In December 2012, Mexico passed legislation that delays previously enacted corporate tax rate reductions which would have reduced the corporate tax rate to 29% in 2013 and 28% in 2014. However, recently enacted legislation maintains the 30% corporate tax rate through the end of 2013 with additional reductions effective in 2014 and 2015. The legislation also limits when the flat tax credit for excess deductions may be used to offset taxable income. As a result, organizations with operations in Mexico will need to analyze the impact of the new legislation on their financial statements when accounting for income taxes under either US Generally Accepted Accounting Principles (US GAAP) or International Financial Reporting Standards (IFRS). In doing so, organizations may need to remeasure deferred tax balances as well as consider the impact on their estimated annual effective tax rate (AETR).
In December Mexico passed legislation that may require tax accounting changes for organizations reporting under either US GAAP or IFRS. The new legislation is largely focused on changes to the Mexican corporate tax rate and limitations associated with the flat tax credit for excess deductions.
The Mexican corporate tax rate was scheduled to be reduced under prior law from 30% to 29% on January 1, 2013 and then to 28% on January 1, 2014, but the newly enacted legislation maintains the 2012 rate of 30% through the end of 2013 and instead scales back the corporate tax rate to 29% on January 1, 2014 with an additional reduction to 28% starting in 2015.
In the case of the flat tax credit for excess deductions, the legislation provides that the credit may no longer be applied to income tax payable for the current period, as was the case with respect to certain prior years, where the flat tax credit was allowed against the current year's income tax. Instead, it may only be credited against flat tax arising during the following ten periods, until the credit is exhausted.
Under US GAAP, Accounting Standards Codification (ASC) 740, Income Taxes, requires organizations to use the tax law in effect at the balance sheet date of the relevant reporting period.
The impact of enacted tax law changes should be assessed on both existing deferred tax balances and current year activity. For existing deferred tax balances, the associated impact would be included as a discrete item in the interim period in which the changes are enacted. To the extent the tax law change relates to current year activity, the impact would be reflected in the estimated AETR.
The effects, both current and deferred, are reported as part of the tax provision attributable to continuing operations, regardless of the category of income in which the underlying pre-tax income or expense or deferred tax asset or liability was or will be reported.
Under International Accounting Standard (IAS) 12, organizations are also required to use the tax law in effect at the balance sheet date of the relevant reporting period. However tax law changes only need to have been substantively enacted by the balance sheet date for deferred tax balances to be adjusted, or for the impact to be reflected in the estimated AETR, if applicable. Unlike US GAAP, under IFRS, organizations should backwards trace the effects of a law change upon existing deferred tax balances in order to determine the portion of the adjustment that is recognized as part of the tax provision attributable to continuing operations or otherwise recognized as part of the tax provision that is allocable to other comprehensive income or equity.
In both cases, a detailed analysis may be required to assess when the temporary differences existing at the date of substantive enactment or enactment are expected to reverse.
For US GAAP purposes, the date of enactment for Mexican law changes occurs on the day following publication of the Tax Bill in the Federal Official Gazette, unless a different date is stated in the law. Whereas under IFRS, substantive enactment for Mexican law changes occurs upon signature of the President. For purposes of this tax law change, the date of enactment occurred on December 18, 2012 and substantive enactment occurred on December 14, 2012.
For both US GAAP and IFRS, temporary differences expected to reverse from January 1, 2013 to December 31, 2013 should be recognized at 30% and those expected to reverse from January 1, 2014 to December 31, 2014 should be recognized at 29% with temporary differences reversing in 2015 and thereafter recognized at 28%.
Therefore for periods with balance sheet dates after enactment / substantive enactment respectively, the estimated AETR used to calculate the current year charge or credit will also need to reflect the new rates for the relevant proportion of the periods for which they apply, as well as any other enacted or substantively enacted rates applicable during the relevant periods.
For those organizations subject to the Mexican flat tax, a credit may be available where flat tax deductions exceed income in a fiscal year. However, the flat tax credit may only be applied against flat tax liabilities that arise in the subsequent ten years (i.e., the credit may no longer be applied to income tax payable for the current period). Organizations should assess whether the new limitations impact the realizability of their credits.
Under US GAAP, deferred tax assets are recognized in full unless it is more-likely-than-not that some or all of the deferred tax assets will not be realized, in which case a valuation allowance is established. Additionally, changes to valuation allowances would be recorded to continuing operations.
Under IFRS, deferred tax assets are recognized only if it is probable that sufficient taxable profit will be available to utilize against temporary differences.
For both US GAAP and IFRS purposes, organizations should consider appropriate disclosure in their financial statements of the impact of each of these changes in tax law. However, in the case of IFRS, the guidance requires disclosure of the allocation of the impact between the income statement, other comprehensive income, and equity if the changes in tax law are considered to have a material impact on the financial statements.
For enacted tax law changes under US GAAP, the current year's reconciliation of the ETR should also include a reconciling item for the effect of the enacted law changes if their effect is considered 'significant.' Significant is defined by Rule 4-08(h) of SEC Regulation S-X as an individual item that is more than five percent of the amount computed by multiplying pre-tax income by the statutory tax rate. There is a similar requirement for IFRS accounts once the changes are substantively enacted and if the impact is considered to be a major component of the tax expense.
Organizations should also consider whether enhanced disclosures over and above the required minimums should be made to assist users of financial statements in understanding the implications of the changes.
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For a deeper discussion of how this issue might affect your business, please contact:
Ken Kuykendall
Global & US Tax Accounting Services Leader
Partner
+1 (312) 298-2546
o.k.kuykendall@us.pwc.com
Doug Berg
Global & US Tax Accounting Services
Managing Director
+1 (313) 394-6217
douglas.e.berg@us.pwc.com
Kristin Dunner
US Tax Accounting Services
Director
+1 (617) 530-4482
kristin.n.dunner@us.pwc.com