Table of Contents
- Introduction
- 1) Comparative Table of the Reform
- 2) Background of the Case
- 3) Complainant’s Arguments About Tax Legality
- 4) Mexican Supreme Court’s Decision
- 5) Complainant’s Arguments About Tax Proportionality
- 6) Mexican Supreme Court’s Decision
- 7) Original Language of this Entry
Introduction
On November 12, 2021, article 27, fraction XV, subsections a)[1], b), and c) of the Federal Law on Income Tax was reformed. Article which regulates the requirements to make valid the structural deduction for irrecoverable debts established in article 25, section V of the same law[2]. Of the previous paragraphs, b) was the subject of analysis by the Second Chamber of the Mexican Supreme Court of Justice while resolving the Indirect Amparo’s Review 560/2022. The subsection that legal entities use to deduct irrecoverable debts whose amount is greater than thirty thousand investment units or 230,800 Mexican pesos.
The reform of paragraph b) of article 27, section XV of the Income Tax Law consisted of modifying the timing in which an irrecoverable credit greater than thirty thousand investment units could be deducted. In this context, for the previous law, it was enough to file a claim with the competent authority demanding payment of an unpaid credit so that the taxpayer could deduct it. However, with the reform now, the taxpayer must obtain a final resolution issued by the competent authority demonstrating that all collection efforts have been exhausted or, where appropriate, that the execution of the favorable resolution is impossible to enforce so that they can apply this structural deduction.
Furthermore, to understand this change, it’s pertinent to highlight that from the statement of reasons for the modification of subsection b) of section XV of Article 27 of the Income Tax Law argued by lawmakers, as well as the Opinion of the Finance and Public Credit Commission of the Chamber of Deputies, the reform was justified based on the following arguments:
1.- It was detected that taxpayers were abusing this deduction by not exhausting the legal remedies to collect the credits they granted and thus reducing their tax base without seeking a result favorable to their interests in court. That as a consequence of this practice, they did not contribute to public spending proportionally and equitably (if you want to know more about these tax principles in Mexico, check my entry called Constitutional Principles of Taxes in Mexico)
2. The main objective of the reform was for companies to professionalize the granting of credit to their clients and take all necessary measures to avoid non-payment or late payment.
3.- Also, it was considered that the federal treasury indirectly assumed the fiscal cost of the losses even though non-compliance with these credits is attributable to the taxpayer for not having made an effective valuation when granting the credit.
1) Comparative Table of the Reform
| Tex Before the Reform | Text After the Reform |
| Article 27.- The deductions authorized in this title must meet the following requirements: […]. XV. In the case of losses due to irrecoverable credits, these are considered to have been made in the month when the applicable statute of limitations expires or earlier if the practical impossibility of collection is evident. For the purposes of this article, it’s considered that there is a notorious practical impossibility of collection, among others, in the following cases: a) […] last paragraph: The provisions of subsection a) of this section shall be applicable when the debtor of the credit in question is a taxpayer who carries out business activities, and the creditor informs the debtor in question in writing, who shall make the deduction of the irrecoverable credit, so that the debtor accumulates the income derived from the debt not covered in the terms of this Law. Taxpayers who apply the provisions of this paragraph must report no later than February 15 of each year the irrecoverable debts that they deducted in the terms of this paragraph in the preceding calendar year. b) In the case of credits whose principal amount on the day of maturity is greater than thirty thousand investment units when the creditor has demanded payment of the credit before the judicial authority or the agreed arbitration procedure for its collection has been initiated and in addition the as provided in the final paragraph of the previous section. | Article 27.- The deductions authorized in this title must meet the following requirements: […]. XV. In the case of losses due to irrecoverable credits, these are considered to have been made in the month when the applicable statute of limitations expires or earlier if the practical impossibility of collection is evident. For the purposes of this article, it’s considered that there is a notorious practical impossibility of collection, among others, in the following cases: a) […] last paragraph: The provisions of this subsection shall be applicable when the debtor of the credit in question is a taxpayer who carries out business activities, and the creditor informs the debtor in question in writing, who shall make the deduction of the irrecoverable credit so that the debtor accumulates the income derived from the debt not covered in the terms of this Law. Taxpayers that apply the provisions of this paragraph must report no later than February 15 of each year the irrecoverable debts that they deducted in the terms of this paragraph in the preceding calendar year. b) In the case of credits whose principal amount on the day of maturity is greater than thirty thousand investment units, when the creditor obtains a final resolution issued by the competent authority, which demonstrates that collection efforts have been exhausted or, where applicable, that it was impossible to enforce the favorable resolution and that what was established in the final paragraph of the previous paragraph was complied with. |
2) Background of the Case
I.- Dissatisfied with this legal reform, a company resident in Mexico City filed an indirect amparo proceeding before the Fourteenth District Court in Administrative Matters of the First Circuit, under file 240/2022 which, eventually, dismissed the Amparo under the argument that there was no legal standing to promote the amparo and, therefore, the ground of inadmissibility contained in article 61, section XII[3] of the Amparo Law was applicable. Consequently, the taxpayer’s substantive arguments were not studied.
