MEXICO: An Introduction to Tax: Controversy

Mexican Supreme Court of Justice Criteria Regarding Offsetting of Civil Debts for VAT

On 15 March 2023, the Second Chamber of the Mexican Supreme Court of Justice ruled on a case regarding value added tax (VAT), which established jurisprudence, thus constitutes a mandatory precedent. This ruling has caused significant concerns in the business sector due to both its legal and commercial implications.

Specifically, the Court established that the offsetting of civil debts (between individuals) cannot be used to pay VAT, nor can it give rise to a VAT refund request or creditable VAT. The final resolution has not been published, therefore the particular details are still unknown.

As of time of writing, we only have knowledge of the draft, discussed and approved unanimously by the five Judges of the Second Chamber of the Mexican Supreme Court of Justice.

Background  

VATproduces the second highest tax revenue in Mexico, therefore, this decision from the Mexican Supreme Court of Justice will have a significant impact in the Mexican tax field

Prior to analysing the decision, we must point out that VAT is a tax levied on consumers, indirectly placing a tax on the spending capability of the final consumer of goods and services.

Even when the VAT is ultimately assumed by the final consumer, the tax is imposed on individuals and companies that sell goods, render services, lease assets or import goods or services, and is calculated applying the tax rate (0% or 16%) on the selling price of the goods sold or value of the services rendered.

VAT works through a system of tax credit that allows the taxpayer who pays the tax, to charge or collect from the final consumer an equivalent to the amount of VAT, placing the economic burden of the tax on the final consumer. This is to allow the supply chain to be taxed without increasing the cost as the value of goods and services increase throughout the production chain.

VAT is calculated by applying the tax rate to the value of the transaction – the price of the sale of goods and services – as well as on lease payments and imports of goods and services.

Additionally, taxpayers can credit against the VAT collected the amount of the tax paid to vendors, lessors, service providers, etc, when acquiring taxed goods or services needed to carry out their own taxed business activities.

Therefore, the amount paid by the taxpayer is not based on the income obtained but ratehr on the value that it has added to the goods or services in question. The taxpayer is obligated to pay the VAT on a cash basis when it is paid for their taxed activities, at the applicable tax rate on the considerations collected.

For this purpose, the VAT law establishes that the considerations are effectively collected when they are received in cash, goods or services, amongst other payment methods, or when the interest of the creditor is satisfied through any form of extinguishing the obligation of payment that the civil legislation recognises.

Within the forms of extinction of obligations, Mexican law recognises the figure of offsetting, which takes place when two people meet the status reciprocal debtors and creditors by their own right.

The offset seeks to extinguish the two debts, up to the lesser amount. It only proceeds when debts are monetary or when they are goods of the same kind or quality. It also requires the debts to be equally liquid and enforceable, except for the express consent of the interested parties.

Resolution of the Mexican Supreme Court of Justice 

This case reached the Mexican Supreme Court of Justice, by virtue of a complaint made about two discrepant criteria of Collegiate Courts of different Judicial Circuits.

On session held on 15 March 2023, the Second Chamber of the Mexican Supreme Court of Justice resolved the Contradiction of Criteria 413/2022, stating that the offsetting of civil debts (between individuals) is not a method through which VAT can be considered effectively paid, therefore, cannot give rise to a VAT refund request or to creditable VAT.

Although the Mexican Supreme Court’s resolution has not yet been published, the reasonings stated in the draft judgement are:

• Article 1-B, the first paragraph of the VAT Law, regulates the moment in which payment must be considered effectively collected to determine the moment the tax is levied, but not as a form of payment of said tax;

• establishing that the civil offset of debts is a form of VAT payment is comparable to confusing the moment in which the obligation to pay VAT is born with the extinction/extinguishing of the same obligation;

• to support that civil offsetting of debts as a form of VAT payment would mean leaving to the will of the obligated individual the obligation to pay the tax; and

• the offset of tax debts is prohibited in accordance with Article 2192, Section VIII of the Federal Civil Code.

Based on the above, the Mexican Supreme Court of Justice concluded that there is an express prohibition for the offsetting between individuals to extinguish the obligation to pay VAT, regardless of whether or not it was paid by any of them, given that this figure is inapplicable, to the margin of a piece of evidence that may exist because it simply would not be suitable for that purpose.

Comments and implications  

From our point of view, the analysis of the Mexican Supreme Court of Justice is incorrect because it ignores two relevant aspects of the calculation and payment of the tax.

The tax is always paid directly to the tax authority by the obligated taxpayers; this integer must be in cash and this obligation is between the tax authority and the taxpayers.

Individuals are obligated to pay the tax, transfer it or collect an amount equivalent to the amount of the tax to consumers; this amount is not the tax itself, and is charged simultaneously with the unit price of the good or service.

In view of the foregoing, the analysis of the Mexican Supreme Court of Justice starts from an incorrect assumption as the offset of tax debts referred to Article 2192, Section VIII of the Federal Civil Code which regulates the legal relationship between the Treasury Tax Authority and taxpayers, but not the legal relationship between individuals where contractual freedom must prevail.

From the interpretation of the VAT law, it can be noted that when it establishes that the considerations are considered effectively collected when the interest of the creditor is satisfied, it is considering not only the moment of the collection, but also the payment of the same along with the corresponding VAT.

Since the moment in which it is deemed that a consideration is effectively collected by a taxpayer with respect to the operations that were carried out between them, it implies that the other side in the operation has already made the payment of said consideration, including an equivalent amount to the tax, which is passed on or charged to the final consumer.

In addition, the fact that VAT is regulated according to a cash flow system does not imply that it must be inevitably paid by the consumer to the taxpayer in cash, but rather that it is caused in contrast to the accrued regime from the moment in which it is understood by effectively collected in cash, in goods, in services or through any form of extinction of the obligations.

Conversely, the Mexican Supreme Court of Justice loses sight of the fact that it is a common practice in commercial activity between individuals/companies to carry out the offset of reciprocal debts, which includes the agreed consideration and the amount equivalent to the actual VAT (as a way of liquidating the transaction as a whole and entirety).

As previously mentioned, the Mexican Supreme Court of Justice’s final resolution has not been published, so there could still be some elements that give a different perspective to the ruling herein analysed.