Mexico's federal tax system is principally based on three taxes: income tax, value added tax (VAT), and special tax on production and services (IEPS, per its acronym in Spanish). Other taxes exist, but these three taxes constitute the principal source of tax revenue for the government, which is significantly supplemented with oil and energy-related revenue.
While aspects, some significant, naturally change over time, this system has generally been consistent in its structure and the key content of the relevant tax laws, Mexico's Income Tax Law (MITL) and VAT Law. In this chapter, we focus on those consistent characteristics as of 2019, and also refer to recent changes because of a recently approved federal tax reform by a new administration, which incorporates general anti-avoidance rules adopting principles of the base erosion and profit shifting (BEPS) action plan, as well as new tax legislation on businesses performed through digital platforms.
Mexico has a significant double taxation agreement (DTA) network. Additionally, it has 30 agreements in force for the reciprocal protection of investments and free trade agreements with 46 countries, and has been active in the negotiation of the Trans-Pacific Partnership Agreement. These conditions, and its geographic proximity with the United States, have allowed the country to perform industrial hub functions, with particular success in the automotive industry.
Mexico is predominantly a capital-importing country, and its tax system (including common characteristics of its DTAs) reflects this. However, over recent years leading Mexican business groups have consistently looked for opportunities abroad, therefore outbound capital movements have also become relevant.
II COMMON FORMS OF BUSINESS ORGANISATION AND THEIR TAX TREATMENT
From a commercial perspective, the stock company (SA) has prevailed for a long time now over other commercial company types established in Mexico's General Law of Commercial Companies. This type of company requires a minimum of two shareholders, can be administered through a board of directors or a sole administrator, and requires an internal audit organ. A minimum paid-in capital is no longer established, although a minimum of 20 per cent of that established in the company's by-laws must be effectively paid in at the time of incorporation.
More recently, the investment-promoting SA (or SAPI), introduced as part of the Law of the Stock Exchange in December 2005, gained favour as a versatile vehicle for co-investing parties. In particular, the SAPI allows for shareholders' agreements and concepts such as tag-along and drag-along rights and obligations, series of shares with special or restricted rights, and special rules regarding entry and exit of shareholders. Shareholder rights are not opposable to the share-issuing company as a third party, although this situation may be altered if the company itself is a party to the shareholders' agreement.
Given the SAPI's success, the traditional SA was overhauled through amendments published in June 2014, and a number of the SAPI's more attractive aspects, such as those mentioned above, are now statutorily available for the ordinary SA, although differences remain.
For closely held commercial companies, an attractive alternative, given its easier corporate compliance requirements and simpler company statutes, is the limited liability company (SRL). As in the case of the SA, a minimum of two partners is required; however, a maximum of 50 partners applies. SRLs cannot issue shares, although they can issue non-negotiable certificates reporting participation in the company. Unlike the SA, the SRL's members may decide whether the company will have an internal audit organ. As a matter of law, and not of special by-law rules or shareholders' agreements, the members of an SRL have a say on who may become a new member in the SRL, as well as a correlative right of first refusal. By-laws can regulate the payment of supplementary capital contributions to the company.
As regards commercial activities, the SA, SAPI and SRL can carry out the same acts and activities; however, for certain areas, such as the financial sector, an SA may be required.
Nonetheless, for companies planning to carry out financial activities, a multiple object financial company (SOFOM) can grant credit to the public from various sectors and perform operations of financial leasing and factoring through obtaining funding resources by financial institutions or by issuing public debt, or both. Since 2006, a SOFOM can opt to become a non-regulated entity, which has some limitations on the activities it may carry out, but it is subject to a reduced regulatory burden.
Regarding company incorporation and organisation, Mexican companies are governed by their contractual by-laws. These are established by the shareholders, so there are not different instruments such as articles of incorporation and by-laws. Such contractual by-laws cover all aspects of corporate acts and organisation, and are different from the shareholders' agreements mentioned above.
Again, regarding organisation, while the administrative organ (board or single member) is the organ charged with legally representing the company, the maximum authority within the company is the partners' or shareholders' assembly.
In the case of companies in which different capital groups invest, shareholders generally speaking, and non-residents in particular, should take special care with shareholder assembly convening rules to guarantee that they have a good arrangement protecting their right to be convened.
All such commercial companies can take the variable capital modality; this is reflected in the corporate denomination used; for example, Co X, SA de CV, instead of Co X, SA. This modality allows for flexible rules governing the increase and decrease of contributed capital without modifying the company's social statutes.2
We can also add that, while the General Law on Commercial Companies establishes a type of company akin to the incorporated limited partnership, with unlimited liability for the administrative partner and limited liability for the passive partners, this type of company has truly fallen into disuse, has some dated aspects – including restrictive rules on member entry and exit – and, even if used, would not be a pass-through but rather a taxed entity.
The typical entity for independent professional services is the civil partnership (SC). In this respect, Mexico's legal system does differentiate between commercial and entrepreneurial acts with which business profits identify, and lucrative civil activities, such as the rendering of professional services; therefore, the use of the word 'business' does not necessarily comprehend both activities, and it is sometimes difficult to draw a distinction between a commercial act and a profitable civil act. This differentiation can be relevant for tax treatment purposes.3
Foreign investment in Mexican companies must be reported to the competent federal authority.
A non-corporate entity often used both for carrying on business activities or for administrative or collateral control purposes is the trust. A trust must typically be established with a bank acting as trustee or fiduciary, which implies a minimum administrative cost for using this vehicle. This cost increases if the trust in question is used to develop business activities.
The trust is a transparent vehicle for tax purposes, so the person to whom the trust property may revert (whether the settlor or the beneficiary) is deemed to be the owner for tax purposes.
When business activities are carried on through a trust, it must be registered with the tax authorities. A taxable profit or loss will be determined for the activity; provisional tax payments made through the same; and then the annual tax profit or loss will be assigned to the beneficiaries, who may proportionally apply the provisional tax payments made by the fiduciary. Tax losses from the trust can only be amortised from tax profits generated through the trust activity, except when the trust is wound down, in which case, for the amount of unrecovered resources contributed to the trust, the losses can be deducted from other taxable income. A non-resident carrying on a business activity through a trust shall have a permanent establishment (PE) in Mexico for those activities.4
Another vehicle is the association in participation (AenP), similar to the unincorporated limited partnership contract found in some common law countries. The associating party carries out the activities in its own name, using the cumulative resources contributed to the partnership by that party and by the associated parties; the associating party has unlimited liability for the activities carried out and the associated parties are only liable to that party for the amounts of their contributions. One defect is that associated parties' contributions are exposed to the associating party's liabilities, even if derived from activities not associated with the AenP activities. Given its nature, this vehicle should be fiscally transparent; unfortunately, a narrow-sighted tax policy has prevailed regarding the AenP and the vehicle is taxed as if it were an incorporated person.
iii Brief comments on private equity investment
Private equity is relatively new to Mexico. According to a number of annual surveys, a certain notable presence as a financing source commenced around 2001, although it has grown steadily since and is now a relevant source of financing. Perhaps as a consequence, Mexico's tax system has lagged behind this phenomenon and has been ill equipped to deal with some private equity situations. However, this situation has been slowly improving with the addition of miscellaneous tax rules that allow for transparency, as well as several changes in the 2020 tax reform to facilitate private equity investment.
