Global Tax Alert (News from Americas Tax Center) | 14 April 2014
Mexican Supreme Court decision regarding non-deductibility of pro-rata expenses
On 19 March 2014, the Mexican Supreme Court of Justice (the Supreme Court) issued a ruling on the deductibility of expenses incurred on a pro-rata basis with nonresident taxpayers. The Supreme Court in effect ruled that the deductibility of pro-rata expenses turns on whether certain requirements are met, not whether those expenses were paid on a pro-rata basis to non-Mexican residents. Unlike other recent cases at lower court levels that focused on the deductibility of these expenses in a treaty or non-discrimination context, this ruling is on the law itself.
Under Article 32, Section XVIII of the Income Tax Law in force through 20131 (Section XVIII), expenses incurred outside of Mexico on a pro-rata basis with someone that is not a corporate or individual taxpayer in Mexico are non-deductible. This law has limited the ability of groups to make intercompany charges or allocations of costs to their Mexican subsidiaries.
The Supreme Court considered a progressive and systematic interpretation of Section XVIII, together with transfer pricing provisions including the guidelines issued by the OECD, and concluded that non-deductibility of pro-rata expenses is only applicable when the corresponding expense does not meet certain requirements. Deductibility is not based on the mere fact that it is a pro-rata expense paid to a non-Mexican resident.
The Supreme Court’s decision specifically sets forth that in order to deduct a pro-rata expense the following requirements must be met:
- •The expense must be strictly necessary to the business purpose of the taxpayer.
- •If the expense was incurred between related parties, the price must be agreed at fair market value.
- •The taxpayer must provide the tax authorities precise information on the foreign transaction, such as: the related parties’ tax information; the activities carried out by each related party, and if applicable, the assets used and risks assumed by each related party; and the method used to determine the transfer price.
- • The taxpayer must maintain supporting documentation that demonstrates the type of transaction carried out, the contractual terms, the transfer pricing method selected and comparable transactions or companies for each type of transaction.
- • The taxpayer must maintain documentation to demonstrate that the allocation was based on objective tax and accounting elements and not in an arbitrary manner by the taxpayer. For these purposes, the taxpayer must always have a valid and evident business reason.
This decision highlights that the deductibility of an expense of this nature (i.e., a pro-rata expense paid to a non-Mexican resident) is reasonable, as the tax authorities have the ability to verify the authenticity of the transaction, including the amount of the expenses incurred abroad, the benefit obtained, and other elements.
Therefore, to the extent that the above requirements are met, the deduction of pro-rata expenses should be allowed. Taxpayers should use this ruling as a guide to review support for intercompany and other pro-rata charges.
The decision also highlights the importance of maintaining supporting documents as part of defense files to demonstrate that the above requirements are duly complied with, as it is expected that the tax authorities will continue to audit taxpayers and review the deductibility of these expenses under the parameters set forth by the Supreme Court.
Please note that legal precedents under Mexican law - albeit issued by the Supreme Court - are not of mandatory application to the lower courts until they become binding judicial decisions.2 However, it is expected that this ruling should substantially influence future decisions of the courts and tax audits. The tax administration has published this ruling on its website, which demonstrates their support of the decision reached by the Supreme Court.
The decision under analysis has not yet been formally published by the Supreme Court. This Tax Alert is based on the information available at this time.
1. Note that effective 1 January 2014 a new Income Tax Law went into effective. This same limitation is included in the 2014 law, in Article 28, Section XVIII.
2. Binding judicial decisions are formed by either uninterrupted reiteration of thesis or contradiction of thesis resolved by the Supreme Court.
For additional information with respect to this Alert, please contact the following:
Mancera, S.C., Latin American Business Center, Mexico City
- • Terri Grosselin
+52 55 1101 6469
- • Koen van´t Hek
+52 55 1101 6439
Ernst & Young LLP, Latin American Business Center, New York
- • Alfredo Alvarez
+1 212 773 5936
- • Ana P. Mingramm
+1 212 773 9190
- • Enrique Perez Grovas
+1 212 773 1594
Ernst & Young LLP, Latin American Business Center, Chicago
- • Michael J. Becka
+1 312 879 3370
Ernst & Young LLP, Latin American Business Center, Houston
- • Oscar Lopez Velarde
+1 713 750 4810