Analysis on Multinational Companies Impact from the FY2020 Tax Reform Initiative

October 4, 2019

 

Dear customers and friends,

 

As part of our continued progress in the analysis of the proposed FY2020 Tax Reform package, we are happy to provide you this study that follows-up on the previous ones sent, going into further details regarding the specific aspects we believe may directly affect Multinational Corporations that have investments or ties to Mexico. We hope you find it useful and will continue to keep you appraised of the progress, as well as any particular issues that relate to this significant Initiative.

 

Executive Summary

 

The FY2020 Economic Package presented by the President (through the Ministry of Finance) to Congress contains significant proposals that relate to international aspects, particularly intending to implement recommendations made by the OECD as part of its BEPS Project.  This newsletter is prepared following up on the ones dated September 13, 2019, which provided an overall summary of the entire Initiative, but focusing only on these BEPS-related matters and others of the like which we believe are of special interest for Multinational Corporations or foreign companies that have investments or ties to Mexico and providing a more detailed analysis.

 

While it would initially seem that they are indeed in line with such recommendations, they will certainly create significant uncertainty for taxpayers and create excessive negative consequences. This is because (i) in some cases, the wording is vague or incorrectly adapted to our Mexican tax system or legislation; (ii) in some cases, the effects are broad and not necessarily only linked to the situations that BEPS itself tries to attend to; (iii) in some other cases, they can be precipitated without there being full clarity on the fundamental issue at hand; and (v) there can also be cases in which they are strictly based on the OECD’s recommendation itself, without regard to specific situations or idiosyncrasies of the Mexican tax practices, legislation or system; all while completely disregarding the difficult political and economic situation Mexico is going through, in which investment, both foreign and national, is essential. 

 

In sum, we believe that these reforms come entirely too soon and, given the potential negative impacts for Mexican companies, could discourage investment, resulting in economic turmoil.

 

I. PE

 

In PE matter, the Initiative proposes to amend the current PE definitions (both assumptions to create a PE and exceptions) in three main pillars: (i) changes to the cases in which a dependent agent creates a PE for a non-resident; (ii) addition of assumptions in which an agent will not have an independent status; (iii) limitations to apply the list of activities that qualify as exemptions to create a PE. 

 

1.1 Dependent agents

 

Currently, Article 3 of the Mexican Income Tax Law (MITL) establishes that a PE will be created through a dependent agent when it exercises powers to conclude contracts in the name of or on behalf of the non-resident. In time, this has meant that the dependent agent not only has to be granted powers to conclude contracts, but it has to actually conclude them.  Also, this provision does not look at any type of periodicity or recurrence in the conclusion of such contracts, so that it may create a PE only by concluding one contract; of course, this should initially lead to creating a PE only with regards to (one) the contract that was concluded and attribute only such income to the PE. 

 

With the proposed changes, a dependent agent would create a PE for a non-resident as a result of the habitual conclusion of contracts or the habitual performance of the principal role in the conclusion of contracts executed by the non-resident, provided that they:

 

  1. are executed in the name of or on behalf of the non-resident;

  2. foresee the sale of property title, or the grant of the temporary use or enjoyment of a good possessed by the nonresident or on which such non-resident has the right to temporary use or enjoyment; or

  3. obligate the non-resident to provide a service.

 

As it can be seen, a dependent agent would now create a PE for a non-resident not only with the mere act of concluding a contract, but with the principal role participation in the conclusion of contracts; whereas, it would no longer look to just one contract, but the habitual conclusion or participation in the conclusion of contracts.  Note that there is no definition of the term “habitual” and in fact, the comments made as part of BEPS Action 7 indeed mention that the facts and circumstances of each particular situation shall be taken into account to identify whether or not the participation is indeed habitual or not, considering all of the business activities of the agent and the non-resident.  

