Mexico: Introduction of mandatory disclosure requirements for TP
As part of a sweeping effort to curb tax evasion and money laundering, President Andrés Manuel Lopez-Obrador’s administration amended the Federal Tax Code (FTC) to introduce a new Chapter VI ‘Disclosure of Reportable Schemes’.
Chapter VI is based on the OECD’s BEPS Action 12‘Require taxpayers to disclose their aggressive tax planning arrangements and provides the framework for Mexico’s mandatory disclosing requirements (MDR).
MDR establish that the tax advisors who designed, commercialised, organised, implemented or managed reportable schemes or the advisors who provide the complete reportable scheme for its implementation will be obligated to disclose it.
The definition of ‘tax advisor’ includes foreign-based advisors that carry out tax advisory activities under the same brand or commercial name as a Mexican-based related party, thus referring to international networks of accounting, consulting and law firms. Also, taxpayers who designed, organised, implemented or managed reportable schemes will be obligated to MDR.
The disclosing obligation applies to the reportable schemes that resulted in tax benefits applicable in fiscal year 2020 and beyond. Advisors or taxpayers are required to submit to the Mexican tax authorities – Servicio de Administración Tributaria (SAT) all the reportable schemes beginning on January 1 2021. For new tax schemes, advisors and taxpayers have to submit the report within the next 30 days after conclusion of the scheme’s design or after making it available to taxpayers.
The scope of the MDR is broad and extensive, since it encompasses all customs and general tax strategies designed or implemented directly or indirectly by the tax advisors or taxpayers.
Article 199 of FTC lists 14 schemes that must be revealed to the SAT in the established periods. Additionally, every February, the tax advisors will have to submit an informative tax return that includes the name and tax ID of the taxpayers that received the reportable scheme and an identification number issued by the SAT that is specific to the reported scheme. The threshold for reveal the reporting is 100 million pesos ($50 million approximately) in tax benefits.
The MDR in Article 199 of the FTC includes specific transactions between related parties regardless of the country of residence of the related party. These transactions include (a) the transfer of hard-to-value intangibles (HTVI), (b) corporate restructures without payment, (c) unpaid transactions such as in alienation of goods or services, (d) transactions with unique and valuable characteristics, and (e) the use of a unilateral protection regime or safe harbours under the terms of a foreign legislation.
The transfer of HTVI and the identification of transactions with unique and valuable characteristics present significant challenges for their assessment since regulations do not provide any definition or guidance.
Reportable schemes that include hard-to-value intangibles
Due to the lack of a definition in the MDR, in order to define whether an intangible should be considered as a HTVI, the immediate reference is the definition of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD TP Guidelines).
According to paragraph 6.189, if an intangible has the following characteristics, it could be considered as a HTVI: (i) no reliable comparable uncontrolled transactions exist and (ii) the projections of future cash flows or income expected, or the assumptions used in the valuing the intangible are highly uncertain, making it hard to predict the level of success at the time of the transfer.
Considering the abovementioned points, at least two questions arise: How is it possible to establish there are no reliable comparables? How is it determined if the forecasts and assumptions used in the valuation of the intangible are uncertain?
When companies are uncertain about the value of the intangible, at the moment of the transfer, the parties usually include, as a part of the agreement, mechanisms that could help to avoid the contingencies or risks involved. These mechanisms have the objective of re-assessing the future market conditions in order to adjust the payment, if required.
The future re-assessment of economic circumstances surrounding the transfer of HTVI and the potential additional compensation based on future outcomes may have a significant impact in the search of comparable transactions. In practice, reliable adjustments to account for these functional differences are sometimes difficult to determined or implemented, thus adding a complexity layer to the MDR.
Regarding the reliability of financial forecasts and assumptions used in a HTVI valuation, the OECD TP Guidelines include guidance in order to assess the situation of the intangible at the time of the transmission. The first and perhaps most important consideration is at which point of development is the intangible.
For instance, if the intangible is partially developed, the related buyer would likely have to complete the rest of the development, so this point leads to when the intangible would be ready to be exploited. If the intangible is not ready for exploitation at the time of the transmission, this introduce additional uncertainty to the forecasts and assumptions, since at the time the intangible is finished, the market conditions may have varied compared to the parties’ expectation at the time of the transmission.
