Impact of changes in interest rates and country risk rates in Mexico

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Mexican transfer pricing (TP) regulations require that any financial instrument that generates attributable income or deductible expense as a result of a related party transaction, be analyzed under the TP regulations established in Mexican law. Income Tax (MITL) to demonstrate that it respects nature at arm’s length.

As mentioned in the MITL, TP analyzes should consider the variables of financial instruments, for example: the amount and duration of the transaction, the credit risk rating of the debtor, the loan guarantees and netting (i.e. i.e. the interest rate).

Regardless, MITL Article 179 does not state that other variables should be taken into account, so it is necessary to take into account other factors for the characterization of the loan and a reliable analysis of the PT, for example : the type of financial instrument, the prepayment or convertible clauses and the country of residence of the debtor, among other aspects.

MITL requires a functional analysis, the contractual terms of the intercompany transaction, the economic circumstances as well as the business strategies and the reason behind the financial instrument, for example in the event of a loan being granted.

As the COVID-19 pandemic began in March 2020 and global economic growth was pushed on a downward trend, monetary policy and, as a result, interest rates were adjusted downward by the Most central banks to push the reactivation of local economies.

COVID-19: Impact on Mexico

In Mexico, before the onset of COVID-19, the Tasa de Interés Interbancaria de Equilibrio or TIIE (the Mexican interest rate usually used as a benchmark for Mexican peso loans) had levels between 7% and 8%, but declined to levels between 4% and 5% in mid-2021.

Other factors that have an impact in a TP analysis are the country risk, a variable that reflects a deviation for the financial instruments of the country where the debtor is located compared to the reference interest rate of the country.

The country risk for Mexico increased during the pandemic and, depending on the database used in the analysis, the value may differ. For example, the “JP Morgan Country Risk Index” had country risk levels of 3.6% as of 2021 for Mexico, although “Ambito” had country risk levels for Mexico of 2.1. %. The difference generally depends on the variables considered by the analysts of the different sourcing companies.

When comparable financial instruments may not be available in the same currency as the financial transaction under review, it may be necessary to make an economic adjustment to account for exchange differences.

An alternative to making this adjustment could be the international Fisher effect for interest rates, where the expected nominal interest rate is equal to the real interest rate plus the expected inflation rate. Since the inflation rate in Mexico fluctuated during the pandemic to values ​​as low as 2% and as high as 5%, it may be relevant to consider a longer term of observations when using the inflation rate.

In addition to the complexities mentioned above, there can be a challenge in TP analyzes in supporting historical rather than predicted observations or vice versa. In financial transactions, the future expectations of an economy play a relevant role in offsets, which may not be included in historical information. It is also a challenge when using swaps to adjust rates.

Due to COVID-19, projections and forecasts for country risk, inflation and other variables in the economic environment are at one point uncertain because no one predicted the COVID-19 pandemic in their forecasts. .

Therefore, one of the main challenges of the TP analysis of financial instruments is the complexity of applying the different adjustments to the economic variables in order to estimate an arm’s length range to prove that the income or deduction conforms to the values. Steps.

Finding the relevant data and information to take into account in a PT analysis to adjust the relevant characteristics of financial instruments and adjust them is crucial for this type of analysis. Thus, it is important to document the economic analysis and to underline in a good practical support the qualitative and quantitative arguments which support it.

Enrique González Cruz

Partner, EY

Ricardo barbieri

Partner, EY

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