INSIGHT: Mandatory Disclosure Rules in the European Union and Mexico (1)

By now, most people know that the Base Erosion and Profit Shifting (BEPS) project was born out of the ashes of the 2008 financial crisis auntil Jan. 1, 2021until Jan. 1, 2021until Jan. 1, 2021nd document leaks that revealed perceived aggressive tax planning by multinational enterprises (MNE). At the G-20’s behest, the Organization for Economic Cooperation and Development (OECD) developed a framework to help curb tax avoidance and ensure that MNEs pay their “fair share” of the global tax burden. Specifically, the BEPS project identified 15 Actions, structured around three key pillars: consistency in domestic legislation that affects cross-border activities, reinforcement of substance requirements in the existing international standards, and the improvement of global transparency.

This article focuses on the third pillar, global transparency, and in particular Action 12 – Mandatory Disclosure Rules (MDR), as recently adopted in in the European Union (EU) (including the U.K.) and Mexico. The two regimes illustrate the potential breadth of MDR and signals the challenges that multinational taxpayers will face as MDR proliferates in various forms.

BEPS Action 12

When tax professionals hear the term “global transparency,” their thoughts likely gravitate toward BEPS Action 13, which introduced new types of disclosures for multinational enterprises: Master Files, Local Files, and Country-by-Country Reporting (Action 13). These three documents provide tax authorities with cross-sections of taxpayer information that had not been generally available, as a supplement to historical tax return data and other accessible information, e.g., annual reports and financial statements. Action 13 documentation gives tax examiners more and better information about how a multinational enterprise organizes itself around the value drivers of its business, including in countries outside the scope of any particular tax audit.

Action 12, in contrast, focuses on specific arrangements of interest and requires stakeholders to flag these arrangements for tax authorities when they arise (or are deemed to arise). Unlike Action 13, Action 12 is not a minimum standard; in other words, the establishment of a mandatory disclosure regime is optional. Consequently, the Action 12 Report is not prescriptive in its approach. Instead, the Report provides a modular framework that facilitates the design of mandatory disclosure rules, taking into account government resources and objectives as well as the additional compliance costs.

Three elements of mandatory disclosure have come as a surprise to taxpayers and their advisors, at least as they have played out in the EU and Mexican regimes. First is the concept of a reportable transaction, which may not in fact be a transaction at all. That is, the Action 12 Report contemplates an expansive concept of a reportable arrangement that includes proposals and plans, even in cases where they are not actually implemented. Along with a contemporaneous reporting requirement, this flags potentially tax-aggressive behavior at its inception—very possibly before plans crystallize into implemented transactions and claimed tax benefits.

The second is the identification of responsible persons. As discussed below, both regimes place the onus for reporting, at least as an initial matter, on advisors involved with reportable transactions. The practical effect, particularly in the EU, is a division of interests between the stakeholders in an arrangement. The taxpayer—the beneficiary of a contemplated structure—may not be the most reliable person to weight the merits of disclosure from a technical perspective; the advisors may not be completely neutral, but liability for non-compliance helps ensure balanced application of the rules.

The final element that grabs our attention is the nature of the reporting triggers, the specific hallmarks or features that bring an arrangement within the scope of reporting. The U.S. has had reportable transactions rules since 2002, and those have, to some extent, framed expectations of how MDR will work. That is, U.S.-based companies tend to think of these rules as identifying tainted transactions and shining a spotlight on aggressive behavior. While that may be true, many of the MDR arrangement hallmarks discussed below are fairly commonplace and may result in the reporting of what most would consider “ordinary course” arrangements.

EU MDR (DAC6)

In May 2018, the European Council adopted Council Directive (EU) 2018/822, the fifth amendment to the original Directive on Administrative Cooperation (“DAC6” or the “Directive”), effectively imposing MDR on all EU Member States, with respect to certain cross-border arrangements featuring at least one “hallmark” identified in the Directive. All reports received under the Directive will be automatically exchanged among the Member States, on a quarterly basis. This arguably creates a much more effective (and pre-emptive) policing mechanism than the historical, single-country tax examination process.