II.- In disagreement with the judgment mentioned above, the taxpayer filed a legal remedy or ‘appeal’ which was studied by the Sixth Collegiate Court on Administrative Matters of the First Circuit under file number R.A 409/2022 and which, in essence, revoked the dismissal decreed by the court of the district, but declared himself incompetent to study the case. Specifically, the issue of constitutionality of article 27, section XV, subsection b) of the Income Tax Law. Therefore, it ordered the file to be sent to the Mexican Supreme Court of Justice to resolve the case on merits.
III.- Once the file arrived at the Mexican Supreme Court of Justice, it was registered under the Indirect Amparo’s Review 560/2022 of the Second Chamber, and the matter was turned over to Justice Alberto Pérez Dayán for the preparation of the draft resolution on the merits. A project that contemplated in seven different sections, a variety of tax topics such as legality, proportionality, tax equity, nonretroactivity, and so on. However, for this entry, I will only summarize those arguments related to tax legality and proportionality because they are the most important in the judgment and were eventually sufficient to deny the protection of our highest court in Mexico.
3) Complainant’s Arguments About Tax Legality
The taxpayer expressed the following arguments:
1.- That the reform of paragraph b) of section XV of article 27 of the Income Tax Law lacked legislative reasonableness and did not pass a proportionality test. To illustrate the above, the complainant proposed verifying whether said reform 1) pursued a constitutionally valid purpose, 2) was suitable, 3) necessary, and 4) proportional in the strict sense.
2.- That with respect to 1) a valid purpose, there was no direct relationship between the measure and the purpose because the lawmakers considered that even if the legal procedures culminated in an unchangeable and favorable ruling for the creditors who intend to deduct irrecoverable debts, on the other hand, they also assumed creditors would not be able to enforce that judgment.
3.- That it was materially impossible to predict whether the debtors would default on their obligations to the taxpayer, regardless of the measures that were taken to avoid non-payment or late payment, which did not imply that they would not default on their obligations.
4.- That it was not 2) suitable because the deduction of debts only differs in time since taxpayers would have to pursue the entire trial to obtain the final resolution of the competent authority to be able to make the deduction.
5.- That the above implied that all the stages of the procedure would have to be exhausted and that, in some cases, it would be delayed for reasons beyond the control of the taxpayer, as if it had to be summoned by the service of summons or the debtor promoted legal remedies and defenses that were notoriously inadmissible with the only intention to delay the trial, resulting in the taxpayer having to assume an additional cost in pursuing that trial and without being able to deduct the irrecoverable debt.
6.- That due to the number of cases litigated in Mexico and its statistics, it was a rational parameter to conclude the unconstitutionality of the reform, considering that it was not an ideal measure to combat the abuse of the deduction for irrecoverable debts due to the delay that would entail since the taxpayer would be deprived of a structural deduction to reveal his real and expeditious financial situation with that delay.
7.- That the legislative measure did nothing to combat debtors to the detriment of creditors, but on the contrary, established more requirements because taxpayers would take longer to make the deduction or, failing that, they would no longer make it, and the debts and debtors would have another incentive to unpay the credit.
