Transfer pricing has become a major tax topic in Mexico's tax audits. Multinational companies (MNEs) are starting to view this issue not only as a mere compliance requirement but as a strategic risk assessment area within the Company's tax division.
The increased importance of transfer pricing can be seen through the current inclusion of new and further development of provisions and regulations in Mexico for transfer pricing matters, such as the informative tax return of relevant transactions, the transfer pricing requirements for local file, master file and the country by country report established in Article 76-A of the Mexican Income Tax Law ("MITL"), the informative tax return of transactions carried out with non-resident related parties, among others.
In addition, there are some other important rules which have been introduced to the Mexican transfer pricing regime through miscellaneous tax resolution, in general those related to advance pricing agreements ("APAs"), mutual agreement procedures and transfer pricing adjustments.
Before year 2016, in general the transfer pricing regime required taxpayers to obtain and conserve contemporaneous transfer pricing documentation as evidence of the arm's length nature for related party transactions. Derived from Action 13 of the base erosion and profit shifting ("BEPS") project, this situation has resulted in a 180-degree turn shifting transfer pricing documentation into a source of privilege information for tax authorities when it comes to design of risk assessment models and efficient tax audit programs.
This was an important development in the Mexican transfer pricing regime. Moreover, the administrative rules for Article 76-A related with transfer pricing informative returns were issued by the tax authorities after a public consultation organized by the tax ombudsman office. This is a reflection of the importance of transfer pricing in the Mexican tax system.
As of today, Mexico's Tax Administration's ("SAT" in its acronym in Spanish) transfer pricing division has well prepared officers participating in many transfer pricing audits and assisting a significant number of taxpayers with APA requests mainly related with maquiladoras. Also, there are tax audits from other divisions in which there are important transfer pricing issues under controversy.
There are related party transactions or tax items commonly under scrutiny by tax authorities such as advertising, marketing and promotion expenses, royalty payments, technical assistance, supply chain structures and interest payments, among others.
In general, within a tax audit taxpayers have to demonstrate compliance with formal requirements and moreover economic substance for the related transactions.
There are significant concepts involved in a transfer pricing audit including alignment of value creation and DEMPE (development, enhancement, maintenance, protection and exploitation of intangibles) activities.
Taxpayers have access to mechanisms for reaching alternative dispute resolutions for handling a tax audit.
A conclusive agreement is a mediation mechanism established in the Federal Tax Code. It can be requested before the tax assessment is issued by the tax authorities before the tax ombudsman office (Procuraduría de la Defensa del Contribuyente "PRODECON" in its acronym), and they have a very important role as a mediator in tax a controversy between the taxpayer and tax authorities.
There are benefits when submitting this mechanism such as the suspension of the term for issuing a tax assessment until the conclusive agreement procedure is over. Another benefit is the forgiveness of the tax penalties on the first conclusive agreement.
The Mutual Agreement Procedures ("MAP"), Bilateral Agreement Procedures ("BAPA") and APAs are additional dispute resolution mechanisms that have proven efficient and successful when a tax controversy arises. These processes involve participation of two Tax Authorities representing different tax jurisdictions invoked by a taxpayer under the umbrella of a tax treaty to avoid double taxation.
Although this has resulted in an important alternative dispute resolution mechanism, it is not mandatory for tax authorities to reach an agreement, this is not in all cases a taxpayer obtains double taxation relief.
In general, these mechanisms are preferred than tax litigation whenever taxpayers face a significant tax contingency subject to the interpretation of transfer pricing matters which in some cases have a high level of subjectivity. Of course, these alternatives should provide better results whenever the tax audit is handled timely in order to also have the possibility to continue with the litigation course if a settlement is not reached.
Mexico has made important efforts to adopt and implement recommendations from the BEPS project. Moreover, Mexico has signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (MLI). In this sense it should be expected an increase in number of MAPs as an alternative dispute resolution instrument for tax audits.
Regarding tax arbitration, historically Mexico has not accepted to enter into this dispute resolution mechanism and recently reconfirmed this position when signing the MLI. Hopefully, Mexico may change its policy so as to accept entering into the tax arbitration mechanism.
As a final thought, timely and skillful representation during audits including high level of economic substance is the essence to resolve transfer pricing controversies, particularly in today's worldwide environment of increased scrutiny on related-party transactions.