Mexico: Taxpayers Face Big Financing Costs From VAT Bill 2017

Amendments to Mexico's VAT Law will significantly increase the costs for business taxpayers. Cesar De la Parra and Ignacio Mosquera of Chevez, Ruiz, Zamarripa y Cia explain the changes.

A bill of tax amendments submitted by the Executive Branch and approved by the Mexican Congress included changes to Article 5-I of the Value Added Tax Law (VAT Law), regarding the creditable VAT of fixed assets or expenses incurred in preoperative periods (i.e. before generating VAT income on its activities).

Under Article 5-I as it now applies, taxpayers may credit VAT paid on the purchase of fixed assets and/or on expenses incurred in a preoperative period.

Prior to the amendment, which will have effect from January 1 2017, taxpayers were allowed to request the refund of monthly favourable balances of VAT and, in general terms, in a 40-day period the taxpayer would receive the VAT refund. However, the government said this VAT crediting system was making it difficult for tax authorities to verify that fixed assets and/or expenses incurred in a preoperative period would eventually give rise to activities subject to VAT.

Under the changes made to the VAT Law, and according to the explanatory memorandum accompanying the legislation, if the taxpayer's activities do not result in a VAT, then the credit against the tax will be disallowed, and therefore the economic burden of the tax will be borne by the taxpayer as the final consumer.

The VAT amendment

From January 1 2017, the VAT associated with the purchase of fixed assets and preoperative expenses may be credited under one of the following two options:

  • The taxpayer may request the related refund to be delayed until the first month in which it performs activities that are subject to VAT (an inflation adjustment is allowed); or
  • Request the VAT refund in each month in which the preoperative expenses or purchase of fixed assets are incurred, according to a forecast of the activities subject to VAT and provided that the taxpayer submits certain information.

It is important to mention that the provision defines the term "preoperative period" as the period of time in which the expenses and purchase of fixed assets are incurred, prior to the beginning of any activities by the taxpayer involving the sale of the goods, provision of services or leasing of the goods.

The VAT Law also defines that the preoperative period may have a maximum duration of one year from the date of the first VAT refund request, unless the taxpayer proves that its preoperative period will extend over a longer duration according to its business model. The tax administration must approve this plan.

However, there is no certainty for the taxpayer that the tax authorities will approve the extension to the preoperative period because there are no specific guidelines for such purposes. As a consequence, this could result in the extension being refused and the refunds being denied.

The financial cost

This amendment will generate a financial cost for investors because the VAT credit will only be allowed until the taxpayer:

  • Has started operating; or
  • In the event that the tax authorities deny an extension to the preoperative period, specifically in the last year of the preoperative period.

For purposes of quantitatively illustrating the financial cost of the bill in the event that the tax authorities deny the request of the taxpayer for an extension, below is a comparison between the costs of a hypothetical investment under the current provisions and the financial costs considering the provisions in force from January 1 2017. The hypothetical investment has the following characteristics:

  • Total investment: $1 billion
  • Preoperative period: three years
  • Operative period: three years
  • Cash flows for the operative period: $400 million, $450 million and $500 million
  • Funds source: debt

Table 1 illustrates the cash flow projection, taking into consideration the VAT crediting mechanism in force during the preoperative period, before the VAT changes apply.

As it may be observed in the chart above, the VAT credit is applied on an annual basis on years -3, -2 and -1, which is in the preoperative years of the project, while the resulting internal rate of return (IRR) is 8.3%.

On the other hand, Table 2 shows the cash flow projection under the VAT crediting scheme that will enter into force from 2017. This chart considers a denial of an extended preoperative period.

As it may be observed, the VAT credit is applied on the last year of the preoperative period and the resulting IRR is 7.8%, which is 0.50% lower than the IRR obtained under the VAT crediting scheme in force until the end of 2016.

All other things being equal, this change in the VAT crediting mechanism makes this hypothetical investment project 0.50% less profitable due to the fact that the positive inflow of the VAT credit for the investment project is delayed by two years.

