The Mexican tax authority SAT (for its acronym in Spanish) has issued expected effective income tax rates for large taxpayers related to 40 industries. The aim of the SAT is to encourage taxpayers to effectively comply with their tax obligations, to review their effective tax rate and, if necessary, to take steps to adjust their tax position (by filing supplements) in order to avoid tax audits.
The SAT has often expressed its intention to increase tax collections from large taxpayers by improving the audit process to provide a framework for legality and security for taxpayers. To achieve this goal, it carried out several actions, of which we highlight:
- In February 2021 the Operation plan 2021 was published by the SAT’s Large Taxpayers Department and indicates which industries were audited in 2020, the scope of those audits and taxes audited, as well as the main industries that will be audited in 2021 and their scope of cooperation and information sharing by SAT with other countries to strengthen Mexican tax audits. Finally, in this document, the SAT mentioned that the recent reforms of Mexican tax law were carried out to optimize the tax system. Recently reformed measures included: i) the provision of benchmarks of profit margins, deductions and rates by sector; (ii) business reasons; (iii) Reportable Transactions; (iv) Provisions for Limiting Interest Expenses.
- In December 2020, an amendment to the federal tax code has been published, in particular Article 33, first paragraph, Section I, subsection i). This change enabled the tax authorities to provide the taxpayer parameters (benchmarks) related to profit, deduction concepts, effective tax rates and profit margins based on economic sector or industry.
The purpose of disseminating this information is to measure tax risks so that taxpayers, their legal representatives or, in the case of legal entities, their management / authority bodies, can identify and address risk assumptions and then decide to voluntarily comply with these parameters.
- On June 13, 2021, the SAT published the first Effective tax rate benchmarks for 40 industries for the financial years 2016 to 2019. This information is relevant for large taxpayers, as the limitation periods for these years have not yet expired.
The above benchmark is the result of analyzes carried out within the SAT of institutional databases that contain information such as annual returns, tax reports (Dictamenes Fiskales), information on taxpayers’ tax situation, informative declarations, digital tax receipts and entry summaries (pediments) .
The purpose of the SAT in issuing the benchmarks is to inform large taxpayers of the rate corresponding to their economic activity (set by the SAT) so that they can compare this with their own effective tax rate for each financial year in order to measure tax risks and, if they adjust their tax positions through an amended annual income tax return. The latter measure would enable them to minimize the risk of further scrutiny by the SAT. The benchmark courses can be viewed on the SAT website.
The SAT has announced that it is currently (in addition to the 40 industries already published) is working on benchmark effective tax rates for the remaining industries in Appendix 6 of the Other Tax Regulations and will publish the results shortly.
What is the benchmark?
The 40 branches of industry Originally viewed by the SAT, they are part of five economic sectors: mining; Manufacturing industries; Wholesalers; Retailers; as well as financial services and insurance. The manufacturing and retail sectors are heavily focused on automotive and pharmaceutical products.
The SAT defines the effective tax rate as the ratio of income tax to revenue. According to the SAT, the “effective tax rate” for each economic activity was determined on the basis of a consolidation of taxpayers according to relevant economic sectors, taking into account the relevant economic activity reported prior to the SAT when registering in the federal taxpayer register as well as the most recent annual income tax return for the respective tax year. In addition, the SAT advises that taxpayers with an effective tax rate above the reference rate have a low audit risk, while taxpayers with an effective tax rate lower than the reference rate have a higher audit risk.
In order to minimize the tax risk of an in-depth review in each of the financial years 2016 to 2019, the SAT assumes that the effective tax rate reported by the taxpayers is equal to or higher than the percentages determined by the SAT for each financial year (expected effective tax rate) . The ratio reflects the taxes a company would have had to pay out of its income. For example, a taxpayer who makes or assembles automobiles and trucks would have paid MX $ 1.32 in tax for every MX $ 100 in sales – meaning that 1.32 percent is the “effective tax rate”. In addition, companies that manufacture parts for automobiles in the same automotive segment should pay 5.32 percent tax on every MX $ 100 in sales.
It is important to emphasize that the “effective tax rate” could be used to calculate an implied pre-tax operating income as a percentage of sales (using certain general assumptions). This ratio can be a more realistic measure of profitability when measuring and performing a benchmark analysis. As an example, we took the same rate – an effective tax rate of 1.32 for car and truck assembly. This rate could result in an implicit operating margin (before tax) of 4.40 percent (under certain assumptions). In the other example, the effective tax rate of 5.32 percent for the automotive other parts manufacturing sector could equate to a pre-tax operating margin of 16.43 percent (including certain assumptions). This expected profitability appears to be a significantly high value for expected profitability for a company operating in this sector in fiscal year 2019 based on benchmarks of listed companies (North America region) with publicly available information contained in a similar branch and branch (NAICS code).
Relevance of the benchmark for transfer pricing
Benchmark analyzes are usually used in the economic analysis in the transfer pricing documentation in order to check compliance with the arm’s length principle.
One of the transfer pricing methods commonly used by Mexican taxpayers is the transactional net margin method (TNMM). This methodology requires benchmarking companies that perform similar functions, take similar risks, and hold similar assets in a similar “industry” as the tested company, which in most cases is the Mexican taxpayer.
This benchmark published by the SAT shows an expected operating margin behind the “effective tax rate” (under certain assumptions) that companies should achieve. When the Mexican taxpayer has a significant portion of his income or deductions with related parties, the natural process of setting a higher tax rate seems to be to adjust his transfer pricing. Therefore, the taxpayer should carefully review its transfer pricing policy, documentation, peer group companies used in the benchmark analysis and any deviation from the results of the tax authority’s expectations in order to arrive at a correct risk assessment that will serve the company and allow appropriate action to be taken to comply with the tax authority To take the arm’s length principle.
In the analysis of the auto parts manufacturing sector, the median of the eight different sectors indicated an operating margin of 8.2 percent over a three-year average. This 8.2 percent operating margin can typically be in the upper range or above the range of potential peers normally used by companies in this industry (in certain circumstances and circumstances). This can anticipate a detailed check of the comparable companies and the range as part of a transfer pricing check.
This benchmark analysis published by the SAT needs to be carefully analyzed by the Mexican taxpayer and its headquarters to carefully review their transfer pricing policies, results and documentation in order to be ready to support the arm’s length results and the potential differences in profitability expectations the local entity should can be obtained through the correct application of the arm’s length principle.
Even if the effective tax rates determined by the SAT for 40 branches of the economy are not binding for taxpayers, it is expected that the SAT will use these effective tax rates as a reference for identifying taxpayers for tax audits.
For Mexican companies – whether or not their economic activity is included in SAT’s initial analysis – it is advisable to be aware of these new developments and the upcoming release of the expected effective tax rates while stepping up their efforts to get solid records to collect that their tax position.