Mexico Increases Its Focus on Transfer Pricing Through Tax Audits and Financial Statement Review

Mexico Increases its Focus on Transfer Pricing Through Tax Audits and Financial Statement Review

Mindy Piatoff, Sheppard, Mullin, Richter & Hampton LLP

After the Organization for Economic Cooperation and Development criticized Mexico for an inadequate number of transfer pricing audits, Mexico agreed to correct the problem. In 2004, Mexico's Finance Ministry split the Central Administration for International Fiscal Audits ("CAIFA") into two offices. The new office of the Central Administration for Transfer Pricing Audits ("CAT") is dedicated to improving and increasing transfer pricing enforcement. The CAT is fulfilling Mexico's promise by examining the restructurings undertaken by a number of companies who have sought to shift the functions and risks of their Mexican operations to lower tax jurisdictions in Europe.

These companies say that the restructured Mexican entity is merely a contract manufacturer and low-level distributor, resulting in a shift of income away from Mexico. The CAT has claimed that certain of the restructurings resulted in no real associated change in business. With only a few administrative employees located in Europe, the decision making authority remains in Mexico. Accordingly, the CAT argues that the activities were not effectively transferred, and remain subject to Mexican tax.

The Mexican Tax Administration Service ("SAT") is cracking down on transfer pricing on another front. The former head of the CAIFA, Gabriel Oliver, confirmed reports that the SAT (after consulting with the CPA Evaluation Committee) recently issued a three-month suspension of a taxpayer's external auditor's license to certify financial statements. This resulted after a review of the auditor's work papers revealed that there was inadequate evidence regarding the existence of the audited company's transfer pricing documentation. This sends a warning to taxpayers that their auditors will demand proof not only that they have a transfer pricing study but that the arm's length prices determined in the study are reflected in the company's results. This has generated substantial discussion in Mexico and will be a topic of an upcoming seminar. Check back for additional information provided at the seminar.

The CAT is taking a hard line on transfer pricing and is making sure taxpayers understand the importance of compliance. Companies with any related party cross-border transactions need to plan carefully and ensure appropriate documentation is in place. However, more specifically, companies considering restructuring their Mexican operations must ensure that they have evidence confirming an actual shift of decision making. For instance, the corporate strategists and planners should be employed and have a presence in the restructured country. Mexico is taking transfer pricing seriously, and companies doing business there must do the same.

For further information, please contact Mindy Piatoff at (202) 772-5339. As Acting Director of the IRS Chief Counsel's Advance Pricing Agreement program, Mindy Piatoff was part of the U.S. team negotiating the resolution of transfer pricing issues for the maquiladora industry with Mexico. Ms. Piatoff is special counsel in the Tax/Employee Benefits/Trusts & Estates Practice Group in the firm's Washington, D.C. office.