8.- That in any case, the reform was not ideal because the tax authorities already had various mechanisms to control abusive practices that seek to reduce the tax base, such as those contained in articles 22, 42, and 69 of the Federal Tax Code.
9.- That it was false that the federal treasury had to assume the fiscal cost of the debts, and this was a reason to reform subsection b) of section XV of article 27 of the Income Tax Law since the debtor of the credit must accumulate the debt as income in terms of article 16 of the Income Tax Law[4], and with this, the treasury would benefit through this accumulation of income by a diverse taxpayer.
10.- That anyhow, there was legal uncertainty for both the creditor and debtor of the debt, as it was impossible to know with certainty when the final resolution would be obtained that would have the effect of the creditor deducting it as an irrecoverable debt and that, for his part, the debtor accumulates it with income in terms of article 16 of the Income Tax Law quoted.
11.- Regarding 3) the need for the legislative measure, the complainant stated that it was an excessive legislative measure and that in no way would it be the one that generated the least damage to the rights of the creditor as a taxpayer since far from granting legal certainty, it generated the taxpayer is uncertain as he does not know when the final resolution shall be issued that determines the impossibility of collecting the credit and, therefore, he does not know when he shall be able to deduct the debt.
12.- That in the face of this excess, taxpayers would naturally seek not to establish commercial relationships with suppliers due to the uncertainty of whether or not they shall pay the debt and if, in addition to this impact, the taxpayer could not deduct it. The above is because, as the complainant insisted, a loan payment could not be foreseen.
13. That this new legislative measure would, in the short term, deprive taxpayers as creditors of a mechanism to recover their capital.
14.- That this reform was not 4) proportional either because there was in no way a direct correlation between the established measure and the purpose sought with it.
15.- The stated was true because while the process by which the taxpayer with credits in his favor seeks to recover, the debtor is freed from the debt and does not accumulate as income, the creditor taxpayer being the one who bears the entire tax burden and in turn, it’s necessary to resort to external financing to avoid bankruptcy.
16.- That in that case, the new measure is not of greater benefit to the intervention in the complainant’s right since due to the impossibility of making the deduction, it would not be able to comply with its obligation to contribute to public spending proportionally and equitably.
17. On the other hand, he stated that the reform violated the right to legal certainty by adopting an ambiguous concept such as the expression “final resolution of the competent authority,” which made it impossible to know precisely when the losses and, consequently, the deduction could be considered to have been realized.
18.- That this was so because by not limiting that expression, it was up to the discretion and interpretation of the tax authority to decide the scope of that concept and at what moment the taxpayer had reached that resolution that revealed the impossibility of collection, which violated his right to legal certainty.
19.- That unlike the reform in the previous law, the taxpayer did know precisely when he could make the deduction since the rule was clear in the sense that it was done after having demanded payment of the credit before the judicial authority or initiated an arbitration procedure for its collection.
20.- That the legal uncertainty also lay in the fact that the debtor of an irrecoverable credit, intending to not pay his debt and accumulate income, filed appeals, legal remedies, or new claims that prevented a final resolution.
21. With the reform, the debtor of irrecoverable credit would be in a privileged position because while the creditor is required to demand the debt be collected, obtain a definitive resolution, and, finally, exhaust all collection efforts, the debtor shall not have an obligation to notify the tax authorities of the irrecoverable debt as income.
22.- That in the event that the debtor is given the corresponding notice when the taxpayer creditor has already complied with the new measure, the tax authority would have expired its verification powers to verify the accumulation of an old debt that was delayed because it was required of the creditor taxpayer undertake a winding trial for collection.
4) Mexican Supreme Court’s Decision
Our highest court cataloged the previous arguments made by the complaining taxpayer as unfounded and ineffective. This was so, according to the following reasoning:
I.- The court stated that the complainant started from a false premise when it argued that in order to deduct an irrecoverable debt, it necessarily had to exhaust all the stages of a process and that this, under facts beyond the control of the taxpayer, could be delayed. This was so, considering that the term of final resolution was not equivalent to that of judgment, since based on article 220 of the Federal Code of Civil Procedures[5], the term judicial resolution covered three types or concepts that are the following: A) decrees, B) orders and C) judgments.
