The Corporate Tax Planning Law Review: Mexico
As evidenced in the OECD's Action Plan on Base Erosion and Profit Shifting (BEPS) and report, many see tax planning as the ultimate cause of countries' economic slowdowns, reduced social welfare and even anticompetitive behaviour from economic agents. It is depicted as the fourth horseman of the Apocalypse: Death itself.
However, Judge Learned Hand's conclusion in Gregory v. Helverin,2 a landmark decision by the United States Supreme Court concerned with US income tax law, still stands true, and taxpayers may arrange their affairs so that their taxes are as low as possible. There is no patriotic duty in paying more than the law demands. Courts have declared time and again that there is nothing sinister in arranging affairs to keep taxes as low as possible. Everyone – rich and poor alike – does it.
As legitimate business goals and transactions often may be arranged in more than one way, it is possible to choose the tax strategy that best works for taxpayers. However, a 360-degree perspective is essential to comply with every rule that might come into play. For example, the substance of a transaction and compliance with the arm's-length standard are fundamental issues to consider, but they are seldom the only ones. Adequate planning requires considering every possible legal and tax issue. In addition, planning should not rely on opacity but rather on transparency and the potential scrutiny of a tax authority or court.
The main purpose of this chapter is to review the elements of Mexican tax legislation that might impact tax planning, business planning or revenues themselves.
Influenced by the BEPS Action Plan and the US, Mexico has enforced rules meant to spot the true essence of transactions and tax them accordingly. These rules have a direct impact on the way tax planning is carried out. Interestingly enough, Mexico is not shifting from a formalistic approach to a substance approach. Formal requirements now coexist with substance requirements, and failure to comply with any of them might equally lead to contingencies. These recently introduced measures on substance and business requirements are further described below.
The most significant development in the Mexican tax system that might affect tax planning is the materiality concept created by case law that has been in place in other jurisdictions for a long time but is rather novel in Mexico.
Materiality has become a standard necessity in proof of indispensability. Taxpayers must be able to demonstrate that a transaction resulting in an otherwise deductible expense has taken place, regardless of whether it is entered into their accounting records or documented in an invoice issued by the supplier.3 In other words, taxpayers must submit proof that the goods acquired or the services received are truthful, and they must also submit proof of their economic value to the taxpayer. It is often challenging to prove materiality from an evidence standpoint as there is no statutory, regulatory or judicial guidance. This materiality is particularly true for services where there might be little or no evidence of the activity, even if the result thereof might be physically tangible. For example, if a service provider repairs a given piece of machinery but fails to provide a malfunction or repairs report detailing the repairs performed, any payment in exchange thereof might become non-deductible.
On 9 December 2019, amendments to the Federal Tax Code were enacted, including the first general anti-abuse provision based on business purposes. Accordingly, any transaction that has a tax benefit (tax reduction, deduction, credit or non-taxation, etc.) but lacks a business purpose will incur tax effects corresponding to legal transactions that were carried out by the taxpayer to gain a reasonably expected economic benefit; in other words, tax benefits are targeted for transactions that have a tax purpose in mind. As a result of the 2022 tax reform, the business purpose concept has been enacted explicitly as the ultimate test to back-to-back loans, corporate restructures and thin capitalisation ('thin cap').
As amended in the 2020 tax reform, the statute establishes several rebuttable presumptions that conclude when a given transaction has no business reason. For example, whenever the tax benefit of a transaction is greater than the economic benefit received, these presumptions apply.
In any case, this conclusion may be reached only at the request of the corresponding examiner, once a body of officials from the Ministry of Finance and the Tax Administration Service issues a favourable opinion. The officials then notify the taxpayer of their conclusion so that the taxpayer may rebut it.
Nonetheless, this provision presents several challenges from an advisory standpoint, including that (1) there is no administrative or judicial experience on 'business reason' standards, (2) there is no guidance as to what evidence will be required to meet this standard, (3) the above-mentioned body of officials is likely to be constituted by career officials with little or no experience in a business environment and (4) there is little understanding of how the rules in force since 2020 will coexist with those enforced in 2022.
From a planning perspective, it is now paramount to document the business needs that lead to a given transaction and how the transaction can, to the extent possible, fully meet these needs.
i Entity selection and business operations
As a result of the fast-paced technological and economic sectors, current developments in Mexican taxation largely vary with time, do not allow any fixed set of planning mechanisms and mostly depend on the facts and circumstances of each particular case. Therefore, it is impossible – and maybe futile – to address planning structures in particular.
