Mexico Tax Alert: Regulations issued to clarify tax consolidation recapture rules

The Mexican tax authorities issued new regulations on 31 March 2010 to clarify various aspects of the amended tax consolidation regime that became effective on 1 January 2010. The new regulations are effective retroactively as from 1 January.


Background

Under Mexico's tax consolidation regime, entities that are more than 50% controlled by a holding company may file a consolidated tax return. The group is treated as a single economic entity for income tax purposes, with the consolidated tax result subject to the standard 30% corporate tax rate. Other benefits of consolidation include the ability to offset net operating losses (NOLs) of individual companies in the group against the profits of other group companies and a tax-free flow of dividends between entities in the group that did not come out of the "CUFIN" account (i.e. the after-tax earnings account). Until the 2010 reform, income tax deferred under the regime was paid upon the occurrence of a triggering event, such as when a member exited the group, its shareholding was reduced or the entire group deconsolidated.

The 2010 tax reform made far-reaching and controversial changes to the tax consolidation regime to limit the deferral of the tax benefits received by groups. As from 1 January, the deferral period is limited to five years (even in the absence of a triggering event), so that in the sixth year consolidated groups must pay any deferred tax benefits. A specific – and complicated – schedule for the repayment of deferred tax benefits has been set up (e.g. consolidated return tax benefits received between FY 1999 and 2004 are payable in 2010). The reform creates significant challenges for companies filing consolidated returns, results in distortions and inconsistencies and a higher tax burden.


Regulations

The new regulations aim to clarify some of the inconsistencies and distortions in the amended rules:

- Under the amended rules, dividends paid from 1999 to 2004 that generated a tax to be paid beginning in 2010, also generate an increase in the RECUFIN (i.e. the individual and consolidated pretax profit accounts registry) balance of 2004, which was decreased to MXN 0 after the 2004 comparisons, and then, any unused balance was effectively lost. The regulations include an option to add to the 2009 consolidated CUFIN balance dividends paid under the consolidated regime from 1999 to 2004 that generated a tax to be paid under the new rules as from 2010, instead of adding the RECUFIN balance of 2004 that is reset to MXN 0 in 2005. Although this is a step in the right direction (in that it recognizes an increase in the consolidated CUFIN instead of the consolidated RECUFIN) and also generates an increase after the 2005 reset to MXN 0 in the RECUFIN, it does not resolve the problem, since the addition is until 2009, when comparisons must be made considering the 2005 to 2008 balances, on 2011 to 2014, respectively.

- The amended law requires the recapture of all individual NOLs that were taken into account in the consolidated result (regardless of whether the consolidated result was a profit or a loss) if the NOLs were not used individually within a five-year period. Although the wording of the new regulations is not entirely clear, it appears that an additional period is granted to recapture NOLs of individual companies that generated a consolidated NOL. In such cases, the benefit of the NOL will be recaptured six years after the consolidated NOL was effectively used against consolidated profits.

- For recapture purposes, the amended law only takes into account NOLs generated in or after 1999 (the year the recapture concept was first introduced), ignoring the fact that the recapture provision was not introduced for most holding companies until 2002. Again, considering unclear wording, the regulations acknowledge that NOLs incurred by a holding company from 1999 to 2001 would not be subject to recapture. However, this recognition does not apply to NOLs incurred on the sale of shares, which together with financing costs, typically are where a holding company would generate NOLs.

- To avoid certain distortions in the RECUFIN comparisons generated by the new law, it was recognized that certain NOLs incurred before 1999 should be added back to the consolidated RECUFIN balance. However, this recognition in the new law was granted up to the 2009 consolidated RECUFIN balance, whereas the distortions were actually created in the 2004 accumulated comparison. The regulations clarify that NOLs incurred before 1999 (2002 in the case of certain holding companies) should be added to the consolidated RECUFIN balance of 2004 (to perform the 2010 calculations), instead of the consolidated RECUFIN balance of 2009.

- One of the main distortions in the 2010 regime arises when a comparison of RECUFIN balances is made considering a balance of consolidated RECUFIN that was decreased by individual NOLs of certain subsidiaries that were used by those companies within the five-year period. The regulations include a rule to recognize the timing effects on RECUFIN comparisons (consolidated vs. individual) generated by individual NOLs that decrease the consolidated profit in a certain year, but were applied within the five-year period. In that case, the consolidated RECUFIN balance could be adjusted in the year the NOL was used by the consolidation and should be recaptured in the year the NOL was used on an individual basis. Unfortunately, this adjustment was only granted for 2004, so we will need to await the issuance of a similar rule for 2005 and subsequent years.

- The consolidated CUFIN should be added by dividends that were subject to payment under the new rules (previously, only the consolidated RECUFIN could be adjusted).

- The regulations grant a credit for dividend tax paid in 2010 (in respect of dividends distributed in 2004 and before) against the consolidated income tax of the year and the following two years, on terms similar to those that apply in a non-consolidation situation. However, the rule does not resolve the credit for dividends distributed in 2005 and subsequent years.

- The regulations retain the deferral of tax generated by comparisons between the consolidated and individual RECUFIN and CUFINRE up to 2004 until a subsidiary exits the group or the group is deconsolidated if the taxpayer accepts that the payment schedule for 2010 includes a 25% payment for 2011 (the amended legislation mistakenly deferred the 2011 payment until 2012). This beneficial option would enable a deferral of all distortions generated by comparisons of RECUFIN and CUFINRE, at least for the 2004 calculation that is due in 2010. Taxpayers must notify the Mexican tax authorities by 30 April 2010 at the latest if they intend to exercise the option. If the authorities conclude that the information included on the request is incomplete or incorrect, the option will be considered invalid. This possibility that an option may be disallowed will create considerable uncertainly for affected companies, since any difference in criteria or amounts could render the option inapplicable.


Conclusion

Although the regulations clarify some of the inconsistencies of the amended legislation, mainly with respect to the 2004 cumulative calculation for 2010, more guidance is needed to avoid distortions resulting from the new rules.