II.- From the above, the court deduced that a process seeking the collection of credit could end, for example, with the conclusion of an agreement and with the consequence that a final judgment would not be needed, but rather a simple order that elevates said agreement to the category of res judicata. Also, the debtor could acquiesce (accept in full the claim) in the trial and end it quickly and early. Consequently, the arguments that the complainant made based on the fact that it had to exhaust all the stages of an ordinary process to be able to deduct an irrecoverable credit were classified as groundless[6] since the taxpayers enjoyed the means to terminate a process early. Hence, throughout the Supreme Court’s Ruling, the merits of the arguments were not studied.
III.- Regarding whether the reform fulfilled a constitutionally valid purpose, the Second Chamber declared the arguments put forward by the complainant as unfounded, as it concluded that the statement of reasons did exceed this standard of the proportionality test since the reform sought to combat the carrying out avoidance, evasion, fraud or illegal acts in tax matters with the abuse of this structural deduction. Purpose that found support in the systematic interpretation of articles 25, first paragraph and 31, section IV of the Political Constitution of the United Mexican States. Also, in the fact that these objectives had already been analyzed in various precedents, and that, in general, the lawmakers had the powers to establish the conditions of economic governance of the State and make taxpayers comply with their fundamental obligation to contribute to public spending.
IV. Regarding the suitability of the measure, the court also cataloged the arguments put forward by the complainant as unfounded, as lawmakers have a wide—but not limited—margin of legislative configuration (legislative freedom), with the limitation of respecting, for example, the principles contained in article 31, section IV of the constitution.
V.- That precisely out of respect for these principles, the lawmakers maintain the structural deduction for irrecoverable debts in the reform since it is interested in revealing the real contributory capacity of the taxpayer and, thereby, respecting the principle of proportionality. However, imposing new conditions for the use of this deduction responded to the teleology of the concept intended to be deduced, that is, to a loss due to a notorious practical impossibility of collection.
VI.- Considering this teleology, the lawmakers considered it necessary that there be a definitive statement by a State body that effectively certifies that the practical impossibility of collecting a credit is well known so that once issued, then that concept—the losses— are deductible for income tax purposes.
VII.- The reform was ideal because through it, the tax authority, when verifying compliance with income tax obligations, would have public documentation (the resolution) proving that the deductible losses come from an irrecoverable debt. At the same time, the same authority would be certain not only of the deduction but also of the accumulation that the debtor of that credit must make.
VIII.- On the other hand, the court also cataloged as unfounded the complainant’s arguments in the sense that the tax authorities, in any case, had verification powers as a more suitable control mechanism to verify compliance with taxpayers’ obligations, because these powers are discretionary and do not conflict with the control imposed by the reform.
IX.- On the other hand, it described as groundless the arguments regarding that the tax authority would have expired its powers of verification to verify the accumulation as income of the irrecoverable debt by the debtor, in principle, because said argument did not cause any direct harm to the complainant as creditor but in any case the debtor. Also, because in terms of article 30, third paragraph of the Federal Tax Code, the lawmakers had contemplated that the period for preserving the accounting regarding those records that were the subject of a legal remedy or trial, its conservation period would be counted from the date on which the resolution becomes definitive (res judicata). Finally, in terms of article 67 of the same body of laws, the expiration of the powers of verification of this point was also suspended until there was a firm resolution of the legal remedy or trial.
X.- Regarding the need for the measure, the Second Chamber cataloged the complainant’s arguments as groundless since, in reality, as it noted, the alleged excessiveness of the measure that the complainant argued was an unfounded statement and, therefore, was not itself an argument that should be analyzed.
XI.- In relation to proportionality in the strict sense of the reform (last stage of the test of proportionality), our highest court decided that contrary to what was expressed by the complainant, the new measure did comply with proportionality in the strict sense because there was a minimum proportional correspondence between the requirements of the deduction (medium chosen) and the goal sought (combat evasion, fraud and illicit behavior in tax matters)
XII.- The above was correct since the final resolution issued by the competent authority would generate legal certainty, both for taxpayers and the Public Treasury, regarding the impossibility of collecting the debts.
