by the safe harbor. Although these options are a step back to the pre-2003 rules for maquiladoras, the fact that the SAT has more experience with APAs could potentially allow for a more efficient resolution of the rulings than a decade ago. This rule in effect would eliminate the current option to use conventional transfer pricing rules plus a 1% return on assets used in the operation.
Changes to treaty administrative requirements
The proposal would include a new provision that would require a foreign related party to prove that double taxation exists before it could apply double taxation benefits in intercompany transactions. The proof would have to be in the form of a signed document under oath by the company’s legal representatives. Other filing requirements for treaty benefits are also proposed.
Changes to compliance requirements
One of the deductibility requirements would be modified for related party transactions by eliminating the benefit of the 60-day response period for submitting Annex 9 of the Multiple Informative Return (DIM for its Spanish acronym) for intercompany transactions with foreign related parties when it is requested by SAT officials during a transfer pricing audit process. Under the proposed tax bill, if Annex 9 of DIM is not presented upon request of an audit, intercompany charges would be 100% non-deductible for income tax purposes.
Definite rules and deadlines for informative returns on maquiladoras
The proposal would establish the obligation for maquiladoras to file an informative return (DIEMSE for its Spanish acronym) in June of the following year. In the past, even though DIEMSE was required, there was no obligation in the income tax law to force maquiladoras to comply with the submission of this document.
New informative returns for maquiladoras under the shelter regime
Shelter maquiladoras are required to submit federal tax informative returns, as well as informative returns for customs and transactions with non-related entities. If an entity fails to comply with these requirements, SAT will grant a 30-day extension in order for the company to correct this situation, or Import Registry will be suspended.
New anti-abuse rule
The proposed reform includes a provision that would allow the tax authorities to determine and assess a tax if it identifies a taxpayer practice or transaction that lacks business purpose. In this regard, a transaction or practice would not have a business purpose when there is no evidence of quantifiable economic income or benefit arising from the transaction for the taxpayers involved, or if its objective relates exclusively to tax optimization.
Corresponding adjustments for Intra-Mexico transactions
Left out from the reform is the inclusion of rules for corresponding TP adjustments on domestic (intra-Mexico) intercompany transactions. This is relevant considering that the tax consolidation regime would be eliminated as part of the proposed reform and double taxation at a domestic level would be more likely. The benefit of applying corresponding adjustments on transactions carried out with foreign related parties is still available based on Article 178 of the MITL.
Use of Financial Information Norms
The terms of the general transfer pricing provisions of the MITL remain practically unchanged except for the fact that reference is made to Mexican Financial Information Norms (FINs) instead of Generally Accepted Accounting Practices (GAAP) when discussing financial information to be used in the transfer pricing analysis. This could affect cases where the tested party is not the Mexican entity, because it seems that there is a need to convert the foreign accounting to Mexican FINs.
Elimination of the Dictamen Fiscal
Finally, the proposal to eliminate the Auditor´s Tax Certification (Dictamen Fiscal) could have potential consequences regarding transfer pricing compliance, as well as the audit process. It is important to remember that the Tax Certification by an external auditor had been made optional in 2011, subject to the submission by the taxpayer of practically the same information that was required from the auditor via a filing called Alternative Information to the Tax Certification. This alternative filing includes four large forms or attachments with a vast amount of information about intercompany transactions. Subject to new regulations clarifying the issue, all taxpayers would now be subject to the Alternative Filing.
As to the audit procedure, having an external auditor signing off on the taxpayer´s tax and more specifically transfer pricing compliance, allows for what is known as the sequential review process. This process consists of a review of the external auditor´s work-papers and of a series of questionnaires that are to be answered by the auditor before starting direct inquires to the taxpayer. The elimination of the Dictamen Fiscal would also eliminate the sequential review process, giving less time to taxpayers to effectively prepare for an audit.
The proposed tax reform is still under review by the Mexican Congress, and it could be amended from its original form as a result of the review from business organizations and Congress.
1. For more information about Mexico’s tax reform, see Tax Alerts: Mexico’s President presents tax reform proposal to Congress, dated 9 September 2013, Mexico’s tax reform bill includes introduction of mining royalty, dated 9 September 2013, Mexico’s tax reform proposal significantly affects maquiladora industry, dated 11 September 2013 and Mexico’s tax reform proposal affects financial institutions, dated 20 September 2013.
This article first appeared in ey.com.