As noted above, what would otherwise be a natural vehicle for private equity investment, the AenP, is not tax-transparent, thus subjecting its profits to the general income tax rate, and to interest and dividend withholding taxes for non-residents commented on further below. The trust, in turn, with exceptions irrelevant for private equity purposes, creates a PE situation even for passive investors. The incorporated limited partnership is very dated in its statutory regulation, is no longer common and would not be transparent for tax purposes.
There is one trust vehicle established in the tax incentives section of the MITL that aims to facilitate private equity-type investment into Mexico. This trust will allow the equity and finance resources pooled for various financing projects, and the dividend and interest income generated for the investors through those projects, to flow transparently through the trust; DTA benefits would apply individually to such investors. This instrument is designed with financing involving numerous projects in mind. However, this vehicle does not solve essential withholding tax problems arising when a non-resident collective investment vehicle amalgamates private equity funds coming from a multitude of jurisdictions, and identification of withholding tax rates and DTA benefit purposes is required for each and every fund source.
Thus, Mexico's tax system is still missing a vehicle that both minimises taxable stages for financial resources being provided by private equity and stabilises withholding rates for foreign private equity sources.
III DIRECT TAXATION OF BUSINESSES
i Tax on profits
The MITL essentially taxes resident corporations and individuals, non-resident corporations or individuals with a PE in Mexico, and non-residents with taxable income coming from a source of wealth found in Mexico; it is divided into Titles I to VII, each of which respectively governs the following:
- general aspects;
- corporate taxation (residents and PEs);
- non-lucrative corporate entities;
- individuals (residents and PEs);
- non-residents (source income not attributable to a PE);
- controlled foreign corporations (CFCs) and multinational companies (transfer pricing); and
- fiscal incentives.
In this chapter we concentrate on corporate taxation and outbound income taxation.
Determination of taxable profit
The MITL applies a worldwide taxation principle for residents. Corporate income is taxed on an accrual basis5 regardless of where the source is found. Taxable income and deductions follow the MITL's special rules, so different items' treatment may vary from their financial accounting reporting treatment.
Regarding deductions, the concepts of expenses, cost of goods sold and investments are deductible, and deductions are also provided for items such as returns, discounts and rebates, non-collectible accounts receivable, and certain losses deriving from the loss or sale of deductible property. Deductions of interest, social taxes and contributions to certain pension and retirement funds are specially regulated.
Allocation of expenses under the MITL is literally provided for only in certain cases of PEs, and is expressly barred in the case of expenses made abroad and shared with persons that are not corporate or individual regime income tax subjects in Mexico. Denying proration shared with non-residents not subject to taxation in Mexico covered by a DTA is potentially discriminatory. However, through a 2014 administrative rule, following a Supreme Court precedent, this expense can be deducted, although it is very inflexible and the compliance burden is relevant. Not only does this rule include meeting transfer pricing parameters and keeping proof of the expense made abroad on file in Mexico, but requires a multi-party agreement that establishes the exact procedure to distribute the expenses, thus not all apportionment-of-expenses agreements would immediately comply with this structure.
A distinguishing feature of the Mexican tax system is the requirement to obtain a digital internet tax receipt (CFDI) to support any deduction. These receipts are digitally stamped upon issuance by the tax authorities' IT platform. The regulations regarding the issuance and requirements for CFDIs have gradually been updated. Some of the most significant changes include formal requirements that must be included in the CFDI and, most recently, the issuance of a supporting tax receipt upon payment.
The concept of deductible investments includes fixed assets, deferred costs and expenses, and certain preoperative outlays. These items are deductible by applying the maximum authorised annual depreciation or amortisation percentages; the taxpayer has a limited ability to apply lesser percentages from time to time. Special percentages have been established for the generation of clean-sourced, renewable energy as well as for certain oil and gas industry cases established in the Hydrocarbons Revenue Law.
A peculiarity of the system is that an inflationary effect is given to the difference between cumulative qualified credits and debts by considering the tax year's inflation rate: when the credits exceed the debts, a deductible inflationary adjustment is allowed by applying the inflationary effect to such difference; when debts are the greater of the two, a taxable value is likewise determined on the difference. Other tax assets, such as net operating losses, favourable tax balances, retained earnings for tax purposes, among others, are also subject to inflationary effects.
The tax is paid on an annual basis; the fiscal year is necessarily identified with the calendar year.
Capital and income
No differentiation is drawn between taxation of ordinary income and of capital gains; both are taxed within the same taxable base. While capital gains generated through the transmission of shares are accumulated as income together with other income, and subject to other deductions, losses coming from transmission of shares may only be deducted in the measure that taxable gains from the transmission of shares are accumulated as income in the current tax year or in the 10 following tax years.
Tax losses determined as per the MITL rules may be offset from tax profits of the following 10 years. There is no carry-back rule. A special 15-year rule exists for deepwater oil exploration and production operations.
Tax losses may not be transferred by merger, although they may be allocated between the relevant companies in the case of split-offs. In the case of a merger where a loss-sustaining company subsists after another company is merged into it, such subsisting company may only offset its losses existing before the merger from tax profits generated by the same lines of business as those that generated the losses.
Regarding change of controlling ownership, limitations allowing for the amortisation of losses apply that in general terms can be described as follows. Specifically, losses can only be offset from tax profits generated from the same lines of business as those that generated the losses when income as shown in the annual financial statements over the past three years is less than the cumulative tax losses amortisable and there is a change of controlling ownership in the company. Change of controlling ownership is defined as a change in ownership of more than 50 per cent of direct or indirect ownership of voting right shares over the past three years.
The corporate income tax rate is 30 per cent.
Administration – federal
Provisional income tax payments are made on a monthly basis by applying the profit quotient of the previous tax year (the taxable profit divided by all income, both corresponding to the previous year) to the income obtained in the year through to the month to which the provisional tax payment refers; tax losses from previous years may be subtracted from the provisional tax profits determined for the monthly instalment payments; and prior provisional tax payments are creditable against the resulting tax.
The annual tax return may be filed no later than March of the tax year following that to which the return refers.
The authority charged with designing legislative tax policy for consideration by Mexico's Ministry of Finance and Public Credit (SHCP). The authority charged with revenue collection and auditing taxpayers is the Tributary Administration Service (SAT); however, state tax authorities may have coordinated powers to audit federal taxpayers.
Rulings can be sought from the tax authorities; negative replies cannot be challenged until applied as part of an assessment issued to the taxpayer's detriment. Favourable rulings are binding on the tax authorities as long as the facts argued are correct.
Audits principally come in the form of requests for taxpayer information and documentation to be filed at the tax authorities' offices, or domiciliary visits where the tax authorities conduct the audit at the taxpayer's address. The time limit for conducting the audit is, as a general rule, one year. In past years, the tax authorities initiated the audit of the fourth or fifth previous tax year. The ongoing pattern is that audits begin from most recent years to older fiscal years.
Official letters of observations are issued before an assessment is made; observations are likewise directly notified to corporate administrative organs (if no member of a board is designated to such effect, in the specific case of SAs, the president of the board of directors is the legal representative of the same).
Assessments may be challenged through an administrative appeal (within a term unfortunately reduced, as of 2014, from 45 to 30 working days) or through a tax lawsuit before the Federal Tribunal of Fiscal and Administrative Justice (within 30 working days). In case of a unfavourable result, a final appeal (amparo) may be made to the federal judiciary.
Directly settling controversies with the federal tax authorities is legally not provided for; however, the Taxpayers' Attorney General's Office (Prodecon) does have powers to oversee settlements in certain cases (see Section XI).