First of all, to achieve tax planning efficiency, we need to consider parties subject to income tax. In Mexico, all the following individuals and legal entities are subject to income tax:
- Mexican residents: all income is subject to tax regardless of the location of the source of wealth;
- foreign residents who have a permanent establishment in Mexico: all income attributable to any permanent establishment they have in Mexico; and
- foreign residents: all income attributable to sources of wealth located in Mexican territory if they do not have a permanent establishment in Mexico, or when they have a permanent establishment in Mexico and the income is not attributable to those sources of wealth.
The taxpayer subject to taxation must be defined, and any Mexican entity subject to the same tax regime must be mentioned. In Mexican tax planning, it is essential to focus on the source of income rather than on entity selection. Despite most entities being subject to the general tax regime, the sources of income treatment is substantially different and also fundamental for the taxation of individuals and corporations.
Domestic income tax
To understand the elements that might impact a tax structure, we first need to be acquainted with the fundamental aspects of Mexican corporate income tax, as are further described below.
General tax regime
The tax regime for Mexican legal entities is outlined in Title II of the Income Tax Law (ITL). In general terms, these entities must calculate income tax by multiplying taxable income earned in a fiscal year by a 30 per cent rate, as shown below:
- (gross4 minus deductions5) minus employees' profit sharing paid in the fiscal year equals tax profit;
- tax profit minus tax loss carry-forwards equals taxable income; and
- taxable income multiplied by 0.3 equals payable income tax.
Commonly, to achieve efficiency, taxpayers focus on deductible items and losses. It is necessary to consider general requirements, specific requirements and limitations, as described below.
Article 25 of the ITL establishes a list of deductible items, such as rebates, cost of goods sold, net expenses, investments, non-performing credits and losses. However, any item must be strictly indispensable for the taxpayer's activity to be deductible, pursuant to Article 27(I) of the same statute.
There is, however, no legal definition of 'strictly indispensable'. For this reason, case law created this very concept. To level up, the Mexican Supreme Court of Justice has reinterpreted this concept considering the business purposes of each company and the specific expense in question, linking the indispensability to the fulfilment of the business purpose of each taxpayer.6
To determine whether an expense is strictly indispensable, it must comply with the following three general elements:
- be directly related to the taxpayer's business purpose;
- be necessary for the taxpayer's activity or its development; and
- the lack thereof should result in a detriment to the taxpayer's activity and development.
More recently, the courts developed an additional element to the strict indispensability concept called the materiality of the transaction so an expense may qualify as deductible.
Tax losses occur whenever deductions are higher than the gross income of any given economic activity. A tax loss sustained in a year may be carried forward to reduce the taxable profit of the 10 following years until it is depleted. No carry-back is allowed.
If, in a given year, a taxpayer fails to carry forward a tax loss, despite being able to do so, the taxpayer shall forfeit the right to do so in subsequent years up to the amount that could have been carried forward.
The ITL establishes that foreign residents with no permanent establishment in Mexico earning income from Mexican sources of wealth may be subject to tax. The source rules are set forth by the ITL as well. Furthermore, the applicable rate depends on certain factors, such as the item of income concerned. In addition, the rate may be reduced or wiped out entirely by a tax treaty, when applicable.
It is important to highlight that the ITL quite often requests that the tax must be paid by the taxpayer through withholding in the transaction. In such cases, withholding effectively becomes a vital issue, as failure to do so might render the relevant expense non-deductible. In addition, the tax authority may claim deficiency from the withholding party, as it is deemed to be jointly and severally liable for that tax under the relevant provisions.
Therefore, when designing a transaction, it is of the utmost importance to determine whether the yielded income may be considered a Mexican source of wealth and, if so, what is the appropriate withholding amount. Many jurisdictions have vehicles that might work quite efficiently for several purposes. For example, Spain has foreign securities holding entities (ETVEs), which are tax-efficient international investments structures. Likewise, Spain and other countries have 'patent boxes'. From a Mexican tax perspective, it is vital to ensure that the tax vehicles qualify for the relevant jurisdiction when designing the relevant structure. Otherwise, Mexico could deny treaty benefits.
Likewise, it is important to analyse the tax treatment of these vehicles in their home country because they may impact the deductibility of any payments made to them by Mexican residents under certain BEPS-related provisions recently enacted in Mexico.