 

Of course, this would seem to be a logical change, however, we believe that the ambiguity of the term “habitual” may eventually lead to uncertainty, which could potentially be abused by either taxpayers or the tax authorities.  Another relevant issue may be that the change to having to habitually participate could eventually generate doubts as to the activities for which the PE is created. This is, while current provisions speak of any particular contract (leading to create the PE only for that such contract and attribute only the corresponding income), the shift to a “habitual” situation could also generate doubts as to which businesses specifically should create a PE and thus, what income may eventually be attributed to such PE (i.e., what if a dependent agent “habitually” concludes contracts, but the contracts concluded represent only 75% of all agreements executed by the non-resident, should the PE be created only for the 75% or all of the agreements?).

 

Furthermore, note that the agreements concluded (or for the conclusion of which the agent actively participated) shall fall within any of the three assumptions established.  Initially, it would seem that these are quite vague and would cover almost any type of transaction; however, the wording used lacks clarity, mainly with regards to the general assumption vis-à-vis the first assumption. Particularly, the general assumption is that the agent shall habitually conclude contracts (or actively participate), while the first criteria is that the agreements are executed in the name of or on behalf of the non-resident, leading to a possible interpretation that the actual execution shall be made by the agent on behalf of the non-resident. Note that this could be a matter of simply not adapting the wording properly from the BEPS recommendation to Spanish, as the former clearly speaks of the contracts being “in the name of” the non-resident and not “executed in the name of or on behalf of the non-resident, which in our view, although subtle, could be a difference.

 

1.2 Independent Agents

 

On this second point, firstly, there is a small clarification to broaden the scope of the list of activities under which an independent agent is not deemed to be acting within its ordinary course of business by adding “among others”. This leads to the list of activities under which an independent agent is not acting within its ordinary course of business (and thus, create a PE for the non-resident) to not be limited to such specific activities, but eventually be interpreted in a broader sense.  Of course, this could clearly lead to uncertainty as to what other activities may eventually be considered (by the authorities) to be within such “among others”.

 

Furthermore, the Initiative proposes to include a provision that clearly establishes that an agent will not be independent when it is “exclusively or almost exclusively” acting on behalf of non-resident related parties.  While there is no definition of exclusively or almost exclusively, Action 7 BEPS Report clearly establishes that this shall be considered to be the case when at least 90% of all contracts executed by the agent are for related parties.  While it is yet to be seen what type of criteria shall be followed regarding this determination- whether it should be on value of the contracts or on the amount of the contracts and if eventually, the revenue stream of the agent should be taken into account- it would seem clear that a problem would arise for the most common multinational structures where a commission agent or other type of subsidiary is set up in Mexico with limited activities only related to the same group.

 

In this sense, note that falling within this assumption would mean that the agent would no longer be independent; that is, it would not automatically create a PE for the non-resident, but rather we would have to go back to the situations where a dependent agent creates a PE (discussed above) and in such cases, confirm what that will entail – i.e. for what activities and how to attribute income.

 

1.3 Excepted activities

 

Finally, the Initiative includes proposals to limit the use of the activities listed in Article 3 of the MITL, which are considered to be exceptions for the creation of a PE.  Currently, this list includes specific activities (i.e. use of a place of business solely for the display, storage, delivery, transformation) and one of them specifically allows the use of a place of business solely to carry out activities of a preparatory or auxiliary nature, whether they be propaganda, supply of information, scientific research, preparation for loan placements or other similar activities.  In this sense, the first change proposed is merely to restructure this list to establish that all of the activities included shall be of a preparatory or auxiliary nature.

 

The other change proposed, far more relevant, seeks to limit the application of these exceptions when activities or contracts are fragmented by adding a new paragraph that establishes that the previous paragraph (the one establishing the exception through the list of activities) will not apply to cases where the non-resident carries out functions in one or more places of business in Mexico that are supplementary to those carried out by a PE it has in the country, or to those carried out in one or more places of business of another related party that is resident in Mexico (or non-resident with a PE), as part of a cohesive business operation. The exceptions will also not apply whenever the non-resident or a related party has any place of business in Mexico where supplementary functions are carried out that are part of a cohesive business operation, but whose combination of activities results in them not being of a preparatory or auxiliary nature.

 

In other words, in order to qualify as preparatory or auxiliary, the activities shall be analyzed basically considering all other activities the Multinational Group may have in Mexico, whether it is through other places of business directly, other Mexican subsidiaries, or other non-resident related parties with places of business in the country. The combination of all activities shall continue to be of a preparatory or auxiliary nature. 