Each of Mexico's 32 federative entities has its own tax system. Commonly, there is a revenue collection administrative split of powers between municipal authorities and state authorities. Real estate property acquisition or sale taxes, property taxes, payroll taxes and other like items are common state taxes. Some states may have a local tax on gross income coming from independent personal services or leases.
As of 2014, a minimal group 'integration regime' exists. In essence, this regime allows an integration factor to be determined in function of the percentage of group results that represent losses and, in application of such factor, companies within groups can defer a part of their individual tax for three years. Tax so deferred must be paid at the end of a three-year period, adjusted for inflation.
ii Other relevant taxes
In addition to income tax, the other relevant federal tax contributing significantly to tax revenue is VAT. VAT taxes sales, the rendering of services (which includes allowing the use of intangibles), the temporary use of tangible property and the importation of such items. The rate is generally 16 per cent, although a 2019 fiscal incentive allows for a reduced 8 per cent rate in specific municipalities located in the northern border of the country. Certain foods and medicines, as well as the exportation of goods and a limitative list of intangibles and services, are taxed at a rate of zero per cent.
There is a special VAT regime for maquiladoras (please refer to Section IV for further information on this type of entity) or IMMEX (in-bond) companies, to avoid the cash outflow that will otherwise result from temporal importations (recoverable through accreditation upon the exportation of the transformed goods), companies can apply for certification (this requires fulfilling sundry requisites, with tax-compliant suppliers being one of them). Such certification grants this type of company the possibility of applying a credit against the importation VAT for the account of the taxpayer. Uncertified companies may opt to guarantee payment of the import VAT.
A special tax on goods and services exists, and taxes such sundry items as fuel, tobacco products, alcoholic beverages and high-calorie foods.
Payroll taxes are a common feature of the Mexican tax landscape, yet these are local taxes, not federal. Tax rates are usually found in the 2 to 3 per cent rate range.
iii Employee profit-sharing
Another feature of investing in Mexico is worker profit sharing (PTU), a constitutionally established right for workers. As a general rule, profits to be distributed to workers are 10 per cent of the taxable profit. Such amount is payable in April or May of the year following that to which the profits refer. PTU effectively paid out in the year may be decreased from the taxable profit of the year before tax loss amortisation (and can also increase the amount of a tax loss). Unpaid PTU accrues to the following year's PTU.
Over the years, a common practice to mitigate the PTU impact and other labour and social security taxes by corporate groups was the establishment of service companies to render all human resource services to the operative companies; thus, the employees share only in the service company's profits. Amendments to Mexico's Federal Labour Law towards the end of 2012, amendments to tax legislation, and the issuance of judicial precedents and authorities tax criteria on outsourcing have put a question mark over the effectiveness of such arrangements, which continue to be used.
iv Tax on digital platforms
Among other changes in the tax reform for 2020, an additional section was added to the MITL, for the withholding of income taxes generated from the sale of goods or the provision of services through the internet, via technology platforms, computer applications and similar platforms.
This addition to the law is based on Action 1 of BEPS, in an effort to adapt the tax framework to facilitate the payment of taxes for individuals performing business activities, such as the sale of goods or provision of services through the internet, through digital platforms. The taxation will be made to individuals that now would need to provide their fiscal information through an automatic withholding that ranges from 2 to 10 per cent, depending on the activity, on the total revenues generated minus VAT. If, however, the individuals do not provide their fiscal information, the applicable withholding rate will be of up to 20 per cent.
Furthermore, the tax reform also considers this digital service to be subject to a 16 per cent VAT rate for both Mexican entities and foreign entities carrying out activities through digital platforms; however, certain requirements must be met, otherwise this services will be considered as imports and subject to customs regulations.
Although the framework for this taxation is already established in the tax reform, this will not enter into force until June 2020, and specific tax rules are expected to be issued no later than January 2020.
It is also worth noting that no taxes have been directly established for the digital platforms themselves, although they would need to get set up their systems to enable the compliance with their new obligations as withholding agents.
IV TAX RESIDENCE AND FISCAL DOMICILE
i Corporate residence
Incorporated persons that have established 'the principal administration of the business or their effective seat of direction' in Mexico are deemed tax residents in the country. Problems with such residency rules have been known to arise from time to time; for example, when a company incorporated abroad has its board integrated by Mexican residents and no proof can be obtained about the board acting outside of Mexico.
DTA double taxation rules may deny any DTA benefits to the dual-resident corporation or subject a case to the mutual agreement procedure.
ii Branch or permanent establishment
Mexico follows traditional Organisation for Economic Co-operation and Development (OECD) PE rules in the legislative design, and has incorporated changes based on Action 7 of BEPS, therefore PE taxation of business income or professional service income can arise from the following general hypothesis:
- when a place of business is found in the country through which entrepreneurial activities or professional services are performed;
- when the non-resident has an agent, different from an independent agent, whom repeatedly carries out the conclusion of contracts or habitual performance of the main role that leads to the conclusion of contracts by or on behalf of the foreign resident for the disposal, granting of temporary use or enjoyment or provision of services by the foreign resident; and
- when the non-resident habitually acts through an independent agent that is not acting within the ordinary framework of his or her activities.
It is important to mention that it will be presumed that an individual or legal entity is not an independent agent, when it acts exclusively or almost exclusively on behalf of foreign related parties.
Specific rules refer to:
- PEs arising for insurance companies when collecting premiums or insuring against risk within the national territory through an agent that is not an independent agent (excluding reinsurance);
- trusts with entrepreneurial activities, for the settlor or beneficiary carrying on the activities through the trust; and
- services relative to construction works, demolition, installation, maintenance or erections on real estate, or for projection, inspection or supervision activities related to the same, when the activity lasts longer than 183 calendar days, whether consecutive or not, within a 12-month period.6
The MITL enumerates cases considered places of business; cases where an independent agent is not considered to act within the ordinary course of their business;7 and cases where no PE is deemed to arise – for example, as long as the activities carried out are considered as auxiliary or preparatory activities, this shall be an exception to the creation of a PE. However, an anti-fragmentation rule is incorporated, which eliminates access to the exceptions when complementary operations are carried out in other places of business, PE or related parties in Mexico
As a general rule, income attributable to the PE includes that deriving from the carrying on of the business activities. The sale of goods or real estate within the national territory by the central office or another PE of the person shall also be attributable to the PE. Income obtained by the central office, in the proportion in which the PE contributed to the expenses necessary to obtain the income, shall likewise be attributable to the PE.
Flow of after-tax profits from the PE to the taxpayer abroad is subject to the 10 per cent dividend tax. To identify the nature of the cash flow, a PE will also have both an after-tax net profit account (CUFIN), further commented on below, and a capital allotment account; the presumption is that the last cash flows out are capital reimbursements.
Additionally, a special case of PE is established in the Hydrocarbons Revenue Law to the effect that a PE arises when a non-resident carries out oil and gas activities referred to by such law in national territory or within Mexico's exclusive economic zone for a period of more than 30 days in a 12-month period.
Regarding scenarios where no PEs arise, Mexico's DTAs typically include the case of a place of business solely engaging in the delivery of goods for the account of the non-resident, an exemption case not provided for by the MITL. Usually contained in the DTAs is the standard OECD rule considering that no income can be attributable to the mere purchase of goods.
Likewise, Mexico's DTAs usually contain the rule of determining the taxable income of the PE as if it were a separate independent entity operating at arm's length.