Mexican tax legislation outlines several rules governing and limiting the deductibility of interests that have been incurred over the years to prevent taxpayer abuse, including thin cap rules, rules on back-to-back loans (this concept is further described in Section IV of this chapter) and the newly enacted limit on 30 per cent of earnings before interest, taxes, depreciation and amortisation (EBITDA), also heavily based on the BEPS Action Plan.
Thin cap rules
Thin cap rules substantially prevent taxpayers from deducting interest associated with debts contracted with related parties residing abroad that exceeds three times the stockholders' equity.
To calculate the debt amount exceeding this threshold, the sum of the shareholders' equity at the beginning and the end of the year shall be divided by two. The quotient thereof shall then be multiplied by three, and the result shall be subtracted from the annual average balance of all the taxpayer's interest-accruing debts.
No interest accrued on those debts may be deducted if the annual average balance of the taxpayer's debts entered into with foreign-resident related parties is lower than the excess amount of the debts referred to in the preceding paragraph. If the annual average debt balance entered into with foreign-resident related parties is greater than the aforementioned excess, debt interest accrued with the foreign-resident related parties shall not be deductible in an amount equal to the result of multiplying the interest by the factor obtained by dividing the excess by the balance.
The following interest-bearing debts are excluded from this limitation:
- debts assumed by members of the financial system when performing transactions relating to their purpose; and
- debts assumed for the infrastructure construction, operation or maintenance related to strategic areas for the country or the generation of electric power.
Limit on 30 per cent of EBITDA
Subsection XXXII of Article 28 of the ITL was enforced in 2020. Under this subsection, the 'net interest' deduction is limited to 30 per cent of the taxpayer's adjusted taxable income. This limitation includes any financing that does not qualify as public infrastructure and projects for the exploration, extraction, transportation, storage or distribution of oil and hydrocarbons, among others. This limitation does not apply to members of the financial system regarding operations relating to their business purposes, or the production carried out by state companies (e.g., Pemex and CFE).
The net interest amount that is not deductible in one year may be carried forward for the following 10 years until it is depleted, to the extent that taxpayers keep a record thereof. For these purposes, these concepts are outlined as follows: net interest for the year means the amount resulting from reducing the total payable interest of the fiscal year and the total income of the accrued interest within the fiscal year in question. This rule will not apply to a de minimis threshold value, a threshold for the value of shipped goods or a threshold of 20 million Mexican pesos of interest accrued individually or as a group during a tax year. The adjusted taxable income will be the addition of the fiscal profit of the year, its total interest expense accrued for the year and the year's total amount deducted for fixed assets, deferred expenses and charges, and disbursements made in preoperative periods.
This limitation is generally applicable in addition to, and not in lieu of, the other general or specific anti-avoidance rules described herein.
ii Common ownership: group structures and intercompany transactions
Article 179 et seq. of the ITL outline that legal entities residing in Mexico that enter into transactions with a foreign-resident related party must calculate their gross income and deductions therefrom, using the prices or consideration that would have been established by independent parties in comparable transactions. Otherwise, the Mexican tax authority is empowered to reassess income and deductions.
In other words, the arm's-length standard must be adhered to in related-party transactions. To determine the arm's-length price, a functional analysis must be performed and certain transfer pricing methods must be used. The analysis and methods largely replicate the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations.
Accordingly, when designing a transaction between related parties that might result in a tax reduction, careful attention must be given to make sure that the transaction is necessary and that it has a sound business purpose, as explained before, but also that the conditions established therein are consistent with the arm's-length standard.
In this regard, the Mexican tax authority is increasingly scrutinising intra-group transactions to verify compliance with the arm's-length standard with the associated risk of very large contingencies. Accordingly, when designing a structure, it is advisable to take a proactive approach by analysing the convenience of risk mitigation strategies, such as requesting an advanced pricing agreement or a bilateral advanced pricing agreement.
Ownership structure of related parties
When restructuring a group either internally or externally to bring in new investors, it is of the utmost importance to consider that this reorganisation could seriously limit the use of an otherwise effective tax attribute for planning purposes: losses.
The transmission of fiscal losses is highly regulated and limited in Mexico, as this arrangement is one of the most typical ways in which otherwise profitable companies reduce their tax liabilities. Some of those limitations are described below.
Limitations in cases of spin-offs and mergers
Tax losses of a company cannot be transferred to another entity, except in the case of mergers and spin-offs.
