Posts Tagged ‘intercompany transactions’

Mexican Transfer Pricing Rules in a Nutshell

May 5, 2014

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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IRS Transfer Pricing Audit Roadmap

May 3, 2014

 

Transfer Pricing NEWS

Dollar Hitch Hiking

The Transfer Pricing Operations (TPO) of the Large Business and International (LB&I) division of IRS released the 26-page Transfer Pricing Audit Roadmap to the public on February 14, 2014.

The Transfer Pricing Audit Roadmap (“Roadmap”) provides audit procedures around an approximate 24-month audit timeline. The stated goals of the roadmap are to assist both the IRS and taxpayer in the discussion and resolution of transfer pricing issues in a timely and orderly fashion, and to resolve issues in the Exam level rather than at Appeals. Also, the Roadmap is intended to provide insight into what to expect during a transfer pricing examination, as well as put a concrete work plan into place for the TPO to execute its transfer pricing audits. The Roadmap is not official guidance; it is a working document for revenue agents in planning their examinations without having to regularly consult the Internal Revenue Manual.

The Roadmap states, “Proper development of a transfer pricing position may take as much as 2-3 years or more.” Given this extended timeline, the Roadmap acknowledges that up-front planning will be essential to the examination process before the IRS commits significant resources to a transfer pricing examination.

There are three phases to the audit process as described in the Roadmap: Planning, Execution, and Resolution.

1. Planning

The Planning phase can last up to 6 months, and starts before the audit cycle begins. The Planning phase consists of a pre-examination analysis, an opening conference (which starts the 24-month examination clock), a transfer pricing orientation meeting (i.e., explanations by the taxpayer of its transfer pricing arrangements and financial information), and the preparation of the initial risk analysis and examination plan.

Company employees involved in the structuring of intercompany transactions will be requested to participate at the transfer pricing orientation meeting. Personnel “responsible for the transfer pricing study” will also be asked to participate. The IRS does not want the transfer pricing orientation meeting to be a high level review of the documentation, but rather a “comprehensive presentation,” according to the Roadmap. Domestic and foreign site visits may also be requested. The transfer pricing orientation meeting is perhaps the most important meeting during the audit, as it gives the taxpayer the opportunity to make its most compelling case for why its transfer pricing methods, analysis, and results are appropriate.

In the Planning phase the IRS will evaluate whether it thinks the taxpayer is shifting income to lower tax jurisdictions using transfer pricing. The Roadmap encourages IRS examiners to assess the functions, assets, and risks of the related parties involved in the intercompany transaction. These functions, assets, and risks should be described in the taxpayer’s transfer pricing documentation, which is reviewed by the IRS examination team. The Roadmap suggests that transfer pricing issues deserve further scrutiny if the taxpayer’s results are “at odds with common sense and economic reality” and if the taxpayer does not provide a convincing transfer pricing documentation report.

2. Execution

In the Execution phase, which can take up to 14 months, the Examiner will request information on the relevant transfer pricing issues from the taxpayer so that the IRS transfer pricing specialist can prepare a report on agreed facts. The IRS team will choose what it thinks is the best method for the intercompany transaction(s) at issue. The IRS team will apply its chosen transfer pricing method to determine an appropriate intercompany price. If this intercompany price is different than the taxpayer’s actual transfer price, and the IRS-determined price is beneficial to the IRS, then the IRS will have arrived at its basis for a proposed Section 482 adjustment.

3. Resolution

In the Resolution phase, which can take up to 6 months, the audit team conducts a pre-Notice of Proposed Adjustment (NOPA) issue presentation, resolution discussions with the taxpayer, and it issues a final NOPA. The taxpayer may disagree with the IRS position and is encouraged to state its reasons for disagreement.

 

Transfer Pricing INSIGHTS

  • The Roadmap states that “Transfer pricing cases are usually won and lost on the facts,” emphasizing fact gathering as a means of building a case not only for exam, but for successful litigation. There is consistent emphasis in the Roadmap reminding the exam team of the importance of first building a solid understanding of the facts before forming hypotheses and ultimately reaching conclusions. Accordingly, taxpayers are well-advised to ensure that their transfer pricing documentation is robust and presents a factual picture consistent with its tax returns and financial statements.
  • Expect increased involvement of IRS transfer pricing specialists within most audits, particularly during the Planning phase. The IRS developed the Roadmap to ensure that field audit teams use the transfer pricing resources within the Service. A key theme in the Roadmap is that “transfer pricing specialists must be involved in assessing potential transfer pricing issues at the earliest possible stage – ideally before the official audit commencement date.” These specialists will “help weed out issues that are not worth pursuing” and also help identify additional expertise that might be required to evaluate a taxpayer’s transfer pricing.
  • Transfer pricing documentation is the first and best opportunity to prevent a transfer pricing audit. While IRS auditors will know something about a taxpayer from tax return information and the company’s website, transfer pricing documentation reports allow companies to explain the business, including reasonable intercompany pricing results. IRS economists will assess the quality of transfer pricing documentation prior to meeting with the taxpayer. Companies without transfer pricing documentation may be surprised by initial IRS positions when meeting for the first time.
  • The IRS will issue the mandatory transfer pricing documentation information document request (IDR) with the IRS’ initial contact letter, rather than at the opening conference with the taxpayer, which has usually been the case.  Taxpayers therefore should be sure their transfer pricing documentation is complete and on hand (transfer pricing documentation must be prepared contemporaneously and be in existence when the Federal tax return is filed, and must be provided to the IRS within 30 days of receiving the documentation IDR).
  • Taxpayers can expect examiners to review the following documents during the Planning phase: IRC Section 6662(e) documentation (i.e., “transfer pricing documentation” – for penalty protection), forms 5471, 5472, 8833, 8858, 8865, 926, and schedules M-3 and UTP. The IRS team may also issue an IDR requesting worldwide, geographic, and segmented accounting data and financial statements from the taxpayer. If foreign data are important to the IRS team, it may request it from treaty partners – during the Planning phase.
  • To the extent the field team follows the roadmap guidance, taxpayers should expect a more rigorous transfer pricing examination. Taxpayers should be prepared for this process, which in most cases means much more will be required than merely updating comparables data in boilerplate or outdated transfer pricing studies.
  • Multinationals are faced with the prospect of double taxation unless the foreign tax authority agrees with the IRS position. While the Roadmap does not mention the Competent Authority process, any proper resolution should consider getting the IRS and the foreign tax authority to agree to a resolution. When there is not a resolution such disputes are typically handed off by the IRS examination team to either IRS Appeals or the Competent Authority process.

 

 

 

 


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