A few DTAs follow some aspects of the UN Model Double Taxation Convention (i.e., those with India and Hong Kong) and will allow a continuing presence in a source country to render services to be constitutive of a PE. However, it is questionable whether this premise for a PE can be derived from the MITL's own PE rules to start with, although the tax authorities have taken up such positions on a number of occasions in the past.
Case of maquiladoras
Under both the MITL and the DTA with the United States, when an agent different from an independent agent transforms an inventory of goods owned by the non-resident utilising assets also owned by the non-resident, a PE is deemed to arise. Specifically, the PE is deemed to exist when the economic and legal conditions existing in the relationship between the two parties is different to that which would be carried out by two independent parties.
Safe harbour rules exist in the MITL according to which even in these cases no PE shall be deemed to arise if either of the following two requisites are met: that the taxable profit be at least 6.5 per cent of costs and expenses, or 6.9 per cent of the value of most assets used to carry on the activity; and that an advanced pricing agreement be obtained from the tax authorities regarding the maquiladora's consideration.
Among other requirements and restrictions, the current rules also require that at least 30 per cent of the assets used be owned by the non-resident or a related party, and that the maquiladora obtain its income exclusively from the transformation of the non-resident's inventory.
V TAX INCENTIVES, SPECIAL REGIMES AND RELIEF THAT MAY ENCOURAGE INWARD INVESTMENT
i Holding company regimes
No special holding company regimes, such as those with participation exemptions, withholding exemptions or exemptions for receipts of non-local dividends or income, exist; likewise, no special IP regimes, such as the patent box regime, exist.
ii State aid
Depending on the sector or activity, some federal or local donations, grants or subsidies may be available, although the new tax reform has in some cases limited state aid amounts. An amendment to the Income Tax Law for 2017 regulates when such government grants or economic aid shall not accrue as taxable income.
VI WITHHOLDING AND TAXATION OF NON-LOCAL SOURCE INCOME STREAMS
i Withholding on outward-bound payments (domestic law)
To tax income obtained by non-residents, other than income attributable to a PE, Title V of the MITL taxes specifically identified types of income tax, as well as the cases in which such types of income are deemed to come from a source of wealth found in Mexico.
Specifically, with respect to dividend, interest and royalty income, the following can be briefly noted.
Regarding dividends, the source of wealth is considered to be found in Mexico when the person distributing the income is a resident of Mexico. A 10 per cent withholding rate was established as of 2014 for dividends distributed to non-residents and individuals, regardless of their residency. This is a somewhat unfortunate development, as there was no income tax withholding for the account of non-resident shareholders for a significant number of years and, given Mexico's considerable DTA network, the resulting new situation will be one of quite disparate taxation (exemptions, and 5, 8 and 10 per cent rates) for non-resident shareholders.
In the case of royalties (the same set of rules taxes technical assistance and publicity), the source of wealth is deemed to be found in Mexico when the intangibles or technical assistance is beneficially used in Mexico, when the party paying the royalties or for technical assistance or publicity is a resident of Mexico or the PE of a non-resident found in Mexico, and when industrial, commercial or scientific equipment is leased to a foreign entity. A 25 per cent withholding rate is applicable.
In the case of interest, the source of wealth is defined as being found in Mexico when the capital is placed or invested in Mexico, or when the interest-paying party resides in Mexico or is a PE of a non-resident found in Mexico. Exemptions exist for governmental entities, and withholding rates vary from 4.9 to 35 per cent depending on the nature of the beneficiary or of the financial agreement.
ii Anti-hybrid rules
Following the recommendations of the final report of Action 2 of BEPS, changes were introduced with the 2020 tax reform aiming a deny of deduction of payments done to related parties or through a 'structured agreement', where the revenue ends up subject to a preferential tax regimes and to the payments made by a controlling entity when they are also deductible for a related party.
iii Capital gains on traded securities
Beginning from 2014, capital gains deriving from the sale of listed securities may be subject to the 10 per cent withholding rate on the gain from the alienation. These were exempted items of income before 2014.
iv Double tax treaties
Mexico has numerous DTAs in place as noted in the table below, and is negotiating other double tax agreements. In addition, it has information exchange agreements with a number of jurisdictions.
The following table outlines the usual maximum withholding rates allowed under each DTA; however, special rules, requirements (including effective beneficiary requirements) or exceptions may apply in all cases:
|Country or jurisdiction||Dividends||Interest||Royalties|
|Argentina||10 per cent if share ownership exceeds 25 per cent; 15 per cent in other cases||Zero per cent for qualifying financial institutions or certain government entities||10 per cent in the case of copyright royalties for certain artistic works; 15 per cent in other cases|
|Australia||Zero per cent if share ownership exceeds 10 per cent; 15 per cent in other cases||10 per cent for qualifying creditors, debtors or securities; 15 per cent in other cases||10 per cent|
|Austria||5 per cent if share ownership exceeds 10 per cent; 10 per cent in other cases||10 per cent||10 per cent|
|Bahrain||Zero per cent||4.9 per cent in the case of interest paid to banks; 10 per cent in other cases||10 per cent|
|Barbados||5 per cent if share ownership exceeds 10 per cent; 10 per cent in other cases||10 per cent||10 per cent|
|Belgium||Zero per cent in the case of 10 per cent or greater participation;10 per cent in other cases||5 per cent for interest paid to financial institutions or derived from qualified securities; 10 per cent in other cases||10 per cent|
|Brazil||10 per cent if share ownership exceeds 20 per cent; 15 per cent in other cases||15 per cent||10 per cent under the protocol to the treaty|
|Canada||5 per cent if share ownership exceeds 10 per cent; 15 per cent in other cases||10 per cent||Zero per cent in the case of copyright royalties for certain artistic works; 10 per cent in other cases|
|Chile||5 per cent if share ownership exceeds 20 per cent; 10 per cent in other cases||5 per cent to banks under the protocol to the treaty; 10 per cent to insurance companies, qualifying and sales credit under the protocol to the treaty; 15 per cent in other cases||10 per cent under the protocol to the treaty|
|China||5 per cent||10 per cent||10 per cent|
|Colombia||Zero per cent||5 per cent for interest paid to financial institutions; 10 per cent in other cases||10 per cent|
|Costa Rica*||5 per cent if share ownership exceeds 20 per cent; 12 per cent in other cases||10 per cent||10 per cent|
|Czech Republic||10 per cent||10 per cent||10 per cent|
|Denmark||Zero per cent for corporate beneficial owner with at least 25 per cent participation; 15 per cent in other cases||5 per cent for interest paid to financial institutions; 15 per cent in other cases||10 per cent|
|Ecuador||5 per cent||10 per cent for interest paid to financial institutions; 15 per cent in other cases||10 per cent|
|Estonia||Zero per cent||4.9 per cent for interest paid to financial institutions; 10 per cent in other cases||10 per cent|
|Finland||Zero per cent||10 per cent for banks, qualifying securities and operations; 15 per cent in other cases||10 per cent|
|France||5 per cent if 50 per cent of the capital of the Mexican entity is held by a French resident; 15 per cent on other cases||5 per cent for banks and insurance companies under the protocol to the treaty; 10 per cent in other cases under the protocol to the treaty||10 per cent under the protocol to the treaty|
|Germany||5 per cent if the effective beneficiary of the dividends is German resident and owns more than 10 per cent of the Mexican entity; 15 per cent in other cases||5 per cent for financial entities; 10 per cent in other cases||10 per cent|
