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Mexico implements country-by-country report and provides exemption from thin capitalization rules

Mexico's president on 8 September sent to Congress an economic package that includes proposed amendments to the Income Tax Law (ITL) and the Federal Fiscal Code (FFC) with transfer pricing implications. According to the legislation's explanatory memorandum, the goal is to incorporate the BEPS agenda in the Mexican regulations, and is considered an international commitment following the country's active participation in the working groups at the OECD and the G-20.

New informative returns

The initiative proposes the inclusion of a new Article 76-A of the ITL, which would create three new informative returns. The returns must be submitted by 31 December of the year following the fiscal year reported.

According to the explanatory memorandum, the information required under this provision from multinational groups meets the standards outlined by the OECD. In particular, the statements seek to incorporate in Mexican law the effects of two documents issued by the OECD, Guidance documents on Transfer Pricing Documentation and Country-by-Country Reporting (September 2014), which includes modifications and annexes to Chapter V of the OECD's Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, and Country-by-Country Implementation Package (June 2015).

Required information includes quantitative and qualitative data. For example, the new provision requires the submission of information on the taxpayer's strategic activities or the financial information of comparable operations when present.

The proposal refers to the following informative returns:

1. Master Related-Parties Informative Return – Multinational business group: Includes information on the multinational group as a whole, such as activities, intangible property, and financial and fiscal position.

2. Local Related-Parties Informative Return: Focuses on the local taxpayer's activities, financial information, and comparable transactions.

3. Country-by-country Informative Return – Multinational business group: Includes detailed information for each jurisdiction of the entities in the group, permanent establishments, company activities, income distribution, and tax payments.

The country-by-country return is applicable only to certain taxpayers. Mexican multinational groups are required to submit this return based on certain criteria, including, for example, the requirement that the taxpayer must have consolidated revenues of 12 billion pesos (about 750 million euros). This means that in practice only a very small group of local taxpayers (approximately 150-200) will be subject to the requirement to file the country-by-country return.

The rule authorizes the Tax Administration Service (SAT) to modify this threshold (that is, reducing the number of taxpayers subject to this requirement) and Congress is allowed to decrease the threshold each year (increasing the number of taxpayers subject to this obligation).1

Subsidiaries or permanent establishments of residents abroad are required to submit the country-by-country report to the extent they have been appointed by the controller of the multinational group as the entity obligated to file that statement. If the taxpayer is not the designated entity, the SAT may request this information by means of the information exchange procedures established in the international treaties that Mexico has in force.

It is important to note that the content of the OECD's country-by-country guidance is applicable under Mexican law to the extent it is based on the OECD's transfer pricing guidelines, as long as it is not inconsistent with the ITL, whereas the OECD's CbC Implementation Package is not valid legally in Mexico per se. Furthermore, Article 76-A does not refer to either of those documents. As a result, the proposed wording for Mexico's country-by-country return is not clear. For example, the process of "assignment" (equivalent to "Reporting Entity" noted in the Implementation Package) cannot be understood in isolation. It does not clarify what happens in cases when Mexico has not concluded a double taxation treaty with the country of residence of the entity designated to file this return.

It is important to note that much of the information to be reported in the Master and Local Related Parties Informative Returns is already required in other information returns, as well as in contemporary transfer pricing documentation (sections IX and XII of Article 76 of the ITL). However, proposed Article 76-A strengthens the existing provisions, because it creates an obligation to submit (not only retain) that information to the authorities, and at the same time creates a specific obligation for the Mexican taxpayer to provide information on the business operations of its foreign related parties, and not just those that relate directly to their business activity. Meanwhile, the country-by country return involves a major change in taxpayer obligations, but is limited its scope to a small number of taxpayers.

The provision, in its current wording, creates legal uncertainty because its scope is unclear. Terms like "financial and fiscal position" are not clarified, although they refer to quantitative data, while terms such as "activities" or "strategic" involve broad concepts. Furthermore, the provision does not state its commitment to the standards outlined in the CbC Implementation Package. Finally, the proposed regulation leaves it to the SAT to determine the general rules for submitting information, including media and formats, and allows for the possibility of requesting "additional information," without limiting or defining the scope of that request.

By reference to Article 32-H of the FFC, Article 76-A exempts taxpayers that are not engaged in transactions with foreign parties from the obligation to file this return, provided they are not listed on stock exchanges or have tax revenues in excess of 644,599,005 pesos (adjusted for inflation) and are not subject to the optional tax regime. It is not clear whether the Master Return applies to firms operating exclusively in Mexico, because they are not covered by the exemptions mentioned above, but they would not fall under the term "multinational enterprise group."

The disclosure statements for fiscal year 2016 would be submitted no later than 31 December 2017. Meanwhile, the initiative to reform the Tax Code Federation adds fines for not filing, late filing, errors, or omissions in the proposed statements. More importantly, taxpayers that do not comply with Article 76-A will find themselves unable to participate in contracts with the Federal government, state-owned companies, and the Attorney General's Office, to provide goods, leases, services, or public works.

Thin capitalization

In a welcome development, the economic package for 2016 also includes a proposal to reinstate the exemption from the application of the thin capitalization rules for companies engaged in the generation of electricity. Thin capitalization rules limit the deduction of interest expense with foreign related parties to a debt-to-equity ratio of 3:1. The constitutional reform to the electric industry that allowed private investment in this industry also removed the generation of electricity from the list of strategic activities of the Mexican state, thus eliminating the exemption from the thin capitalization rules that the industry enjoyed until then.

The changes resulting from the energy reform eliminated the generation of electricity as an exempt activity under the thin capitalization regime. The proposed amendment reinstates the exemption to expressly mention it. It is worth noting that this does not exempt taxpayers engaged in this activity from the need to demonstrate that their interest deductions comply with the arm's length principle in accordance with Article 179 of the ITL.

  1. The Federal Executive cannot unilaterally impose tax obligations on taxpayers; Congress is the authority empowered to decrease the threshold.