COVID-19 – Potential Tax Issues
With the global situation and the impending recession, governments all over the world have already begun to do their part in helping small, medium and large businesses. This has been done through different types of benefits, including tax or financial stimuli and at the very least, the deferral of tax payments and extensions of filing deadlines.
Unfortunately, that is not the case of Mexico. While countries like the United States and Canada have offered total Fiscal Response of 7.8% and 10.5% of their GDP respectively (combined total of credit enhancement, government spending and tax relief), Mexico has only offered so far a mere 1% of its GDP consisting mainly of government spending and some microloans.
The Social Security Institute has now also released a statement offering a deferral of social security contributions and at the State level, a lot of the States (Aguascalientes, Baja California Sur, Coahuila, Colima, Durango, State of Mexico, Guanajuato, Jalisco, Nayarit, Nuevo Leon, Quintana Roo, Sonora Yucatan, Guerrero, Hidalgo, Michoacan, Morelos, Oaxaca, San Luis Potosi, Sinaloa and Zacatecas) have indeed issued agreements granting the extension, deferral or reduction of local taxes such as payroll tax, lodging tax and property taxes, obviously the payroll tax being the most significant for the majority of the businesses. Mexico City and Queretaro will offer microloans and direct cash benefits respectively. Baja California, Campeche, Chiapas, Chihuahua, Puebla, Tabasco, Tamaulipas, Tlaxcala and Veracruz have yet to confirm if any incentives offered or not.
However, the above is clearly not enough to help mitigate the impact and therefore, ahead we will provide some possible alternatives that could be evaluated by companies in Mexico, some based on the possibility to defer revenue, increase deductions or simply defer payments, all to help companies with their cash-flow position.
1. Reduction of monthly income tax advances
Taxpayers must make monthly installments on their annual tax liability, which are computed by applying the profit ratio of the prior fiscal year to the nominal revenue obtained in the month, with the possibility of using favorable balances or carryforward losses.
Tax provisions foresee the possibility for taxpayers to have significant differences in the profit of one year versus the other and therefore, there is a possibility for taxpayers to reduce their monthly advances, but this can only be done starting July and not before, unless the tax authorities authorize it. However, given the circumstances, the probability of obtaining such authorization and the time it would take would have to be evaluated.
Alternatively, there is a Supreme Court jurisprudence that limits the tax authorities’ audit capacities on monthly advances of the current year only to the review of the compliance, impeding the assessment of taxes until the annual return is filed. Note that any amount not paid at the monthly level could eventually be subject to inflationary adjustment and interests even if paid at the annual level, resulting in expensive financing.
There could be additional alternatives that can be evaluated to reduce the profit coefficient without any authorization such as:
Re-evaluating FY2019 result to review if there are any deductions that could be accelerated or revenues that could have been deferred.
The possibility to transfer a portion of the business to a newly created company (which is exempt of filing monthly advances, as there is no profit coefficient) or to another company of the Group without a profit coefficient. This could be done through an asset transfer or a merger, of course caring for the limitations and assumptions of undue use of losses. A joint venture can also be considered.
2. Deferral of recognition of revenue
According to tax provisions, revenue is taxable at the earliest of: (i) delivery of goods or rendering of services; (ii) issuance of the invoice; or (iii) collection or due date of the collection, with the entire consideration agreed being taxable even in the case of advances.
As a result, an evaluation could be made to identify whether the conditions of the sales could lead to the deferral of the recognition of the taxable revenue such as sales through consignment terms, conditions that suspend the transfer of legal title or financial leases, which for tax purposes, are treated as a sale on installments, but with the possibility to defer the recognition of revenue until each lease payment (and the financing charge) is due or paid.
Due to the situation, interests may play an important role and it is important to keep in mind that while ordinary interests are recognized as they are accrued, late interests after the fourth month are only recognized when effectively collected.
Additionally, Miscellaneous Rule 3.2.4 allows taxpayers to only recognize the revenue of amounts actually collected in the year in the case of sales on installments, but cost of sales (if applicable) will also be allowed to be deduction in proportion. This is subject to certain restrictions which shall be reviewed, and it is essential that the good is not delivered or the service rendered.
3. Forex effects
The Mexican peso has taken a big hit from this situation and has had more than a 20% devaluation in the past couple of months, which obviously leads to significant foreign exchange effects. Note that Mexican tax provisions obligate Mexican taxpayers to recognize the phantom foreign exchange fluctuation effect in debts and credits, whether they are deductible or taxable. In this sense, we would strongly advise evaluating the effects of the fluctuation. Eventually, the term accrued could be analyzed (along with court precedents) to allow offsetting profits and losses generated from the sale credit or debt.
Obviously, a lot of companies will seek to hedge their positions and therefore, it will be very important to carefully analyze the tax effects of such derivative, considering the annual computation (phantom), partial payments, anticipated cancelations or changes or readjustments to the agreements.