|Greece||10 per cent||10 per cent||10 per cent|
|Hong Kong||Zero per cent||4.9 per cent for financial institutions; 10 per cent in other cases||10 per cent|
|Hungary||5 per cent in the case of 10 per cent or greater participation; 15 per cent in other cases||10 per cent||10 per cent|
|Iceland||5 per cent in the case of 10 per cent or greater participation; 15 per cent in other cases||10 per cent||10 per cent|
|India||10 per cent||10 per cent||10 per cent|
|Indonesia||10 per cent||10 per cent||10 per cent|
|Ireland**||5 per cent in the case of 10 per cent or greater participation; 10 per cent in other cases||5 per cent for financial institutions; 10 per cent in other cases||10 per cent|
|Israel||5 per cent in the case of 10 per cent or greater participation; 10 per cent in other cases||10 per cent||10 per cent|
|Italy||15 per cent||10 per cent under the protocol to the treaty||Zero per cent in the case of copyright royalties for certain artistic works; 15 per cent in other cases|
|Jamaica||5 per cent in the case of 25 per cent or greater participation; 10 per cent in other cases||Zero per cent for qualifying financial institutions or certain government entities||10 per cent|
|Japan||5 per cent in the case of 25 per cent or greater participation; 15 per cent in other cases||10 per cent for interest paid to financial institutions and qualifying securities markets; 15 per cent in other cases||10 per cent|
|Kuwait||Zero per cent||4.9 per cent for interest paid to financial institutions; 10 per cent in other cases||10 per cent|
|Latvia||5 per cent in the case of 10 per cent or greater participation; 10 per cent in other cases||5 per cent for interest paid to and by financial institutions; 10 per cent in other cases||10 per cent|
|Lithuania||Zero per cent in the case of 10 per cent or greater participation; 15 per cent in other cases||10 per cent||10 per cent|
|Luxembourg||8 per cent in the case of 10 per cent or greater participation (in the case of Mexico); 5 per cent in the case of 10 per cent or greater participation (in the case of Luxembourg); 15 per cent in other cases||10 per cent||10 per cent|
|Malta||Zero per cent||5 per cent for financial institutions; 10 per cent in other cases||10 per cent|
|Netherlands||5 per cent in the case of 10 per cent or greater participation; 15 per cent in other cases; exemption for Dutch entities if, under the local laws of Netherlands, dividends are exempted||5 per cent for financial institutions and qualifying securities markets; 10 per cent in other cases||10 per cent|
|New Zealand||5 per cent in the case of 10 per cent or greater participation; zero per cent with respect to specific participations of at least 80 per cent of the voting power for at least 12 months before the date the dividend is declared; 15 per cent in other cases||10 per cent||10 per cent|
|Norway||Zero per cent if share ownership exceeds 25 per cent; 15 per cent in other cases||10 per cent for interest paid to financial institutions; 15 per cent in other cases||10 per cent|
|Panama||5 per cent in the case of 25 per cent or greater participation; 7.5 per cent in other cases||5 per cent for interest paid to financial institutions; 10 per cent in other cases||10 per cent|
|Peru||10 per cent in the case of 25 per cent or greater participation; 15 per cent in other cases||15 per cent||15 per cent|
|Philippines||5 per cent in the case of 75 per cent or greater participation; 10 per cent in the case of 10 per cent participation up to the aforementioned 75 threshold; 15 per cent in other cases||12.5 per cent||15 per cent|
|Poland||5 per cent in the case of 25 per cent or greater participation; 15 per cent in other cases||10 per cent for financial institution and qualifying securities; 15 per cent in other cases||10 per cent|
|Portugal||10 per cent||10 per cent||10 per cent|
|Qatar||Zero per cent||5 per cent for interest paid to financial institutions; 10 per cent in other cases||10 per cent|
|Romania||10 per cent||15 per cent||15 per cent|
|Russia||10 per cent||10 per cent||10 per cent|
|Saudi Arabia||5 per cent||5 per cent for interest paid to financial institutions; 10 per cent in other cases||10 per cent|
|Singapore||Zero per cent||5 per cent for interest paid to financial institutions; 15 per cent in other cases||10 per cent|
|Slovak Republic||Zero per cent||10 per cent||10 per cent|
|South Africa||5 per cent in the case of 10 per cent or greater participation; 10 per cent in other cases||10 per cent||10 per cent|
|South Korea||Zero per cent in the case of 10 per cent or greater participation; 15 per cent in other cases||5 per cent for interest paid to financial institutions; 15 per cent in other cases||10 per cent|
|Spain||Zero per cent in the case of 10 per cent or greater participation;10 per cent in other cases||4.9 per cent for banks, insurance companies or qualifying securities; 10 per cent in other cases||Zero per cent in the case of copyright royalties for certain artistic works; 10 per cent in other cases|
|Sweden||5 per cent in the case of 10 per cent or greater participation; zero per cent in the case of 25 per cent or greater participation if at least 50 per cent of the voting power of the shareholder is owned by residents of Sweden; 15 per cent in other cases||10 per cent for interest paid to financial institutions; 15 per cent in other cases||10 per cent|
|Switzerland||Zero per cent in the case of 10 per cent or greater participation or to pension funds; 15 per cent in other cases||5 per cent for financial institution or qualifying securities; 10 per cent in other cases||10 per cent|
|Turkey||5 per cent in the case of 25 per cent or greater participation; 15 per cent in other cases||10 per cent for interest paid to banks; 15 per cent in other cases||10 per cent|
|Ukraine||5 per cent in the case of 25 per cent or greater participation; 15 per cent in other cases||10 per cent||10 per cent|
|United Arab Emirates||Zero per cent||4.9 per cent for interest paid to banks; 10 per cent in other cases||10 per cent|
|United Kingdom||Zero per cent for dividends paid to pension funds; 15 per cent in other cases||5 per cent for banks, insurance companies and qualifying securities; 10 per cent for other qualified loans by financial institutions of operations; 15 per cent in other cases||10 per cent|
|United States||5 per cent in the case of 10 per cent or greater participation; 10 per cent in other cases||4.9 per cent for banks, insurance companies or qualifying securities; 10 per cent for other qualifying financial institution loans or operations; 15 per cent in other cases||10 per cent|
|Uruguay||5 per cent||10 per cent||10 per cent|
|* Mexico–Costa Rica: The effective date of entry into force for the application of the DTT will be 1 January 2020. ** Mexico–Ireland is currently under re-negotiation. Mexico currently has DTTs under negotiation, or in process of entering into force, with Egypt, Guatemala, Malaysia, Mongolia, Pakistan and Slovenia.|
v Multilateral instrument
In 2014, the OECD issued its report on Action 15 of the BEPS plan, in which the convenience and the viability of adopting a multilateral mechanism to level the use and prevent the abuse of double tax treaties is thoroughly discussed. As a result, the tax authorities of more than 80 countries have signed the Multilateral Instrument (MLI) with the completion of Action 15 of the BEPS plan, with Mexico being a signing party thereof.
The MLI intends to include and extend the application of the provisions of BEPS Actions within bilateral tax treaties. Likewise, it will give greater certainty regarding the application of the agreements covered by the MLI. It is important to mention that the MLI does not directly modify the text of the bilateral treaties, but its provisions apply in conjunction with the existing provisions of such treaties.
Through the MLI, Mexico will adopt the minimum standard on anti-abuse rules for its entire double taxation treaty network. Among the alternatives to do so, Mexico opted for the inclusion of a simplified limitation of benefits test, which means that a non-Mexican resident claiming treaty benefits would only be able to do so if it is a qualified tax resident. In general terms, a tax resident of a treaty partner county would be considered a qualified tax resident through a test of its ownership chain. If its ultimate shareholders are also tax residents of the same jurisdiction or a publicly traded entity, treaty benefits should be available. Otherwise, a test on the substantial presence of such tax resident in the relevant jurisdiction would need to be evaluated.
