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Introduction to transfer pricing in Mexico
Transfer pricing rules
- Mexico’s transfer pricing (TP) legislation is stated in the Income Tax Law (ITL), Article 76 Sections IX, X, XII, Article 76-A, Article 179, and Article 180 and is based on the arm’s length, ie it follows the OECD Guidelines.
- The TP rules apply to Mexican taxpayers, including Mexican branches of foreign companies and there is a self-assessment regime, ie the burden of proof is on the taxpayer to confirm its TP meets the standard.
- The filing of TP Tax Returns before the Tax Administration Service (SAT – Servicio de Administración Tributaria in Spanish) is mandatory for companies with foreign intercompany transactions. For domestic transactions, it depends on whether the taxpayer chooses or is obliged to other tax obligations in which a TP section is included. If SAT requests transfer pricing documentation, the taxpayer will normally have a deadline of 10 business days to respond.
- The OECD concept of Master File and Local File is an obligation for taxpayers that exceed $791,501,760 pesos of cumulative income during the immediately preceding fiscal year, among other assumptions. It is important to mention that in Mexico, the TP report differs from the OECD local file, so there are taxpayers that must prepare the TP report and not the local file and taxpayers that must prepare both documents. In addition, for larger groups (more than $12,000,000,000 pesos of consolidated income) Mexico has applied Country by Country Reporting (CbCR).
- The Mexican ITL provides, as a means of interpretation the Transfer Pricing Guidelines for Multinational Companies and Tax Administrations (TPG), approved by the Organization for Economic Cooperation and Development (OECD) in 1995, or those that replace them, specifying that they will be applicable as long as they are consistent with the provisions of the Mexican ITL and the treaties entered into by Mexico. This regulation is not exclusive for legal entities, since in a harmonic interpretation of the ITL, the TPG are applicable to fiscal persons.
Transfer pricing methods
- Taxpayers must first apply the Comparable Uncontrolled Price Method (CUPM), and may only use the Resale Price Method (RPM), Cost Plus Method (CPM), Profit Split Method (PSM), Residual Profit Split Method (RPSM) and the Transactional Operating Profit Margin Method (TOPMM), when the CUPM is not the appropriate one to determine the arm’s length principle of the transactions performed in accordance with the TPG.
- Considering that the TPG establish that the order of application of the methods includes first the traditional methods (CUPM, RPM and CPM) and then the transactional methods (PSM and TOPMM), in Mexico this is the hierarchy of methods: (i) CUPM, (ii) RPM and CPM and (iii) PSM, RPSM and TOPMM.
- Mexico has a self-assessment regime, where the burden of proof is on the taxpayer to ensure that TP regulations are adhered to.
Transfer pricing documentation
Preparation of transfer pricing documentation
- In Mexico, there are four types of TP documentation: (i) transfer pricing report, (ii) local file, (iii) master file and (iv) CbCR.
- The ITL establishes the content of a transfer pricing report, which taxpayers will be obliged to prepare as long as they exceed 13,000,000 pesos as income in the immediately preceding fiscal year, and for taxpayers who provide professional services, the threshold is 3,000,000 pesos. Additionally, although the ITL expressly does not mention it, if a taxpayer carried out foreign intercompany transactions, they must prepare the transfer pricing report in order to be able to complete a return to which they are bound by having foreign transactions, regardless the income threshold.
- As far as the CbCR is concerned, Mexico is attached to what is expressed by the OECD, so the content that this report should include is the same as what the OECD indicates it should contain. The threshold for the CbCR is $12,000,000,000 pesos of consolidated income in the immediately preceding fiscal year.
Master and Mexico local file
- The Local File and Master File is an obligation for taxpayers that exceed $791,501,760 pesos of cumulative income during the immediately preceding fiscal year, among other assumptions. It is important to mention that in Mexico, the local file differs from the OECD local file, since part of the content that the OECD indicates must contain a master file, in Mexico it must be included in the local file. In addition, it is worth mentioning that the local file for Mexican purposes must be prepared in Spanish.
Some risk factors for challenge
- Limited risk distributor and contract services and maquila are high-risk schemes.
- Persistent losses in any entity.
- Transactions with low tax jurisdictions resident related parties.
- Business restructurings, or changes in TP model, can also trigger a challenge but needless to say, businesses can evolve, and if the previous TP method no longer appears the most appropriate, it should always be reviewed, rather than being ignored for the sake of maintaining consistency.
