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As of January 2008, NIF B-10 changed the mechanics ... in Mexico, NIF B-10 required companies operating in. Mexico to .... Misión de San Javier 10643, p.8.
Mexico Baja California - Sonora - Chihuahua Tax flash No. 28, 2013 Inflation (NIF B-10) and its effect on Transfer Pricing Analysis The objective of this paper is to highlight the importance of inflation within the technical analysis of Transfer Pricing studies. Currently, there is stability in terms of how prices behave in the Mexican economy; however, this situation does not imply that Transfer Pricing analysis stop taking into consideration inflation as part of the relevant adjustments it would need to consider. Therefore, this paper provides a general guidance on the situations and elements that should be evaluated in terms of inflation in order to generate a reliable Transfer Pricing analysis in Mexico. NIF B-10 NIF B-10 stands for “Norma de Infomación Financiera Boletín 10” which provides the guidance for the treatment of inflation in companies operating in our country according to Mexican Accounting Standards. As of January 2008, NIF B-10 changed the mechanics of how inflation should be computed and recorded in Mexican books. Previously, due to high inflation levels in Mexico, NIF B-10 required companies operating in Mexico to adjust for inflation their financial statements on a yearly basis; however, starting 2008 the NIF B-10 acknowledges that Mexico operates in a price stable economy since in the last ten years INPC1 in Mexico has remained below 6.5% and in line with the Mexican Government goals. Therefore, now NIF B-10 defines two scenarios: a) Non-Inflationary - When accumulated INPC in the three previous years is lower than 26%. If this scenario appears, then companies in Mexico are not required to affect their financial information for inflation effects. b) Inflationary - On the contrary, when accumulated INPC in the three previous years is 26% or greater, then there is a “reconnection” mechanism that requires

companies operating in Mexico to record inflation from the current and previous years. So far, the non-inflationary scenario has prevailed and it is expected that will remain in the long term, since Mexican Government policies are oriented to keep relatively low inflation. However, this does not mean that Transfer Pricing analysis stops adjusting for inflation. There will be scenarios where there will be a need to consider inflation effects, regardless the changes established in NIF B-10. Hence, it becomes relevant that you identify your particular situation in order to generate a reliable Transfer Pricing analysis in Mexico. Accordingly, next you will find a group of considerations it will be worth to consider when executing or reviewing your Transfer Pricing study. 2. The economic relevance of inflation Inflation is considered part of macroeconomic variables and has become relevant in terms of decision taking and business prospective planning. For Central Banks, including Banco de México, inflation is the key element that guides its monetary policy2 to provide stability to the economy. For Government, inflation affects decisions on budgets and forecasts, and for Consumers has a direct effect on their purchasing power. Therefore, NIF-B10 acknowledges the relevance of this variable for Mexican Accounting Reporting by establishing the following at the beginning of its Bulletin: “This Norm has the objective of establishing the norms to be observed in the recoding of inflation effects within the financial information” The need of having guidance on how to record ¹ INPC stands for Indice nacional de precios al consumidor which is the index that measures price movements of goods and services in Mexico. Similar to the Consumer Price Index in the U.S. ² Banco de México’s mission is to “provide stability to the purchasing power” in Mexico.

inflation effects became evident in the 80’s when Boletín 10 was issued. During the 80’s, Mexico recorded inflation rates as high as 100% or greater as it can be observed in the following chart.

3. Circumstances to consider in the execution of Transfer Pricing analysis. For Transfer Pricing analysis it is possible to set two types of scenarios. Next I provided the explanation of each one. a. The company has never applied B-10 Usually maquiladoras report their financial information without applying provisions set forth in NIF B-10. This has become a general standard in the maquila industry. For reporting purposes, the independent Certified Public Accountant (“CPA”) reveals through the audited financial statements a note of non-compliance that does not have material effects on its final opinion.

Source: Instituto Nacional de Estadística, Geografía e Informática

Based on a strict monetary discipline, Mexico could reduce and control inflationary levels by the end of the 90’s. In 2000, Mexico recorded inflation below one digit (9% in 2000) and since then, inflation has remained between the average range of 3 to 4%. This stability has provided certainty in investments and consumption decisions to all participants in the Mexican economy. Accordingly, NIF B-10 adequates its guidance to this circumstance and provides new criteria to record inflation in the financial information of companies operating in Mexico. Please observe that NIF B-10 does not stop recognizing the relevance of adjusting financial information for inflation effects, but it just adapts to acknowledge that there may be non-inflationary scenarios where there is no need to adjust for inflation and accepting that the statistical bias of such financial information would be equivalent to the inflation rate (i.e. 3 or 4% depending on the inflation rate of the year). Regardless the mentioned stability, nobody can ensure that such will remain forever. This uncertainty was considered by the NIF B-10, which provided the space to allow for reconnection of inflation. Reconnection could affect Transfer Pricing analysis in Mexico in terms of comparability, since selected companies for a profit based analysis may not have the same “reconnection” situation and there may be a need for adjustments to increase comparability. Therefore, if “reconnection” shows in some time in the future, please review that your Transfer Pricing analysis incorporates comparability adjustments to compensate for this difference.

