By Guillermo Villaseñor-Tadeo (Partner, Sánchez Devanny, Mexico) and Pedro Palma-Cruz (Attorney, Sánchez Devanny, Mexico)
Mexico’s Tax Administration Service on July 11, 2018, updated the country’s existing regulations concerning transfer pricing adjustments as set out in rules 188.8.131.52 to 184.108.40.206 of the Resolución Miscelánea Fiscal. The changes are aimed at clarifying many questions that arose from the enactment of the first set of regulations on transfer pricing adjustments last year. In broad terms, the regulations can be classified as: definition and types, application, requirements, and timing issues and deadlines. These are discussed below.
Definition and types
The regulations are focused on Mexican tax residents and foreign tax residents with a permanent establishment in Mexico (taxpayers). Accordingly, regulations provide that any modification to the prices, amount of consideration, or profit margins of controlled transactions, shall be considered as ‘adjustments.’ Adjustments can be ‘real,’ when they affect both taxpayers’ accounting and tax position, or ‘virtual,’ when they only affect taxpayers’ tax position.
Regulations provide for a classification of adjustments as voluntary or compensatory (when the transaction is adjusted before the annual return (normal or amendment) is submitted), primary (derived from a tax assessment), national/foreign correlative (derived from a primary adjustment to a controlled transaction with a national or foreign related party), and secondary (characterized as deemed dividend).
These regulations become applicable to taxpayer adjustment increases and decreases derived from controlled transactions, which modifications have a direct impact on income, deductions, and withholding tax recognition by taxpayers. Regulations provide that these adjustments are only allowed in the form of voluntary or compensatory, or for national or foreign correlative adjustments.
According to the regulations, taxpayers who receive income, from an adjustment increase, shall consider as nominal income for the monthly provisional payments for which the adjustment is made, the amount received.
On the other hand, an adjustment decrease will allow taxpayers who receive income from the controlled transaction to increase their deduction in an amount equivalent to the adjustment (subject to conditions).
In case of an adjustment increase in deductions, taxpayer will be allowed to increase its deductions in an amount equivalent to the adjustment (subject to conditions).
For purposes of an adjustment decrease in deductions, taxpayers must decrease deductions in an amount equivalent to the adjustment.
Withholding tax adjustment
Regarding adjustment increases affecting withholding taxes, the withholding agent shall be liable for an amount equivalent to the one he or she has withheld considering the adjustment.
For purposes of an adjustment decrease, the withholding agent will be allowed to compensate the foreign resident an equal amount to the one withheld in excess as consequence of the adjustment, on the condition that the adjustment is ‘real’ and actually decreases cost and expenses, as well as payable accounts incurred with its related party.
Furthermore, regulations provide that in cases where the withholding tax was withheld using decreased tax treaty rates, the withholding tax adjusted shall be determined under domestic law, provided that the adjustment is ‘virtual.’
It is also important to note that regulations provide that VAT and Special Production Tax (“IEPS,” per its Spanish acronym) shall be also adjusted as a consequence of the transfer pricing adjustment’s application.
The requirements to conduct the aforementioned adjustments are extensive. We note here the ones we consider most important: information disclosure about the person completing the documentation; the obligation to keep the Digital Fiscal Invoice (“CFDI,” per its Spanish acronym) and issuance of tax invoices fulfilling tax requirements regarding the transactions adjusted, as well as those reflecting the adjustment; and the demonstration that the counter party to the controlled transaction accrued the income or decreased the deduction, in the same taxable year, which shall be demonstrated by the issuance of a sworn affidavit of the legal representative of said counter-party.
Timing issues and deadlines
According to the regulations, taxpayers are allowed to conduct “voluntary or compensatory” adjustment deductions only for the taxable year in which the income or deductions were originally incurred from the controlled transactions.
Furthermore, the regulations state that the “voluntary or compensatory” adjustments shall be reflected in the tax returns or in the accounting audit report, no later than: March 31 of each year for taxpayers who have not elected the option contained within Article 32-A of the Federal Fiscal Code; or June 30 each year for taxpayers who elect to take the option contained within Article 32-A of the Federal Fiscal Code (subject to conditions).
In cases where taxpayers conduct a voluntary or compensatory adjustment after the aforementioned deadlines, they will be allowed to deduct the adjustment in the taxable year in which they recognized as income or deduction the relevant controlled transaction, subject to submitting Form 130/ISR. Likewise, when taxpayers conduct a national correlative adjustment as a consequence of a primary adjustment, they will be allowed to deduct it by submitting Form 134/ISR.
Finally, taxpayers are allowed to request an adjustment deduction derived from APA’s or tax treaty’s correlative adjustment, with different deadlines to the ones mentioned above. In no case may the delayed submission go beyond the term permitted by the APA rules.