 

Obviously, all of the above provisions and modifications should not override any particular Treaty provision that may be applicable to each case, mainly considering that the Multilateral Convention has not yet been concluded or in force.

 

II.Hybrid Mechanisms and CFC

 

These reforms derive mainly from Action 2 of the BEPS Report and basically seek to avoid the use of hybrid mechanisms, which are generally defined as transactions or vehicles treated in one way in one country and in another way in the other country involved resulting in a mismatch of the tax symmetry.  As we will mention ahead, notwithstanding that the wording may seem to be in line with the BEPS recommendations, we believe that again, a high level of uncertainty would be generated because of the different situations that may exist in all the countries that could eventually be involved, based on legislative or practical issues.

 

2.1 Foreign Tax Credit

 

Specific assumptions are incorporated to Article 5 of the MITL to disallow the foreign tax credit when: (i) the tax was also claimed as a credit in another country, unless such tax credit is an indirect credit of corporate tax or if the revenue on which the tax was paid is also taxed in the country or jurisdiction in which the other related party also crediting resides; or (ii) in the case of indirect credit of corporate tax when the dividend to which the tax corresponds is claimed as a deduction or reduction for the entity paying it.

 

As it can be seen, unfortunately, this wording is extremely vague and causes a lot of uncertainty. Of course, it is clear that the intention is to avoid a duplication of a tax credit at the Group level without the corresponding revenue recognition, however, it does not contemplate all of the different situations that could eventually take place in different countries, such as the reason for which the credit is allowed, if it is a temporary issue or if there any practical issues permitting it (i.e. just using the word “reduced” could lead to any kind absurd situations such as losses, nettings, etc.).

 

Also, it is worth noting that, while this reform would seek to close out such opportunities, we believe that the Mexican government should have taken advantage of the reform to the foreign tax credit system to also deal with existing shortcomings such as the fact that individuals are not directly dealt with in this Article 5 for the of the indirect corporate tax paid by a foreign subsidiary when the profit is distributed or the possibility to claim Mexican corporate income tax paid as an indirect credit.

 

2.2 Payments made to transparent foreign entities or vehicles

 

Currently, Title V of the MITL deals with all situations in which non-residents are subject to Mexican income tax on their Mexican-sourced income.  This applies regardless of the type of entity or vehicle, applying to any person (individual, legal, corporate or otherwise) not resident in Mexico for tax purposes.  While each type of income will be subject to a specific rate based on the assumptions established in each Article, Article 171 establishes that in cases where the income is generated by a non-resident is that subject to a preferential tax regime (i.e. less than 75% of the income tax payable in Mexico – 22.75%), an increased 40% rate will apply.  Note however, that this same Article establishes that such rate will not apply to dividends or interests arising from the placement of the instruments referred to in this article 8, and from the instruments placed abroad, set forth in article 166. 

 

Furthermore, through administrative rules, the tax authorities have established that this increased rate will not apply when: (i) the payment is to unrelated parties; and (ii) when the payment is to related parties that reside in a country with a broad exchange of information agreement in place with Mexico. It is also established that when the payment is made to a transparent entity or a vehicle (without legal personality), they can be looked through and the members or partners will be the ones deemed to receive such income so that the corresponding treatment can be applied.

 

For this particular case, it can be seen that the corresponding administrative rule looks through transparent entities or vehicles.

 

However, the Initiative proposes to add Article 4-A that establishes that foreign entities (with legal personality of their own) that are transparent for tax purposes and vehicles (without legal personality of their own) will be taxed as legal entities in Mexico regardless of whether or not their members, partners or beneficiaries are taxed on their income and consequently, will be subject to Title II, III, V or VI of the MITL as applicable. It goes on to further establish that they will be considered Mexican tax residents whenever their effective place of management is located in the country.

 

Although with very unclear wording, this is in essence seeking to completely disregard the possibility to look through these types of entities or vehicles and only look at them as one sole taxpayer that can be taxed in Mexico.  As a result, there may be two main situations:

 

  1. If their effective place of management is located in Mexico and they become Mexican tax residents, they would be taxed in Mexico pursuant to Title II (general tax regime for corporations), Title III (regime for non-profit organizations) or Title VI (preferential tax regime, or CFC in case they have any foreign low-tax controlled subsidiaries).