XIII.- That would also allow taxpayers to comply with their obligation to contribute in accordance with their accurate and effective contributory capacity since by exercising the deduction of losses due to irrecoverable debts due to the material impossibility of collection, the payment of income tax would be over a base that reflects the cumulative income that should be taxed.
XIV.- That it was wrong that the delay in the trial to recover the expired credits produced adverse effects since this assumption would depend solely on their diligence and conduct to obtain a favorable result, as well as on the compliance and risk evaluations in the granting of credits in which the tax authorities were not involved.
XV.- On the other hand, the court pointed out that it was not possible to attempt to reach the absurdity of the taxpayer demanding that the lawmakers define, as if it were a dictionary, each of the words used in the tax legislation. The only thing sure was that the principle of tax legality obliged them to determine the taxpayers’ contributions, their purpose, and, in general, their essential elements in a law that any ordinary person could understand.
XVI.- Finally, the competent authority’s expression of final resolution was in no way ambiguous or uncertain, and, therefore, the complainant’s fundamental rights of legality and legal security were disrupted. This was so because, from the outset, the phrase comprised two parts: final resolution and competent authority. From such ideas, both the tax legislation and precedents issued by the Mexican Supreme Court of Justice itself, it was possible to understand what the legislator wanted to refer to without, in any case, such ideas giving rise to contradictory or incongruent definitions in the context of tax matters.
5) Complainant’s Arguments About Tax Proportionality
As background arguments in this section, the taxpayer stated the following:
1.- That the reform ignores the principle of tax proportionality to the extent that it does not allow taxpayers to pay taxes in accordance with their authentic contributory capacity by not recognizing, at a reasonable and objective time, the possibility of deducting irrecoverable debts and thereby neutralizing an income that at the time it was accumulated.
2.- The complainant also reiterated that the deduction of irrecoverable debts is subject to the termination by final judgment of a trial, as well as the collection efforts carried out at the stage of execution of the judgment, which does not reveal an immediate, objective and perfectly determined moment that allows the taxpayer pay taxes according to his actual taxable capacity, at the moment in which the uncollectible account is no longer a manifestation of wealth.
3.- That in the case of the accumulation of income derived from an irrecoverable credit, it could not be considered that the taxpayer was paying taxes under a positive equity impact and, therefore, under a real profit if it’s not recognized that the deduction of the irrecoverable debt surge from the impossibility of its collection at an objective and opportune moment.
4.- That until he complies with obtaining a final ruling and exhausting the collection procedures to deduct an irrecoverable credit, the taxpayer would have to neutralize the effects of that artificially accumulated income with cash unrelated to the income that gave rise to it, as could be using their social capital.
5.- That lawmakers overlooked that the contribution to public spending by taxpayers had to be made based on income collected, otherwise, the taxpayer would have to pay the contributions out of their pocket according to other forms of financing, such as their own social capital.
6.- That the contested paragraph did not allow the artificially accumulated income to be tempered with the account receivable, with the corresponding deduction. Insisting that the deduction was not subject to an immediate, objective, and perfectly defined moment.
6) Mexican Supreme Court’s Decision
Once again, the Second Chamber of the Mexican Supreme Court of Justice cataloged the complainant’s arguments as unfounded in part and groundless in another, based on the following reasonings:
I.- At the outset, our highest court reiterated the ineffectiveness derived from the false premise that the taxpayer, to make the deduction of irrecoverable debts, has to wait until he files a trial, concludes all his procedural stages, carries out collection efforts and, finally, obtain a favorable resolution issued by the competent authority attesting to these efforts. This was so because the provision does not explicitly establish that it’s through a definitive judgment that this impossibility of collection must be obtained.
II.- In another sense, the court declared unfounded the arguments that the complainant made in the sense that the new temporality for deducting irrecoverable debts was not timely, objective, and accurate. That this was so because the opportunity and diligence with which the creditor taxpayer promoted the trial was his entire responsibility, so his procedural conduct shall determine the opportune moment in which he begins the steps to make effective at the time the deduction of an irrecoverable credit.
III. Similarly, the Second Chamber deduced that, having undertaken a proportionality test on the contested reform and concluded that it has a constitutionally valid purpose, it’s suitable and necessary, and it respects the proportionality standard in the strict sense, it was evident of the objectivity of the contested reform.
