The fact that parties participating in commercial transactions offset amounts payable between them constitutes a common practice today.
In Mexico, this practice has been carried out in respect of the amount of commercial transactions, as well as VAT related thereto. This situation by no means implied the non-payment of the referred tax but the offsetting thereof, considering that the offsetting is a legal mean to extinguish obligations, evidently with the remittance of the applicable taxes to the federal treasury once the corresponding calculation is made in accordance with the VAT Law.
This commercial practice obviously facilitated the way in which this type of transactions were carried out thus making them more efficient, as a result of avoiding unnecessary cash flows between the parties of the same.
Nevertheless, the Mexican tax authorities questioned such practice and derived from certain means of defense, a Division of the Mexican Supreme Court issued a court precedent due to criterion contradiction, which unfortunately restricts the offsetting previously referred to for tax purposes.[1]
In view of all of the above, in this article we will analyze the implications of the determination of the Division of the Mexican Supreme Court in respect of the restriction to treat the offsetting as a means to extinguish obligations for tax purposes and, therefore, that the tax payable between private parties is not actually paid in order that the latter may be considered for purposes of the credit thereof against the payable tax.
Commercial Transactions
It is widely known in Mexico that in several commercial transactions, the parties decide to offset any amounts payable between them for purposes of facilitating the management of their activities.
In fact, let’s think of a relationship in which a supermarket acquires any of its products from its suppliers (essential items or any other) and, in turn, such supermarket renders services to its supplies for which it is entitled to collect a consideration, such as the placement of the product in the corresponding shelves or the leasing of spaces within the supermarket.
Thus, instead of liquidating on the one hand, the cash amounts applicable to the acquisition of the goods, and on the other, collect the cash amounts derived from the rendering of the services, it has become a common practice to proceed to the offsetting of the amounts up to the lowest amount and, in this manner, only cover the differences between the parties.
The above assertion due to the fact that federal common law recognizes as a form of extinction of the generated obligations, the extinction thereof through the legal device of an offsetting.
Within the aforementioned commercial practice, the parties involved in the transaction have also opted to treat VAT as collected and paid so that in the related transactions there is the less possible flow of funds. Actually, from a business administration standpoint, it is useless to liquidate a transaction with flows of both parties since there is no reason for the funds to be deposited between them for purposes of liquidating the transactions that might have generated amounts to be offset.
Tax standpoint, position of the tax authorities and Court criteria
From a tax standpoint, the aforementioned transactions should be treated as transparent transactions for Mexican tax purposes because the applicable movements are recorded in the taxpayer’s books of account and, in addition, considering that in accordance with the legal provisions (article 1, 1-B of the related law) due to the fact that as a general rule VAT is triggered through cashflows, it is necessary that it has been collected so that it generates the applicable consequences. In this respect, the VAT Law provides that, among others, it is deemed that a consideration on any transaction is actually collected at the time in which the creditor’s interest is satisfied by means of any form of extinction of the transactions that give rise to the consideration. It should be reiterated that, as previously commented, in accordance with Mexican federal civil law, the offset is a legal form to extinguish an obligation.
Despite the fact that the above circumstances should be clear, the problem with the tax authorities was in respect of the VAT credit and the party that finally had the obligation to remit it to the Federal Treasury in the event of a payable difference. A tax credit is a concept that allows the recognition of the tax that is passed on to a taxpayer and, once certain requirements are met and after the payment thereof, there is the opportunity to face such tax against that payable by the taxpayer in order to remit to the federal treasury either the payable difference in the event that such amount is greater, or request a refund or credit the applicable VAT balance when creditable VAT is greater than payable VAT.
In fact, VAT is deemed an indirect tax which, due to the nature thereof, is passed on and intends to impact the final consumer of goods and services; in view of the foregoing, such tax is afforded the nature of a creditable tax in the chain of operations. This implies that the tax may have repercussions in each stage and the final consumer will be the payer thereof.
Thus, VAT in Mexico is a tax payable on a monthly basis which, as previously commented, is calculated by the taxpayer considering two elements, the tax payable as a result of its activities (output VAT), less the creditable VAT (input VAT), which corresponds to the tax that is passed on to the taxpayer generally by its suppliers or providers of services in accordance with the procedure set forth in the related law. Therefore, in order for a taxpayer to determine its payable or creditable tax applicable to any given month, it should consider the tax on the transactions it carries out during such month, as well as that which was passed on in order to carry out its activities that is actually paid during the same period, in accordance with the procedure previously referred to.