The business environment, the stage of the intangible development and the information that could be reasonably foreseeable are very important considerations at the time of the transmission, these factors could be the difference between an intangible that could be analysed with uncontrolled transactions or a HTVI.
The information and facts at the time of the transmission should be evaluated and supported very carefully in order to define the appropriate methodology to value the intangible. If the intangible complies with the one of the above-mentioned considerations to be considered as a HTVI the transactions should be reported by the tax advisor as a reportable scheme.
It is important to mention that in case of a review of the tax authorities, the asymmetry of the information provided at the time of the review will be essential to determine if the tax authorities may accept the analysis made at the time of the transaction.
If the tax authorities do not have complete and similar information to the one available to the taxpayer at the time of the transmission, they may conclude that the conditions of the intangible transmission are not reliable and they may perform an ex-post valuation and adjust the price of the controlled HTVI transaction.
Reportable schemes: Unique and valuable
Similarly, to the discussion in the previous section, a reportable scheme is required when there are no reliable comparables because the transactions include functions or assets with ‘unique’ and ‘valuable’ characteristics. For the definitions of reliable comparables, we could use the same definition mentioned in the above paragraphs.
The Mexican laws do not provide a definition for either ‘unique’ or ‘valuable’, even though those concepts are included in other transfer pricing (TP) compliance requirements such as the appendices to the tax report (SIPRED, for its acronym in Spanish) and non-binding criterion (criterios no vinculativos). Also, it is important to clarify that ‘unique’ and ‘valuable’ characteristics in a controlled transaction is not limited to the analysis of intangibles, however, the definition available is the one is included in Chapter 6 (Intangibles) of the OECD TP Guidelines (The Mexican Income Tax Law mentioned that for interpretation the OECD TP Guidelines could be used as reference)
In the majority of TP analysis, few ‘unique’ and ‘valuable’ features are usually identified separately. Once the functional analysis is completed, the review of the financial support documentation is performed and it is possible to identify comparable transactions or companies in order to consider to apply any of the most common TP methods, such as comparable uncontrolled price (CUP), resale, cost plus or transactional net margin method (TNMM) methods.
However, if after the proper evaluation of the functions, assets and risks, it is not possible to perform a reliable benchmark analysis, it could imply that ‘unique’ and ‘valuable’ intangibles are likely to be present and the profit split method should be considered to test the arm’s- length nature of the controlled transaction and, as a result, it would have to be reported by the tax advisors as a reportable scheme.
Central America: TP audit trends
In Central America, tax administrations have carried out audits systematically over the years. A trend can be observed in the increase of audits derived from the fact that, over time, both taxpayers and tax administrations have acquired greater technical knowledge of TP regulations in the region. See below the audit actions of each country.
According to a recent interview carried out by the Guatemalan Institute of Certified Public Accountants and Auditors with the Inspection Intendant of Guatemala’s Superintendency of Tax Administration, the tax authority has taken the following actions:
- Audits of large and medium-sized taxpayers with operations with non-resident related parties;
- Audits based on a risk matrix, which identifies the operations with non-resident related parties that have the greatest impact on TP adjustments;
- Analysis of the information reported by taxpayers in the TP annexes to the tax return;
- Requesting information from taxpayers that, according to SAT records, failed to report operations with non-resident related parties;
- Requesting the TP documentation to taxpayers (approximately 1,500 taxpayers);
- Carrying out investigations using data included publicly available databases regarding business groups to determine possible unreported links.
Industries subject to increased scrutiny
According to public statements from the Inspection Intendant, taxpayers operating in the following industries would be subject to increased scrutiny: transport services, retail and wholesale trade, agriculture, livestock, hunting, forestry and fishing, construction, communication services, computer services, administrative and support service activities, electric power, manufacturing, insurance and leasing services.
According to Article 173 of the Tax Code, inspection, investigation and control are competencies and powers of the Tax Administration to ensure taxpayers’ effective compliance with tax obligations.
Recently, the newly appointed Minister of Finance publicly stated that tax oversight plans would continue and intensify in search of greater collection of tax revenues, with him particularly referencing the ‘anti-tax evasion plan’ that is being implemented.