The U.K.—for now at least—has adopted DAC6 as if it were still a member of the EU, notwithstanding Brexit. The Withdrawal Agreement, signed on Jan. 24, 2020, requires the U.K. to apply the Directive through the Brexit transition period which ends on December 31, 2020 (but could be extended). What happens after the transition period is still uncertain, but even if the U.K. formally exits the EU under a “no-deal” scenario, it is generally expected that local implementation of DAC6 would not be affected, though future negotiation may be required with respect to the automatic exchange of information with the remaining EU Member States. For purposes of this article, references to the EU include the U.K.

As with all EU Directives, Member States are required to implement the rules locally, but have some flexibility in the interpretation of terms not defined in EU law and, in particular, application of the Directive in conjunction with other local laws. In addition, the Directive establishes a minimum standard; individual Member States may adopt more onerous rules—as has been the case in Portugal and Poland (which, among other things, expanded their reportable arrangements to include purely domestic structures). Thus, while the EU is playing with one general set of rules, MNE groups have to contend with 28 different referees who may view the rules in their own, unique light.

We describe highlights of DAC6 below. Our discussion touches on the general framework, with occasional reference to local interpretations. Local interpretations will evolve, perhaps significantly, over the next few months, and may continue to evolve over the next few years. Specific questions or issues regarding DAC6 implementation should be referred to tax professionals in the relevant Member State(s).

When?

As initially adopted, DAC6 requires contemporaneous reporting of reportable arrangements, beginning July 1, 2020. For these purposes, contemporaneous reporting must occur within the 30 days following the earliest of: (a) the day the arrangement is made available for implementation, (b) the day the arrangement is ready for implementation, or (c) the day the first step of implementation occurs. This means, for example, that reporting of an arrangement that was made available for implementation on July 1, 2020, would have been due by July 31, 2020. In addition, the Directive provided for disclosure of reportable arrangements (look-back period reporting) by August 31, 2020, if the first step of implementation fell during the period beginning June 25, 2018 and ending July 1, 2020.

In response to hardships caused by Covid-19, the Council of the EU adopted an amendment to DAC6 allowing Member States to defer the reporting deadlines by up to six months (i.e., until Jan. 1, 2021, for contemporaneous reporting and until Feb. 28, 2021, for lookback period reporting). MDR remains effective from July 1, 2020, so Member States deferring for the entire six-month period will require reporting for arrangements between July 1 and Dec. 31, 2020, by Jan. 31, 2021 (interim period reporting).

To date, most of the EU Member States have opted to defer the beginning of contemporaneous reporting and the deadline for look-back and interim period reporting, for the full six-month period allowed by the EU. One Member State, Poland, was an early adopter of MDR, having implemented the Directive since Jan. 1, 2019. In light of Covid-19, however, Poland has suspended DAC6 reporting, which will be reinstituted in stages. Contemporaneous reporting in Poland, starts back up on Jan. 1, 2021, in line with the EU amendment granting deferral. Look-back reporting is due on different dates—depending on roles with respect to the reportable arrangements—ranging from Dec. 31, 2020, to Feb. 28, 2021.

Two Member States, Germany and Finland, opted out of deferral. Consequently, contemporaneous and look-back period reporting followed the chronology originally established for DAC6: July 1 and August 31, 2020, respectively.

Austria has effectively adopted a three-month “de-facto deferral,” by indicating that late-filing penalties would not apply before the end of October 2020.

Who?

DAC6 places the initial reporting requirement on “intermediaries,” i.e., any persons that design, market, organize, or make available for implementation or manages the implementation of a reportable arrangement (commonly referred to as “primary intermediaries”). Also included are persons who know or could reasonably be expected to know that they have provided aid, assistance or advice with respect to designing, marketing, organizing, making available for implementation, or managing the implementation of a reportable arrangement (commonly referred to as “secondary intermediaries”). Note that intermediaries are not required to be engaged in the provision of tax advice. Consequently, the rules literally catch bankers, valuation experts, and corporate attorneys, and other advisors involved with the arrangement—although they are afforded a defense, if they “did not know and could not reasonably be expected to know” that their client was involved in a reportable cross-border arrangement, based on available information and relevant expertise.

In addition, an advisor must have sufficient EU nexus to be treated as intermediary. Specifically, the advisor must:

1. Be resident for tax purposes in a Member State;

2. Have a permanent establishment (PE) in a Member State through which the services with respect to the arrangement are provided;

3. Be incorporated in, or governed by the laws of, a Member State; or

4. Maintain registration with a professional legal, tax, or consultancy services association in a Member State.

This last factor should be considered carefully, with respect to individual professionals who are, e.g., EU-licensed attorneys and transferred or seconded to a non-EU jurisdiction.