IV.- That it was also objective since the provision generated certainty because the taxpayer would have full knowledge that the final resolution of the competent authority would consist of the definitive pronouncement—regardless of the stage in which it’s and the contestability of the same—of the body empowered for this purpose, in which it is determined that there is a practical material impossibility of collecting the required credits. Reiterating that waiting for the pronouncement of a final judgment was unnecessary.
V.- On the other hand, our highest court noted that credit would only have the nature of cumulative income when, in terms of articles 16 and 17, section I of the Income Tax Law, the tax receipt that covers the price or agreed consideration; the good is physically sent or delivered or when the service is provided; or the agreed price or consideration is collected or payable in whole or in part, even if it comes from advances; so that, if it ultimately results in an irrecoverable debt, it shall be that portion that can be deducted.
VI.- Finally, on this point, the court highlighted that the complainant’s discomfort resided not in the moment in which it had to accumulate the income for the credit it granted and has not collected but rather was generated by the supposed lack of certainty of the moment in which it could deduct it in the event of non-payment. Uncertainty that had been overcome in the proportionality test undertaken by the Second Chamber of the Mexican Supreme Court of Justice.
VII.- Regarding the comparison made by the complainant about the reform and the previous law, our highest court declared said arguments as unfounded due to the fact the lawmakers respected the principle of tax proportionality of the taxpayer by not having changed his right to deduct losses due to concept of irrecoverable debts, with which he would continue to pay taxes according to his authentic taxable capacity. If anything, its requirements to access it were modified, but these were constitutional for the reasons given when undertaking the proportionality test.
VIII.- That with what was stated and founded, the claimed paragraph did recognize an objective moment to carry out the deduction, and it was feasible to neutralize the effects of the income that the debtor would accumulate at the time and that, therefore, at no time would the creditor taxpayer finance the payment of the tax on that accumulation with different amounts.
7) Original Language of this Entry
This entry is just a translation of the original one that I wrote and published on La Suprema Corte de Justicia de la Nación frente a la deducción de créditos incobrables. Therefore, if you have any doubts about my translation, please check the source for more information. Finally, keep in mind that English is not my native language, so from now on, I apologize to the reader for any errors or confusion that may arise from this translation.
By Omar Gómez
Mexican Tax, Constitutional and Administrative Attorney
Partner at beLegal abogados S.C
Visit https://belegalabogados.mx for more legal information
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[1] Subsection that regulates how to deduct irrecoverable debts whose credits do not exceed thirty thousand investment units and that was incorrectly recorded in file 54/ISR of Annex I-A of the Miscellaneous Tax Resolution 2023 as applicable to both individuals and legal entities, when in reality it’s only applicable to the latter because it is based on Chapter II, Title II of the Income Tax Law, which refers exclusively to legal entities, as well as rule 3.3.1.23. Also, because the structural deductions of individuals vary between regimes or tax brackets. Hence, it’s not possible to equate a deduction that was not expressly contemplated by the legislation.
[2] Article 25.- Taxpayers may make the following deductions: […]
V. Irrecoverable debts and losses due to unforeseen events, force majeure or the alienation of assets other than those referred to in section II of this article.
[3] Article 61.- The Amparo Proceeding is inadmissible: […]
XII.- Against authority acts that do not affect the legal or legitimate interests of the complainant (standing), in the terms established in section I of article 5 of this Law, and against general regulations that require an application act after the start of its validity.
[4] Article 25.- Taxpayers may make the following deductions: […]
V. Irrecoverable debts and losses due to unforeseen events, force majeure or the alienation of assets other than those referred to in section II of this article.
[5] Article 220.- Judicial resolutions are decrees, orders or judgments; decrees, if they refer to simple procedural determinations; orders when they decide any point within the business, and judgments, when they decide the merits of the case.
[6] In Spanish our highest courts use the term inoperancia that I translated as groundless but it may be understood as inoperative, to ascribe those arguments that cannot be studied because they violate the rules of basic logic or are not appropriate for the case, such as when a higher court decided in a binding precedent a similar case, and there is not need to study a similar case.