  2. If their effective place of management is not in Mexico and they maintain their non-resident status, they would be taxed pursuant to Title V of the MITL, which applies to non-residents with Mexican-source income (passive).

 

With this in mind, we believe that the clarification as to the creation of Mexican tax residency would have most likely already been achieved through current provisions, although it may seek to close a slight interpretation loophole that may have assisted in vehicles (not legal entities) in avoiding Mexican tax residency pursuant to Article 9 of the Federal Tax Code. The most common situations that may be affected by this could be foreign partnerships or similar vehicles with some (or all) management in Mexico (i.e. such as LP’s with Mexican general partners) that would then become Mexican tax residents.  This could be very relevant for certain investments fund managers, among others and thus, we recommend reviewing all current structures that may involve this type of entities or vehicles since it could affect both private and institutional foreign investors, discouraging investment in the country, as well as Mexican investors that participate in investment funds or similar structures affecting not only the effective tax rate, but possibly even leading to double taxation.

 

With regards to the treatment applicable to those who remain non-residents, we believe that it is a clear step back with regards to the recognition of substance over form and the possibility to look through such entities to the treatment applicable to their members, partners or beneficiaries. Assuming that the current administrative rule would most likely be eliminated or would no longer apply, the Mexican tax authorities could eventually seek to apply the 40% withholding tax rate, which would now mean that any payment to a transparent entity or vehicle would be subject to such increased withholding rate, regardless of whether it is a related party or not, or even if it resides in a country with an exchange of information agreement in place.

 

Another issue may be the application of the corresponding Tax Treaties.  Although the proposal includes a paragraph stating that this Article will not apply to the Treaties, in which case the provisions contained in such Treaties will apply, this is again, very unclear wording and in fact, the legislative intent clearly mentions that the intention is for these types of entities to not enjoy Treaty benefits. It could then be that the only situation where a Treaty would indeed apply and (and fall within such assumption of Article 4-A making reference to Treaty provisions) would be those in which the Treaty specifically establishes that its benefits are applicable to transparent entities and vehicles, such as the case of United States partnerships and LLC’s, to the extent their members or partners are US tax residents.  In all cases, it will be important to fully review the situation and confirm if any Treaty override is taking place with negative effects for the taxpayers (beneficial owners).  Note that the legislative intent (in justifying that Treaties should not apply to transparent entities and partnerships) bases such comment on the current Commentaries to the Model Convention made at the OECD, however, paragraph 8.13 of such Commentaries clearly state the contrary (that Treaty benefits should indeed apply to the extent that the partners income is taxed in such country).

 

2.3 Restrictions to deductions

 

There are three main restrictions that would be introduced to the MITL for deductions that are BEPS-related: (i) deduction of payments made to non-residents that are subject to a preferential tax regime; (ii) deduction of payments that are also claimed as a deduction in another country, whether it is by another company of the group, or the same company in another country (by having double tax residency or by being a PE in Mexico); and (iii) deduction on net interests that exceed 30% of an adjusted tax profit (similar to an EBITDA). 

 

Note that the third one is based on the recommendations made in the BEPS Action 4 Final Report and would make net interests that exceed 30% of the adjusted tax profit non-deductible, very similar to the limitation recently enacted in the US, but with a MX$20M of excess to be allowed as a deduction among all companies in the Mexican group and the possibility to carry forward any non-deductible interests to the following 3 years.  Due to this, several particularities of the mechanic and other interpretations, we believe that it will initially seem to affect very few cases in practice and will prepare a separate newsletter analyzing this in detail.

 

Now, with regards to the other two, we can comment the following:

 

2.3.1 Payments to preferential tax regimes

 

Article 28.XIII of the MITL currently establishes that payments to entities, trusts, joint ventures, investments funds or any other type of vehicle whose income is subject to a preferential tax regime are non-deductible, unless the consideration or price is proven to be at arm’s length. Furthermore, Article 28.XXXI currently disallows the deduction of interest, royalty or technical assistance payments made to a foreign company that controls or is controlled by the taxpayer that is (i) considered transparent (unless the shareholders, members or partners tax the income and the payment is at arm’s length), (ii) considered inexistent for tax purposes in the recipient’s country of residence, or (iii) that the recipient does not tax the payment.

