American Bar Association Section of Taxation; International Bar Association Taxation Section. Mexico Recent Trends in Transfer Pricing

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1 American Bar Association Section of Taxation; International Bar Association Taxation Section Mexico Recent Trends in Transfer Pricing Roberto Schatan Technical Assistant Advisor at the Tax Policy Division of the Fiscal Affairs Department, IMF Tom Ralph Manager, IRS Advance Pricing and Mutual Agreement Program David Ernick, the Associate International Tax Counsel at the U.S. Treasury Department Moises Curiel-Garcia Baker & McKenzie Mexico Responsible TP Latin America Moderator October 21st, 2011 Denver, Colorado 1 Agenda Tax Audit Experience Dispute Resolution Actual Case Experience Hot Topics 2

2 Tax Audit Experience 3 Dispute Resolution Audits Mexico Audited industries include pharmaceuticals, automotive, electronics, hotels, maquiladoras Audit issues: Segregation of financial information, confidential information, selection of comparables, thin capitalization, intangibles, services, manufacturing changeover 4

3 Growth in Audits in Process * Significant decline in inventory Source: SAT March, 2011 Dispute Resolution Post-Audit Competent Authority Procedure (CAP) Advance Pricing Agreements (APAs) 6

4 Dispute Resolution Post-Audit Mexico Payment Administrative Appeal Tax Court Alternatives MAP APA Tax Court Circuit Courts Competent Authority Injunction Supreme Court 7 Dispute Resolution APAs Significant reduction in the number of maquiladora APAs in recent years. Increase in bilateral requests and mutual agreement procedures. Diversification of sectors with respect to companies seeking APAs. Filing and ruling on thin-cap APA requests. 8

5 MAPs Sectors involved: Maquiladora industry (IMMEX program) Contract manufacturers Distributors and commission agents Service arrangements. BAPAs & MAPs Source: SAT March, 2011

6 Actual Audit Case Experience 11 Intercompany Services USCo MxCo USCo renders intercompany services (internal audit, credit analysis, legal, etc.) to MxCo. MxCo pays costs plus 7% markup. MxCo is audited MxCo is not authorized to deduct intercompany service payment under the following arguments: MxCo does not prove that the services were received; MxCo does not show that the payment equals USCo s costs incurred in the service plus 7% markup; and MxCo does not comply with formal aspects required to deduct a payment. (poner que formalidad es)

7 Intercompany Services Discussion: a) Under US-MEX treaty and OECD Guidelines, what is the appropriate documentation to prove a service was received and the cost base is accurate? b) When can a taxpayer be certain that its intercompany service payments comply with arm s s length dealings? c) What are the possible consequences if costs are allocated on a pro rata basis? Royalty Payments UsCo 1 Legal Owner Ownership of Intangible USCo2 Royalty Collector 5% Royalty Payments MxCo Subsidiary A USCo2 Receives royalty payments from MEX Corp relating to trademarks and knowhow MxCo Pays and deducts 5% royalties on net sales to UsCo MxCo is audited in FY 2010 and SAT rejects 100% of royalties payments SAT asserts that US Corp is not the legal owner of the intangibles and the payments are nondeductible accordingly.

8 Discussion: Royalty Payments a) According to the OECD Guidelines and the US- Mex Tax Treaty, what would be the decisive factor to be considered to comply with the royalty deduction? b) How would this be managed under a MAP? c) Is there any consideration for USCo 2 if it contributes to the creation, maintenance, and development of the intangible to determine the royalty rate for UsCo1 and UsCo 2? USCo MxCo Maquila Companies Maquila Services Permanent establishment Machinery Inventory Design MxCo provides maquila services to foreign related party UsCo Due to the uncertain situation in USA, UsCo requests that MxCo cut production MxCo closes production lines and dismisses staff The settlement expenses are considered as reimbursements Maquila transfer pricing rules under ITL Article 216- Bis I. Transfer pricing study : Total cost + 1% for IT and Total Cost + 1.5% for CTF, using a TNMM II. SAFE HARBOR 6.9% (operating assets) or 6.5% (total cost), higher tax III. ROA (financial ratio) using TNMM

9 Maquila Companies Authority s s Position The main activity of MxCo is maquila services The expenses for closed production lines and staff dismissal must be part of the cost basis for the markup. Therefore MxCo is below the interquartile range and does not comply with Art. 216-Bis. Discussion: a) Should the expenses incurred in this situation have the corresponding operating markup? b) Does MxCo lose the tax benefits under the Income Tax/ Flat Tax Decree? c) Does USCo have a PE in Mexico? d) How would this be managed under a MAP? USCo Unilateral APA Purchases of Finished Products MxCo Sales of Finished Products Clients MxCo activity: Distribution of electronic goods. USCo maintains a unilateral APA covering its transactions under IRC section 482 and the Treasury Regulations. Based on the APA, USCo established a worldwide intercompany policy. MxCo determines its arm s s length profit according to APA methodology: markup under the value-added added cost (marketing, administrative, warranty, expenses, etc.)

10 Unilateral APA Differences: Fiscal Year Alignment: Fiscal Year USCo vs. MxCo Accounting Standards: Accounting Basis USGAAP vs. FRS (MEXGAAP) Cost Basis: : Under APA methodology, some items are not included in the markup basis. Discussion: a) MxCo does not comply with the Mexican TP regulations. b) SAT audited MxCo and determined an adjustment of the purchase price. c) How confident USCo should feel to avoid double taxation under MAP based on the unilateral APA? d) Can the US tax authorities change their APA position in a MAP, creating uncertainty for the taxpayer on worldwide basis? Hot Topics 20

11 Hot Topics Notices Timing of MAP within 4.5 years after annual return is filed Adoption of MAP Position of applying Pacta Sunt Servanda (In good faith) clause to participate in MAP and not be precluded due to asserted failure to comply with local law Arbitration Now an issue This presentation is made on the personal capacity of the speakers and does not represent the standpoint of the institutions they belong to.