Tuesday, September 23, 2008

Mexico Tax Audits

Excerpt from August 2008 Issue of Practical Mexican Tax Strategies by Jaime González-Béndiksen (Baker & McKenzie)

The Mexican tax administration continues to increase its audit activity in practically all sectors of taxpayers, with special emphasis being paid lately to the pharmaceutical and oil sectors. This article excerpt will briefly discuss some of the transfer pricing issues being raised in recent audits.

Transfer Pricing
Secret comparables. It appears that the tax administration is testing the waters with respect to the use of the so-called secret comparables. These are comparables that the tax administration gathers from its own internal records, such as customs records. The administration gathers information on imports of what it considers to be products similar to those of the taxpayer and, on the basis of such information, rejects the prices paid by the Mexican taxpayer to its related parties abroad. The taxpayer is allowed to review the information gathered by the tax administration and to make notes. It does not, however, have any access to the entire customs files of the administration such that it could confirm whether or not the information gathered by the administration is correct or such that it could locate other information to disprove the administration’s findings. In our view, use of the secret comparables violates Constitutional principles and, as such, should be overturned by our courts when this matter comes to their attention.

Business Restructuring. The tax administration continues to audit business or supply-chain restructurings. It is not that the restructuring, as such, are prohibited. The tax administration’s arguments are basically that the restructuring and, consequently the transfer pricing study to support it, lacks substance. The administration tries to disprov the functions and risks that have arguably being transferred from the Mexican entity to one or more foreign companies within the same group. Regarding functions, the administration generally argues that in fact no functions were transferred abroad. Typically, where the taxpayer argues that purchasing and sales functions are now outside of Mexico, the tax administration looks into whether the foreign entity now charged with the functions has, in fact, employees to carry on these functions and whether or not the Mexican personnel formerly charged with these functions has left the Mexican company or continues to work there. Where managerial functions have reportedly been moved outside of Mexico, the tax administration also looks into whether the employees of the Mexican company formerly charged with the managerial functions in question, have or have not been relocated. On the risks side, the administration looks into whether the Mexican company’s history shows any such risks in fact occurring in the past, such as inventory risks, product liability, bad debts, etc. Its motto is that where there is nothing to lose no risk is being assumed.

These audits, however, typically forget to address the fact that whatever flaws the functions or risks may have, assets have in fact moved. Intangibles are now owned by a foreign member of the group. The production is also owned by a foreign principal who either sells it to a commissionaire in Mexico or sells it to the Mexican company for distribution. No doubt the mere fact that the Mexican taxpayer now owns virtually no assets, calls for a lower return. As mentioned earlier, this is often ignored by the auditors.

More on Business Restructuring

Tuesday, September 16, 2008

Tax Auditors Look to Substance in Centralized IP Structures

Excerpt from August 2008 Issue of Practical US/International Tax Strategies by John Henshall (Deloitte & Touche LLP)

In the early 1990s the first businesses transformed corporate efficiency, and profitability, by taking a holistic view of their business and optimizing their supply chain networks—the complex web suppliers, production and R&D facilities, distribution centers, sales subsidiaries, channel partners and customers. Typically the best commercial structure involved a centralization of regional activity into “Principal” company supported by “contract” or “toll” manufacturers and “commissionaire” sales or “simple” distributors, supported by “shared service centers” to take care of back-office functions. Today most multinationals don’t derive a significant proportion of their profits from the physical act of making products but rather from the ideas they generate that lead those products, wherever products are made. As this state of affairs evolved so did the centralized business model and IP planning is now a signifi cant element in any business restructuring.

Business restructurings are by their nature an enormous strain on the organization and they are not undertaken purely for tax reasons. Tax is, however, taken into account when deciding where the centralized entity should locate; in most reorganizations high-tax countries then see high-profit activities moving away. These governments are fearful of the fiscal consequences of the more profitable element of their tax base moving offshore and will audit the transition vigorously.

Read More: Why Is Substance Important?

Tuesday, September 9, 2008

The Internal Revenue Service Provides Limited Relief from the AHYDO Rules for Pre-2009 Financing Commitments

Excerpt from Practical US/Domestic Tax Strategies by Yoram Keinan and Mark H. Leeds (Greenberg Traurig, LLP)

The Internal Revenue Service has responded again to the troubled credit markets by easing the potential tax burden on corporations that issue debt pursuant to previously established financing commitments (Commitments).

On August 8, 2008, the Service issued a Revenue Procedure that describes circumstances under which it will not treat a debt instrument issued pursuant to a Commitment as an applicable high yield discount obligation (AHYDO) for federal income tax purposes. The AHYDO rules can result in both deferral of interest and original issue discount (OID) deductions, as well as a disallowance of such deductions. As a result, corporate borrowers who were lucky enough to lock Commitments prior to the current credit crunch will not face possible deferral and/or disallowance of interest and OID deductions on their debt as a result of actions taken by their lenders.

Read More on the Background of the AHYDO Rules (free)