- Global marketing expenses payments if locally this type of expense are also incurred.
- Its important to mention that the elaboration of the TP report, could lead to reductions in fines for certain taxpayers.
- Tax authorities may calculate the taxpayers’ gross income and authorised deductions by determining the price or consideration amount of transactions entered into between related parties, on the basis of the prices and consideration amounts that would have been used by independent parties in comparable transactions, whether such parties are legal entities, Mexican or foreign residents, individuals, or permanent establishments in Mexico of foreign residents, and even when the activities have been carried out through trusts.
- When the commission of one or more violations leads to a total or partial failure to pay contributions, including contributions withheld or collected -except in the case of foreign trade duties- and this is discovered by the tax authorities through the exercise of their powers, a penalty of between 55% and 75% of the unpaid contributions will be imposed.
- When a taxpayer who has committed a violation covers unpaid contributions and the corresponding ancillary charges after the tax authorities have begun to exercise review powers but before the taxpayer is notified of the final audit report of the field audit or the audit report, the penalty will be equivalent to 20% of the omitted contributions, when the taxpayer who has committed a violation pays them together with their accessories after the exercise of the faculties of verification of the tax authorities begins and until before the notification of the final act of the domiciliary visit or the office of observations is notified to him.
- If the taxpayer covers the unpaid contributions and the corresponding ancillary charges after he is notified of the final audit report of the field audit or the audit report, as applicable, but before the notification of a ruling determining the amount of unpaid contributions, he will pay a fine equivalent to 30% of the omitted contributions. In the case of a failure to pay contributions due to noncompliance with the obligations, the penalties shall be 50% less. In the case of losses, the penalty shall range from 15% to 20% of the difference between the declared tax loss and the loss actually sustained, when the former is greater.
- The obligations regarding withholding and payment of taxes on account of third parties must be complied with, or, as applicable, a copy of the documents evidencing payment of said taxes must be obtained from such third parties. Payments made abroad may only be deducted if the taxpayer provides the information required under TP terms.
- Failure to file an information return on transactions conducted with foreign resident related parties during the immediately preceding calendar year or filing it incomplete or with errors. From $10,410 pesos to $34,730 pesos for each transaction not identified in the information return or for each error or mistake.
- Failure to file or incomplete filing of the information return on the tax situation, from $86,870 pesos to $173,730 pesos.
- Failing to provide the Information on Transactions Described In Official Format or the Information Annual Tax Returns From Related Parties, or provide it incomplete, with mistakes, inconsistencies or in a manner different to that indicated in the tax provisions. From $154,800 pesos to $220,400 to pesos.
Economic analysis and how to demonstrate an arm’s length result
- SAT will expect to see that a search for potential internal or external comparable transactions has taken place before defaulting to an external database search for comparable companies.
- In the case of using comparable companies from a region, the SAT would like to see an adjustment applied for differences in the markets where the comparable companies operate vs. the analysed taxpayer.
- Usually, the use of worldwide comparable companies search is employed.
- The use of the interquartile range is required and there is a methodology in ITL to perform this calculation.
- SAT is allowed to use 'secret comparables'.
Advance Pricing Agreements (APAs), dispute avoidance and resolution
- Advanced Pricing Agreements (APAs) are written agreements between a taxpayer and SAT to govern the appropriate transfer pricing method for a forward-looking period.
- APAs are common in maquila transactions. Although due to the volume of APAs filed, SAT response is very slow.
- Except for maquila APAs, it is extremely rare for a taxpayer to file an APA, although some cases do exist.
- The only exception to the TP rules in Mexico would be for taxpayers that do not exceed the income of $13,000,000 pesos in the immediately preceding fiscal year. In the case of partnerships that provide professional services, the exception would be for those that get income lower than $3,000,000 pesos in the previous fiscal year.
Digital services tax
- There are new VAT rules for companies dedicated to the digital economy. Therefore, those do not have TP effects.
SAT and taxpayer behaviour
- SAT has reinforced the elaboration of robust functional analyses that describe the assets used, risks incurred, and functions performed in each of the intercompany transaction analysed, exposing that a deficient functional analysis could lead to erroneous conclusions.
- In terms of TP and considering the effect of COVID-19, it is expected to postpone the filing date of the TP returns in order to be able to make 2020 comparisons and compare the 2020 financial information of the tested party against the 2020 financial information of comparable companies.