In compliance with the Law on Income Tax [in Spanish: la Ley del ISR], and under the terms of titles II and IV, prorated expenses made abroad will not be deductible for individuals who do not pay Income Tax.
However, during the 2014 tax year, the Supreme Court of Justice of the Nation [in Spanish: la Suprema Corte de Justicia de la Nación (SCJN)], indicated that such a prohibition must be understood as relative, and not absolute, since the fiscal authorities are obligated to verify that such expenditures fulfill the legal requirements to be considered authorized deductions.
In accordance with what is established by the Supreme Court of Justice of the Nation in the Periodic Amendments for the 2015 tax year, requirements were established that must be complied with for the deduction of prorated expenses that are made abroad; the same which are reproduced below:
“The provisions of article 28, section XVIII of the Law on Income Tax shall not apply when dealing with prorated expenses that are made abroad by those individuals who do not pay Income Tax, under the terms of Titles II or IV of the same Law, when all of the following requirements are fully complied with:
I. That the expenditure incurred be strictly indispensable for the purpose of the activity of the taxpayer.
II. That the individuals who make prorated expenses abroad be residents of a country that has a broad information exchange agreement with Mexico.
III. Prove that the service is related to the aforementioned expense and that it has indeed been provided.
If the expense was made between the related parties it will be considered, unless proven otherwise, that the service in question was not provided; if any of the following assumptions are revised:
a) Under the same terms, an unrelated party may not have been willing to pay for the aforementioned service or to carry it out on its own;
b) Regarding services that a related party carries out due to the interests of one or various related parties; that is, acting as a shareholder or partner.
c) Regarding services or transactions carried out by a related party that implies duplication of a service that is carried out by another related party or third party; or,
d) The expense is duplicated or deducted along with other costs, expenditures, or investments made by the taxpayer for the purposes of, among others, commissions, royalties, technical support, advertising, and interest.
For the purposes of this section, under no circumstances shall the invoicing and/or payment be proof in itself that a service was indeed provided.
IV. If the expense was made between related parties, it must be proven that the agreed upon price or amount of the remuneration was established within the range that may have been used with or between independent parties in comparable transactions.
V. That a reasonable relationship exists between an expenditure incurred and a benefit received or one that is expected to be received by the taxpayer that participates in the expense.
To that end, taxpayers who intend to make the prorated expense must enter into an agreement or contract that is based on the same prorated expense that, must at least comply with the following conditions:
a) Each participant of the agreement or contract must have full access to the details of the transactions that are going to be made within the framework of the same, as well as to the projections upon which the prorated expenses are based. The expected benefits will be determined, together with the prorated expenses that were effectively disbursed and the benefits that were indeed received regarding the transactions of the agreement or contract.
b) The participants will be exclusively companies that can mutually benefit from the entire agreement or contract.
c) The agreement or contract must specify the nature and reach of the overall and individual benefit obtained by the group that the taxpayer belongs to, with espect to the expenditure made, which prorated it, or that was prorated among other members of the group.
d) The agreement or contract must allow the prorated expense to be adequately distributed utilizing a method of allocation that reflects the aforementioned expense in relation to the benefits that you expect to obtain from the agreement or contract and,
e) The agreement or contract must indicate the scope of the specific transactions that are covered, as well as the duration of the contract and that of the agreement or contract.
VI. Keep the following documentation and information regarding each of the transactions, when the transactions are performed abroad on a pro rata basis:
a) Name, country of incorporation, residence for tax purposes, and main area of business or the place of effective managment, business address, as well as the tax identification number of each of the related parties that participated in the apportioning of the total expense or that will utilize or make use of the results.
b) Type of transaction peformed as well as the contractual terms.
c) Functions or activities performed from the transaction in question by each of the related parties who are involved in the aforementioned transaction and, where applicable, the utilized assets and the assumed risk for the same.
d) Documentation that covers the fulfillment of the total cost that is carried out. To that end, you must have all the documentation which proves that the expense that was charged to it was indeed made by the overseas resident.
e) Detail the manner in which the prorated expense was paid to the taxpayer with documentary evidence of the said payment.
f) The method that was applied under the terms of article 180 of the Law on Income Tax to establish that the transaction is at market price, and to carry out the aforementioned method.
g) Information that is utilized to determine that the transactions or companies are similar in each type of operation, and,
h) Support for the operations that may be carried out from those that are based upon a prorated are indeed disbursed; and the benefits that are really received.
Notwithstanding, taxpayers must have documentation that proves that what was prorated was based on fiscal aspects and accounting objectives, confirming that there is an underlying reason for business which is valid and evident”.
To summarize, we can conclude that if prorated expenses are incurred, they will not be deductible if they do not comply with the established requirements as indicated in the Periodic Amendments.
In case you require any further information for your company for a situation that is distinct, we would appreciate it if you contacted us. We will be pleased to help you.