The annual adjustment for inflation It is one of the tax calculations that causes the most confusion due to its complexity.

Its purpose is to reflect the impact that inflation has on a company's debts and credits, and how such inflation can generate accrued income or an authorized deduction.

What is the Annual Inflation Adjustment?

For a better understanding we will define “inflation” as:

“The general increase in prices in an economy, which reduces the purchasing power of money”

According to the Income Tax Law (ISR), the inflation adjustment depends on the relationship between the credits Y debts of the company. If a company's credits are older that their debts, inflation decreases their real value, which represents a loss of purchasing power for the company. In this case, the inflation adjustment is deductible, as it reflects a financial loss. On the contrary, if the debts are older that credits, the company benefits because inflation reduces the real value of what it owes, generating a economic benefit. In this case, the inflation adjustment is cumulative, increasing the company's taxable base.

How is the Inflation Adjustment Calculated?

The calculation of the inflation adjustment is carried out at the end of each fiscal year, and consists of the following steps:

1. Determine the average annual balance of debts and credits:
   • The debt and credit balances are added up at the end of each month and divided by the number of months in the year. This results in the average annual balances.
2. Compare average debt and credit balances:
   • If debts are greater than credits, the inflation adjustment will be cumulative, that is, it will increase the taxable base.
   • If the credits are greater than the debts, the adjustment will be deductible, reducing the taxable base.
3. Apply the annual adjustment factor:
   • The annual adjustment factor is obtained by subtracting the unit from the quotient between the National Consumer Price Index (NCPI) of the last month of the fiscal year and the NCPI of the last month of the previous fiscal year.

Example of Calculation of Inflation Adjustment

Let's imagine that a company has an average annual debt balance of $1,000,000 and an average annual credit balance of $800,000. The difference between the two is $200,000, and let's assume that the annual adjustment factor is 5% (0.05).

The calculation would be as follows:

Cumulative inflation adjustment = $200,000 * 0.05 = $10,000

This adjustment of $10,000 would be cumulative, which means the company would have to include this amount as additional taxable income.

Examples of Credits and Debts in the Inflation Adjustment

Now, let's look at some more detailed examples of what is considered credit or debt for inflation adjustment purposes.

Credit Examples:

1. Customers: If the company sells merchandise or services on credit, the amount of unpaid invoices at the end of the month is considered a credit.
2. Loans granted to third parties: If the company has lent money to another entity or a person, this loan is a credit until it has been paid.
3. Investments in debt instruments: Investments in bonds, promissory notes or certificates that generate interest are considered credits, since the company has the right to receive payment of the principal and interest.
4. Balances in favor of contributions: If the company has tax balances in its favor, these are considered credits from the day after the declaration is filed until they are offset, credited or returned.
5. Accounts receivable from financial operations: Rights arising from derivative financial contracts, such as swaps or futures, are also considered credits.

Examples of Excluded Credits:

Not all claims to money or property are considered credits for inflation adjustment purposes. Examples of exclusions include:

• Accounts receivable from partners or shareholders whether they are natural persons or residents abroad, except in very specific cases.
• Income whose accumulation is conditional to their effective perception, such as some financial leasing contracts.
• Cash on hand: Although technically an asset, it is not considered a credit for inflation adjustment.

Examples of Debts:

1. Loans from banks or other financial institutions: Any loan or credit that the company has received and has not paid at the end of the month is considered a debt.
2. Accounts payable to suppliers: If the company purchases goods or services on credit, accounts payable to suppliers are debts until they are settled.
3. Financial leasing: If the company has financial leasing contracts, the debt is considered for the amount that is still pending payment each month.
4. Contributions causedTax obligations that have not yet been paid (such as ISR or VAT payable) are also considered debts until they are settled.
5. Borrowed capital: If the company receives a loan in cash or in kind, it will be considered debt from the moment the capital is received.

Examples of Excluded Debts:

Not all obligations are considered debts for inflation adjustment purposes. Some of the exclusions are:

• Non-deductible items: Any debt arising from items that are not tax deductible (such as some personal expenses or non-deductible taxes) are not included in the calculation.

Conclusion

The annual adjustment for inflation is recognized in the annual calculation with a deductible or cumulative effect as the case may be, and may have a significant impact.

If you require assistance in fulfilling your tax obligations, do not hesitate to contact us.