Mexico, the world’s 15th largest economy in the world in terms of GDP, has encountered new challenges following the 2016 United States presidential election, particularly the devaluation of the Mexican peso and the possible renegotiation of NAFTA.
Uncertainty with respect to possible reforms in the United States, Mexico’s most important business partner, and its impact on Mexican economy have not become a constraint for attracting foreign investments; however, on migration-related diplomatic topics, both countries have become more distant.
Following the tax reforms introduced in 2014 by the executive branch of Mexico’s federal government, important national sectors are still facing an ongoing shifting process derived from such reforms. Private investments in the oil sector are in a maturing process; however, oil dependence in Mexico’s economy remains strong.
Mexico, a member of the Organisation for Economic Co-operation and Development (OECD) since 1994, remains one of the world’s most important emerging market economies, and has become an attractive destination for international investments within the Latin American region, which has led to the existence of an important number of wealthy individuals within an environment of unequal distribution of wealth. According to the OECD’s latest Economic Survey on Mexico,2 the country’s economic potential has been hindered by important challenges such as high levels of poverty, extensive informality and insufficient educational achievement.
Since the second half of the 1990s, Mexico has taken a more active approach to become an attractive investment spot by broadening its double taxation treaty network, and tax authorities are playing an active role in renegotiating current tax treaties with several countries.
Taxation in Mexico is founded on a series of laws and regulations that are in constant flux. The major tax reform of 2014, which derived in the enactment of a new Income Tax Law, had an important impact on individuals, by incorporating new tax brackets up to a 35 per cent tax rate from the previous limit of 30 per cent and imposing taxation to gains obtained from the sale of publicly traded shares (until 2013 these were generally tax-exempt) and dividends received from both national and international companies at a rate of 10 per cent.
Inequality of income has, historically, been a problem for Mexican society. The authorities have constantly focused on developing policies for establishing additional taxes to the already captive taxpayers, while the informal economy keeps growing as a response to the lack of formal employment that could provide the means of support for a significant number of Mexican households. Such inequality derives from the existence of a very big number of high net worth individuals in Mexico who hold investments abroad.
A major concern of wealthy individuals, not only in Mexico but worldwide, is the current trend of tax administrations to execute information-exchange agreements intended to provide additional elements for exercising audit faculties with respect to capital placed in investment structures abroad. Mexican tax authorities, along with foreign tax administrations, are playing an active role in response to the US Foreign Account Tax Compliance Act regulations, the OECD Base Erosion and Profit Shifting (BEPS) action plan and the Common Reporting Standard of the OECD.
Mexico’s initial response to BEPS has resulted in incorporating in its legislation the obligation for taxpayers to comply with filing informative returns according to the OECD action plan: master file, local file and country-by-country report. These returns must be filed by the end of 2017 at the latest, with respect to transactions executed between related parties in tax year 2016.
An outcome of the 2014 tax reform was the elimination of the option for income tax payment on a no-name basis. This payment alternative was applicable to Mexican-resident individuals for income obtained from investments held overseas and represented a secure method of tax compliance under a confidentiality scheme.
In 2017, a temporary tax incentive programme for capital repatriation was enacted. This programme requires the payment of income tax due on investments held overseas as of 31 December 2016 and taxpayers that adopted such benefit are obliged to return to Mexico funds by 19 October 2017.3 The benefit of this programme consists of a reduced income tax rate of 8 per cent conditioned to a minimum two-year holding period in specific types of investments authorised by the Mexican tax authorities. Additionally, those taxpayers who elect to apply such repatriation programme are relieved from the formal obligations that were not timely complied with.
Tax authorities continue to focus on gathering information with respect to inbound transactions conducted by taxpayers. Several tax provisions oblige individuals and corporations to constantly inform of specific transactions targeted as part of aggressive tax planning or with the intention of detecting money laundering. Additionally, tax audits conducted by the Mexican tax authorities are focused on validating the substance of transactions. In 2017, the Mexican tax authorities launched a campaign of massive electronic audits.
Owing to the regulations that have recently been enacted, additional administrative resources must be invested by taxpayers so as not to fall into default with any of the obligations established therein, in addition to the fact that more complex requirements for issuing electronic invoices have to be dealt with.