In the case of the commercial practice mentioned in preceding paragraphs, this should not represent a problem because in order to be entitled to treat VAT as a creditable tax, the parties in a commercial transaction, should have previously complied with the related obligation; that is to say, to conclude the commercial transaction and that the VAT payable as a result thereof is also extinct, that is, liquidated or paid.
Thus, when assessing VAT applicable to the period, only those transactions that are already concluded are considered and, as a result thereof, the taxpayer may credit the tax for purposes of determining whether there is any amount payable to the Mexican Federal Treasury.
Notwithstanding the above, the problem arose at the time of applying verbatim the provisions of article 5 of the VAT Law, which provides that in order for the tax to be creditable, it should be actually paid, based on which the Mexican tax authorities have been denying the refunds of credit balances that were generated when the creditable tax was greater that the payable tax (output VAT), asserting that an offset does not imply that the tax may be treated as actually paid when having been offset.
In other words, the argument of the authorities seemed simple and with no grounds other than the strict grammatical wording of the provision and not an interpretation in accordance with the nature of the tax and harmonious with the remaining articles that integrate the law.
In view of the rejection of the credit balance refund applications, a series of means of defense were filed, which usually were resolved favorably for the private parties; however, a Circuit integrated by several Collegiate Tribunals, which is part of the Mexican Judiciary Power, sustained the same criterion of the authorities to the effect that in order to treat VAT as creditable, it was necessary that it be actually paid, as a result of which an offset should not be considered for purposes of complying with the VAT credit requirements.[2]
Consequently, due to the criteria contradiction with other tribunals, such contradiction was contested so that the Maximum body of justice of Mexico ruled in respect of the correct criterion that should prevail in this type of matters.
Criterion of the Supreme Court of Mexico
Recently, the Second Division of the Supreme Court of Justice of Mexico resolved the court precedent contradiction previously referred to, which sustains that the civil offset is not a mean for the payment of VAT and, also, that it cannot give rise to a credit balance application or credit. It should be noted that at the time we wrote this article, we were only aware of a draft of the decision that resolved the criterion contradiction, but the wording of the applicable court precedent is not yet known.
The above circumstance implies that once the final wording of the court precedent that will derive from the resolution of the Second Division is known, all the courts in Mexico will be obliged to adapt the criterion set forth therein, that is to say, that the offset is not a mean to consider that the tax that is passed on to a taxpayer is paid and that, as a consequence thereof, that it is not creditable. In addition, in a very similar sense, the Superior Division of the Federal Tribunal of Administrative Justice, in line with the above, also issued a court precedent (it only obliges the Divisions of first instance of the cited tribunal) which provides that the concept of an offset, applicable within the civil scope, does not give rise to the credit because, in order to do so, it is necessary to prove that the tax has actually been paid in the related month, that is, that is has been remitted to the Federal Treasury.
We consider that the wording of the court precedent issued by the Superior Division is not entirely in congruence with the credit mechanism of the tax because, as previously commented, for purposes of determining the obligation to pay this tax in the applicable month, two elements should be considered, to wit, the payable (output VAT) and the creditable VAT (input VAT); and not necessarily in every case there will exist an obligation to remit or pay the tax to the federal treasury due to the fact that frequently there might exist credit balances to be recovered or credited in subsequent months.
In addition, in our opinion, the criterion adopted in the aforementioned court precedents is congruous with the nature of the commercial or mercantile transaction carried out by taxpayers and will only imply an additional administrative burden, with no reason to justify it.
In fact, there is no reason to justify the intention to establish that in a commercial transaction VAT should be paid through the delivery of cash to the creditor because this would imply that the accounting systems and records should be updated with the costs derived as a result thereof. In addition, it seems that not even under this scenario, the tax authorities may be satisfied since they might claim that they have no certainty to the effect that the applicable amounts paid in cash exclusively correspond to VAT and, therefore, deny the credit. It should be noted that this criterion has already been sustained by the tax authorities in the past and has given rise to means of defense that by that time were resolved favorably for the taxpayer.
In view of the foregoing, in first instance, it may seem that the only feasible solution in accordance with the current court precedents, is that all transactions be liquidated by means of transfers and with no possibility of an offset, because we consider that only in this manner the tax authorities would not be in a position to question the credit of the tax by the taxpayer.
