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Pedro A Palma

Sánchez Devanny, Mexico

ppalma@sanchezdevanny.com

 

Eduardo Barreira-Reynoso Monterrubio

Sánchez Devanny, Mexico

ebreynoso@sanchezdevanny.com

 

In 2020, Mexico enacted a domestic general anti-abuse rule (GAAR),[1] the application of which within the domestic context is evident. However, it is relevant to determine to what extent the GAAR could be applicable to tax treaties, and whether said application could violate the treaty obligations of Mexico in previous tax treaties – especially considering that the Multilateral Instrument (MLI) has not entered into force.

The Mexican GAAR

The Mexican GAAR[2] provides that legal acts lacking business reasons generating a direct or indirect ‘tax benefit’[3] shall have the taxable effect corresponding to those that would be conducted to obtain the taxpayer's expected reasonable ‘economic benefit’.[4] Accordingly, the tax authority could use the following rebuttable presumptions to determine the lack of business reasons:[5]

• The expected economic benefit (as defined by law) is less than the tax benefit (as defined by law); or

• The expected economic benefit could be achieved through the performance of fewer acts, but resulting in higher taxation (similar to a step-transaction doctrine).

Under the GAAR and its explanatory statement,[6] its objective is to level the playing field for taxpayers substantially conducting the same economic transactions, regardless of the legal acts undertaken to obtain a more advantageous tax position. Therefore, it is foreseeable that the Mexican tax authorities could seek to apply the GAAR to cross-border transactions to level the playing field on transactions that could be perceived as ‘abusive’ and are not caught by the existing anti-abuse rules contained within the current tax treaties signed by Mexico.

The Mexican situation

A common international discussion is whether a domestic law provision (the GAAR) could deny or interfere with the terms agreed to by contracting states to a tax treaty, particularly for countries where treaties are hierarchically above domestic law (which is the case for Mexico).

According to the Organisation for Economic Cooperation and Development (OECD), a general guiding principle is that domestic GAARs and tax treaties are aligned.[7] Therefore, no conflict should exist between them. The principle seems to be in line with the additional object and purpose of the Model Convention as modified in 2003, which is ‘the elimination of tax evasion and avoidance’.[8] Nevertheless, said additional purpose was incorporated in the Model Convention preamble until 2017[9] and materialised by the MLI minimum standard – which is not actually in force in Mexico (as of September 2020).

In short, it could be argued that to the extent the tax treaty contains a general anti-abuse rule (principal purpose test (PPT) or limitation on benefits (LOB)), said rule would be aligned to domestic GAARs, as the OECD’s guiding principle suggests. Nevertheless, it is questionable to what extent said general guideline is met in cases where the tax treaty does not contain a general anti-abuse rule other than the beneficial owner[10], and the treaty preamble is not aligned with the OECD 2003 modifications (which could be the case for many tax treaties signed by Mexico).

In that vein, without the MLI in force in Mexico, it will suffice for taxpayers of the other contracting state to meet the residency test to access the treaty benefits (no other requirements exist). Assuming further that the tax resident of the other contracting state was located therein with the sole purpose of benefiting from a treaty disposition with Mexico (treaty shopping), then the questions are:

• Whether the Mexican GAAR could apply to the case; and

• Whether its application could violate the treaty obligations previously agreed to by Mexico.

As mentioned above, it could be expected that the Mexican tax authority seeks to apply the Mexican GAAR to tax treaty cases. Nevertheless, it is not quite clear whether its application could derive into a failure to perform the treaties previously agreed to by Mexico, as the Vienna convention mandates,[11] particularly considering that the MLI has not entered into force in Mexico. Similar cases have been resolved by Canadian courts rejecting domestic GAARs' application against treaty benefits.[12]

As long as Mexico does not ratify the MLI, a conflict between the Mexican GAAR and treaty obligations might exist. Even in cases where the MLI enters into force, the Mexican tax authority has applied domestic anti-abuse provisions retroactively.[13]

Therefore, it is yet to be seen whether Mexican tax authority would seek to use both (1) domestic GAAR and (2) PPT or LOB clauses retroactively, and whether such an application would be aligned with the object and purpose of the parties in entering into the MLI.

Otherwise, we can find a similar argument where the Mexican GAAR could still lead to a treaty compliance failure. In any event, a thorough analysis of existing cross-border transactions with Mexico should be conducted, with a special focus on the GAAR application.

 

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