Since maquiladoras are not public companies and usually do not have liabilities with banks or other parties that would be interested in knowing the details of their financial information, then maquiladoras’s management decide to avoid implementation of B-10. Also, since maquiladoras usually consolidate their information with the foreign related party in U.S. dollars, then the procedure of including inflation in the financial information in pesos is not operative for them. However, for Transfer Pricing compliance the non-implementation of NIF B-10 detonates the need to review the appropriateness of applying an inflation adjustment. As a general rule, article 216 of the Mexican Income Tax Law (“MITL”) requires that the Transfer Pricing analysis be performed considering the financial information according the Mexican General Accounting Accepted Principles (Currently NIFs). This means that all criteria established in NIFs should be applied, including NIF B-10. Since maquiladoras usually have not applied NIF B-10 since the beginning of their operations, then Transfer Pricing analysis should include inflation adjustments to comply with provisions of article 216 of MITL. This approach was also implemented by the Servicio de Administración Tributaria (“SAT”) when Advance Price Agreements (“APAs”) were negotiated for maquiladoras. In the APA negotiations, part of the requirements of SAT was to provide a Transfer Pricing analysis that already includes recognition of inflation, since SAT requried to evaluate Transfer Pricing compliance on a real basis. This criterion currently prevails in SAT audits for Tax and Transfer Pricing. In this process, SAT and practitioners have identified that the account that may be more affected for inflation are the fixed assets of the company. The effects of not recognizing inflation could impact the

balance sheet (via a lower value of net fixed assets) and income statement (via a lower depreciation expense). Therefore, profit based Transfer Pricing analysis could derive unreliable results if there is no inflation adjustment. It may be assumed that since NIF B-10 changed in 2008, then currently no inflation adjustment would be needed for the Transfer Pricing analysis… but that is not totally true! Please observe the situation where the company purchased fixed assets in 2007 or in previous years. If those assets are still operative for accounting purposes, then the rule of updating for inflation purposes on a yearly basis still applies, only up to year 2007 (since that was the last the yearly update for inflation was required). On the other hand, if fixed assets were purchased in 2008 and years on, then they become part of the new NIF B-10 provisions, which means that there is no need to recognize inflation effects. Therefore, please be careful in reviewing your particular situation; in particular if you are an asset intensive company. If you find that your company falls within this scenario “3.a.” then review that your Transfer Pricing analysis is updating in balance sheet and income statement your fixed assets up to year 2007. This review is important to ensure that you maintain compliance with provisions set forth in article 216 of the MITL and be ready to explain compliance to SAT in case of an audit review. b. The company has applied B-10 If your company applied B-10 since the beginning of its operations, then your Transfer Pricing study reflects correctly inflation effects and maintains compliance with provisions of article 216 of MITL. However, it is important to keep in mind that if accumulated inflation reaches 26% or more in the last 3 years, then “reconnection” procedure activates and comparability adjustments should be considered when performing the Transfer Pricing analysis as explained previously. For this purposes, you can find valuable guidance in the Transfer Pricing Guidelines issued by the Organisation for Economic Cooperation and Development (“OECD”) of June 2010. 4. Final Remarks It is important to clarify that previous considerations apply not only to Transfer Pricing analysis of transactions with foreign related parties, but also for Transfer Pricing analysis of intra-Mexico related party operations. This means that, in order to comply with provisions set forth in articles 86-XV (domestic intercompany operations) and 86-XII (transactions with foreign related parties), the company operating in

Mexico has to perform the Transfer Pricing analysis considering its financial information according to NIFs, including the mentioned NIF B-10. Finally, we invite you to review your Transfer Pricing study to identify these issues and verify compliance, since SAT reviews and audits have become more regular within several industries. The more you are prepared and in compliance, the lesser the risk of Transfer Pricing adjustments or Tax implications. Cordially. M.E. Antonio Ochoa Díaz Transfer Pricing Director at Deloitte I thank the comments to this article to CPA Isaac Amador and MSC Simón Somohano

Contacts Baja California - Sonora Simón Somohano Socio Líder México y Latinoamérica Tel. +52 (664) 622 7872 [email protected] Antonio Ochoa Tel. +52 (664) 622 7874 [email protected] Esperanza Cortés Tel. +52 (664) 622 7978 [email protected] Mayda Ríos Tel. +52 (664) 622 7881 [email protected] Patricio Yañez Tel. +52 (664) 622 7884 [email protected] Chihuahua Esther Sánchez Tel. +52 (656) 688 6581 [email protected] Francisco Díaz Tel. +52 (656) 688 6512 [email protected] Daniel Medrano Tel. +52 (656) 688 6534 [email protected] Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee, and its network of member firms, each of which is a legally separate and independent entity. Please see for a detailed description of the legal structure of Deloitte Touche Tohmatsu Limited and its member firms. Deloitte provides audit, tax, consulting, and financial advisory services to public and private clients spanning multiple industries. With a globally connected network of member firms in more than 150 countries, Deloitte brings world-class capabilities and high-quality service to clients, delivering the insights they need to address their most complex business challenges. Deloitte has in the region of 200,000 professionals, all committed to becoming the standard of excellence. As used in this document, "Deloitte" means Galaz, Yamazaki, Ruiz Urquiza, S.C., which has the exclusive legal right to engage in, and limit its business to, providing auditing, tax consultancy, financial advisory, and other professional services in Mexico, under the name "Deloitte". This publication contains general information only, and none of Deloitte Touche Tohmatsu Limited, its member firms, or their related entities (collectively the “Deloitte Network”) is, by means of this publication, rendering professional advice or services. Before making any decision or taking any action that may affect your finances or your business, you should consult a qualified professional adviser. No entity in the Deloitte Network shall be responsible for any loss whatsoever sustained by any person or entity who relies on this publication. © 2013 Galaz, Yamazaki, Ruiz Urquiza, S.C.

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