Mexico is introducing a tax reform to be enforced on 1 January 2020, implementing a general anti-abuse rule. Its aim is to increase governmental control over the transactions carried out by taxpayers. To counter abuse of tax law, the anti-abuse rule will allow tax authorities to adjust the nature of the operations reported and, consequently, also the tax that has been accounted.
The New article 5A of the Federal Fiscal Code (es. Código Fiscal de la Federación -CFF-), allows the tax administration to recharacterize a transaction that doesn’t reflect any economic rationality and which has been carried out with the aim of gaining a tax benefit; a benefit that was not intended nor foreseen by the legislator when the law was created.
This new rule doesn’t seek to tackle tax fraud or tax evasion. Its real purpose is to be able to disregard transactions that comply with the formal requirements of the law, under the premise that those transactions constitute an abusive practice, even though the taxpayer’s behavior is not strictly violating the written tax law according to its literal interpretation.
Comparative view: EU’s approach to prohibit abusive practices
These kinds of measures against the abuse of tax law are not a new concept. Several territories like Australia, Canada, Hong Kong, India, Israel, New Zealand, South Korea, among others, embrace similar mechanisms in their legal framework to stop abusive practices from taxpayers.
In the EU, The Court of Justice of the European Union (CJEU) has developed an unwritten principle to the same effect through its jurisprudence for more than 40 years.
In the sphere of VAT, the principle prohibiting abusive practices was invoked in 2006 for the first time, in the landmark case Halifax, in which the CJEU established guidelines to assess why, when and how to apply this principle in order to modify certain transactions artificially created to obtain a tax benefit not foreseen or intended by the lawmaker. This judgement introduced a test based on two requirements that must concur in order to assess the abusive practice:
- An objective element consisting in the tax advantage obtained contrary to the purpose of the VAT provisions laid down by the Directive and the national legislation despite formal application of the conditions settled in those provisions; and
- A subjective element consisting in the essential aim of the transactions to obtain a tax advantage, based on objective factors.
Only these circumstances can determine whether the operation performed by the taxpayer should be deemed as abusive and be recharacterized to reflect the real purpose of the transactions.
Mexico’s general anti-abuse rule
In Mexico the new article 5-A of the reform to the Federal Fiscal Code envisages the possibility to recharacterize legal acts when the following concurrent circumstances occur:
- The legal acts lack business purpose.
- The gain of a direct or indirect tax benefit.
If those two factors are present, the result will be that the effects of that legal act will be the same as if the taxpayer had carried out the transaction to obtain the expected “reasonable” economic benefit. In other words, that transaction will be recharacterized to produce the legal effects as if the transaction would have a reasonable economic purpose.
This general anti-abuse rule, as it was approved, bestows a broad discretionary power to the tax authority to decide if a transaction falls under the scope of the rule. In practice it means that for the taxpayer to counter a tax authority decision, it must be able to demonstrate not only that the transaction was effectively carried out, but also that it has a congruent business or economic motive other than the fiscal benefit gained.
The main issue with this provision is the lack of a comprehensive and well-established test based on objective circumstances or elements of the legal acts to assess whether a transaction is abusive from a tax perspective. On the contrary, it heavily relies on the subjective assessment of the business purpose of the transactions and the reasonable economic benefit sought by the taxpayer. Consequently, the legal certainty risks being jeopardized when this rule is applied, and the foreseeability of the tax law and the legitimate expectations of the taxpayers could be diminished. This in turn would make it even harder for economic operators to plan the fiscal effects of the transactions carried out in their businesses, creating an uncertain an unpredictable economic impact.
The application of this general anti-abuse rule for VAT risks creating tensions with the principle of fiscal neutrality because certain operations could be recharacterized directly affecting the right to deduct input VAT or hinder the expected VAT recovery.
The application of this new rule entails a big responsibility for the tax authorities and courts of Mexico. Taxpayers are entitled to organize their economic transactions in the most favorable way also taking into consideration the most favorable tax planning. To assess the abusive nature of a tax scheme is certainly a difficult task and it is therefore possible that the legislative branch of the government will have to re-evaluate and improve this general anti-abuse rule after the impact of its application has been assessed in practice. However, for the time being, businesses operating in Mexico must consider the possibility of having their transactions recharacterized to the detriment of their carefully crafted tax schemes.