Nevertheless, if the treaty partner jurisdiction choice for the adoption of the minimum standard is not compatible with the position of Mexico in the MLI (i.e., the principal purpose test), then a more subjective test would need to be done through the principal purpose test of the relevant structure or arrangement, to define whether treaty benefits would be applicable.
The following jurisdictions have also opted for the simplified limitation of benefits test: Argentina, Armenia*, Bulgaria*, Chile, Colombia, India, Indonesia, Kazakhstan*, Russia, Senegal*, Slovakia and Uruguay.8
Although already in force for the first five signatories, Mexico has not yet ratified the MLI. Thus if Mexico ratifies the MLI in 2020, the treaty shall enter into force on the first day of the month following the expiry of a period of three calendar months beginning on the date of the deposit by such signatory of its instrument of ratification, acceptance or approval, but, the provision applicable to the withholding of taxes shall enter into force on the first day of the next calendar year (i.e., 1 January 2021).
vi Taxation on receipt
As a general rule, income tax paid abroad, including withholding tax, is creditable against the income tax determined as per the MITL rules. This requires accumulation as taxable income of the gross income amount before taxation abroad.
In the case of dividends, in comparison to those received by a resident corporation from other resident companies, which are not taxable income, dividends coming from non-residents are taxable income. However, tax paid abroad on the profits from which the dividend distribution came is creditable against Mexican income tax. Given a greater flow of capital investment abroad by Mexican companies, this same system of accreditation was streamlined as of 2014. Currently, the characteristics of this accreditation system are as follows.
Taxes paid abroad by foreign companies, both first corporate tier and second corporate tier, can be creditable. Formulae are established in the MITL to determine the proportion in which the income tax was paid by such companies with regard to the profits distributed directly or indirectly to the Mexican resident company.
Regarding foreign tax credits, the following additional aspects may be noted.
A limit to the creditable amount is established in function of the corporate tax rate applicable in Mexico, wherefore any tax paid above that rate on the gross profits in question is not creditable.
For direct income, a taxable profit to determine the limit of the creditable tax is established that takes into account deductions totally or partially identified with obtaining such income.
Regarding dividend income, an accounting entry system is established to identify each tranche of income taxed abroad and the corresponding tax credit limit per year, to not commingle foreign tax credits applicable to such income. Failure to register with this system impedes accreditation from applying.
Taxpayers must keep on file documentation proving the payment of the tax to be credited abroad, although for jurisdictions covered by a broad agreement for the exchange of tax information, the certificate of withholding shall suffice.
When tax paid abroad cannot be credited against the income tax payable in Mexico for such income, a 10-year term over which such accreditation can take place is granted. The omission to apply the foreign tax credits when the taxpayer is in a position to do so will cause the credits to be lost in the measure that they were not applied.
VII TAXATION OF FUNDING STRUCTURES
Unlike other Latin American countries, Mexico does not have exchange controls or any similar restrictions to prevent or restrict cash flows into or out of the country. Exchange rates are defined by the open market, and almost all forms of hedging for currency fluctuation are available.
Under these circumstances, entities are commonly funded with a combination of equity and debt. Depending on the type of business, inbound financing may take place through a simple internal loan or a more sophisticated structured financing; for example, in the case of infrastructure development businesses.
i Thin capitalisation
Thin capitalisation rules are included in the MITL seeking to prevent companies from using debt as a means to distribute profits to shareholders through interest payments.
Interest paid on interest-bearing loans granted in cash by related parties in excess of three times shareholders' equity may not be deducted. These rules are, however, not applicable to taxpayers that obtain an advanced pricing agreement from the tax authorities, to financial institutions, or to infrastructure investments linked to strategic economic areas or to the generation of electric energy.9
Additionally, the 2020 tax reform has included another limitation on the deduction of interest, consisting of calculating a net interest (accrued interest minus interests received), which will not be deductible in the amount that exceeds an adjusted fiscal profit (tax profits plus accrued interest) by 30 per cent. However, the non-deductible amount can be deducted on the three following fiscal years.
ii Deduction of finance costs
The definition of interest under the MITL is rather exhaustive and most likely will include any type of revenue derived from financing operations. Interest, discounts, premiums, commissions and guarantee fees would be considered an interest expense, among other concepts, together with the gain on transfer of financial instruments.
Interest expense, together with other costs related to securing financing, would be generally deductible. Currency fluctuation would be considered interest for tax purposes; this means that the revaluation or devaluation of debt will have a tax effect that could either result in additional taxable income or deductions depending on the specific situation.
The MITL has rules on back-to-back loans related to transactions between related parties. Interest deriving from triangular financing arrangements among related parties shall be treated as dividends for income tax purposes when the interest proceeds from back-to-back credits, including credits granted through a financial institution residing in this country or abroad.
In general terms, back-to-back credits are deemed to consist of:
- operations whereby a person furnishes cash, assets or services to another that in its turn furnishes cash, assets or services directly or indirectly to the former or to a related party of said person or former person; or
- operations in which a person grants financing and the credit is guaranteed with cash, a cash deposit, shares or debt instruments of any nature of the creditor or a related party of said creditor are also deemed back-to-back credits for such purposes to the extent of such guarantee.
An exception to this rule applies in operations whereby financing is granted to a person and the credit is guaranteed by shares or debt instruments that are the property of the borrower or of a related party residing in Mexico, if the borrower is unable lawfully to dispose of such shares or instruments, unless the borrower defaults on any obligation contracted under the respective credit agreement.
iii Restrictions on payments
Mexican legislation provides for a 10 per cent withholding tax on dividends paid to non-residents and individuals, regardless of their residency, from profits generated from 2014. Additionally, dividends are taxed at the level of the paying company on a grossed-up basis at the corporate tax rate in the year of payment, if the dividend does not come from the CUFIN balance (net after-tax profit account). In such a scenario, the income tax paid can be credited by the Mexican company against its income tax liability of the current year or of the next two years.
The CUFIN concept is similar to the earnings and profits statement. It attempts to reflect the true economic earnings of the company for tax purposes that have already been subject to corporate taxation.
The CUFIN balance shall be increased by the taxable profits of the year (minus paid income tax and non-deductible expenses), the amount of dividends received from other companies that are residents in Mexico, and with the income, dividends or profits generated or distributed by investments made in a preferential tax regime; and shall be reduced by any dividend or profit paid out during the year.
Regarding corporations, rules in the General Law of Commercial Companies require financial statements approved by the shareholders' or partners' assembly showing the retained profits for dividends to be payable. Losses from prior tax years must be redeemed or absorbed through other shareholders' equity items or capital reductions before the dividends can be paid. Supreme Court precedent would require profits to be determined once each fiscal year closes. A capital reserve (20 per cent of contributed capital stock) is also needed, which is built up through 5 per cent of each year's profits.
iv Return of capital
Mexican entities can repay capital to their stakeholders as long as they comply with corporate law and the legal entity's own by-laws. A two-prong test is necessary to determine if a capital redemption should give place to taxation.
For this purpose, taxpayers must keep a record of the effectively paid-in contributed capital for tax purposes through the capital contributions (CUCA) account. It will register all capital contributions made to the Mexican entity by its shareholders and its balance is restated by inflation on an annual basis.