The presidential succession in 2018 is creating expectation and uncertainty in certain sectors of Mexican economy and consequently its impact in taxation. At time of writing, no candidates have been officially been proclaimed in what is expected to be a very competitive election race.
Overall, taxation in Mexico for private wealth is constantly changing, and tax authorities are playing an active role not only in verifying whether individuals’ tax obligations are duly being complied with, but also in promoting actions to reach agreements on a broad exchange of information and obliging taxpayers to keep providing information on their transactions.
Domestic legislation establishes that Mexican-resident individuals are subject to income tax with respect to their worldwide income.
An individual is deemed resident in Mexico if his or her dwelling is located within the country. If such individual holds property in Mexico and in another country, the Mexican residence would be afforded if his or her main centre of interest (the place where more than 50 per cent of its overall income is obtained) is located in Mexico.4
Mexican resident individuals are subject to a progressive tax rate on their annual income. The maximum tax rate of 35 per cent introduced in the 2014 tax reform is still in effect.
Depending on the type of activities conducted by individuals, miscellaneous formal obligations may have to be complied with.5
Individuals are obliged to file an annual tax return on 30 April, following year-end; however, depending on the type of income received, advance income tax returns may have to be filed before the Mexican tax authorities during the ongoing tax year. Mexican tax legislation provides that the tax year runs from 1 January to 31 December.
Several items of income are fully or partially income tax-exempt. Until 2013, individuals were fully exempt on gains derived from the sale of dwellings, to the extent that in the five previous tax years no other sale of dwellings was carried out. Since 2014 such sales are partially exempt for an amount of approximately US$220,000 (considering 2017 figures).
A major impact on individuals resulting from the most recent tax reform is a limit on the amount of personal deductions that could offset taxable income, such as medical expenses, additional contributions to private pension funds and interests on mortgages for acquisition of dwellings. The annual limit of personal deductions corresponds to the lower of approximately US$7,500 (considering 2017 figures) or 15 per cent of the individual’s annual taxable income. An exception for people with physical disabilities (according to the Federal Labour Law) was incorporated in order for them not to consider the aforementioned threshold. Additionally, since 2016, contributions to savings and retirement plans were excluded from such general threshold; however, a specific deductibility limit for such type of contributions is applicable.
Most tax-exempt items of income must be reported to the Mexican tax authorities to maintain such status, otherwise they are deemed taxable income.
i Taxation on real estate
Individuals are subject to income tax on gains derived from the sale of immoveable property. The tax basis of immoveable property is subject to restatement by Mexican inflation and subject to depreciation rules (except for land).
The Income Tax Law provides a tax computation procedure for individuals that results in having two types of gains, determined based on the number of years of their investment holding period. The first basket is taxed as part of taxpayers’ ordinary income, while the second basket is taxed at their previous five-year effective tax rate following the procedure established for such purposes.
Gains obtained from immoveable property deemed as ordinary income are subject to the annual progressive rate (maximum rate of 35 per cent), and in the case of sale transactions they are conducted before a notary public, who is then responsible for computing and remitting the corresponding tax to the authorities.
Local taxes apply to the acquiring party of immoveable property. State and municipal legislation may vary; however, property taxes normally range between 2 per cent to 5 per cent, which is habitually applicable to the greater out of cadastral value, according to each state’s records, appraisal value or transaction value.
ii Taxation of gains of publicly traded securities
The tax exemption regime for gains obtained by individuals and non-residents derived from the sale of shares through the stock exchange was repealed by the 2014 tax reform.
Since 2014, individuals and non-residents in certain cases are obliged to pay income tax at a rate of 10 per cent over gains derived from the sale of securities through authorised stock exchanges or recognised derivative markets.
Specifically, this new regime is applicable to shares issued by Mexican companies, or where the value stems more than 50 per cent from Mexican real estate, and securities that represent them such as American depository receipts; foreign shares that are listed on the Mexican stock exchange through its international quotation system; securities that represent indexes such as ETFs or TRACs, which are sold on the Mexican Stock Exchange and equity financial derivative transactions referred to shares listed on the Mexican Stock Exchange or referred to indexes on such shares that are realised in the Mexican market.
Mexican financial intermediaries must conduct the computation of gains or losses derived from sale transactions. Mexican-resident individuals are entitled to offset losses against gains from the sale of securities.