 

This is very closely related to the increased 40% withholding rate previously mentioned and in fact, the same administrative rule also applies to this (establishing that the restriction will only apply to related parties that do not reside in a country with an exchange of information agreement), but without providing any benefit over the MITL’s own provisions.

 

As a result, it could be seen that under the general assumptions of the current provisions, payments made to preferential tax regimes could be subject to an increased 40% withholding rate and also be non-deductible; however, this is not the case through the exceptions established in both the MITL and administrative rules and in reality, would only be the case of payments to non-residents that are (i) related parties, (ii) subject to a preferential tax regime, including transparent entities or vehicles, (iii) do not reside in a country with a broad exchange of information agreement and (iv) the price or consideration is not at arm’s length. The same would have to be true even if we want to look at only the deduction.

 

However, the Initiative proposes to eliminate Article 28.XXXI and amend Article 28.XXIII of the MITL to broaden the scope of such limitations significantly.  If approved, it would now consider any payment made to a non-resident related party that is subject to a preferential tax regime as non-deductible, thus effectively eliminating the exception where the consideration is at arm’s length. In fact, the legislative intent clearly mentions this and states that any payment to a related party subject to a preferential tax regime should be non-deductible even if the payment is at arm’s length since an erosion of the Mexican tax base continues to take place, even if to a smaller extent. 

 

Note that the wording would now refer to “payments made to related parties or through a structured arrangement, when the counterparty’s income is subject to a preferential tax regime”, thus also including cases where, even if not a related party, the payment qualifies as part of a structured arrangement.

 

Additionally, this proposal would also apply to payments that are not considered income subject to a preferential tax regime if the direct or indirect recipient of such uses the amount to make other deductible payments to another member of the group or by virtue of a structured arrangement, that is considered income subject to preferential tax regimes, regardless if the payment made by the recipient is made before the payment made by the Mexican taxpayer. Unless proven otherwise, this is assumed when said recipient makes deductible payments that are considered to its counterparty subject to a preferential tax regime if their amount is equal to or greater than 20% of the payment made by the Mexican taxpayer and the non-deductible amount in Mexico will be the amount paid that is income subject to a preferential tax regime.  This would apply regardless of the number of transactions involved and will be applicable only for transactions among members of the same group or by virtue of a structured arrangement.

 

Please note that a structured arrangement is defined as any agreement in which the taxpayer or any of its related parties participates and which consideration is based on payments made to preferential tax regimes that favor the taxpayer or one of its related parties, or when based on the facts and circumstances it can be concluded that the arrangement was made for this purpose.

 

Note that the application of this Section (non-deductible) would have the following exceptions:

 

  1. When the income subject to a preferential tax regime derives from the execution of a business activity of the recipient, provided that it proven to have the personnel and assets necessary for such activity, provided that the recipient has its effective place of management and is incorporated pursuant to a country or jurisdiction with an exchange of information agreement in place with Mexico. It is not clear if this exception would also apply to cases where the one subject to a preferential tax regime is not the direct recipient of the payment from the Mexican taxpayer (i.e. further payments as described above).

 

However, note that this exception does not apply when the payment is considered income subject to a preferential tax regime by virtue of a hybrid mechanism (defined as when the tax Mexican and foreign counterparties’ tax legislations treat a company, vehicle, income or owner of the assets differently, resulting in a deduction in Mexico and the payment is partially or entirely not subject to tax abroad) or when the payment is attributed to a PE or a branch of a member of the group or by virtue of a structured arrangement, provided that such payment is not taxed in the recipient’s country or jurisdiction or where the PE or branch is located.  Again, extremely broad and vague.