In the event of a merger, the merging entity may use tax losses pending to be carried forward at the time of the merger only to offset tax profits from the same businesses of those losses.
In spin-offs, if the original company primarily conducted commercial activities, tax loss carry-forwards shall be divided between the original company and the spun-off companies by dividing the total value of inventories and accounts receivable related to the commercial activities of the original company. According to the 2021 amendment, a spin-off is considered a disposition of property despite the formal disqualification requirements. A spin-off typically entails the transfer of some of or all the assets, liabilities and equity of the original company to the new company or companies. A disposition of property occurs whenever an item in the stockholders' equity accounts of any of the companies involved in the spin-off was not recorded or acknowledged in the financial statements prepared, submitted and approved at the general meeting of the partners or shareholders who agreed to the spin-off of the company in question.
If the original company primarily conducted other entrepreneurial activities, the tax loss carry-forwards shall be divided between the original company and the spun-off companies in the proportion to the division of the fixed assets. To calculate the proportion referred to in this paragraph, investments in real property not related to the original company's principal activity shall be excluded.7
Limitations in cases of change of control
If there is a change in the partners' or shareholders' control of a company that has tax loss carry-forwards, and the sum updated for inflation purposes of the company's income in the previous three years is less than the amount of those losses at the end of the year before the partner or shareholder change, the company may carry forward losses only to offset tax profits corresponding to the same business lines of losses. For these purposes, income declared in the financial statements for the period in question approved by the shareholders' meeting shall be considered.
A change of the control of a company by partner or shareholder is the change of direct or indirect holders of more than 50 per cent of the voting shares or ownership interest of the company in one or more acts carried out in three years.8
In the event of a reorganisation, merger or spin-off, these limitations do not apply to changes of partners or shareholders as the result of an inheritance, donation, corporate reorganisation, merger or spin-off not considered to be a transfer of property, provided that the direct or indirect partners or shareholders that controlled the company prior to those acts continue to do so afterwards.
Undue transmission of losses
The authority may presume that an undue transmission of tax losses took place if, during the analysis of its databases, it finds that the taxpayer acted as part of a restructuring, spin-off or merger, or underwent a change in shareholders and, as a result, this taxpayer ceases to be part of the group it used to belong to. This rebuttable presumption shall be available whenever the taxpayer of such losses meets one of the following conditions:
- tax losses in any of the three tax years following its incorporation are greater than its assets, and more than half of its deductions resulted from transactions with related parties;
- tax losses in any of the three tax years following its incorporation, derived from the fact that more than half of its deductions arise from transactions between related parties, and they have increased by more than 50 per cent compared with those incurred in the immediately preceding tax year;
- a reduction of more than 50 per cent of its physical capacity to perform its main activity in the tax years after the year in which a tax loss was incurred, as a result of the transfer of all or part of its assets through restructuring, a spin-off or a merger, or if these assets were transferred to related parties;
- whenever losses and the segregation of property rights are incurred and there is a transfer of property and the segregation was not considered while determining the cost of acquisition;
- whenever losses are incurred and there is a change in the depreciation rate of investments under the ITL before at least 50 per cent of the investments is depreciated; and
- whenever losses are incurred and there are deductible items whose corresponding consideration was secured with negotiable instruments and this debt was extinguished through means other than those set forth in the ITL.9
If any opportunity is given to taxpayers to rebut this presumption from an advisory perspective, it is advisable to take a proactive approach rather than a reactive approach.
International intercompany transactions
Mexican legislation has very strict and specific rules involving tax havens and transparent entities, so it is vital to analyse whether the planned transaction makes an income subject to preferential tax regimes while developing the tax structure.
It is important to mention that income subject to preferential tax regimes shall not be subject to tax abroad or an income tax lower than 75 per cent of the income tax that would be incurred and paid in Mexico (30 per cent rate).
In those cases, there is also a rebuttable presumption of the arm's-length standard that establishes inconsistencies of transactions between Mexican residents and corporations or entities that are subject to a preferential tax regime between related parties.
In addition, income earned from Mexican sources of wealth by foreign persons residing in Mexico with preferential tax regimes relating to a Mexican-resident payer shall be subject to a 40 per cent withholding rate on a gross income basis.
Therefore, when dealing with preferential tax regimes (tax havens), the expense associated with a given transaction may not be deductible if the concerned parties fail to rebut the presumption that this transaction is inconsistent with the arm's-length standard. Furthermore, it is necessary to consider that the highest possible withholding rate under the ITL may be applied to this sort of transaction.
