January 27, 2017 / 6:08 AM / 6 months ago

Exclusive: Telefonica fends off Mexico $1.4 billion tax audit, in talks on others

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The sign of Telefonica building is seen in Caracas, Venezuela July 30, 2016.Carlos Jasso/Files

MEXICO CITY (Reuters) - Spain's Telefonica has fended off a bid by Mexico to slap the telecoms giant with a 30 billion Mexican peso ($1.42 billion) tax bill and is in talks with local tax officials to resolve over 20 other open audits, people familiar with the matter said.

The audit Telefonica successfully challenged, which was opened in 2013, claimed the telecoms provider had failed to declare all of its income in its 2007 tax filing. Mexican tax agency SAT issued a preliminary assessment of about 30 billion pesos, two of the sources said.

But under mediation through Mexico's independent taxpayer ombudsman, Prodecon, the entire tax bill was wiped out and the audit closed in late 2015, three of the people said.

The preliminary assessment, which would have been about 90 percent of Telefonica's 2015 Mexico revenues, came after the company angered tax authorities by slashing its 2013 tax bill through a merger of some of its Mexican subsidiaries, three sources said.

Telefonica was one of a handful of companies in Mexico that merged units to generate losses in the lead-up to 2014 when a rule change forced companies to begin to pay back deferred income tax, three sources said.

Telefonica is negotiating with tax authorities over at least two dozen open audits regarding its tax arrangements in Mexico, two of the people familiar with the matter said.

SAT and Prodecon declined to comment.

In an emailed statement, Telefonica confirmed that authorities had conducted an audit of its 2007 tax filing, which has since been closed after the probe showed the company had acted correctly.

"It is a normal procedure for all companies, and it is precisely SAT's job to review for correct compliance with current tax legislation," it said. "Telefonica is cooperating and collaborating closely with authorities to supply all documentation and information."

For Telefonica, the audits are just the latest in a series of headaches in Mexico, where the Spanish company has struggled to become an important player despite a 2013 telecoms reform aimed at taming Carlos Slim's America Movil, the local heavyweight.

After 17 years in Mexico, Telefonica has fewer than 26 million mobile users compared to Slim's 72 million.

Telefonica's Chief Executive Officer Jose Maria Alvarez Pallete said in October the company was not satisfied with its Mexico situation and was working on alternatives for the operation, which account for under 4 percent of its global revenue.

The 2015 mediation deal was a blow to Mexico's aggressive efforts to boost its tax intake, which, as a percentage of gross domestic product, is the weakest among the 35 members of the Organisation for Economic Co-operation and Development (OECD).

Under pressure from a slide in oil tax revenues, Mexico has stepped up efforts to collect more from other sources, boosting its intake by over 60 percent in 2015 compared with 2012, the year President Enrique Pena Nieto took office.

Mexican Headwinds for Telefonica

Telefonica's battles with SAT have roots in the Spanish company's entry into Mexico in 2000 by buying four Motorola Inc wireless units for about $1.8 billion. It further widened its network in 2002 by spending about $1.3 billion in debt and equity for a controlling stake in Pegaso PCS, a local mobile operator.

Telefonica began consolidating its Mexican earnings a few years later, a source said, taking advantage of rules that allow firms to reduce their overall tax burden in the short term by applying one unit's losses to its total bill.

In 2013, Mexico changed its rules on consolidation and asked firms to begin paying back deferred tax bills.

Faced with a hefty bill thanks to the rules change, a source said, Telefonica got approval in December 2013 from Mexico's telecoms regulator to sell the four units that it had acquired from Motorola to Pegaso PCS, which it also controlled, according to company filings.

That allowed the company to declare a loss on the sale, lowering its tax bill and earning SAT's ire, three sources said.

Telefonica financial statements show the company paid 47 million euros in tax in 2013 in Mexico, without specifying the type of tax.

After the December 2013 merger, SAT proposed a tax assessment of around $30 billion pesos for Telefonica based on the audit.

Telefonica brought the issue to tax ombudsman Prodecon, which acts as an intermediary between SAT and an audited taxpayer. The outcome was a "conclusive agreement" that killed the audit in late 2015, the sources said.

($1 = 21.1582 Mexican pesos)

Editing by Christian Plumb and Edward Tobin

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