 

It is established that the previous paragraph would not apply to payments made by the taxpayer to one of its shareholders or partners, when the tax legislation in the country where they reside considers them inexistent or not taxable by virtue of considering the taxpayer as transparent for such country’s tax purposes, provided that such non-resident taxes the revenue generated by the Mexican taxpayer in proportion to its participation.  An example of this could possibly be a US shareholder that has checked the box on its Mexican subsidiary and therefore, does not tax the revenue received from payments by the Mexican subsidiary, but taxes the Mexican subsidiary’s revenue (not clarified, but it can be implied that it must tax all the Mexican subsidiary’s revenue).  If the total amount of payments exceeds the total amount of the Mexican taxpayer’s revenue taxed abroad, the excess will be non-deductible. Any amount originally non-deductible as a result of temporary differences will be allowed through administrative rules.

 

 

2. When the payment is indirectly taxed pursuant to Article 4-B (also included in the Initiative to tax income generated by Mexican taxpayers through transparent entities or vehicles) or CFC rules, also making reference to the possible issuance of additional assumptions through administrative rules.

 

3. When the payment is subject to the increased 40% withholding rate.

 

As it can be seen, this wording is extremely broad and vague and there is no way to clearly identify the transactions that could indeed qualify.  The fact that the wording merely makes reference to using the amounts to pay to another member of the group subject to a preferential tax regime, could eventually involve payments of any type, which could even be of a different nature. Likewise, the reference to the assumption of at least 20% being paid could be arbitrary and even excessive since it would disregard any real business reasoning behind the entire Group’s intragroup transactions or structuring. An absurd interpretation could be that all companies shall have at least an 80% profit margin in intercompany transactions.

 

2.3.2 Payments deducted in the same Group

 

Article 28.XXIX currently establishes that payments will be non-deductible when they are also deductible for a related party resident in Mexico or abroad, except when the related party that deducts the payment made by the taxpayer taxes the revenue generated by the latter in the same fiscal year or the following one.

 

With the Initiative, an amendment is proposed to Article 28.XXIX to broaden the current scope and apply to additional cases. 

 

Particularly, it would now cover three situations: (i) where the payment is also deductible for another member of the same group (only modifying the language from related party to member of the same group); (ii) when the payment is also deductible for the same taxpayer, but in a different country, basically, that is dual resident entities; and (iii) in the case of a PE of a non-resident in Mexico and the home office also claims the deduction.

 

As a general exception to this restriction, the deduction would be allowed when the member of the same group or non-residents referred to above tax the revenue generated by the taxpayer in proportion to their participation or in the case of dual resident entities, that the revenue taxable in Mexico is also taxable in the other country of residence.

 

Note that if the total amount of payments made exceeds the total amount the taxpayer’s revenue taxed by the mentioned persons, the difference will be non-deductible. Any amount originally non-deductible as a result of temporary differences will be allowed through administrative rules.

 

Again, we believe that there is significant lack of clarity and the situations described are very broad and vague, which will lead to difficulty in their application, without any description of what any supporting documentation may be.

 

III.Digital Economy

 

At the outset, please note that even though it has been highly publicized as a reform on the digital economy and that the intention to force them to be taxed in Mexico, we believe this is in fact, not a tax reform on the industry, nor does it create any taxes on them directly. Instead, it is a revenue-based reform to allow the Mexican government to collect the taxes levied on Mexican individuals that operate through digital platforms, by obligating such digital platforms to withhold or collect such taxes.  Ahead is a brief summary:

 

  1. Today, VAT is triggered by the Mexican users of a digital platform as an import of services; however, this tax is difficult to control and collect and therefore, the proposal changes this structure and now considers the platforms (resident or non-resident) as the VAT taxpayers, with the obligation to shift and collect the tax from the Mexican users and report and pay it to the Mexican government. Of course, this would mean having to register in Mexico.

  2. Additionally, in the case of platforms that act as intermediaries between Mexican users and Mexican providers (of goods or services), the non-resident digital platform is obligated to act as a withholding and/or collection agent with regards to both the VAT (50%) and income tax triggered on the underlying provision of goods or services between the Mexican parties.

  3. On the income tax side, the individuals can opt to have the withholding (which is based on a specific rate based on the amount of revenue) as a definitive payment, otherwise, although it is not clearly established, it would seem that the individual will compute its annual tax liability as professional fees, thus being able to claim the corresponding deductions.