In addition, new rules for transparent entities and legal concepts outlined in the 2020 tax reform were introduced in 2021. According to the new rules, the tax transparency of entities and concepts is not recognised for tax purposes in Mexico. As a result, payments received by these tax-transparent entities and concepts will be considered earned by the entities and concepts, rather than by their shareholders or members.10
The important courses of action are to (1) analyse and identify the structures that involve transparent entities or legal concepts with non-transparent entities, (2) determine whether this new regime is to apply and (3) determine whether it is subject to a tax haven.
iii Third-party transactions
Sales of shares or assets for cash
The source of wealth shall be deemed to be located in Mexican territory when the person who issued the shares or securities is a Mexican resident or when more than 50 per cent of the accounting value of the shares or securities derives, directly or indirectly, from real properties is located in the country for disposition of shares or securities that represent the ownership of assets. The tax shall be calculated by applying the 25 per cent rate to the total amount of the transaction without any deductions. In certain cases, however, taxpayers may choose to be taxed at the 35 per cent rate on the gain.
If a buyer is allowed to elect between buying shares or the underlying assets, the interests of the parties must be balanced.
By way of example, the seller will want to sell whatever has a higher basis to deduct a lower profit. Conversely, the buyer should consider that if they buy shares, the purchase price cannot be deducted, and it must be part of the shares' cost for a subsequent sale, whereas asset investments generally would be deductible.
It is also necessary to consider that the sale of shares would certainly result in the companies' contingencies to be tagged alone. Although Mexican tax law establishes that purchasers may be held jointly and severally liable for previous tax liabilities, this might not be the case in an asset deal.
Tax-free or tax-deferred transactions
As for reorganisations of corporations that belong to the same group, the tax authorities may authorise the deferral of the tax payment to gain the disposition of shares within the group. In these cases, the deferred tax must be paid within 15 days following the date on which a subsequent disposition is carried out, resulting in the exclusion from the group of the shares referred to in the corresponding authorisation. The payment shall be updated from the time it was incurred until it is made. The disposition value of the shares must be considered to calculate the gain that would otherwise have been used between independent parties in comparable transactions or as the value indicated by an appraisal practised by the tax authorities.
The authorisation shall be granted only before the reorganisation, provided that the consideration stemming from the disposition consists solely of an exchange of shares issued by the corporation that purchases the shares being transferred, and provided that the purchaser and transferor are not subject to a preferential tax regime and do not reside in a country with which Mexico does not have a broad agreement for the exchange of tax information.
We must note, however, that certain tax treaties afford exemptions in cases of corporate reorganisations within the same group where no cash consideration is paid. As a result, the deferral under the statute should be considered a solution of last resort.
International developments and local responses
i OECD-G20 BEPS initiative
On 9 December 2019, amendments to the ITL and the Federal Fiscal Code were enacted. Many of those amendments were added to reflect BEPS actions to prevent abuses based on international transactions.
To reflect BEPS Action 7, the concept of 'permanent establishment' was modified to prevent artificial avoidance of permanent establishment where there is significant activity in a country. The modification was intended to prevent entities from claiming that they are not permanent establishments by fragmenting their operations or abusing exceptions applicable to independent agents and the performance of previous and auxiliary activities.
Specifically, dependent agents trigger a permanent establishment if they typically exercise an authority to conclude binding contracts in their country. In addition, it will be presumed that an agent is not independent when acting exclusively or almost exclusively for related parties.
Measures against hybrid mechanisms
The foreign tax credit for income tax purposes will now be denied to Mexican residents if (1) the credit is indirect (not incurred directly by the taxpayer) and the payment of the dividend or distributable profit was deductible for the payer or (2) the credit is direct and the tax in question is also creditable in another country or jurisdiction.
Recently enacted reporting obligations
According to certain amendments to the Federal Tax Code enacted in 2020, an obligation was established on taxpayers and on tax advisers to disclose certain tax planning devices – namely any that can generate, directly or indirectly, a tax benefit in Mexico and have any of the characteristics identified as risk areas.
Once this information is disclosed, tax authorities may request additional information from tax advisers or taxpayers.