Subject to local rules, each intermediary has a reporting obligation. Intermediaries that are liable for reporting in multiple jurisdictions (e.g., through branch offices), only need to file in a single jurisdiction, in accordance with an ordering rule provided in the Directive. An intermediary is excused from filing if it obtains proof that another intermediary has filed a report with respect to the same information. (The Directive, however, does not require intermediaries to investigate facts and tax implications beyond the scope of their own services; this may significantly reduce the practical coverage that this exception affords.)

In cases where intermediaries are precluded from disclosing details of any particular engagement by legal professional privilege, they may be exempted from their reporting requirements. In such cases, however, the advisor asserting privilege must generally notify the other intermediaries of their exemption (without delay) and a potential shift of the reporting obligation.

If no intermediaries are available or they are collectively unable to provide a full report of the arrangement—due to privilege, lack of EU nexus, limited scope of services, etc.—the burden to report generally shifts to the taxpayer. Significantly, the taxpayer must self-report the arrangement within 30 days. To complicate matters, the local rules may not reset the 30-day period for self-reporting situations (e.g., upon notice that intermediaries are precluded by privilege) but may require reporting based on the intermediaries’ original deadline.

Any one of these rules alone could raise a lot of questions; taken together, they have the potential to create a mountain of uncertainty. Consider, for example, a scenario in which a technology group headquartered in one of the Member States, EU Tech, engages with a U.S. law firm, ABC US, to assist with an IP transfer. As part of its engagement, ABC US hires an EU firm, E-Valuate, for assistance in valuing the IP. Assuming the IP transfer implicates at least one of the reporting hallmarks (discussed below), who has to report? Let’s take the stakeholders one by one:

• ABC US: Given the facts above, there is nothing that brings ABC US within the scope of an intermediary reporting obligation. Having said that, ABC US may have a reporting requirement if the services were provided through an EU branch office or an individual professionally licensed in the EU, or the IP transfer involves Poland (whose DAC6 implementation is extraterritorial in reach).

• E-Valuate: E-Valuate has EU nexus, but depending on its level of involvement, may not have the requisite knowledge or expertise to understand (or be liable for) potential reporting obligations. Other considerations include whether E-Valuate’s Member State extends professional privilege to non-attorneys and whether, if so, privilege applies—or is lost because EU Tech is not the protected “client” under those rules. Note, even if eligible for a privilege exception, depending on the jurisdiction, E-Valuate may nonetheless be required to file a partial report.

• EU Tech: If no “intermediaries” are available, EU Tech would have a reporting obligation. (In fact, even if E-Valuate is obligated to report, EU Tech could be required to file as well, if EU Tech were treated as a primary intermediary with respect to its own transaction or E-Valuate’s report does not cover the same information, e.g., E-Valuate’s only makes a partial filing due to professional privilege restrictions.)

What?

Putting aside implementation applying MDR to domestic arrangements (i.e., in Poland), the Directive applies to reportable cross-border arrangements. The concept of an “arrangement” is both broad and vague, and can apply to a single step of a structure, multiple steps, or even multiple structures taken together. “Cross-border” arrangements must involve more than one Member State, or at least one Member State and a third country. Significantly, to the extent that reporting hallmarks refer to tax benefits or advantages, DAC6 does not mandate that they arise as a direct consequence of activities within a Member State; nor do they need to be EU tax benefits or advantages.

Whether an arrangement is “reportable” turns on whether one or more “hallmarks” (i.e., characteristics or features) are present. The hallmarks are grouped into five categories, some of which are further subject to a main benefit test (MBT). Note, whether reporting applies in the first place is a “one and done” exercise; the existence of a single hallmark renders an arrangement reportable. The resulting disclosure, however, must list all applicable hallmarks. Therefore, cross-border arrangements must ultimately be analyzed under each and every hallmark.

If the MBT applies in conjunction with a hallmark, one of the main benefits expected from the arrangement must be a tax advantage based on all relevant facts and circumstances. Subject to local interpretation, tax advantages could include tax refunds or rebates, waiver or reduction of tax claims, and deferral of income or acceleration of deductions, etc. As noted above, the tax advantages may not be limited to specific tax consequences within a Member State or even the EU.

