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The new rules provide more certainty on transfer pricing adjustments. Taxpayers, however, should ensure that they comply with these new rules and have sufficient documentation to support their adjustments.

Mexico published the second resolution of amendments to the Miscellaneous Tax Resolution (MTR) for 2018 in the Federal Official Gazette (DOF, for its acronym in Spanish). The second resolution of amendments to the MTR includes definitions and the types of transfer pricing adjustments, which might represent additional tax and transfer-pricing compliance risks for taxpayers.

In particular, the amendments affect transfer pricing Rules 3.9.1.1, 3.9.1.2, 3.9.1.3, and 3.9.1.4, which have been in force since tax year 2017, and add new Rule 3.9.1.5, which applies to transfer pricing adjustments as of July 12, 2018.

Rule 3.9.1.1 — Transfer pricing adjustments

This rule clarifies the concept of "adjustment" for transfer pricing purposes and defines it as:

Any modification to the prices, consideration amounts or profit margins corresponding to the transactions carried out by the taxpayer with its related parties; incurred to consider the taxable income or authorized deductions derived from said transactions determined by considering the prices or consideration amounts that third parties would have used in comparable transactions under comparable circumstances, even when there is no delivery of cash or other material resources between the parties.

In addition, the rule specifies that transfer pricing adjustments may be classified as:

1. Real: When a transfer-pricing adjustment directly affects both tax and accounting matters or,
2. Virtual: When a transfer-pricing adjustment affects only tax matters.

Also, either type of adjustment may have the following possible variants:

1. Voluntary or compensatory: An adjustment that a taxpayer resident in Mexico, or a foreign taxpayer with a permanent establishment (PE) in Mexico, performs to consider a related-party transaction at market value. The adjustment is incurred before the filing of the annual income tax return, whether original or amended.
2. Primary: An adjustment that results from the tax authority's review powers and modifies for tax purposes the amount of the related-party transaction so that the transaction may be considered at arm's length.
3. Domestic correlative: An adjustment that a taxpayer resident in Mexico may apply as a result of a primary adjustment made directly to the taxpayer's related-party resident in Mexico.
4. Foreign correlative: An adjustment that a taxpayer resident in Mexico or a foreign taxpayer with a PE in Mexico may apply, as a result of a primary adjustment made directly to the taxpayer's related-party resident abroad.
5. Secondary: An adjustment resulting from the application of a contribution, in accordance with applicable tax legislation, after having determined a transfer-pricing adjustment to an operation that is generally characterized as a deemed dividend. Secondary adjustments result from applying Article 11, fraction II; Article 140, fractions III and VI; and Article 164, fraction I of the Mexican Income Tax Law (MITL) (deemed dividends) to a transaction.

This rule also applies to taxpayers who, according to the rules in the MITL, obtain their income at the time that the price or the agreed consideration is charged. The rules provide that the adjustments to the transactions will have a tax effect when they are actually collected or paid.

Finally, Rule 3.9.1.1 establishes that transfer-pricing adjustments will have the same concept or nature as the transaction subject to the adjustment.

Rule 3.9.1.2 - Increase or decrease in income or deductions derived from transfer pricing adjustments

According to Rule 3.9.1.2, there are two main situations for which specific requirements are provided:

a) Voluntary or compensatory transfer pricing adjustments, as well as national and foreign correlative adjustments that increase the price, the consideration amount or the profit margin.

For these types of adjustments, taxpayers or PEs should do the following:

1. When taxable income has been obtained as a result of an operation, the income must be increased by an amount equivalent to the adjustment. In addition, for purposes of monthly tax prepayments, for voluntary or compensatory adjustments, the new increased amount must be considered as monthly taxable income for these purposes in the month in which the adjustment is made in accordance with Article 14, third paragraph of the MITL.
2. When deductions have been made because of an operation, deductions may be increased by an amount equivalent to the adjustment as long as the taxpayer complies with Rules 3.9.1.3, 3.9.1.4 and 3.9.1.5.
3. For adjustments that must be considered, for withholding purposes, to be made to a resident abroad without a PE under the first, third and fourth paragraphs of Article 153 in the MITL, the withholding agent will receive an amount equivalent to that which should have been withheld as a result of said adjustment in compliance with Rule 3.9.1.3, section XI.

b) Voluntary or compensatory transfer-pricing adjustments, as well as national and foreign correlative adjustments, that decrease the price, the consideration amount or the profit margin

For these types of adjustments, taxpayers and PEs that have obtained income from a transaction may increase their deductions by an amount equivalent to the adjustment as long as they comply with Rules 3.9.1.3, 3.9.1.4 and 3.9.1.5. Likewise, when the taxpayers or PEs claim deductions for the transaction, they must decrease the authorized deductions by an amount equivalent to the adjustment.

For adjustments to payments to non-Mexican residents without a PE in Mexico that are subject to withholding tax under the terms of the first, third and fourth paragraphs of Article 153 of the MITL, the withholder (i.e., the Mexican taxpayer that made the payment) may compensate the foreign resident without a PE in Mexico, with an amount equivalent to the amount the foreign resident overwithheld as a result of the adjustment. The compensation will be applied to the amounts withheld when the withholdings of the operation with related parties that was subject to adjustment are to be made. The compensation applies as long as: (1) the adjustment corresponds to a real transfer-pricing adjustment, which reduces costs or expenses, as well as accounts payable between the taxpayer and its related party (e.g. the foreign resident without PE in Mexico), and (2) accounting records are available to fully identify the compensation from the first time the withholding was made up to the moment in which the compensation was done.

