Mexican Transfer Pricing Rules in a Nutshell

The Basics of Documentation, Penalties, and Red Flags   Mexico Flag

 

Mexico first enacted transfer pricing documentation requirements in 1997. The Mexican Income Tax Law (MITL) requires application of the OECD transfer pricing guidelines (OECD Guidelines) to the extent consistent with the MITL and any applicable treaty. The transfer pricing rules are included primarily in Articles 86, 215, 216, and 216-BIS of the MITL.1

Article 86 discusses transfer pricing documentation. Article 215 discusses comparability, business cycles, permanent establishments and transfer pricing, tax havens, and OECD Guidelines. Article 215 also states that two or more persons (parties) are deemed to be related when one participates directly or indirectly in the administration, control, or capital stock of the other (person or party).2 Article 216 discusses transfer pricing methods, ranges, and selection of the most appropriate method.

Mexican taxpayers are required to maintain transfer pricing documentation demonstrating that intercompany transactions are conducted at arm’s length. Taxpayers whose revenue in the preceding fiscal year did not exceed MXP 13 million (MXP 3 million for professional services companies) are not required to comply with the documentation requirements, unless the foreign party is located in a preferential tax regime (on audit these smaller companies must still prove intercompany transactions are arm’s length). Transfer pricing documentation must be in place at the time the company files its annual income tax return (typically by March 31 of the following year) and must be kept along with the company’s accounting records for at least five years after the filing of the last tax return for each year.3

Article 86 (Section XII) of the MITL requires taxpayers to include the following elements in transfer pricing documentation (Mexican tax authorities require all documentation to be in Spanish):

  • Name of the company and corporate name
  • Names of the related parties
  • Description of the ownership structure – covering all related parties engaged in transactions of potential relevance
  • Overview of the taxpayer’s business
  • Analysis of economic factors affecting the pricing of intercompany transactions
  • A description of the functions performed, assets employed, and risks borne by each related party to the intercompany transaction (i.e., functional analysis)
  • Annex 9 of the Information Return requires a confirmation of the existence of transfer pricing documentation for each intercompany transaction, the amount of the transaction, the type of transaction, the gross or operating margin obtained by the tested party for one of the transactions, the transfer pricing method used for each transaction4, the taxpayer identification number of the related party, and the country of residence and address at the tax domicile of the related party
  •  Appendix 32 of the Statutory Tax Audit Report (“Dictamen Fiscal”)5 must be completed and filed by June 30, including details of the intra-group transactions carried out by the related party, information on the related party, as well as some details of the analysis
  • Appendix 33 of the Statutory Tax Audit Report must be completed and filed by June 30, including information with regard to whether the taxpayer has documented the arm’s length nature of all domestic and cross-border intra-group transactions
  •  The Questionnaire of Transfer Pricing Matters must be completed by the external auditor filing the Statutory Tax Audit Report. This questionnaire is the auditor’s responsibility, and it covers what the auditor reviewed relating to transfer pricing documentation.

 

Transfer Pricing Penalties

The transfer pricing penalties are included in the Federal Fiscal Code. Article 76 states that if taxpayers do not have documentation supporting the determination of taxable income, and a transfer pricing adjustment is determined by the SAT, penalties could vary from 55% to 75% of the omitted taxes, plus surcharges and inflation adjustments.

When the taxpayers have transfer pricing documentation that supports the determination of taxable income and an adjustment is proposed, the penalty is 27.5% to 37.5% (a 50 percent reduction in the penalty if the taxpayer keeps supporting transfer pricing documentation).

If a transfer pricing adjustment reduces the net operating loss (NOL), the penalty ranges from 30% to 40% of the difference between the determined NOL and the NOL in the tax return, plus surcharges and inflation adjustments. In the case of over-determined NOLs, penalties could be reduced to 15% to 20% of the overstated NOL if the taxpayer has transfer pricing documentation.

 

Red Flags

Mexican tax authorities are focusing audits on the following transfer pricing areas:

  • Business Restructuring – The following business structures are high risk from an audit perspective: limited risk structures, migration of intangible property and centralization of functions and risks in favorable tax jurisdictions, highly leveraged structures, and cost-sharing agreements
  • Headquarter Service Fees – The Mexican tax authority Servicio de Administración Tributaria (SAT) is challenging service fees paid to a foreign related party. A frequent concern is lack of sufficient evidence to establish that the services were provided, and that there was a business reason to pay for them. Taxpayers must show that the following tests are met:
  1. The “strictly indispensable deductibility criteria”
  2. The service was actually received
  3. The service received carried an economic benefit
  4. The service is not duplicative
  5. The service is not stewardship
  • Certain Industries – Offshore drilling, mining, pharmaceuticals, automotive, retail, and tourism industries are under high scrutiny
  • Aggregation of Intercompany Transactions – Mexican tax authorities are challenging the grouping of products and different types of transactions. Also, the aggregation of operating results to test transactions is being disallowed, resulting in required separate analyses of purchases, sales, royalties, etc., rather than accepting overall operating results.

 

Footnotes:

Article 216-BIS of the Mexican Income Tax Law sets out the conditions under which a foreign related party with maquiladora operations in Mexico is considered to have a permanent establishment in that country. However, the foreign related party may be exempt of a permanent establishment if an Advance Pricing Agreement (APA) is obtained with the tax authority. A discussion of rules relating to maquiladoras and APAs are outside the scope of this article.

2 The is no specific threshold for the entities to be considered related parties (even if there is a 1 percent ownership of the shares, the entities are considered related).

3 It is important for the taxpayer to have five years of transfer pricing documentation on hand since the statute of limitations on the assessment of transfer pricing adjustments is five years from filing date of the tax return. When the tax authority requests a taxpayer’s transfer pricing documentation, the taxpayer has 15 business days to submit it to the SAT.

4 Article 216 of the Mexican Income Tax Law defines six transfer pricing methods allowed for analysis of transactions between related parties. These methods are consistent with those defined in the OECD Guidelines: Comparable Uncontrolled Price, Resale Price, Cost Plus, Profit Split, Residual Profit Split, and Transactional Operating Profit (equivalent to the Transactional Net Margin Method in the OECD Guidelines). According to the Mexican regulations, companies must apply the Comparable Uncontrolled Price (CUP) method in their transfer pricing analysis unless they are able to demonstrate that this method is not appropriate to determine that the transactions were conducted at arm’s length. Profit-based methods are to be applied if the CUP, Cost Plus, and Resale Price methods are not applicable.

5 According to PricewaterhouseCoopers’ guide “International Transfer Pricing 2013/14”, the following taxpayers must file a dictamen fiscal:

  • Companies that obtained gross receipts in excess of MXN 34,803,950 during the prior fiscal year (approximately USD 2.9 million)
  • Companies or groups of companies whose net worth (calculated pursuant to the Mexican Assets Tax Act) during the prior fiscal year exceeded MXN 69,607,920 (approximately USD 5.8 million)
  • Companies with at least 300 employees in every month of the prior fiscal year (1 January – 31 December)
  • PEs that fall in any of the above scenarios described under (1), (2) or (3)
  • Companies involved in or arising from a corporate division or a merger during the year of the transaction and during the subsequent year
  • Entities authorised to receive deductible charitable contributions
  • Companies in the liquidation period if they had the obligation during the prior fiscal year

Please feel free to use this contact form for any questions or further explanation on “Mexican Transfer Pricing Rules in a Nutshell”

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