The 2020 tax reform published on the Federal Official Gazette, on December 9th,modifies section XXIII of article 28 of the Mexican Income Tax Law (MITL), disallowing the deduction of payments made to foreign based related parties or transactions executed through “structured arrangements”, to the extent that the recipient is subject to a preferential tax regime (PTR).

The tax reform is based on the recommendations set forth in the context of Action 2 of the Final BEPS Report “Neutralizing the Effects of Hybrid Mismatch Arrangements”, issued by the OECD (Organization for Economic Cooperation and Development) and the G20.  

General rule

The tax reform disallows the deduction of all payments made to a foreign based related party or through a “structured arrangement”, when the recipient of the income is subject to a PTR, as defined in the MITL. 

Income should be considered to be subject to a PTR if (i) it is not subject to tax abroad, or (ii) it is subject to income tax which is lower than 75% of the income tax that should have been paid under the MITL.

We believe that authorities should consider excluding, through Temporary Tax Rules, payments made to foreign pension funds, multilateral organizations to which Mexico is a party and foreign government agencies of countries with which Mexico has executed a double tax treaty with, all of which are not ordinarily subject to taxation abroad.

The new rule also applies if the direct or indirect recipient of a payment, regardless of it being subject to a PTR, uses the proceeds of such payment to make other deductible payments to a member of the same group that is subject to a PTR. Such payment would be presumed to exist, unless proven otherwise, if they are greater than or equal to 20% of the original payment made by the Mexican taxpayer. 

In these cases, the moment of the payment should be irrelevant due to the fact that the new rule applies to those payments that have been made prior to or after the moment in which the Mexican taxpayer makes the payment. Further, the number of transactions or parties involved in such transactions should also be irrelevant since the rule covers all transactions executed between members of the same group or through “structured arrangements”.  

Two or more members are deemed to be part of the same group when one has effective control over the other, or when a third party has effective control over both.  For such purposes, the reform establishes a comprehensive “effective control” definition that not only covers direct or indirect voting control, but other control benchmarks such as economic rights or accounting control. 

The rule defines a “structured arrangement” as any arrangement in which a taxpayer or any of its related parties participate, which is priced based on payments made to a PTR that benefit the taxpayer or any of its related parties, or when based on the facts and circumstances of the transaction, it is reasonable to conclude that such arrangement was implemented with the purpose of producing such benefit.  

The reform requires tax authorities to issue temporary tax rules clarifying the application of this rule, based on similar rules applicable in foreign jurisdictions which disallow the deduction of payments made to PTR or payments made through hybrid mechanisms.