Capital redemptions out of the CUCA balance can be paid with no further Mexican tax consequences. However, capital redemptions in excess of CUCA would be considered a deemed dividend and, therefore, subject to CUFIN-related consequences (if the CUFIN balance is insufficient, then the gross up and tax determination mentioned above occur). A first test compares CUCA per share to reimbursement per share, and a second test compares the CUCA balance to the shareholder equity value to determine whether, for tax purposes, profits are being distributed to the shareholder.
VIII ACQUISITION STRUCTURES, RESTRUCTURING AND EXIT CHARGES
Mexico has one of the largest networks of DTAs in its region, with over 50 treaties in force and a handful of treaties under negotiation and renegotiation.
This fact brings an extensive array of options to define an appropriate and efficient corporate structure. However, although some treaties can bring significant benefits over others in the specific cases of capital gains and interest withholding rates, attention must be paid to the substance of the structures and the anti-abuse rules that each DTA or applicable legislation may impose.
Stamp duties or direct taxes on equity are not applicable in Mexico. This fact gives a lot of flexibility to either setting up operations or acquiring operating businesses in Mexico. When setting up in Mexico, companies should focus on a structure that allows for certainty while doing business in Mexico and a flexible and efficient exit in the future.
This is normally achieved through application of DTAs. As mentioned above, capital gains are taxed under the general tax regime. However, in the case of non-Mexican residents, direct or indirect disposal of Mexican shares may be taxed at a 25 per cent rate over the gross proceeds of a disposal of shares, or at a 35 per cent rate over a net gain if certain requirements are met, such as appointing a Mexican legal representative, not residing in a low taxation jurisdiction and filing a special report before the Mexican tax authorities containing tax calculations certified by a third-party registered certified public accountant (CPA).
Nevertheless, depending on the structure of the non-Mexican investor, they may be able to claim a reduction on the 35 per cent statutory rate through the application of a DTA.
In addition to capital gains, as mentioned above, as of 2014 Mexico incorporated a 10 per cent withholding tax on dividend payments to non-residents and individuals. Owing to the fact that this tax was not previously part of Mexican legislation, most Mexican treaties include the approach suggested by the OECD on a dividend's tax reduction or even elimination in the case of countries with a capital exemption regime, adding another ingredient to corporate structuring from a tax perspective.
Finally, it is uncommon to see non-residents establishing entrepreneurial activities directly in Mexico. Although in theory any activity undertaken in the form of a taxable branch or PE should be subject to the same tax regime as a Mexican legal entity, this is a figure that is perhaps not very frequently used because of the practical complexity of profit attribution and the inability to limit responsibility for legal purposes.
Mexican legislation provides the possibility of transferring Mexican shares with a deferral of the corresponding tax, to the extent that certain requirements are met. The transfer of shares must be done within the same group and the consideration must be in the form of shares of the acquiring entity. The tax deferral is only possible with the authorisation of the tax authority, which may be a time-consuming process.
Similar restructure operations are contemplated in some DTAs, as in the case of the convention between the US and Mexico, the main difference being that the transaction can be carried out under an exemption through the application of the DTA; therefore, an authorisation from the tax authorities is not necessary, although certain formalities may apply.
In addition, mergers and spin-off transactions are allowed under Mexican corporate law.
Mergers between Mexican corporations can be carried out under tax-free circumstances if certain requirements are met, which consist of having business continuity over the activities of the merged entities with some exceptions; filing certain notifications to the tax authorities after the operation takes place; and ensuring compliance with the residual tax obligations for the entities that may have ceased to exist in the event.
Similarly, a tax-neutral demerger or spin-off of a Mexican corporation may be carried out to the extent that the shareholders in the new and spun-off entities remain the same for three years (one year prior to and two years following the transaction) and comply with residual tax obligations for a demerger entity in the event that it disappears after the transaction; and if the transaction is duly notified to the tax authorities.
A test on the monetary assets position also needs to be done. In cases where any of the entities' monetary assets result in more than 51 per cent of its total assets, a capital redemption may need to be recognised over the demerged entity and the tax-free treatment may be partially or totally lost.
If a merger takes place within five years following another merger or a spin-off, then additional information may need to be filed before the relevant tax authorities to obtain an authorisation for tax-neutral effects.
Although 'exit taxes' as such do not exist within the Mexican tax regime, when the restructure of a business results in the relocation of functions, assets or risks from Mexico to another jurisdiction, a transaction may be deemed to exist and should be valued under transfer pricing regulations so that if any tax consequence is identified, it can be considered for tax purposes.
Migration of legal entities is also a possibility to relocate business activities from Mexico to another country. This can be done through a change in the place where its management is executed to another jurisdiction.
In any of those cases, a deemed liquidation for income tax purposes would take place. Although the rules are not very clear, the Mexican company would need to determine if a tax should be recognised considering the fair market value of its total assets against the tax basis that may apply.
IX ANTI-AVOIDANCE AND OTHER RELEVANT LEGISLATION
i General anti-avoidance
As of the 2020 tax reform, articles have been added to the tax legislation for transparent entities, which establishes that these will be considered as Mexican entities, and thus subject to taxation in Mexico, for those that have their effective management headquarters in the country, unless there is a DTA.
Additionally, when a resident in Mexico has direct participation over a transparent entity or foreign legal entity, or indirect that involves other entities with this nature, income tax will be paid for the income obtained through them in proportion to their participation therein.
Furthermore, there is a provision applicable to cross-border transactions involving low-tax jurisdictions that gives the tax administration the possibility of recharacterising transactions entered into by taxpayers under the assumption that a simulation of acts took place. Although this disposition has been available for tax administration since 2008, it has not been extensively used in tax assessments.
It is worth mentioning that tax authorities have attempted to include additional rules into the Mexican tax system that could allow the analysis of the substance over form of transactions, but such attempts have failed in obtaining approvals in the legislative processes.
ii Controlled foreign corporations (CFCs)
CFCs and entities or contractual arrangements obtaining passive revenues that are subject to a low tax rate will be subject to taxation in Mexico, regardless of the moment at which such profits are actually taxed. However, the tax paid abroad could be credited against Mexican income tax generated for those activities.
The 2020 tax reform has included specific regulations for CFC-generated income, such as specifying when an entity has effective control of a CFC, as follows: (1) when the entity has over 50 per cent of voting shares; (2) when it has rights over more than 50 per cent of the assets; (3) when the combination of this two rights exceeds 50 per cent; (4) when the financial statements of the CFC are consolidated in the entity; and (5) when the entity has the complete right to define agreements on assembly or administrative meetings. For related parties, this are obliged to comply with requirements even if they do not have the effective control.
For the purposes of Mexican CFC anti-deferral rules, passive revenue would include that obtained from interest, dividends, royalties, services, and even trade revenue in some cases, especially when the origin or destination of the traded goods involves Mexico. It is understood that passive revenue is subject to a low tax rate when it is either not taxed at all or when taxed at a rate lower than 75 per cent of the tax that would have applied had such revenues been taxed under Mexican tax legislation, with special rules for dividend payments.
Therefore, as a general rule, income from this kind of activity that is subject to taxation at a rate lower than 22.5 per cent would be subject to anti-deferral rules; however, some exceptions may also be applicable.
iii Transfer pricing
Mexican regulation on transfer pricing is rather mature and must be observed for transactions with related parties, whether they reside in Mexico or abroad. It follows OECD guidelines and is generally harmonised with other jurisdictions. However, there are certain topics that are relevant to the Mexican approach.