On the other hand, there is currently a discussion in several legal forums on whether the court precedent issued by the Second Division of the Supreme Court of Justice of the Nation may have retroactive effects, that is to say, whether it may be applied to situations that took place in the past, such as those cases in which the tax authorities might have refunded a credit balance, considering that the offset was in fact a mean to consider that VAT was actually paid.
The above circumstance due to the fact that the Amparo Law, which governs the obligatory nature of court precedents, provides that under no circumstances the latter will have retroactive effects to the detriment of any person.
It is worth mentioning that the court precedent set forth herein analyzes a requirement that should be met in order to treat VAT as actually paid and, therefore, a creditable tax. In this respect, despite that there is a provision that governs the requirements that should be met in order for the tax to be creditable, the truth is that there is an interpretation on the scope of such provision; therefore, in our opinion, the authorities will be considering this criterion on all the refund procedures and, maybe, in the audits that are carried out.
Further, it should also be borne in mind that the Superior Division of the Federal Tribunal of Administrative Justice, which is a tribunal that in first instance solves any controversy on tax matters, issued a court precedent with terms very similar to those of the Court in accordance with the comments set forth herein, which will also be mandatory for the divisions that integrate it, and that there is no restriction in the law in respect of the application thereof, as is the case of the Amparo Law.
What to do?
Derived from the serious problem that is to come related to the court precedents previously referred to, it would be advisable to bear the following aspects in mind:
- Analyze within the books and systems of the company whether it would be feasible that VAT passed on be paid by means of a transfer or reflect it in any manner from which it can be clearly inferred that the tax is actually paid and, as a consequence thereof, prevent the position that the authorities may take against the taxpayers, such as denying the refund of the credit balance.
- Verify whether, operationally, is it feasible that the transactions that are carried out are fully paid by means of a transfer or a personal check to credit the account of the recipient.
- Have evidence of clear book records of the form in which the transaction was paid, as well as the applicable VAT.
- In the event that a refund application of any VAT credit balance is filed, confirm that the related application is sustained with documentary evidence that allows to verify the existence of the transaction and the payment of VAT to the creditor.
- As far as possible, and particularly in respect of transactions with significant amounts such as the acquisition of inventories, try to obtain evidence to the effect that the supplier or the contracting party determined and made the payments of VAT applicable to the related month.
In our opinion, it would be advisable to take the above points into consideration in order to be in a better position with the tax authorities for purposes of obtaining the refund of credit balances of taxpayers and avoid acts of nuisance and possible lawsuits.
Finally, we consider that it would also be important to be aware of the meetings held by several business bodies in Mexico with the tax authorities to discuss the problem, because, as previously commented, the matter may be so relevant for the transactions in the country that it may have an administrative solution or give rise to a reform of the provisions that govern the VAT credit.
In summary
The fact that parties participating in commercial transactions offset amounts payable between them constitutes a common practice today, by both the amount of the transactions, and VAT payable as a result thereof.
The Mexican tax authorities questioned such practice and derived from certain lawsuits the Second Division of the Mexican Supreme Court issued a court precedent due to criterion contradiction which, unfortunately restricts the offsetting for tax purposes. Further, the Superior Division of the Federal Tribunal of Administrative Justice issued a court precedent which provides that the concept of an offset, applicable within the civil scope, does not give rise to the credit because, in order to do so, it is necessary to prove that the tax has actually been paid in the related month.
Derived from the serious problem that is to come related to the court precedent previously mentioned, it is important to take into consideration the aspects set forth in this article, particularly the need to record in the systems of companies, VAT that is passed on and paid by means of transfers or personal checks, and in the case of transactions with significant amounts, try to obtain evidence to the effect that the suppliers or contracting parties determined and made the payments of VAT applicable to the related month.
[1] A court precedent due to a criterion contradiction is generated when a superior body elucidates dissenting criteria sustained between the divisions of the Mexican Supreme Court or between Collegiate Circuit Tribunals. Depending on the dissenting criteria, the contradiction will be solved by the Full Seating of the Mexican Supreme Court, the Divisions of the Mexican Supreme Court, or the Regional Full Seating Divisions.
[2] In Mexico, as a general rule, the Judicial Power is integrated by Circuits or Jurisdictions, so that the tribunals of one circuit resolve the matters of the governed parties of the corresponding circumscription.