Increased oversight over the income tax has been observed in recent years, with one of the main areas of adjustment being the strict indispensability (materiality) of intra-group services and challenges to costs and expenses with related parties because they are not considered necessary.
In previous years (2019 and 2020), the Court of Appeals for Internal Revenue and Customs (TAIIA) issued a total of 298 rulings (more than in other previous similar period). From these rulings, it is possible to observe that 45% correspond to income tax, 18% to the tax on the transfer of movable goods and the rendering of services (VAT), and the remaining 37% to other taxes and contributions. Nearly 45% of these are confirmatory rulings. Therefore, it is clear that oversight efforts have focused mainly on income tax.
As expected, the Tax Administration has focused on intragroup charges when carrying out TP examinations. The examinations also cover the analysis of strict indispensability of the services received. The Tax Administration carries out a pre-defined procedure to verify whether the deduction of these costs or expenses is applicable, declaring many of them inadmissible in the first two stages of the process.
If the strict indispensability of the cost or expense is proven, the Tax Administration verifies the other requirements, concluding with the verification of whether pricing is arm’s-length, through a review of the taxpayer’s TP documentation.
Costa Rica has one of the most updated TP legislative framework in Central America. This is the result of legislative changes required to align the tax regulations with the OECD TP Guidelines and Action 13 of the Inclusive Framework to put an end to the BEPS as a requisite to its OECD membership in 2020.
Despite the robustness of the regulatory framework, the tax authority’s compliance review process has not been extensive, targeting relatively few taxpayers, many of them in the retail and consumer-products industries. At the level of technical claims in those examinations, the tax authority has frequently rejected the selection of the most appropriate method and the modification of the comparable search processes; resulting in the modification of the arm´s-length range and the subsequent adjustment to the taxpayer’s taxable base.
Honduras introduced TP regulations in 2014 with the mandatory submission of information on related party transactions by means of an informative return.
The current regulations only require compliance with two formal duties: the timely submission of the aforementioned informative return and the existence of TP supporting documentation confirming compliance with the arm’s-length principle. Both documents will be required up on an examination.
“Articles 1 and 153 of the MITL sets forth that foreign residents with no permanent establishment in Mexico earning income from Mexican sources of wealth are required to pay income tax in Mexico”.
The most common technical challenges in recent TP examinations include the lack of reliable segmented financial information, the rejection in the selection of the best method, the verification of the selected comparable transactions or companies and the source of their financial data, and objection of the deduction for the use of intangibles licensed from non-resident related parties.
In case of payments for intra-group services, the tax authority usually challenges the taxpayer information to support this type of operations. The tax authorities frequently extend the scope of its examinations to include other aspects of the taxpayer’s tax compliance, which include the verification of a list of eleven requirements set forth by the tax authority to approve the veracity and therefore the deduction for intra-group service payments for tax purposes.
In relation to the economic sectors inspected, the agricultural sector – fruit production, mining, insurance and taxpayers in general that reported the existence of inter-company service transactions stand out.
The current TP regulation was reactivated in 2017 after a dormant period and required taxpayers to produce and maintain TP supporting documentation that must be available by the date of filing the income tax return, however, there is no mandatory filing of the supporting documentation.
Specifically for Nicaragua, no audit trends have been observed neither by sector nor by type of taxpayer, nor by type of inter-company transaction.
Taxpayers have seen an increase in TP-related requests that include the submission of the TP supporting documentation (including BEPS Action 13 master file).
No evident pattern with respect to industries or intra-group transactions for taxpayers subject to such requirements has been detected. On the other hand, usually TP examinations are triggered when differences arises in amounts disclosed between the income tax return and the TP informative return (Form 930).
When differences are identified, the tax authority usually invites taxpayer to amend the income tax return (if errors or omissions are found in the return). In case the taxpayer does not file the amended return, the omissions or late filing for the TP return carries a penalty amounting to 1% of the total amount disclosed inter-company transactions up to 1,000,000 balboa ($1 million).
Generally, TP audit process can be summarised in five steps where taxpayer and tax authority interact:
- Notification or communication;
- Resolution and liquidation;
- Appeals and reconsideration; and
- Substantive resolution.