Below is a quick flowchart illustrating the analytical path for determining whether an arrangement is reportable under the Directive:

KPMG LLP

DAC6 provides a list of 15 hallmarks, grouping three of them as generic and three as specific hallmarks linked to the MBT, four as specific hallmarks related to cross-border transactions, two as specific hallmarks concerning automatic exchange of information and beneficial ownership, and three as specific hallmarks concerning transfer pricing. It may be easier to consider them in substantive groups of MBT-related and non-MBT-related (mandatory) hallmarks, summarized below.

1. MBT-related hallmarks that assess the overall structure of the arrangement:

• Arrangements obligating the taxpayer to comply with confidentiality conditions;

• Arrangements including contingent fees; and

• Arrangements in which standardized documentation (including forms) is used.

2. MBT-related hallmarks that assess the overall effect of the arrangement:

• Acquisition of a loss-making company and subsequent discontinuation of its main activity and utilization of the losses;

• Conversion of one type of income into another that is exempt or taxed at a lower level; and

• Circular transactions resulting in the round-tripping of funds.

3. MBT-related hallmarks arising in the context of cross-border transactions featuring deductible payments, based on the low-tax consequences of the income:

• The recipient is tax resident in a jurisdiction with no corporate income tax (CIT), or 0% (or almost 0%) CIT rate;

• The payment benefits from a full exemption from tax; and

• The payment benefits from a preferential tax regime.

4. Mandatory hallmarks related to more traditional mechanisms for aggressive tax planning:

• Deductible payments to a related party that either is not a tax resident in any jurisdiction or is resident in a “non-cooperative” jurisdiction as defined by either the OECD or EU;

• Depreciation deductions taken in multiple jurisdictions with respect to the same asset;

• Double tax relief claimed in multiple jurisdictions; and

• Transfer of assets with significant differences in valuation.

5. Mandatory hallmarks related to transactions in which financial accountholders or beneficial owners go unidentified:

• Undermining of reporting obligation on automatic exchange of financial account information; and

• Legal structure lacking substantive economic activity where beneficial owners are unidentifiable.

6. Mandatory hallmarks arising in the transfer pricing context, i.e., transactions between related enterprises. Significantly, “associated enterprises” generally include a person who: participates in the management of another person, has more than 25% of the voting rights in another person, directly or indirectly holds more than 25% of the capital in another person, or is entitled to 25% or more of the profits of another person.

• Use of unilateral safe harbor rules;

• Transfer of hard-to-value intangibles (i.e., intangibles for which, at the time of transfer, no reliable comparables exist and future cash flow, income projections or valuation assumptions are highly uncertain); and

• Cross-border transfer of functions, risks and/or assets resulting in a decrease of the transferor’s earnings before interest and taxes (EBIT) of greater than 50% over the following three years.

Consequences of Mistakes

The Directive also requires that Member States adopt penalties with teeth—that is, penalties that are “effective, proportionate and dissuasive.” Not surprisingly, the resulting penalty provisions range widely across jurisdictions, from 30,00 euros to 5 million euros based on the nature of the miss or mistake (including intent). Notably, at least one jurisdiction (Germany) has adopted penalties applicable to individual enterprise directors.

Mexican MDR

Mexican MDR resembles DAC6 in the same way that Formula 1 resembles Indy Car. The framework is generally the same—contemporaneous and look-back reporting, triggering hallmarks, advisor reporting obligations—but anything more than a passing glance at the two regimes reveals significant differences.

When?

Let’s start with timing. The Mexican statute provides that contemporaneous reporting begins on Jan. 1, 2021, with first reports due 30 days after the occurrence of a triggering event. That sounds familiar, but it is critical that advisors understand the nuances lurking below the surface.

First, Mexican deadlines are generally based on business days, not calendar days, so a reportable arrangement arising on Jan. 1 must be reported by Feb. 15, 2021—two weeks after a Jan. 1 arrangement would need to be reported under DAC6. The period is shortened for subsequent modifications to the reportable arrangement or amendments to a submitted report, to 20 business days following the modification or the original submission date, respectively.