Losses obtained from the sale of shares can only be offset against gains obtained from the sale of shares. A 10-year period is established for carrying forward losses obtained by taxpayers.
At year-end, Mexican financial intermediaries are obliged to provide Mexican-resident individuals with the details of the annual computation of gains or losses obtained during each calendar year. If a final gain is obtained, Mexican-resident individuals are obliged to remit to the tax authorities the 10 per cent income tax jointly with their annual tax return. The annual tax return for individuals is due to be filed on 30 April of the following year.
Non-residents can apply tax treaty benefits based on their tax residence. Mexico has an extensive network of tax treaties and exchange of information agreements.
There are some exceptions to which the 10 per cent rate does not apply, such as publicly traded securities that were acquired or sold in private transactions (the 10 per cent tax regime is applicable in cases where shares sold do not represent more than 1 per cent of the issuer’s overall stock) and sales conducted by a person or group that within a 24-month period sells more than 10 per cent of an issuer’s stock or its control, as defined in the Stock Market Law.
iii Taxation on dividends
Until 2013, Mexican legislation established an integrated profit distribution system in which profits were taxed at the level of the distributing entity, and no additional taxation was imposed on the recipients of such dividends.
As a result of the 2014 government’s tax reform, individuals and non-residents are subject to an additional 10 per cent income tax on dividends received from profits generated in 2014 and the following years. Such income tax must be withheld by the distributing entity and remitted to the tax authorities.
Mexican-resident entities are required to maintain separate records of profits generated until 2013 and of profits generated starting 2014 for the purposes of determining whether the additional 10 per cent income tax withholding is applicable or not in case any distribution to individuals or non-residents is conducted.
Additionally, Mexican-resident individuals are subject to the additional 10 per cent tax on dividends received from non-resident entities, which must be paid in the month following such in which they receive profits.
In certain cases, tax treaties can reduce or eliminate the 10 per cent rate on dividends paid by Mexican-resident corporations.
iv Preferential tax regime rules
Mexican residents holding investments in foreign vehicles are obliged to determine whether income arising from such investment is subject to a preferential tax regime.
Under Mexican legislation, and from a general approach, income is subject to a preferential tax regime when it is not subject to taxation abroad or is subject to income tax lower than 75 per cent of the income tax that would have been triggered and paid in Mexico, even when such situation derives from the application of special regulations, tax refunds, tax credit or any other procedure.
Income obtained from entities or foreign transparent legal vehicles is deemed as subject to a preferential tax regime, except when such vehicle conducts entrepreneurial activities and its passive income represents 20 per cent or more of its overall income.
An exception for not considering that income is subject to a preferential tax regime is established by the Mexican Income Tax Law for such cases where a Mexican resident does not exert control (directly or through a third party) in the management of foreign entities or legal vehicles to such a degree that could decide the moment of profit distribution. The Mexican Income Tax Law assumes that the Mexican resident exerts control; thus, proof to the contrary must be obtained in such applicable cases.
Income subject to a preferential tax regime is taxed at the level of the Mexican-resident investor at the moment in which such income is generated, regardless of whether it has been distributed to such investor.
Mexican-resident individuals and entities are obliged to comply with filing an informative return in case they obtain income subject to a preferential tax regime, conduct transactions through foreign transparent legal vehicles or obtain income arising from any territory established on the black list of the Mexican Income Tax Law transitory provisions. In 2017, a more complex informative tax return was required to be filed as the Mexican tax authorities introduced a new official form enforcing taxpayers to provide information in a more detailed manner.
Failure to comply with such informative return or providing incomplete information is a criminal offence. Administrative rules6 provide relief on specific cases for not filing the informative return, specifically if income is derived from a country that has entered into a broad exchange of information agreement with Mexico.
Gifts in Mexico are tax-exempt in the following cases:
- a gifts between spouses or those received by descendants from their lineal ascendants;
- b gifts received by ascendants from their lineal descendants, to the extent goods that received are not sold or given to other lineal descendants in any degree; or
- c other gifts that do not exceed an approximate amount of US$4,500 (considering 2017 figures). For the excess amount thereof, income tax must be paid.
A donee must consider the tax basis of goods received in relation to the donors immediately before they granted such goods as a gift. The acquisition date of goods received must also correspond to the acquisition date of donors.