The complete process lasts on average two years or more.
The rulings issued by the Panamanian tax courts, specifically the Tribunal Administrativo Tributario or TAT became guidance for taxpayers and practitioners. Some recent rulings cover the following technical issues:
- Comparable company information double check against databases;
- Challenge when using gross profit-based TP methods;
- Use of at least two comparables when defining the arm’s-length range; and
- Comparable agreements in force when used to test arm’s-length pricing.
The TP legislation has been applicable since 2011, with the obligation to submit information on related party transactions in an informative return. Consistent with the practice in other countries across Latin America, taxpayers are required to produce and maintain supporting documentation confirming compliance with the arm’s length principle. Dominican tax authorities require such supporting documentation before an eventual formal review process.
Regarding the most relevant technical aspects of TP examinations, it is possible to mention the rejection of the selection of the best method, the effort to carry out transactional analysis (as opposite to a global approach which test the taxpayer’s overall results). In this case, the tax authority usually tries to segment the financial information if the taxpayer does not provide the segmentation.
Other aspects commonly subject to challenge include the rejection of adjustments to increase comparability when they are inconsistent with the criteria used in the income tax return and the deduction of inter-company services received in cases where the taxpayer cannot demonstrate several factors among which the effective receipt as well as the need and benefit in its receipt.
At the level of the type of taxpayers subject to recent examinations, most cases observed range from large and medium taxpayers in manufacturing industries. Recent modification of the regulations to the general provisions on this matter, which include the obligations established in Action 13 of BEPS Inclusive Framework, could lead to new audits, based on the availability of additional and more detailed information to the tax authority.
The fact that the tax authority has access to data in the master file and the country-by-country report would provide a more profound macro view of how the taxpayer and its multinational group operate, the role and importance in the participation of related parties, the split of benefits, among others.
On the other hand, it is also worth mentioning that the tax authority has been willing to sign advance pricing agreements, as well as to negotiate procedures for the establishment of inter-company prices, all of this with the purpose of minimising litigation processes with taxpayers.
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Simón Somohano is a partner based in Tijuana responsible for Deloitte’s TP practice in Latin America and the Caribbean region.
Simón has more than 29 years of experience in the application of tax, economic and financial criteria in TP valuation analysis of intangibles, double tax issues, planning, business model optimisation, structuring and economic consulting. He advises across a variety of industry sectors, with a focus on automotive and manufacturing, maquiladoras, retail and consumer goods, real estate and the energy and resources market.
Simón holds a master’s degree in economics and finance from Warwick University’s Business School (UK) and abachelor’s degree in economics from the Universidad Panamericana (Mexico City).
Carla Segura is a partner at Deloitte Mexico.
Carla has more than 14 years of experience assisting multinational companies in TP matters including business valuations, intangible analysis, inter-company group policies. She specialises in TP topics for the finance, energy and construction industries.
Carla has a degree in public accountancy and financial strategy from the Instituto Teconológico Autónomo de México(ITAM), where she specialised in financial strategy and corporate advisory.
|Mario Roberto Coyoy González|
Mario Roberto Coyoy González is a partner based in Guatemala, working on the tax and TP practices for both Guatemala and El Salvador. He has more than 18 years of experience serving local and multinational clients.
Mario has developed experience in local and international tax planning strategies and structuring assistance, including TP analysis.
Mario is an active professor of the Faculty of Economics at the Francisco Marroquin University and the Faculty of Attorney at Law at the Rafael Landivar University in Guatemala. He is also an instructor in a number of public courses and seminars about tax, TP, accounting, and financial and business issues.
Roberto Revel is a partner in charge of the TP departments of Costa Rica, Dominican Republic, Honduras and Nicaragua. He has more than 15 years’ experience in the area.
Roberto has experience in TP projects in Venezuela, Costa Rica, Honduras, Nicaragua and Dominican Republic. He currently provides TP compliance services, preparation of documentation to support TP policies before and within an audit processes, as well as TP policy definition for multinational groups.
Roberto graduated from the Central University of Venezuela with a degree in Business Administration as well as a specialisation in Finance.
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