The specific triggering event differs depending on the type of structure. For “generalized” structures, i.e., structures, the tax benefits of which can be obtained for multiple taxpayers with little or no adaptation, the triggering event is the first contact for commercialization, which in turn is deemed to be made when the existence of the structure is communicated to third parties. Personalized structures, which are customized based on a specific taxpayer’s circumstances, must be reported no later than 30 business days following the earlier of (1) the day on which a structure becomes available to a taxpayer for implementation, or (2) the occurrence of the first fact or legal transaction that is part of the structure. Notably, as in DAC6, none of these metrics depends on a transaction actually being implemented (or, correlatively, intended tax benefits being realized). Mexican MDR applies to any express or implicit plan, project, proposal, advice, instruction or recommendation that contemplates the generation of a Mexican tax benefit and includes one of the specific hallmarks.

Not surprisingly, the rules also require reporting on arrangements arising during a look-back period, for structures designed, marketed, organized, implemented or administered from Jan. 1, 2020, onwards. The deadline for look-back reporting is 30 business days from then, i.e., Feb. 15, 2021.

A little more surprising is that pre-2020 arrangements are caught, if any kind of tax benefit from the transaction is sustained in 2020 or thereafter. Notably, the statutory language contains no start date for pre-2020 reporting—something that advisors are hoping will be addressed in upcoming regulations. In the meantime, many filers are considering a practical approach, focusing primarily on transactions arising during the open (five-year) statute of limitations period.

Advisors should also be aware that, if a structure yields Mexican tax benefits but the advisor concludes it is not reportable (e.g., because the structure does not include a specified feature), or if the structure is reportable but the advisor is unavailable to complete the reporting (e.g., due to privilege), the advisor must provide the taxpayer with a certificate explaining its reasoning. This certificate must be delivered within five business days after the earlier of (1) the day the reportable structure is made available to the taxpayer, or (2) the day the first fact or legal transaction occurs with respect to the reportable structure. As a practical matter, this five-day requirement forces acceleration of the reportability analysis, particularly as compared with DAC6, for which the analysis may be backloaded to the end of the 30-day reporting period (and potentially go unconveyed to the taxpayer). It would not be surprising to see advisors routinely providing a preliminary Mexican MDR analysis to their clients, as a component of their initial structuring proposals.

Who?

The reporting dynamic is another point of departure between the EU and Mexican rules. Both DAC6 and Mexican MDR begin with a focus on the advisors. As discussed above, advisors that qualify as “intermediaries” for DAC6 purposes are the first ones potentially obligated to report. The same is true under Mexican rules. Under the Mexican rules, if several tax advisors are required to disclose the same structure, a single report will suffice so long as it is filed in all the advisors’ names. Similarly, while individual tax advisors can be obligated to file, their filing requirement can be satisfied by a legal entity through which they are rendering services.

Like DAC6, if intermediaries are unavailable (e.g., they are excused from reporting due to privilege), the reporting obligation falls back on the taxpayer. The rules apply to a taxpayer regardless of tax residence, provided that the taxpayer realizes a Mexican tax benefit. This “advisor first” approach is mandated by DAC6, which does not allow for the taxpayer to take up reporting unless there is no advisor to do it. Mexican MDR, on the other hand, allows taxpayers to take on reporting obligations via contract. This gives taxpayers a little more flexibility to control risk and resource spend.

Mexican MDR also identifies a different scope of advisors subject to reporting. DAC6, aside from alluding to relevant expertise and reasonable knowledge for rendering advice or assistance on a reportable arrangement, casts a wide net for responsible persons qualifying as “intermediaries.” The practical limitations of this net are maintained by additional conditions requiring (with the exception of Poland) some kind of EU nexus.

In contrast, the Mexican rules apply to relevant taxpayers and their “tax advisors,” individuals or legal entities that perform tax advisory activities in the ordinary course, and who are responsible for or involved in designing, trading, organizing, implementing or managing a reportable arrangement, or who make a reportable arrangement available for implementation by a third party. Mexican MDR applies only if an advisor has some kind of Mexican nexus—Mexican tax residence or, for foreign resident advisors, a Mexican PE—and the relevant activities are in fact performed by a tax advisor. The rules apply a rebuttable presumption that this is the case so that, consequently, the PE, related party, or third party picks up responsibility for the relevant structure.