However, in cases where income tax is paid on a gift transaction, the acquisition cost would correspond to the appraisal value considered for computing such tax and the acquisition date on which the tax is paid.
The donee has to declare the amount of gifts received in his or her annual tax return in order not to lose the exemption.
Successions do not give rise to a taxable event provided the recipient of the deceased’s estate reports this situation in his or her annual tax return. If such report is not made, the transferred estate is taxable.
Non-residents are not exempt from tax on real estate and shares that have a source of wealth located in Mexico. Transfer of such assets would be subject to taxation according to the corresponding provisions.
Contrary to what occurs in other jurisdictions, Mexican legislation does not include an estate tax. Notwithstanding this, certain property taxes may be triggered depending on the local legislation of each state and municipality.
No forced heirship regime exists in Mexico; however, upon intestacy, succession rules would be applicable in any of the following cases:7
- a the deceased left no will, or the will is void;
- b the will does not provide for the entirety of the estate;
- c conditions established to heirs are not complied with; or
- d beneficiaries renounce the will.
If the succession rules are required, descendants, spouses and ascendants, among others, are considered as heirs in different amounts and according to specific rules. In case of any dispute, the civil courts will decide according to the civil legislation applicable.
It is not essential to have a will executed under Mexican law. In general terms Mexican legislation recognises any will executed and formalised in a foreign jurisdiction, to the extent it is valid in such jurisdiction and is not against Mexican law.
Mexican and foreign residents can make wills in Mexico. Even though there are several types of wills in Mexico, the most common is the ‘public open will’, which is executed before a Mexican notary public in the presence of a witness and is formalised in a public deed.
Under Mexican legislation, the beneficiaries of a will are entitled to decline or transfer their rights under such will in favour of other persons.
The Federal Civil Code provides specific situations in which wills may be contested for specific cases in which they are deemed void pursuant to the corresponding provisions.
An executor manages the deceased’s estate and handles the disposal of the assets of the estate. Such executor could be appointed in the will or could be elected by the beneficiaries.
In general terms, the executor of the estate should make an inventory of all the assets of the estate and manage such assets until their distribution to the beneficiaries.
In addition, the executor is obliged to file the annual estimated tax returns of the estate. Alternatively, the beneficiaries could opt to recognise the taxable income corresponding to their share of the estate.
IV WEALTH STRUCTURING & REGULATION
Tax wealth structuring in Mexico has been focused primarily on estate planning and preserving confidentiality.
A very common vehicle used in wealth structuring is the Mexican trust or fideicomiso, which is a commercial contract governed by the Mexican General Law of Negotiable Instruments and Credit Operations.
Such law includes several mandatory provisions, but also allows fideicomisos to include other legal contractual provisions, making them one of the most flexible types of contracts in Mexico, enabling them to be used for different purposes.
In general terms, a fideicomiso consists of three parties: settlor; trustee and beneficiary. The settlor is the individual or entity that transfers title or management of certain assets and rights to the trustee. The trustee is the party that holds the assets in trust and has the responsibility of performing and complying the purposes and goals of the fideicomiso. Finally, the beneficiary is the party that is designated to benefit from the assets and rights contributed to the fideicomiso, whether by using and enjoying the assets or rights, or by receiving income from such assets or rights, among others. Under Mexican law, the beneficiary can be the settlor itself.
Even though legal title over the assets and rights is actually transferred to the trustee (which means the trustee is the legal owner of such assets and rights), such legal title is limited, since the trustee cannot dispose for his own benefit of the assets and rights transferred to it, as it holds title under a fiduciary capacity. Thus, Mexican legislation requires trustees to keep separate accounting books and records for assets and rights held in trust.
In general terms, only a Mexican bank or other qualified and regulated financial institution may act as trustee in a fideicomiso. Trustees are required to exercise good faith and shall use diligent and professional efforts to promote and protect the best interests of the assets and rights in trust.
Regardless of the purpose for which a fideicomiso is created, it shall either be revocable or irrevocable. The first case occurs when the settlor reserves for himself or herself the right to revoke or modify the agreement (i.e., settlor maintains the legal ability to ‘reacquire’ the assets and rights from the trustee). In the second case, the settlor cannot revoke the agreement, at least until the settlor has fulfilled his or her obligations.
From a tax perspective, when asset contributions are made to a fideicomiso in which settlors reserve the right to reacquire such assets, no sale is deemed to exist at that moment. Tax is triggered when such reacquisition right is lost or when a third party is appointed as beneficiary of the trust.
Depending on the purposes of the fideicomiso, the trustee may require either constant or specific supervision and direction, or simply certain assistance in satisfying the fideicomiso’s purposes. This is accomplished by a governing body working in the form of a committee, which is called the technical committee. The committee’s duties can be as specific or as broad as determined by the parties creating the fideicomiso.
Fideicomisos are normally created for a specific period, and in terms of law they cannot exceed 50 years; although, under certain specific cases the term can be extended.
Fideicomisos can terminate for several reasons, such as the fideicomiso reaching its purpose; such purpose becoming impossible to satisfy; by agreement of the settlor, trustee and beneficiary; when revoked by the settlor; among other cases. Upon expiration, and unless otherwise provided by the fideicomiso agreement, the assets and rights in trust will be transferred to the settlor or to the beneficiary, as the case may be.
While the three persons that are part of this agreement have legal personality, the fideicomiso itself does not have any legal personality; this means that there is no new legal person formed under the contract, but rather the trustee acts on behalf of the parties. Thus, fideicomisos are not deemed to hold the capacity of a ‘resident’ vehicle.
Therefore, all income received for any activities carried out by the fideicomiso is not taxable to the trustee but taxable for the beneficiary, as the activities are being carried out on behalf of the parties of the fideicomiso.
Mexican legislation provides a specific tax treatment for fideicomisos through which entrepreneurial activities are carried out. Mexican fiduciary institutions are obliged to compute a tax profit or tax loss derived from activities conducted thereof and report them to the fideicomiso’s beneficiaries, who are obliged to consider as part of its annual taxable income the tax result in the corresponding participation; therefore, such type of fideicomisos are pass-through vehicles. Losses generated in fideicomisos are not shifted to the beneficiaries, as they can only be offset against income generated in such vehicle.
In addition, fiduciary institutions are obliged to file advance and final tax payments on behalf of the fideicomiso’s beneficiaries, who are entitled to claim credit for the portion of those payments that corresponds to their participation.
ii Foreign investment structures
Investment structures held overseas are commonly implemented by high net worth Mexican resident individuals.
Overseas structures are commonly established with estate planning and confidentiality purposes. Mexican tax authorities are constantly striving to obtain information about Mexican individuals and their investments abroad.
As a result of this, Mexican resident individuals and companies are investing important resources in complying with all informative obligations enacted by Congress and regulated by the Mexican tax authorities.
iii Anti-money laundering regulations
The Anti-Money Laundering statute became effective in July 2013, which from a general overview requires financial and non-financial institutions to report ‘vulnerable’ transactions.
A series of vulnerable transactions must be reported such as gambling or betting games, issuance of credit or prepaid cards not issued by financial institutions, lending activities not conducted by financial intermediaries, sale of jewellery or watches, sale of new or used vehicles, armoured services and acquisitions on behalf of third parties.
Each vulnerable activity must be reported in case the transaction thereof exceeds the amounts established for each case within the period of time provided thereof.
The Mexican government created a special Financial Intelligence Unit that is responsible for receiving all the reports that must be filed according to the anti-money laundering statute and administrative rules and is responsible for analysing them in order to detect transactions linked to money laundering.
Non-compliance with anti-money laundering reports leads to penalties from the tax authorities. Providing false information is deemed a criminal offence punishable by jail.
iv Reporting obligation on ‘relevant’ transactions
The 2014 tax reform introduced a new provision to the Federal Fiscal Code that obliges taxpayers to report ‘relevant’ transactions determined by the tax authorities through administrative rules.
Upon issuance of the corresponding tax form, which must be used for reporting purposes, a series of transactions required to be reported were disclosed. Among such transactions are the following:
- a financial derivative transactions;
- b financial transactions involving coupon strips;
- c change in an entity’s shareholders;
- d sale of shares;
- e change of residence to Mexico;
- f sale of intangible assets;
- g financing transactions;
- h accrued interests in long-term financing; and
- i financial assets contributed to fideicomisos.
Taxpayers are relieved of reporting such transactions if their aggregate amount in a tax year is lower than 60 million pesos. This exception is not applicable to financial institutions.
This new obligation is part of the current trend of the Mexican tax administration for gathering information on transactions conducted by taxpayers in order to provide additional elements for conducting tax audits that might result in an increase in tax collection from both individuals and legal entities.
On November 2016, the Supreme Court of Justice established that the provision of the Federal Fiscal Code containing the obligation to report such relevant transactions infringes the fundamental rights of legality and juridical certainty. The overall effect of such ruling results in taxpayers being obliged to inform relevant transactions until the applicable rules are amended. In response to this, the Mexican tax authorities issued a press release informing that through the Ministry of Finance, a tax reform initiative would be submitted in order to remedy the constitutional defects of such provision.
v Exchange of information agreements
As a G20 and OECD member country, Mexico has actively participated with other OECD countries in the development of new standards for the exchange of financial information in a more expeditious manner.
Mexican authorities have shown a keen interest in acquiring information on overseas investments of Mexican residents by being part of the Early Adopters Group (EAG) for adopting the Common Reporting Standard (CRS), which is the standard in automatic exchange of information between tax authorities developed by the OECD.
Mexican tax authorities, acting as signees of the Multilateral Competent Authorities Agreement, have sent a clear message on their position on challenging tax evasion by enabling the exchange of information in an automatic standardised manner.
It is expected that Mexico will conduct its first automatic exchange of information under the new standard in September 2017, jointly with the rest of the EAG members.
V CONCLUSIONS & OUTLOOK
The ongoing ambitious tax collection policy of the tax authorities has been supported by tax reforms in Mexico that have resulted in an increase in the federal government’s revenue derived from tax collection and have enabled Mexican tax authorities to gather more information on transactions conducted both by corporations and individuals in Mexico and abroad. Validating substance of transactions is a common practice in the tax authorities’ audit trends, and taxpayers if their counterparties do not provide evidence that suffices the tax authorities demand to prove the actual existence of transactions.
As part of a global trend, tax policies are being focused on gathering information of each country’s tax residents with respect to assets and investments held overseas in a more efficient, standardised and automated manner. Fiscal secrecy appears to be the central topic to be challenged by tax administrations worldwide, through a scheme of unparalleled international cooperation, which will actively begin in 2017.
Jurisdictions that in the past were considered traditionally secretive are currently adopting a more open position for exchanging information with foreign governments. Mexican tax authorities are currently executing exchange information agreements that will allow them to exercise their audit faculties on investments held by Mexican resident individuals.
Mexican high net worth individuals have been constantly concerned about the confidentiality of their investments both in Mexico and overseas. The current trend of tax administrations seems challenging and more scrutiny is expected. The five-year statute of limitation of the Mexican tax authorities’ audit faculties has led an important number of Mexican investors to follow a voluntary tax regularisation programme with respect to such investments; however, more complex investment structures should be expected to try to achieve privacy and confidentiality for Mexican investors.
The 2017 temporary programme for capital repatriation has led certain high net worth individuals to withdraw from complex overseas investment structures, as automatic exchange of information among tax administrations worldwide has become an important concern to certain individuals who are not willing to run any possible risk, having as a downside the loss of confidentiality, which has frequently been the major concern for investors.
Several external factors are still having a major adverse effect on foreign currency exchange rates with respect to the Mexican peso, and will certainly encourage investors to seek alternatives for hedging their position, considering that Mexican-resident individuals are obliged to recognise as part of their taxable income unrealised foreign exchange gains generated in each tax year.
The presidential succession process that will soon begin in Mexico will have an impact on the economic scenario of the country and in foreign investment policies of key players, in addition to the impact on foreign exchange rates with respect to the Mexican peso.
The following years will be important in knowing the actions the tax authorities might follow once the exchange of information between governments is conducted in a more automated manner.
1 Alfredo Sánchez Torrado and Roberto Padilla Ordaz are partners at Chevez Ruiz Zamarripa y Cia, SC.
2 OECD (2017), OECD Economic Surveys: Mexico 2017, OECD Publishing, Paris.
3 The original text of the Decree established as the initial due date 19 July 2017; however, a three-month extension was published in the Official Gazette on 17 July 2017.
4 2017 Federal Fiscal Code.
5 2017 Mexican Income Tax Law.
6 2017 Miscellaneous Tax Resolution.
7 Federal Civil Code.