Mexico: Tax controversy
Ortiz Abogados Tributarios
Among the OECD member countries, Mexico has the lowest tax collection in terms of GDP ratio. OECD’s collection average is 34.2%, while Mexico collects only an amount equal to 16.2% of its GDP.
This has put significant pressure on the Mexican state to improve the collection rate, but without paying the political cost of implementing a substantial tax reform.
Therefore, since the 2012-2018 federal administration took office, audit practices and strategies by Mexican tax authorities have become more aggressive, in order to achieve the task of raising tax collections.
The Mexican Tax Administration Service (“SAT” by its acronym in Spanish) has focused its audit efforts on preventing taxpayers from eroding their taxable base with simulated transactions, even if they are supported by a valid invoice.
This collection policy responds to a harmful avoidance practice adopted by many taxpayers: to issue invoices without providing any services or selling any assets or goods, in exchange for specific compensation.
Nevertheless, in practice, SAT auditors regularly demand excessive requirements and conditions from taxpayers, which are sometimes almost impossible to comply with. These requirements are demanded to demonstrate the effective provision of a service or the acquisition of an asset or good, in order to take the deduction for income tax purposes or the crediting of the input VAT. Therefore, audits result in assessments in which deductions and input VAT are rejected.
The other main source of controversies is transfer pricing-related issues. The SAT has a strong audit policy regarding transactions between related parties; as a rule, transfer pricing audits, along with all their complexity and lack of rigid criteria to value a specific transaction, usually result in an assessment against the taxpayer.
In order to challenge the assessments issued by the SAT, in case the controversy is not settled in an alternative dispute resolution process, taxpayers are entitled to file an administrative appeal before the tax authorities or an annulment complaint before the Federal Court in Administrative Justice (Tax Court) and, as an appeal remedy, to the federal courts.
According to Mexican law, tax assessments are presumed to be lawful and valid, therefore the burden of proof rests with the taxpayer. For this reason the taxpayer, as one of the parties in a controversy, has to demonstrate that the legal provisions have been wrongly applied or interpreted, or that the facts were unduly appreciated by SAT’s auditors.
There are no reliable statistics, but the general perception among tax controversy practitioners is that the ratio of successful litigations before courts has dramatically decreased in the last few years.
In this context, taxpayers and practitioners have looked for alternative options to find a reasonable solution to their day-to-day struggle with the tax authorities. A first path to follow is to have intensive assistance from tax lawyers at the audit stage in order to submit a robust number of elements, documentary evidence and legal reasoning to sustain the company’s position.
A second option that has been used by taxpayers is the alternative dispute resolution mechanism provided by Mexican law. Taxpayers are entitled to request the Mexican Taxpayers Rights Defence Agency (“Prodecon” by its acronym in Spanish), to execute its mediation faculties in order to procure a settlement between the private company and the SAT.
The adoption of a conclusive agreement has resulted in an effective instrument to find a consensual solution to a controversy and adopt a mutual position regarding the nature and tax effects of specific transactions. Although the agreement has to be supported with evidence and technical elements, tax controversy practitioners have been forced to develop negotiation skills, in addition to their litigation capabilities.
On 1st December 2018, a new federal administration took office and proposed two relevant promises, among others: to increase public spending to support low-income families, students and senior citizens; and not to create new taxes nor increase the existing ones.
Therefore, the efforts of the new government to collect a higher amount of taxes have been focused on addressing (i) the issuance of invoices regarding simulated transactions, and (ii) aggressive tax planning.
As of 2020, several reforms to Mexican laws entered in force; these reforms establish more severe sanctions on taxpayers who issue invoices without providing any goods or services, and on those who, by way of such invoices, erode their taxable base.
Relevant penalties include not only the cancellation of the electronic seals in order to issue invoices, but also criminal penalties as said transactions are deemed felonies that deserve preventive prison.
Additionally, Mexican legislation has adopted several recommendations of multiple BEPS action plans, such as:
(i) The non-deductibility of payments made, directly or indirectly, to related parties whose revenue is subject to a preferential tax regime.
(ii) The non-deductibility of interests, paid to related or independent parties, if they exceed an amount equal to 30% of the adjusted tax profit.
(iii) The obligation of tax advisors to disclose to the tax authorities the structures in which they participate, by designing or implementing them, if they are identified as risky transactions, regarding aggressive tax strategies.
(iv) A general anti-avoidance rule, according to which SAT is entitled to ignore the tax effects of legal acts lacking a business reason, but that create a tax benefit for the taxpayer.
(v) New rules regarding the taxation in Mexico of foreign fiscal transparent and disregarded entities, and the taxation of revenue obtained by a Mexican resident whose origin is a foreign fiscal transparent or a disregarded entity.
In addition to the foregoing, the COVID-19 outbreak increased the need for public revenue in order to fulfil the extraordinary demand of public healthcare services to battle the current crisis.
Also, it revealed the tax weakness of the Mexican state, as the government was reluctant to provide broad monetary help to the population in order to diminish the impact of the lockdown and its economic effects on Mexican families.
During 2020, as the pandemic has been active in Mexico, SAT was able to reach agreements with high-profile taxpayers in order to collect large amounts that were being challenged before the courts and in the process of being audited and assessed.
In the future, we may expect the intensive use of the new legal instruments described above in audit procedures that will require taxpayers to have the advisory of highly skilled controversy practitioners.