Mexico has introduced new substance-over-form procedures that change the country's formal approach into one more compliant with the BEPS Project. Taxpayers should take note of these developments as they may impact tax disputes, writes Bernardo Ramírez and Valentín Ibarra of Chevez, Ruiz, Zamarripa y Cía.

Resulting from a G20 world leaders' request, the OECD created an action plan to deal with base erosion and profit shifting (BEPS) issues. The 15 actions of this plan provide governments with instruments to confront tax avoidance and seeking to tax profits in the jurisdiction where the economic activity is performed, considering the actual economic nature and substance of the said activity.

For years, the tax system in Mexico has been mainly formal. Therefore, taxpayers, tax authorities and tax courts have interpreted tax law based on a strict approach, with greater emphasis on formal procedures and compliance of formal requirements.

However, in recent years tax authorities have begun to carry out audits and assessments of tax deficiencies where they intend to tax the transaction according to its economic substance, prioritising the actual nature of the transaction, rather than its formal structure and more often, pushing into the background the compliance of formal requirements, in spite of the fact that such a substance approach exceeds the powers granted by the law to the tax authorities (With the exception of cases regarding criminal offenses and transfer pricing situations).

In this context, even some tax courts have begun to analyse cases and issue their judgments based on the economic substance of the transactions carried out by taxpayers, in spite of its form.

Following these local and international trends, in 2016 the Executive Branch proposed an amendment to the Federal Tax Code and the Federal Administrative Litigation Procedure Law, to introduce a new administrative procedure (substance-over-form administrative appeal) and a new law suit (substance-over-form annulment suit). This provides legal support to resolve tax controversies weighing economic substance of the business transactions involved, over formal requirements.

In January 2017, a legislative reform was published, allowing taxpayers to challenge a tax assessment through traditional means of defence (in which the form and the substance of the transaction would be analysed) or, alternatively, through the new substance-over-form procedures. According to this reform, only specific tax assessments derived from certain fiscal audit procedures in which the amount of the case exceeds 200 annual times the unit of measure (approximately $300,000), may be challenged through these new means of defence.

The substance-over-form administrative appeal will be analysed and resolved by the current tax-dispute authorities, whereas the substance-over-form annulment suit will be ruled upon by a specialised chamber of the Federal Court of Administrative Justice, which began to operate on July 1 2017.

Substance-over-form annulment suits will follow the principles of orality and celerity, where hearings will be carried prioritising communication between the judge and the parties, and reducing timelines through the elimination of certain excessive procedural formalities.

During this substance-over-form administrative appeal there is a possibility to hold a hearing where the taxpayer will have the opportunity to put forward his arguments orally in the presence of the tax authority that issued the challenged resolution and where the tax dispute authority will preside.

On the other hand, the regulation of the substance-over-form suit provides for a mandatory oral hearing in which the parties at trial will present their arguments, and the judge will determine the core issue and the merits of the dispute.

When filing these substance-over-form procedures, taxpayers may only present arguments related to the substance of the case. These are defined by law as those referring to the taxpayer, scope of the tax, taxable basis, rate or tariff of the tax obligations assessed by the tax authorities.

This being the case, taxpayers may challenge:

  • The facts or omissions expressed in the tax assessment as a breach of tax obligations;
  • The application or interpretation of the tax law;
  • The effects attributed by the tax authority to the total or partial breach of formal requirements or procedures that affect or transcend the merits of a dispute; or
  • The evaluation or lack of assessment of evidence related to those situations. In these terms, the judgment issued on substance-over-form procedures could declare the nullity of the tax assessment when:
  • The facts or omissions that served as a base to the dispute did not occur or were unduly assessed by tax authorities;
  • The applicable law was incorrectly interpreted or unduly applied in the challenged ruling; or
  • The effects attributed by the tax authority to the total or partial breach, as well as to the late compliance with formal requirements or procedures, are excessive or unreasonable.

For instance, if a taxpayer deducts an expense, but files the corresponding informative return out of time, which is a formal requirement established by law in order to be able to consider a deduction as valid, the tax authorities would most likely reject that deduction through a tax assessment. In this case, the taxpayer may file a substance-over-form annulment suit, in which the specialised chamber, should focus its analysis on the substance of the case (the validity of the deduction itself), considering that a late fulfilment of a formal request, such as an informative return, should not result in the rejection of a valid deduction, as this would be excessive.

In summary, these new substance-over-form procedures are a remarkable step forward in administering justice, which is in accordance with the current international trends, and allows courts to focus on the resolution of tax disputes attending the reality of the economic substance of the taxpayers' transactions, eliminating or diminishing the effects of the breach of excessive or unreasonable formal requirements or procedures.

Originally published by International Tax Review.

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