Mexican VAT Refunds are subject to a Drastic Change affecting Business Models in Mexico

The Supreme Court of Justice of the Nation resolved the case 413/2022 holding that the civil law rule to offset receivables and payables between parties to a transaction is not considered payment for VAT credit purposes.

On March 15, 2023, the Second Chamber of the Supreme Court (the "Court"), in a unanimous voting, held that taxpayers are not entitled to credit 16% VAT paid to suppliers if the VAT is paid by offsetting receivables against payables between the parties to a commercial transaction. The Court's Resolution arose from the contradiction of positions held in VAT refund cases by the Circuit Courts of Appeals.

In the most relevant case for this legal discussion, Empacadora del Golfo de México, S.A. de C.V. ("Empacadora") claimed a VAT refund for period of December 2019. The Tax Authority denied the refund alleging that Empacadora did not prove that the 16% VAT charged by its suppliers was effectively paid as required in article 5 Section III of the Value Added Tax Law ("VAT Law").   Empacadora filed a lawsuit before the Federal Tax Court, which upheld the Tax Authority's position contending that the 16% VAT charged to it by its suppliers was effectively paid when Empacadora offset its receivables against the payables of its suppliers, which included VAT and then Empacadora moved and filed a constitutional claim against the Tax Court's judgement. The Fourth Circuit Court of Appeals for the Auxiliary Centre of the Tenth Region held in favor of Empacadora considering there is no legal prohibition to consider the offset transaction as valid means to pay the VAT to the suppliers who charge it to clients, and the taxpayers will be entitled to a refund to the extent the VAT, so offset is reported and paid to the Tax Authority.

The Supreme Court heard and resolved the case because there were two opposite resolutions: one issued by the Sixteenth Circuit Court of Appels in Administrative Matters, which held that the offset of receivables and payables, including VAT, should not satisfy the "effectively paid" requirement provided in the VAT Law to allow the VAT refund (i.e., receivable US$100 plus US$16 VAT and payable US$100 plus US$16 VAT, following the offset client pays in cash only US$16 of VAT to the supplier who in turn should report the US$16 VAT to the Tax Authority). The other arose from the Empacadora Case where the Fourth Circuit Court of Appeals for the Auxiliary Centre of the Tenth Region rendered its opinion in favor of Empacadora where it required no cash payment of VAT between the parties only to the Tax Authority (i.e., receivable US$100 plus US$16 VAT and payable US$100 plus US$16 VAT, following the offset supplier pays only US$16 of VAT to the Tax Authority irrespective of the lack of cash between supplier and client).

In resolving the opposite criteria, the Supreme Court analyzed the law and concluded that the effectively paid requirement can only be satisfied when there is a payment of the VAT in cash. Further, the Supreme Court clearly affirmed that the effectively paid VAT requirement cannot be construed to include the offset rule provided in the Civil Code to consider that the VAT amount included in the receivables and payables has been paid in refund request cases.

The conclusion reached by the Supreme Court is mandatory for all courts and judges in Mexico and will ensure that all taxpayers pay the VAT charged to them by suppliers in cash. If there is no cash payment of the charged VAT, the taxpayers will not be able to obtain the VAT credit, and they will not be able to request the refund of the balance that would have generated in their favor.

The Supreme Court's conclusion was based on the following considerations:

• In the Court's view, the set off legal transaction is not a means of payment of VAT; accordingly, it cannot be considered that the VAT is paid to satisfy the effectively paid requirement to be entitled to the refund of a balance in favor of the VAT paid over the VAT charged to clients.
• The offset mechanism provided for in Federal Tax Code applies only when the reciprocal debtors and creditors are the private individual and the Treasury, and not when it concerns individuals only, and civil compensation is not applicable for tax receivables.

Taxpayers and businesses are reacting to the Decision and effects.

Some taxpayers, advisors and scholars have questioned the rationale of the Court arguing that preventing the VAT credit when the parties offset the VAT is pointless because the VAT caused must be paid to the Treasury by the relevant person (disposer, service provider or lessor) in cash and in national currency.

Other implications arising from this case include, if this interpretation will be applied retroactively by the Tax Authorities, effects on business models where the offset of receivables and payables is the most efficient mechanism to pay debts (i.e., corporates for intercompany transactions, financials system, retail, and others).

Taxpayers should revisit their procedures to determine if there is an offset in accordance with the law, if it does, ensure that they pay in cash the VAT transferred to them by the service provider, the disposer, or the lessor, even if they decide to compensate for the rest of the agreed consideration.

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