If withholding rates lower than those established in the MITL were applied because of a treaty to avoid double taxation, the adjustment amount will be taxable according to the MITL when the transfer-pricing adjustment is virtual.

When adjustments of income or deductions derived from transfer-pricing adjustments are made, the adjustments for value-added tax (VAT) and the special tax on production and services (IEPS, for its acronym in Spanish) also must be made.

For all situations contemplated by this rule, the tax authorities may exercise their review powers with respect to the transfer pricing adjustments.

Rule 3.9.1.3 - Deduction of transfer-pricing adjustments

Under this rule, taxpayers making a transfer-pricing adjustment that increases their deductions must fully comply with a series of requirements to be considered compliant with the MITL provisions on deductions and transfer pricing. Among the requirements are the following:

1. Filing on time and in the manner prescribed for original or amended tax returns that include the transfer pricing adjustment
2. Obtaining and keeping the documentation that shows the transaction was not completed as it would have been with or between independent third parties in comparable transactions
3. Obtaining and keeping a statement signed by the preparer of the documentation mentioned in items 2) and 5) of this rule explaining why the transaction was not originally agreed upon as it would have been with or between independent third parties in comparable transactions
4. Obtaining and keeping a statement signed by the preparer of the documentation mentioned in items 2) and 5) of this rule explaining the consistency (or inconsistency) in the application of transfer-pricing methodologies in relation to the immediately preceding tax year
5. Obtaining and keeping all documentation that verifies the transactions were agreed as they would have been with or between independent third parties in comparable transactions
6. Having a digital tax receipt (CFDI, for its acronym Comprobante Fiscal Digital por Internet in Spanish) for the original transaction to which the adjustment is made
7. Having the supporting documentation, if applicable, for the corresponding payment of VAT and IEPS for deductions associated with the acquisition of imported goods
8. Issuing a CFDI to support the adjustment and correlate it with the CFDIs initially issued for the adjusted transaction, in the case of real adjustments; the CFDI must include, at least, the following information:
1. Description of the operation with voluntary or compensatory adjustments
2. Amount of the original transaction
3. Gross or operational profit subject to the adjustment made
4. Tax year in which the original transaction was declared as taxable income or an authorized deduction
5. Description of the transfer-pricing adjustment
9. Recording of the voluntary transfer-pricing adjustments in the memorandum accounts and recognition of virtual adjustments in the accounting-tax reconciliation for income tax purposes
10. Having written proof, in Spanish, that the related party with whom the adjusted transaction was entered into has accumulated the corresponding adjustment or, when applicable, the corresponding deduction
11. Complying with the obligation to withhold and recover income tax payable by third parties in accordance with Article 27 of the MITL when the income is derived from the adjustment

In accordance with this rule, taxpayers may only take the deduction in the tax year in which the income or deductions are derived from the related-party transactions, i.e., if the related-party transaction was carried out in 2018, the taxpayer would be expected to take the deduction from the transfer-pricing adjustment in the same tax year.

Finally, the transfer-pricing adjustments should be reflected in the annual income tax return or statutory tax report (as applicable): a) when the period provided to file the annual income tax return specified in Article 76, Section V, expires for taxpayers that have not exercised the option of Article 32-A of the Federal Fiscal Code (FFC) or do not have to file the tax return for Article 32-H of the FFC; or b) on the date established in Rule 3.9.3 to file the tax return referenced in Article 32-H of the FFC, or the statutory tax report for taxpayers that have opted for Article 32-A of the FFC, whichever is later. If applicable, taxpayers must submit amended returns to reflect transfer-pricing adjustments.

As reinforced by this rule, the tax authorities may exercise verification powers regarding the information described previously.

Rule 3.9.1.4 - Deduction of transfer-pricing adjustments (prior notice)

According to this rule, taxpayers that make a voluntary or compensatory transfer pricing adjustment after the deadlines established in Rule 3.9.1.3 may deduct the adjustment in the tax year in which the income or deductions derived from the related-party transaction were recognized, as long as a notice is presented complying with the requirements of filing card 130 of the MITL.

As a consequence of a primary adjustment to a related party, however, domestic correlative adjustments may be deductible only if they derive from a tax correction of the counterparty and a notice is presented that complies with the requirements of filing card 134 of the MITL. Similar to the previous rule, the tax authorities may exercise verification powers regarding this information.

Rule 3.9.1.5 - Deduction of transfer-pricing adjustments as a result of an advance pricing agreement (APA)

In accordance with this rule, taxpayers may request the deduction of transfer-pricing adjustments derived from an APA and, if applicable, the foreign correlative adjustment, to be in different tax years than those established in Rule 3.9.1.3, but the adjustments must fall within the APA's term. Also, the amended returns filed by the taxpayers in these cases will not be considered within the limits established in Article 32 of the FFC.

Key considerations

Although the new rules discussed in this Alert provide more certainty to taxpayers in Mexico on the application of transfer-pricing adjustments, the specific requirements established in these rules also represent additional tax and transfer-pricing compliance efforts and risks for taxpayers, with potential direct repercussions to their tax results.

In the specific case of Rule 3.9.1.3, regarding transfer-pricing adjustments leading to an increase in deductions, the comprehensive list of requirements to ensure deductibility of these adjustments highlights the importance of identifying potential situations that might trigger these types of adjustments. Taxpayers should aim to either verify the effective application of transfer-pricing policies or prepare the required supporting documentation.

Finally, it is relevant for taxpayers to either discard or determine potential transfer-pricing adjustments before year-end and, if applicable, perform a detailed analysis to corroborate compliance with the new requirements contained in each of the rules before proceeding with the application of any transfer-pricing adjustment in Mexico.

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