Following a ruling of the Mexican Supreme Court of Justice on 19 March 2014, pro rata payments made outside of Mexico to non-residents are deductible – given that certain conditions are met. The ruling follows several cases before lower Mexican courts, where tax payers argued that the provision in question (article 32, Section XVIII of the Mexican Income Tax Law) violates the non-discrimination provision included in Mexico’s income tax treaties by denying the deduction of aforementioned payments.
One of the important issues addressed by the Supreme Court is that the Income Tax Law requires the application of the OECD transfer pricing guidelines. These guidelines approve the pro rata method of cost allocation (under certain circumstances). However, the Income Tax Law denies the deductibility of those costs, simply because they are calculated on a pro rata basis (and paid to a non-resident).
The Supreme Court ruled that pro rata expenses are deductible, unless they do not meet specific requirements. According to the Supreme Court, these are the conditions that must be met:
- The expense must be necessary to the business activities of the taxpayer
- If the expense has been incurred between related parties, the expense must be established in compliance with the at arm’s length principle
- The taxpayer must supply the tax authorities with information about the foreign transaction:
- a. Information about the related parties
- b. Activities carried out, assets used and risks assumed by each of those related parties
- c. The transfer pricing method used
- The tax payer must maintain supporting transfer pricing documentation, and;
- The tax payer must maintain documentation to prove the allocation of the costs was based on valid business grounds and not made arbitrarily.