This first point can be found on the definition of related parties. A party would generally be considered related when there is a participation in the control, capital or administration of another, or when a party in common has a participation in such elements. Under this definition, one party having a single share in another party makes them related, even if from a factual analysis it can be concluded that they operate at arm's length, which can result in unnecessarily onerous compliance issues.
The 'best method rule' under Mexican tax legislation indicates that transactional methods are preferred over general profit-based methods, as opposed to OECD guidelines, which suggest the use of the method that best adapts to the circumstances under analysis. As such, a comparable uncontrolled price method should be applied whenever possible, and then the gross profit-based methods would be preferred over the transactional net margin or profit-split methods.
As per the use of statistical methods to perform as transfer pricing analysis, the Mexican approach is also aligned with global practices of building a range with comparable transactions data; however, and although not stated in Mexican regulations, Mexican tax authorities do not necessarily accept the comparison of multiple year data for the corresponding tested party. In other words, the Mexican taxpayer information from a single year would need to be compared against multiple-year data of comparable transactions, which in some cases can create distortions in the analysis.
As of 2016, country-by-country reporting is considered for companies belonging to certain multinational groups qualified by level of consolidated income, to which effect three different returns shall have to be filed: a master informative return of related parties within the global group, a country-by-country informative return for the multinational group and a local informative return for the local related parties. These returns must be filed by 31 December of each year. Fines in the range of US$10,000 to US$20,000 are established for an omission in filing or incorrectly filed information.
In 2018, a series of tax rules for transfer pricing adjustments were amended to provide clarity to the recognition of income and the deduction of the corresponding adjustments that may derive from a transfer pricing self-evaluation. Furthermore, additional requirements and supporting documentation would need to be provided when such adjustment yields a deduction for Mexican tax purposes.
iv BEPS-inspired limitations to deductions
As of 2014, there are BEPS-inspired rules that can limit deductions in the case of payments to hybrid entities or in the case of double non-taxation.
v Informative returns
The following returns are mandatory under Mexican legislation, and each entity could be subject to certain filings under certain scenarios.
The Information about Fiscal Situation (ISSIF) return is mandatory for entities falling within any of the following scenarios: (1) entities earning taxable revenues in the year exceeding 644,599,005 Mexican pesos; (2) entities that are part of the optional group regime under MITL; (3) entities that are part of the federal public administration; (4) foreign residents with a permanent establishment in Mexico; and (5) entities resident in Mexico that carry out transactions with foreign related parties (subject to certain thresholds). ISSIF is due by 30 June of the following year to that in which the taxpayer falls within any of the scenarios listed above. Note that this return could not be filed if a taxpayer elects to file instead a statutory tax report of its financial statements (also due by 30 June of the following year) per Article 32-A of the Federal Tax Code.
In addition, the 2016 Mexican tax reform amended the Income Tax Law to implement the transfer pricing (master file/local file) documentation requirement. Mexican companies must submit the required documents by the end of the year (i.e., 31 December) following the fiscal year. This reform also introduced country-by-country reporting by large multinational enterprises based in Mexico.
Filing Form 76 is mandatory whenever an entity performs transactions under the scope of such form. Among others, the following could trigger such obligation: (1) financial operations; (2) transfer pricing adjustments; (3) equity participation and tax residency; (4) reorganisations and restructurings; and (5) other relevant operations. All of the above are pursuant to the thresholds stated by the law and the regulations issued by tax authorities.
X YEAR IN REVIEW
2019 was the year in which a takeover of a new administration took place, because of the elections carried out throughout 2018. One of the main changes is the 2020 tax reform mentioned throughout this document, which is adapting our legislation towards international tax trends based on OECD recommendations and the BEPS project.
XI OUTLOOK AND CONCLUSIONS
Certain notable amendments were approved for 2019, as follows:
- the implementation of anti-hybrid rules, such as the taxation of transparent entities as Mexican entities;
- a broader PE concept and changes in PE constitution presumptions;
- adaptation of CFC rules, specifically regarding effective control;
- taxation of individuals receiving income from digital platforms through withholding, as well as VAT on said services;
- further limitation on interest payments; and
- leasing of industrial, commercial or scientific equipment by a foreign resident will now be considered as a royalty.
Another notable development since 2015 has been the introduction of a publicly traded security that will allow certain businesses of the oil and gas, electric energy and infrastructure sectors to partially divest shares of special purpose vehicles placed in a trust, which in turn will place certificates on the stock exchange, and a transparent tax regime for investors following the master-limited partnerships models found in the US. It has generally been referred to by the misnomer Fibra E, as the acronym Fibra refers to the Mexican version of a real estate investment trust, whereas the new investment security actually relates to very different businesses and risks. 2016 saw adjustments to the model that make it more competitive; notably, gains on the sale of shares by a sponsor to a trust can be deferred up to 15 per cent per annum if paid with tradable certificates issued by the trust.
Regarding the tax authority–taxpayer relationship, we note the following: a hallmark of the current administration continues to be to audit in depth all VAT refund requests. This continues to cause significant delay in the payment of such refunds for up to six months.
Regarding taxpayer audit planning, supply chain tax planning and, generally, transnational companies with excessively low taxable profits as compared to their overall income, continue to be targeted for audit.
The ability of Prodecon to mediate settlement efforts between the tax authorities and taxpayers on substantive issues involving the interpretation of laws and rules continues to represent an opportunity to lessen the pressure on a tax system in which the tax authorities do not have powers to settle directly with taxpayers and are under the strict scrutiny of an internal control organ, to the degree that such authorities often take a questionable pro-government stance for fear of incurring personal liability.10 However, an increasing demand for the settlement mechanism, even in cases that may not warrant its use, has put a new strain on this option.
1 Eduardo Barrón is an international tax partner at Deloitte Impuestos y Servicios Legales, SC (Deloitte Mexico). The author would like to thank Carl E Koller Lucio for his assistance in preparing this chapter.
2 The tax authorities have on occasion taken the position that such capital contributions not recorded with a commercial or civil notary cannot be considered by them as capital contributions, although such lack of formality is precisely the sort of benefit that variable capital rules grant. However, they have been unsuccessful in a number of litigation cases, and the Taxpayer's Attorney General has also criticised the practice.
3 Business or entrepreneurial activities are defined by the Federal Fiscal Code as industrial, commercial, livestock, agricultural, fishing or forestry activities; personal independent services are defined by the VAT Law as those that do not fall within such business activity definitions.
4 Although some passive investment activities are excluded through administrative rules, we are critical of this rule as being overbroad, because a truly passive investor in a trust with entrepreneurial activities is more easily assimilated to a shareholder than a person with active business activities, and shareholders in Mexican companies do not constitute a PE in Mexico for having such quality.
5 However, SC-type company income is taxed on a receipt-basis, and some items (for example, certain payments to individuals) also generate their tax effects on a receipt basis.
6 Special rules have been established in the Hydrocarbon Revenue Law for certain oil and gas industry cases, but DTA benefits should still apply to those cases when covered.
7 Essentially taken from the Commentary on Paragraph 6 of Article 5 of the OECD's Model Tax Convention on Income and on Capital, as explained up to the July 2010 version.
8 The asterisk indicates jurisdictions with which Mexico does not have a DTT in force.
9 The MITL that came into effect in 2014 did not expressly consider the exception for the generation of electricity until an amendment for 2016; as per a transitory rule, this exclusion shall apply retroactively even as of 2014.
10 Amendments to the administrative appeal a few years ago lessened this problem to a minor degree, but did not generally resolve it.