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Materiality from a transfer pricing perspective: Why is a study no longer sufficient?
Background
On October 11, 2024, non-binding criterion 44/ISR/NV, entitled "Deduction of expenses for services rendered. They are not deductible if it cannot be proven that the service was actually provided." A little over a year after its publication, this criterion has become a topic of constant analysis among specialists and taxpayers, who seek to understand its practical implications for the deduction of services, particularly in intercompany transactions.
This article addresses the issue from a transfer pricing perspective, with the aim of analyzing the relationship between criterion 44/ISR/NV and the technical documentation required to comply with the arm's length principle. In our opinion, the criterion reinforces a trend already contained in the OECD Guidelines (2022): the deductibility of services depends not only on the market price, but also on the materiality and economic substance of the transaction. Now, with this non-binding criterion, the idea already contained in the Transfer Pricing Guidelines is reinforced and the tax authority's approach to the deductibility of intercompany services is clarified.
Criterion 44/ISR/NV: substance and evidence as conditions for deductibility
The official text of the criterion states that:
"Article 27 of the Income Tax Law establishes the requirements that expenditures must meet in order for taxpayers to consider them deductible (...). However, the requirement of strict indispensability of deductions can only be verified in transactions that actually exist, that is, when it can be corroborated that they were actually carried out (...). In this regard, expenditures made for the provision of services, paid either to a person resident in Mexico or abroad, are not deductible if it cannot be proven that the service was actually received (...). Therefore, those who deduct expenses for services rendered without having evidence to prove that they were actually received, regardless of whether they have a tax receipt, are considered to be engaging in improper tax practices."
This criterion reaffirms the SAT's position: deductions for services must be supported by evidence demonstrating their actual provision, their relationship to the taxpayer's activity, and their real economic benefit. The mere existence of a contract, invoice, or transfer pricing study is not sufficient.
From a transfer pricing perspective, the criterion does not alter the taxpayer's formal obligations, but it does influence how they should be understood and documented. A transfer pricing study demonstrates that the value agreed between related parties is consistent with the arm's length principle; however, its scope is mainly documentary and economic. Proof that the service was actually provided requires other types of evidence, such as contracts, reports, deliverables, minutes, or accounting receipts, which confirm the performance and benefit of the service. In practice, this information is concentrated in a defense file, complementary to the study, which serves to support the substance and materiality of the transaction in the event of a review by the authority.
From transfer pricing studies to functional evidence
In recent years, the SAT has strengthened its enforcement capabilities and adopted a more comprehensive approach to tax compliance. In transfer pricing reviews, the authority no longer limits itself to questioning the method applied or the comparables used. It now analyzes the existence, execution, and economic substance of the transactions.
This means that transfer pricing studies must be supplemented with functional evidence: activity reports, deliverables, communication records, financial flows, time logs, performance reports, or indicators that prove the provision of the service and its contribution to the taxpayer's activity. If this type of evidence is not available, the SAT may determine that the transaction lacks substance and reject the deduction, even if the price is duly supported.
What the OECD Guidelines (2022) say
The OECD Transfer Pricing Guidelines (2022) already contemplate this approach and address the treatment of intra-group services and the need to demonstrate their existence and economic value. According to these Guidelines, an intra-group service must, first, exist in economic reality, i.e., have actually been provided and be capable of being substantiated with objective evidence; and second, generate or be expected to generate an economic or commercial benefit for the recipient entity. In practical terms, this means that an independent company, in comparable circumstances, would have been willing to pay for such a service or to perform it internally.
The Guidelines also clarify that certain activities should not be considered services for transfer pricing purposes, such as those that are purely share-based, duplicated, or that produce incidental benefits derived simply from belonging to a business group. These activities, as they do not generate direct economic value, cannot be remunerated or give rise to tax deductions.
On the other hand, the OECD establishes that companies must have sufficient documentation to demonstrate the effective provision of services and the reasonableness of the charges assigned. This involves clearly identifying the nature of the service, its economic purpose, the basis for cost allocation, and how the market value remuneration was determined.
Finally, the Guidelines emphasize that all transactions between related parties must be analyzed based on their actual economic substance and not solely on their contractual form. This means that contracts and internal policies must reflect how the parties act in practice and the value that is actually generated.
Overall, the OECD provisions and SAT criterion 44/ISR/NV agree on the same principle: expenditures for services must have verifiable existence, economic substance, and a verifiable benefit. Only real and functional services, supported by objective evidence, can be considered valid for tax and transfer pricing purposes.
The Benefit Test
The Benefit Test is the operational concept that links transfer pricing analysis with the materiality requirement of criterion 44/ISR/NV. Its purpose is to determine whether the service generates an economic or commercial benefit for the recipient and whether an independent company, in similar circumstances, would be willing to pay for it.
In practice, this means that companies must document not only the market value of the service, but also evidence of the benefit received. For example, if a Mexican subsidiary pays its parent company for administrative support services, it must keep reports, minutes, or results that prove the effective assistance. If the expense does not generate an identifiable benefit or its execution cannot be demonstrated, it could be rejected under criterion 44/ISR/NV, even with a valid transfer pricing study.
Conclusion
A little over a year after the publication of criterion 44/ISR/NV, companies must assume that compliance in intercompany services requires two inseparable components: a transfer pricing study that supports market value and substantive documentation that demonstrates the existence and benefit of the service.
This criterion and the OECD Guidelines converge on the same line: deductions and charges for services must be based on actual events, with sufficient functional evidence to prove their execution and economic contribution. It will be important to review whether, with respect to previous fiscal years, there is sufficient evidence to demonstrate that intercompany services were material and generated an identifiable benefit for the recipient entity. The existence of reports, deliverables, communications, or accounting records that prove the effective provision of services will be key to supporting the deductibility of such expenses.
Looking ahead to future years, it is advisable to consider these provisions and strengthen contemporary documentation by integrating defense files that bring together both economic analysis and the functional evidence needed to support the substance and benefit of each service in the event of a review by the tax authority.
At PGA, we assist companies in preparing and updating their transfer pricing documentation, incorporating evidence of substance and materiality in accordance with criterion 44/ISR/NV and the OECD Guidelines 2022. Our expert team is at your service to address your company's tax and transfer pricing needs. We invite you to contact our firm's staff, who will be happy to answer your questions or comments.
Written by Juan Hernández.