  4. On the VAT side, the individuals can opt to have the withholding be the definitive payment, renouncing to their right to the VAT credit. Also, note that the general structure and credit mechanism for the non-resident platforms (on the new VAT triggered on their services) is uncertain.

  5. The proposal comes with extensive formal obligations, such as having to periodically provide a significant amount of information on the users, customers or parties involved, as well as all transactions executed and the appointment of a legal representative in Mexico.

  6. Lack of compliance with registration or formal obligations would initially allow the Mexican tax authorities to require the local carrier to suspend the non-resident’s internet connection in Mexico (practical and legal feasibility should be analyzed). 

 

IV.Anti-abuse provision

 

This proposal would include the “recharacterization” and “inexistence” of legal acts for tax purposes as legal concepts within the Federal Tax Code, establishing that legal acts that lack a business reason and generate a tax benefit will be recharacterized to those that would have been carried out to obtain the economic benefit sought or will be deemed inexistent when such benefit does not exist. Tax authorities, in the course of an audit, would be able to presume that legal acts executed by taxpayers lack a business reason when, among others, the economic benefit sought could be achieved with a lesser number of legal acts and its tax effect is more burdensome. Likewise, if the tax authorities discover that there is no economic benefit behind the execution of legal acts, these could be deemed inexistent.

 

The term “tax benefit” is understood to be any reduction, elimination or temporary deferral of a tax payment, which includes those achieved through deductions, exemptions, “not subject to” activities, no recognition of a gain or taxable revenue, adjustments or lack of adjustments or on the base of the tax, the recharacterization of a payment or activity, a change of tax regime, among others; however, the reform lacks a definition of “business reason” merely stating that there would be none when the economic benefit is less than the tax benefit, which could give rise to serious injustices by the tax authorities.

 

Although the tax authorities will not be able to reclassify or not recognize the acts without granting the taxpayer the right to argue and provide evidence against it, and it is established that it would be revealed as a result of the audit procedure, we consider that the provisions should also establish a particular moment in which the tax authorities shall duly analyze and evaluate the documentation and evidence provided to assure due process.

 

V. Disclosure of reportable schemes

 

Justified on Action 12 of the BEPS Report, which recognizes and recommends an opportune disclosure of relevant information so the tax authorities can act efficiently in combatting tax evasion, mainly in international financial transactions, the Initiative includes a proposal that can be seen as excessive and probably unjustified with the incorporation of a new Title “The Disclosure of Reportable Schemes”.  This new Title establishes the obligation for taxpayers and their tax advisors to reveal and secure authorization from the tax authorities on what they define as “reportable schemes”, divided into generalized and personalized schemes. Article 199 would define a reportable scheme as any that generates or may generate, directly or indirectly, a tax benefit in Mexico, along with 29 Sections of characteristics of such schemes mentioning both related party and independent transactions in Mexico or with non-residents.

 

Through this report, the tax authorities (through a Committee formed of people from the Tax Administration Service and the Ministry of Finance and Public Credit) would evaluate the legality of the benefits of the tax schemes in order to validate or reject their application within 8 months of the disclosure by notifying their opinion and granting an identification number for the scheme to be included in the return. Evidently, the approved and rejected schemes would be published in the tax authorities’ webpage.

 

We consider that in addition to being an excessive measure that goes beyond the current tax system, which is that taxpayers self-determine their taxes and the tax authorities have the ability to review them, this reform would limit the taxpayers’ activities since they will need a prior authorization to carry out practically any corporate, business or related-party activity.

 

Note that although the main obligation to report is mainly for tax advisors, there are several situations considered in which the taxpayer will also have the obligation to disclose the schemes they implement and there are situations in which they can both be subject to economic sanctions.

 

Lastly, the tax authorities have auditing powers to verify the compliance of these obligations and the statute of limitations will be suspended when the reportable scheme is not disclosed or it is incomplete or with mistakes, until the existence of the reportable scheme or missing or incorrect information is acknowledged.

 

 

*  *  *

 

 

As always, the Partners and Associates remain at your service for any questions or comments on the content of this Bulletin.

 

 

 

 

 

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