Exclusive: P&G, Hasbro in crosshairs of Mexico's taxman - sources

By Alexandra Alper

MEXICO CITY (Reuters) - The world's largest household product maker Procter & Gamble and No. 2 toymaker Hasbro are at the heart of a Mexican probe into tax avoidance that could cost the firms hundreds of millions of dollars in back-taxes between them, sources told Reuters.

In January, Mexico said it had launched a probe of 270 companies for allegedly exploiting tax loopholes that have leaked income out of Mexico for years.

At first, seven multinationals were the focus of the government's "informal audit," led by Oscar Molina, who audits big companies at Mexico's tax collection agency SAT.

But Molina says he is in advanced discussions with two companies to pay more income tax for prior years.

He didn't name them but said one of the two has been involved in litigation since 2005 over the extent of its taxable presence in Mexico. The other, he said, has been less aggressive and had made gradual changes to its tax scheme.

Five sources have told Reuters the firms are Hasbro and P&G.

In its 2014 second quarter report released in July, Hasbro said it is defending itself against outstanding tax assessments by Mexican authorities totalling about $250 million for the 2000 to 2007 period related to how it accounts for cross-border transactions, known as transfer pricing issues.

"The company is party to discussions with the Mexican tax authorities to determine if the two parties can reach an agreed settlement of these issues," Hasbro said in the filing.

It said it has made a settlement offer to authorities without specifying the amount.

SAT says the probe, which still includes a handful of firms, involves examining corporate structures that ensure profits based on Mexican manufacturing activities or sales to Mexican customers are reported in offshore units, beyond the reach of the Mexican tax authority.

Molina is arguing that these offshore units which derive profits from economic activity in Mexico, had a de facto taxable residence or permanent establishment in Mexico and so, he can tax their Mexico-related profit.

Tax authorities in Spain, France and Norway have previously gone to court to argue a multinational using such profit shifting structures, had a deemed permanent establishment in their countries.

However, those efforts largely failed, which is partly why countries are now pressing for changes in international tax rules which would bring profits shifted offshore by convoluted arrangements back within reach of tax authorities.

Mexico levies 30 percent income tax on firms, above OECD countries' average of 25 percent.

"We are working under the understanding that there is permanent establishment," Molina said in a June interview about the probe. "They send away part of the income. And we say: No, no, no. Your income is bigger than that. And it is because of your permanent establishment."

P&G and Hasbro declined to comment on whether they are being probed. Neither company revealed their tax obligations in Mexico.

Hasbro spokeswoman Julie Duffy said that the global toymaker is often involved in tax audits around the world.

P&G spokeswoman Jennifer Corso said in an email that the company pays all taxes owed in more than 150 tax jurisdictions and does not pursue aggressive tax planning.

Ohio-based P&G, the maker of Gillette razors and Tide detergent, employs about 7,000 people at eight plants, two distribution centres and an office in Mexico, the company said.

RULES REVIEW

An undated confidential document that a source said P&G submitted to the Mexican government last year described the company's operations in Mexico. It was reviewed by Reuters and shows about $1 billion in revenue and some $3 billion in exports from P&G Mexico in 2012.

Neither Hasbro nor P&G have said how much income tax they pay annually in Mexico. SAT would not say how much it believed the two companies it is in advanced talks with should pay.

Hasbro, known for its My Little Pony toys and Transformers action figures, generates nearly $200 million in Mexican sales annually, according to a confidential document, also undated and about its operations in Mexico, that the source said the firm presented to the government in 2013.

The toymaker has offices in Mexico City, a distribution centre and sales personnel in five cities, the document said. The Rhode Island based-firm, which trails only Mattel in the world toy market according to Euromonitor, says it has 245 employees in Mexico.

Mexico's actions reflect growing frustration among some large developing countries, including China and India, with legal loopholes in international tax rules that companies can exploit to shift profits to tax havens. Mexico's SAT argues that by doing so, some companies are avoiding their tax dues.

In 2012, the group of 20 leading economies stepped up efforts to crack down on corporate tax dodging, after reports of firms like Apple and Google using complex structures to slash their tax bills sparked outrage.

The G20 asked the Organisation for Economic Co-Operation and Development (OECD) to review the rules on how multinationals are taxed, emboldening Mexico to pursue its own tax avoidance probe.

Mexico, a haven for auto manufacturers and light assembly plants, has the lowest tax take in the OECD, crimping its ability to spend on programs vital to boosting economic growth and living standards.

The main factor in determining whether a company has a taxable presence or a "permanent establishment" in a country is the extent of its sales operations there.

But loopholes allow companies to avoid hefty levies in high-tax countries where they generate big sales revenue, for example, by signing sales contracts abroad.

Molina said he could complete formal audits of the firms he is in advanced talks with quickly and go to court if they don't reach a deal.

(Additional reporting by Tom Bergin in London and by Ana Isabel Martinez and Carlos Gonzalez in Mexico City; Editing by Simon Gardner and Kieran Murray)