Significantly, this presumption also applies if a non-Mexican tax advisor shares a trademark or trade name with a Mexican resident or the Mexican PE of another non-resident engaged in tax advisory services, regardless of relatedness from an ownership perspective. The breadth of these rules has been an unpleasant surprise for advisors and their clients.

Consider, for example, the fairly common scenario in which a U.S. law firm, ABC US LLP (“ABC US”), provides both tax and corporate legal services and has a Mexican PE which is staffed only with corporate attorneys. ABC US has no related entity in Mexico, but practices in cooperation with an unrelated Mexican firm, ABC Mexico LLP (“ABC Mexico”). ABC Mexico also provides tax and corporate legal services. A U.S. client engages ABC US to provide preliminary advice on how to structure future manufacturing and sales activities in Mexico. The engagement letter provides only for the services of ABC US. ABC US discusses a few high-level ideas with the client but, given the preliminary nature of the discussion, does not bring ABC Mexico in to assist. Assuming the ideas included at least one of the reporting hallmarks (discussed below), and that ABC US provided sufficient detail that the discussion could be characterized as a reportable structure (also discussed below), who has the obligation to report? Let’s walk through the possibilities.

1. ABC US: ABC US gave the tax advice but does not have requisite Mexican nexus. (Note, even if the meeting were attended by an attorney employed by ABC US and professionally licensed in Mexico, so long as the attorney did not provide advice while located in Mexico and the advice cannot be attributed to a Mexican PE of either the attorney or ABC US, Mexican nexus does not exist for these purposes.)

2. ABC US, Mexican PE: The advice could theoretically be attributed to the Mexican PE, but there are no tax advisors associated with the Mexican PE, who provide tax advice in the ordinary course of the Mexican PE’s business.

3. ABC Mexico: The advice could be presumptively attributed to ABC Mexico and cannot be rebutted solely with ABC US’s engagement letter for offshore services. Assuming that ABC US can demonstrate (e.g., via billing detail including location of the advising attorneys) that no tax advice was actually provided in Mexico, ABC Mexico is also excused from reporting.

4. US Client: Although the reporting rules generally apply without regard to whether the “taxpayer” is a Mexican resident, the obligation to report applies only to a non-Mexican resident if that person has a PE in Mexico. Having none, US Client has no filing obligation.

What?

As noted above, Mexican MDR follows the same general path as DAC6, with a primary focus on cross-border structures featuring one or more identified hallmarks. To be reportable, a structure must generate, or have the potential to generate, a tax benefit in Mexico. Direct as well as indirect Mexican tax benefits count, so advisors should be careful to understand the knock-on, Mexican implications of non-Mexican planning.

In addition, a reportable structure must include at least one of a list of specified features. Some of the Mexican hallmarks are essentially the same as the DAC6 hallmarks; some are similar to DAC6, with material differences; and some are not found in DAC6. Mexican hallmarks that also appear as DAC6 hallmarks (allowing for translation differences and level of legislative detail) are as follows, although filers will need to wait for regulations to be issued, to determine how closely aligned the rules will be as a practical matter:

1. Structures to avoid the application of information exchange rules related to financial accounts (e.g., FATCA, CRS);

2. Circular transaction structures;

3. Related-party transfers of hard to value intangibles;

4. Structures that use a non-Mexican “unilateral protection regime”; and

5. Structures used to avoid identification of the beneficial owner of income or assets, including through the use of foreign entities or concepts.

Hallmarks under the Mexican rules that are generally similar to DAC6 hallmarks, but contain material distinctions include the following (notably, some of the hallmarks below, unlike their DAC6 counterparts, are not conditioned on cross-border activity):

1. Reorganizations between related persons involving the transfer of assets, functions and risks for no consideration, which result in a greater than 20% reduction of the transferor’s operating profits;

2. Transfer of an asset that has been depreciated by the transferor (in whole or in part), that enables a related party to depreciate the same asset;

3. Structures that result in the transfer of loss carryovers, to a person other than the taxpayer that generated the losses;

4. Structures that allow utilization of a taxpayer’s expiring tax losses, by the taxpayer or a related party, via generation of taxable profits; and

5. The grant of temporary use or enjoyment of an asset, if the lessee grants temporary use or enjoyment of the same asset back to the lessor or a related party of the lessor.