From a financial standpoint, the fact that a positive inflow is delayed will reduce the profitability of the project as a whole, provided all other things remain equal. However, the actual reduction in the profitability will depend on the characteristics of each project.

This decrease in the profitability of the project would be transferred to the Mexican government because VAT paid at the beginning of the preoperative period would be held until the last year of the preoperative period, which would involve financial benefits for the Mexican government over time.

The reduction in the profitability of the project, as described above, only derives from the change of the VAT crediting system. It does not consider any other possible impacts, such as the reduction of the cash flows of a project resulting from a higher financing cost.

In this sense, it is important to analyse the financing cost that the amendment of the VAT provisions implies. For such purposes, a hypothetical loan is considered for the project with the following characteristics:

  • Principal amount: $1 billion
  • Financing period: six years (three preoperative years and three operative years)
  • Interest rate: 6.18%

Table 3 illustrates the amortisation of the abovementioned loan.

As it may be observed, the total interest expense in the six-year period is $227 and the annual payment is $205.

In comparison, Table 4 illustrates the amortisation of the loan, taking into consideration a 16% increase in the principal amount in order to finance VAT during all the preoperative periods of the project. An additional payment in year -1 is considered, once VAT from the preoperative period is recovered. The annual payment is recalculated to account for the additional payment.

As it may be observed, the total interest expense in the six-year period is $243, which represents an increase of 6.9% of the total interest expense on the original loan. Moreover, the annual payment in the preoperative period is increased by $32, which represents a 16% increase from the original amount. This increase will certainly have a negative impact on the cash flows of the project, reducing its profitability.

Moreover, the significant increase in the annual payment may complicate the conditions for the creditworthiness of the investor so that the latter may obtain the loan necessary to start the project and may lead the investor to search for better financial conditions in other countries.

Comparative indicators

Once we have analysed two key indicators of the profitability of a project, it is important to review certain comparative indicators for an investment project in Mexico.

According to the OECD, the average three-month interbank rate across the OECD member countries as of October 2016 is 0.50%, whereas in Mexico it is 5.19%. Furthermore the average income tax rate across the OECD nations is 22%, while the income tax rate in Mexico is 30%. Moreover, according to the OECD, the average consumer price increase for 2016 across OECD countries is 1%, whereas in Mexico it was of 2.8%.

In addition, the graphic below shows the behaviour of the exchange rate (Mexican peso v. US dollar) during the 2005-2015 period.

As shown in the graphic, the exchange rate of the Mexican peso compared to the US dollar has increased considerably over the past decade. Moreover, considering the maximum exchange rate registered in 2016, it represents a depreciation of the Mexican peso of approximately 20% in 2016 alone.

This situation highlights that if an investment project is funded through a loan denominated in US dollars, the financial cost may increase significantly over the life of the project. On the other hand, if the project is funded in Mexican pesos, the costs of the project may increase since the prices of machinery, equipment, raw materials, among others are normally quoted in US dollars.

These indicators show that in general terms, Mexico is a country with comparatively high financial and tax costs, as well as a higher than expected increases in prices.

The fact that the financial costs are increased as a result of the changes to the VAT rules means Mexico has not helped its position as an attractive jurisdiction for investment.

Finally, it is important to note that in the explanatory memorandum of the 2013 tax bill, the VAT has favourable effects on investments, savings and employment and consequently on the economic growth of the country. This is because VAT does not tax the investment because it allows the credit on the VAT paid in the acquisition of fixed assets even in a preoperative period, avoiding an increase in the cost of capital and without establishing a limit for preoperative periods.

Conclusions

The modifications of the VAT provisions from January 1 2017 may significantly damage investment into Mexico by increasing the financial costs of an investment project, thus potentially decreasing both the domestic investment and the foreign investment.

Originally published by International Tax Review (Dec-Jan issue).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions