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Nov. 25 — Mexico needs more legal clarity on the kinds of deductions allowed for promoting and advertising businesses with a related foreign-owned trademark, according to tax practitioners who said the ambiguity has resulted in conflicts with the tax authorities.
The country’s tax authority, the Servicio de Administracion Tributaria (SAT), is starting to take a more aggressive approach toward disallowing many of these expenses for intangibles between related parties, said Moises Curiel, a Mexico City-based tax partner and transfer pricing practitioner with Baker & McKenzie.
“I have several clients who are being audited by the Ministry of Finance, who are challenging the total amount of marketing and promotional expenses as not deductible, arguing that they belong to the owner and not the Mexican affiliate,” Curiel told Bloomberg BNA earlier this month.
The controversy over accounting for intangibles has heated up, with tax authorities challenging previously deductible promotional expenses in the financial, pharmaceutical, telecommunications and food and beverage sectors, tax practitioners said.
“It is a position that the SAT has expressed for two years, probably as a consequence of the weak finances of the country and the low oil prices,” said Guillermo Villasenor, a tax partner with Mexico City-based Sanchez Devanny. “We have been seeing a more aggressive perspective on changing some of the interpretations they gave us previously.”
At the heart of the contention is whether the tax authorities have the legal right to disallow promotional expenses on the basis that they are actually marketing expenses for the brand itself, increasing the value of the brand owned by the foreign parent company and for which the subsidiary pays a royalty.
“There are no legal provisions or guidelines on this topic in Mexico at this point,” said Jorge Ramirez-Dorantes, a Mexico City-based tax partner with Baker & McKenzie. “It is very complex and the SAT position goes to the extreme position, saying that all the expenses a subsidiary makes are designed to increase the value of the brand.”
The battle over how deductions are treated for intangibles between a foreign headquarters and its local subsidiary is one that has been fought internationally. In 2002, for example, the U.S. Court of Appeals for the Ninth Circuit in a case involving the sale of U.S.-based DHL Corp.'s trademark to a foreign affiliate established a bright-line test for what could be considered reasonable marketing expenses for the brand development and what could be deducted as a promotional expense for a specific product.
The Mexican tax authorities are hoping to find a similar benchmark or industry standard for reasonable percentage of marketing and promotion expenses, according to Charikleia Tsoukia, a member of the International Fiscal Association. IFA has been working with the Mexican tax authorities to provide insights on industry benchmarks and guidelines on possible benchmarks by sector.
“I think in their minds they were trying to see if those benchmarks could result in a bright-line text,” said Tsoukia, a Mexico City-based transfer pricing and tax partner at Ernst & Young. “It might be a tool that they could start their audits from, but it would still be a negotiable process,” she told Bloomberg BNA Nov. 22.
Accounting firms and tax attorneys in Mexico also are calling for this kind of clarity from the tax authorities in what should be considered a marketing expense related to building up the trademark value and what is a promotional expense, something potentially deductible for the subsidiary as a cost of promoting a product in the country.
“We still need to wait for the tax authorities to reach a final conclusion on this,” said Teresa Quinones, a Mexico City-based tax partner with KPMG. “What we are seeking more clarity on is having an appropriate understanding of what those marketing expenses versus promotional expenses are and the tax consequences of having those expenses.”
An alternative approach that more closely paints the economic reality, according to Quinones, would involve an analysis of which party is entitled to the profit of the intangible, based on the party that developed and enhanced it and is responsible for its maintenance, protection and exploitation.
“Marketing expenses might imply the existence of a local intangible, but you need to do an appropriate analysis to see whether you are entitled to the whole ownership of the local intangible,” Quinones said. “It is a complex analysis that includes additional factors.”
The variance between sectors and even within a sector may also make a bright-line test more challenging.
“With the data we gathered, we found that it is very difficult to promote a bright-line test because each industry is different,” Tsoukia said. “And companies are all over the place in terms of how much they spend—I honestly cannot find a reliable statistical pattern that each industry follows.”
The Mexican tax authorities, in turn, have indicated they may provide more guidance on the topic. The SAT has requested a professional opinion on the treatment of marketing intangibles from IFA’s Mexican branch, and these comments are under discussion, Quinones said. The comments are expected to be made public in the coming weeks.
The Mexican Supreme Court is also expected to rule on several specific tax cases involving the treatment of marketing and promotion expenses for the marketing of an intangible.
Rodrigo Gomez, a Mexico City-based tax partner at Jones Day, warned, however, that companies transferring an intangible to a foreign parent as a means to then deduct marketing expenses in Mexico shouldn’t consider themselves eligible to make the same deductions as other subsidiaries that are freshly trying to establish their brand for the first time in the country.
“A lot of taxpayers were migrating all the intangibles to Europe or Luxembourg. That is how this issue came into the eyes of the authorities,” he said. “In those cases, whatever expenses are related to that intangible, it is not a defendable deduction, because the intangible was created in Mexico, so there is no reason why it should go outside.”
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