Mexican MDR also introduces a series of transaction features not found in DAC6:

1. Related-party transactions involving the uncompensated transmission of goods or rights (or the temporary use and enjoyment thereof) or provision of services;

2. Related-party transactions for which there are no reliable comparables, i.e., transactions involving unique and valuable functions and assets;

3. Avoidance of the creation of a Mexican PE;

4. Structures involving a hybrid mechanism (e.g., through foreign transparent entities or through entities benefitted by a preferential tax regime);

5. Avoidance of the 10% Mexican withholding on dividends;

6. Structures extending Mexican tax treaty benefits to a nonresident, with respect to income that is not subject to tax or subject to a lower than normal tax rate in the beneficial owner’s country of tax residence; and

7. Transactions resulting in book-tax differences greater than 20% (with the exception of differences due to the calculation of depreciation).

Note that for purposes of the Mexican rules, two or more persons are treated as related parties when one person participates directly or indirectly in the administration, control, or capital of the other. Joint venture partners are also treated as related parties, and a permanent establishment is considered to be related to its parent company or other permanent establishments thereof.

Finally, any mechanism that avoids application of any of these hallmarks is subject to disclosure. Query how that would work as a practical matter, e.g., if a taxpayer chooses inbound sales activities through a Mexican PE.

Consequences of Mistakes

Like DAC6, Mexican MDR provides for penalties for non-compliance, i.e., missed or incomplete reporting, and penalties for failure to answer information requests issued by tax authorities, with respect to reportable structures. Disclosures will be provided via a forthcoming information return. While the required elements of the report do not explicitly include the relevant hallmarks, the report must walk through a detailed description of the reportable structure and the applicable Mexican and non-Mexican legal provisions. Each step of a transaction plan, project, proposal, advice, instruction or recommendation must be included, as well as a detailed description of the tax benefit obtained or expected (including for structures where Mexican tax consequences are avoided).

The level of penalties imposed depends on the nature of the non-compliance. EU stakeholders winced at the DAC6 fines implemented in Poland, which can reach as much as 5 million euros per missed report. Tax advisor penalties can reach up to 20 million pesos (approximately $950,000, assuming an exchange rate of $1 / 21 pesos). Taxpayers face an even steeper downside: Among other things, failure to report, or filing an incomplete report or a report containing errors, is punishable with the potential loss of the tax benefit from the undisclosed structure (regardless of the correctness of the position taken), plus a fine of 50% to 75% of the amount of the tax benefit.

Conclusion

Over the last five years, as various BEPS-related measures have been implemented around the world, global transparency initiatives have garnered much more time and attention than taxpayers anticipated. Since the final Action 13 report was issued in 2015, more than 90 countries have adopted Action 13 requirements in part or in full. It remains to be seen whether MDR is adopted with the same breadth and speed, but it’s an undeniably attractive mechanism for increasing audit efficiency even factoring in implementation costs. Indeed, by the turn of the new year, between DAC6 and Mexican MDR alone, 29 countries will have mandatory disclosure regimes in effect. The Channel Islands, Israel, and South Africa also have MDR in effect or nearly so; Norway, Argentina and Chile are expected to implement MDR in the near future.

To the extent dealing with global transparency-related compliance was already part of a tax professional’s daily life, it’s only going to get more complicated as more countries come into the fold. For those tax professionals fortunate enough to have escaped such compliance measures, it’s hard to imagine this reprieve will last much longer.

This column doesn’t necessarily reflect the opinion of The Bureau of National Affairs Inc. or its owners.

Author Information

Kimberly Tan Majure is a principal with the international tax group of the Washington National Tax practice of KPMG LLP and also serves as the inbound tax services lead for KPMG U.S.; she is based in the firm’s Washington, D.C. office.
Armando Lara Yaffar is a partner and the Head of International Tax Services of KPMG Mexico, and is based in Mexico City, Mexico.
John DerOhanesian is a managing director with the international tax group of the Washington National Tax practice of KPMG LLP and is based in the firm’s Washington, D.C. office.

The information in this article is not intended to be “written advice concerning one or more Federal tax matters” subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. This article represents the views of the authors only, and does not necessarily represent the views or professional advice of KPMG LLP.

The authors would like to thank Michael Plowgian, KPMG LLP and Raluca Enache, KPMG Meijburg, for their valuable comments and insight.