Mexico Implements BEPS Action 4 To Limit Interest Deductibility

The Mexican government has set out to reform the tax system to include the OECD's recommended limits on interest deductibility in accordance with BEPS Action 4. Mexican tax reform will define 2020.

On October 30 2019, the Mexican Congress approved the 2020 tax reform which, among other amendments and additions to several tax provisions, included the incorporation of a new subsection to Article 28 of the Mexican Income Tax Law in order to limit the deductibility of interest payable by companies in a given tax year in accordance with Action 4 of the OECD BEPS project.

Through the Statement of Intent (Exposición de Motivos in Spanish), the Executive Branch described that the use of related and non-related party interest is perhaps one of the simplest profit-shifting techniques available for international tax planning due to the mobility of money.

BEPS Action 4

In this regard, Action 4 provides that in many high tax countries, specific provisions on thin capitalisation have been enacted to counteract such debt tax planning strategies, but these seem to be inadequate as such strategies are still widely used to create value for companies. Main risks in this area may arise in three basic scenarios:

Groups placing higher level of third-party debt in high tax countries; b Groups using intra-group loans to generate interest deduction in excess of the groups' actual third-party interest expense; and Groups using third-party or intra-group financing to fund the generation of exempt tax income. The final BEPS Action 4 Report was released on October 5 2015, while an updated final version was released on December 22 2016. The report contained recommendations on so-called best practice in the design of rules, in order to prevent base erosion through the use of excessive interest expenses and other financial payments. The recommended best practice approach is based on a fixed ratio rule, where the net deduction of interest and payments economically equivalent to interest is limited to between 10% and 30% of the entity's or group's earnings before interest, tax, depreciation and amortisation (EBITDA), thus the deductibility of net financing costs should therefore be limited to between 10% and 30% of EBITDA.

Mexican tax legislation contains several rules to limit the deduction of interests that have been introduced over the years to establish greater limitations and prevent abuse by taxpayers

The recommended approach to interest limitation rules represent a...