Foreign transparent legal entities and foreign legal figures
Through amendments to the ITL, this regime was divided into (1) transparent entities and legal figures and (2) preferential tax regimes (REFIPRES), as follows:
- transparent entities and legal figures: income earned through this regime must be recognised by Mexican residents; and
- REFIPRES: income earned in preferential tax regimes must be recognised on an immediate basis and on a scheduler system.
ii EU proposals on taxation of the digital economy
On 21 March 2018, the European Commission issued two proposals intended to ensure that digitalised business activities are taxed fairly. These proposals related to (1) a common corporate tax and (2) a digital services tax. As the world moves in this direction, Mexico has responded with the following measures.
The Federal Tax Code reform dated 9 December 2019 included a section applicable to individuals who sell goods or provide services through technological platforms or computer applications or third parties that are suppliers of goods or services, and clients that provide intermediation services between parties.
The foregoing provision is established to tax the income they earn through digital platforms in the execution of the aforementioned business activities, including payments that they might receive for any additional item relating to these platforms.
Value added tax
The provision of digital services by residents abroad without a permanent establishment in Mexico may be subject to Mexican VAT. The provisions establish the different digital service categories subject to tax, the criteria to define whether the recipient of the digital service is in Mexico, the obligations of the digital service providers residing abroad without a permanent establishment in Mexico and the VAT credit incurred by the recipients, among others.
Intermediation between third parties that supply and demand goods or services through digital platforms that provide their services to foreign residents without a permanent establishment in the country are required to withhold 100 per cent of the VAT collected. If the VAT is withheld, foreign residents without a permanent establishment are exempt from submitting information to the tax authority.
The tax authority may temporarily block internet services delivered by concessionaires of public telecommunications networks in Mexico to digital platforms that do not comply with the information or withholding requirements described in the value added tax law. The authorities will be empowered to block internet services until those obligations are fulfilled.
iii Tax treaties
Mexico is part of a vast network of treaties to prevent double taxation, with almost 70 treaties in force and several more at different pre-enforcement stages. To take advantage of these treaties, reviewing the requirements to qualify for their protection and fully defining the type of transaction to be carried out are of utmost importance.
It is essential to consider that the fundamental purpose of the treaties is to prevent double taxation and, if appropriate, to apply for benefits through lower withholding rates than those established in the local legislation; however, the anti-abuse rules recently added to local legislation should not be overlooked.
Therefore, it is of utmost importance that the transactions establish a reasonable business purpose and do not seek only the treaty benefits.
Recent changes to and outlook for treaty network
On 7 June 2017, Mexico signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (Multilateral Instrument) (MLI), issued by the OECD. Its entry into force does not replace bilateral treaties previously executed by Mexico but aims to simultaneously implement measures developed in the BEPS project. The amendments derived from that implementation will be different for each treaty because the MLI will be applied according to the notifications and reserves made by each jurisdiction.
The MLI is pending ratification by the Mexican Congress.
For Mexican tax purposes, back-to-back loans are transactions through which a person provides cash, goods or services to another person, who in turn, directly or indirectly, provides cash, goods or services to the former person or a related party thereof. Back-to-back loans are also transactions in which one person extends financing, and the credit is guaranteed by cash, cash deposits, shares or debt instruments of any kind from a related party or the same borrower, to the extent that the credit is guaranteed in this manner. Interest from back-to-back loans is recharacterised as dividends and therefore it is not deductible.
Unfortunately, the definition of 'a back-to-back loan' seems to be all-encompassing so almost any transaction might fall within its scope. In this regard, in a recent case, a taxpayer subject to an examination argued in court that this definition should be interpreted consistently with the financial definition of a back-to-back loan, which is narrower, and that the definition should be applied only whenever there is the intent to artificially reduce taxation. Nevertheless, the court ruled that the tax definition of a back-to-back loan is an anti-avoidance provision that does require to be associated with the financial definition thereof and whose applicability should not be subject to proving the taxpayer's intent.11
Case law on deduction of publicity
Until recently, the general approach concerning publicity expenses made by a licensee of a given trademark was that they were deductible because these expenses were necessary to promote the sales of the products under the same trademark.
However, the tax authority in certain examinations contested this position on the grounds that these expenses benefited the owner (and licensor) of the relevant trademark rather than the licensee.
These contradictory positions were heard by the Federal Court of Administrative Justice, which upheld the tax authority's view.12 However, this court ruling is not binding for the tax authority or any court, including this one, in other matters. Nonetheless, in similar situations, it is quite likely that the tax authority will deny the deductibility of the relevant publicity expenses, and the outcome in the event of litigation is uncertain.
Thus, from an advisory standpoint, it is necessary to take into consideration the terms of this ruling when structuring not only publicity expenses but also licensing agreements themselves.
Non-binding criteria on deduction of royalties stemming from intangibles originated in Mexico.
The Mexican tax authority is empowered to issue non-binding criteria so taxpayers know which structures are considered abusive from its point of view. Although these criteria are not binding to taxpayers from a practical standpoint, they warn taxpayers that if they adopt a position contrary to these criteria, it will certainly be contested by the authority and likely will be ultimately solved by a court in litigation.
For deduction of royalties, the following non-binding criteria must be considered.
1. Royalties paid to related parties residing abroad for the use or temporary enjoyment of intangible assets originated in Mexico; previously owned by the taxpayer or any of its related parties resident in Mexico, and transferred for no consideration or for consideration inconsistent with market standards, should not be deducted, since the need for migrating the assets and the subsequent payment of royalties is unjustified.
2. Investments on intangible assets from Mexico should not be deducted, when they are acquired from a related party residing abroad or this related party changes its tax residence to Mexico, unless said related party acquired those investments from an independent party and proves to have paid the acquisition cost thereof.
3. Investments in intangible assets originated in Mexico should not be deducted when acquired from a third party who in turn has acquired them from a related party residing abroad.13
Outlook and conclusions
In Mexico, taxpayers may arrange their affairs so they pay the least amount of taxes. As Judge Learned Hand said in 1934 in the US, there is no patriotic duty in increasing one's taxes. However, in doing so, taxpayers must be mindful of several limitations and requirements, both general and specific.
None of those requirements is more essential than others. They are all equally important, and failure to comply with any of them might result in burdensome contingencies. Thus, proper planning requires a 360-degree perspective on all the issues to align them appropriately with the relevant business objectives.
Nowadays, proper planning cannot rely on opacity but on the assumption that it might (and will) be subject to scrutiny and must therefore be supported by evidence and sound legal judgment.
1 Mario Barrera-Vázquez is a partner and Catalina Mandujano-Ortiz is an associate at Holland & Knight LLP.
2 Helvering v. Gregory, 69 F.2d 809, 810 (2d Cir. 1934), aff'd, 293 U.S. 465 (1935).
3 'Facultades de comprobación. Al ejercerlas la autoridad fiscal puede corroborar la autenticidad de las actividades o actos realizados por el contribuyente, a fin de determinar la procedencia de sus pretensiones, sin necesidad de llevar a cabo previamente el procedimiento relativo a la presunción de inexistencia de las operaciones previsto en el artículo 69-B del Código Fiscal de la Federación', 67 S. J. F. 2186 (10ª época 2019).
4 Gross income is any kind of income from whatever source derived.
5 Deductions are all those expenses necessary for the development of the taxpayer's business. As a general rule, expenses whose benefit does not extend beyond the year in question are fully deductible in that same year. Expenses whose benefits extend beyond a single fiscal year, such as fixed assets, deferred expenses and deferred charges, are subject to depreciation, typically under a straight-line method. In those cases, the depreciation rate depends on the item in question and the industry involved.
6 'Renta. Interpretación del término 'estrictamente indispensables' a que se refiere el artículo 31, fracción I de la Ley del impuesto relativo (Legislación vigente en 2002)' XX S. J. F. 565 (9ª época 2004).
7 See Articles 58 and 59 of the ITL.
8 id., Article 58.
9 See Article 69B bis of the Federal Tax Code.
10 See Articles 4A and 4-B ITL.
11 'Renta. El término 'créditos respaldados' contenido en la fracción V del artículo 92 de la Ley del impuesto relativo (vigente en el 2007), tiene un propósito antielusión o antiabuso' (Legislación vigente hasta el 1 de Octubre de 2007)' 69 S. J. F. 4637 (10ª época 2019).
12 'Gastos de propaganda y publicidad. su deducción es improcedente, al no ser estrictamente indispensables para la empresa que vende productos bajo marcas cuyo uso y explotación le fueron otorgados mediante un contrato de licencia no exclusiva'. Revista del Tribunal Federal de Justicia Adminstrativa (July 2019), page 285.
13 Non-binding criteria 4/ISR/NV are outlined in Annex 3 of the general miscellaneous tax provisions published on 28 December 2019 in the Official Gazette.