4. Indirect cash-flow based taxes
Value Added Tax (VAT) and the Special Excise Tax on Goods and Products (IEPS, for its Spanish acronym) are both indirect taxes (i.e shifted through the different levels of the production, sales or services chain) that are entirely based on a cash-flow system, that is, they are triggered only at the moment the corresponding collections are effectively paid or collected.
They are computed and paid on a monthly basis and due to the ordinary course of business and their nature, it is common to have some months with a payable balance and some months with a favorable balance. In this sense, as previously mentioned, lack of payment could eventually be used, but could result in a very expensive financing, therefore, we would strongly suggest properly planning all transactions that trigger these taxes and the moments in which payments are made and received (i.e. commercial conditions with clients), in order to avoid unnecessary cash outflow and maximize the company’s financial position.
5. Transfer Pricing
Eventually, the global transfer pricing policy followed by MNC’s could be used to maximize the position in one country vs another and identify what may be most beneficial as a whole. Therefore, it will be very important to consider the ranges that can be applied locally in one country vs the other (i.e. Mexico vs the counterparty), as well as the overall group effect in order to identify whether an adjustment could actually be made.
Obviously, we believe that we are living extraordinary circumstances that should also be taken into account from a transfer pricing perspective and significant adjustments could be supported. Another important aspect will also be the financial impact from the inflationary and foreign exchange effects and it could be possible to try to modify the conditions and currency used to mitigate the impacts.
Particularly, we also believe that we could evaluate the possibility to suspend or defer certain cross-country charges, such as royalties, interests and others that may trigger withholding taxes when their deduction does not depend on the actual payment or due date, or even the forgiveness or waiver as a mechanism to use tax losses without triggering withholding taxes.
6. Tax Consolidation
The Mexican tax consolidation regime suffered a significant change a few years ago and has become extremely out of use. However, it may be worthwhile to evaluate considering that it does provide the possibility to use tax losses at a group level and grants a 3-year deferral of the income tax, being much more transparent and simple than the previous regime.
7. Certain non-deductibles
Due to the circumstances, we would just like to point out the following specific issues related to the deductibility of certain expenses that could be very important to place the company in the best tax position possible; particularly, seeking to avoid non-deductible expenses.
In this sense, financing could become key for the continuance of the operations of a lot companies in Mexico, significantly increasing their debt. As a result, note that Mexican tax provisions have to general anti-avoidance rules that limit the deduction of interests.
While thin capitalization rules limit the deduction of interests paid to non-resident related parties when the overall debt exceeds three times the company’s equity, the new limitation introduced this FY2020 disallows the deduction of any interest (paid to related party or not, resident in Mexico or not) exceeding 30% of the adjusted tax profit (similar to an EBITDA); therefore, considering the possibility of the need to increase debt, along with the potential reduction in profits or even generation of losses, it will be very important to carefully analyze this situation and plan accordingly.
Likewise, note that also as of FY2020, new limitations were introduced to the deduction of payments to non-resident related parties that are subject to a preferential tax regime (i.e. less than 22.5% income tax). Very vague provisions were included that seek to apply this limitation also to payments to unrelated parties or high-tax jurisdictions when they in any way benefit a low-tax related party.
8. Special Deductions
Some additional deductions or issues related to them that could be taken into account are the following:
Write-off of fixed assets that are no longer useful or identify possibilities to accelerate the deduction of investments.
Evaluate the current depreciation rates used to identify any possible changes to such rates. This could be useful to increase if the maximum rate is not currently being used, or decrease, depending on the planning needs.
Deduction of obsolete inventories
Evaluate the deduction of the provision for bonuses or rewards to employees to be paid in the following year.
Deduction of advance payments on expenses related to the following year
Restate or update the cost of sales pursuant to court precedents.
9. Reduction of Mexican investment
Similar to the transfer pricing situation and the different operating models that each corporate group may have, it may be possible to evaluate the migration of certain businesses, activities or allocate certain revenues out of Mexico and into countries with more competitive tax rates, as well as the allocation of revenues.
Eventually, Mexico could be used as a sub-holding to try to utilize the foreign tax credit related to taxes paid by other high tax jurisdictions and reduce the Mexican tax, or identify alternatives to allow the consolidation of international results such as by creating a branch/permanent establishment outside Mexico.
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As always, the Partners and Associates are at your service for any comments or doubts on the content of this Bulletin.
Please be advised that the matters discussed and content of this bulleting are not and shall in no way be construed as specific tax advice provided by SKATT Asesores Fiscales, S.C., its Partners, Associates or employees, nor does it involve the design, commercialization, organization, implementation or administration of a service that could relate to a “reportable scheme” in terms of the Federal Tax Code currently in force or any related provision. Its use is merely for informative purposes and therefore, any use given to its content or interpretation thereof will be the sole responsibility of the reader.
 Comparison released by the International Monetary Fund