Contributed By Arias y Meurinne, S.C.
In Mexico, businesses generally adopt a corporate form. Corporations may be either commercial in nature or civil in nature. Commercial corporations pursue profits as their main goals, while civil corporations, although entitled to obtain profits, pursue other goals, mainly the incorporation of professions such as lawyers, accountants, doctors and other similar professionals.
All corporations, whether civil or commercial in nature, are taxed as separate legal entities from the individuals that incorporated them.
There are several different forms of corporations available. In some corporations - such as the comandita simple - the shareholders (or partners) are personally liable for any default obligation in an unlimited amount. On the other hand, there are other corporations - such as the sociedad anónima - in whichthe shareholder is only personally liable for any default obligation up to the amount of their capital investment in the company.
The most common transparent entities used in Mexico are the fideicomiso and the asociación en participación.
The fideicomiso is a civil law country equivalent of a trust. A person designates certain property or funds to an authorised financial institution, which acquires the property of them and performs the lawful instructions given by the grantor of the fideicomiso, for the benefit of himself or other persons (corporations or individuals) named fideicomisarios.
There is a special type of fideicomiso used to invest in real estate, which then makes an offer in the stock exchange named FIBRA.
Fideicomisos are commonly used in Mexico when the taxpayer wishes to dispose of certain assets, but still wants to control how those assets are invested and delivered to another person.
The asociación en participación is a transparent partnership from a commercial perspective, but is taxed as a corporation. They are commonly used when two competing companies wish to develop a business together, but do not want to incorporate a commercial corporation.
Corporations that have established their effective management or main seat of administration in Mexico, shall be considered residents of the country.
Incorporated businesses are subject to a 30% income tax rate. As long as the corporation is considered a legal entity for tax purposes, then it shall be subject to this tax rate. There are progressive tax rates applicable to individuals, 35% being the maximum rate.
Although not formally a tax, businesses are liable to pay to their employees 10% of their taxable base for income tax purposes. This is commonly known as profit sharing.
Taxable profits are calculated by subtracting from all items of income, as defined by the Income Tax Law, and permissible deductions (including profit-sharing payments), also defined in law.
Accounting profits are not the same as taxable profits. The Income Tax Law does incorporate some general accounting principles in order to assess the taxable profits (normas de información financiera), such as in the case of the determination of the cost of goods deduction and transfer pricing issues, where general accounting principles apply with some modifications provided by law.
The general rule for corporations is that profits are taxed on an accrual basis. Civil corporations are subject to receipt basis taxation, as are individuals as a general rule.
There are no patent box incentives in Mexico.
30% of qualifying R&D expenses are creditable versus the annual income tax. This tax credit has an annual limit of MXN1.5 billion and MXN50 million per taxpayer. R&D projects need to be approved by the government to get access to this grant.
R&D donations are deductible when made to an organisation that has a special authorisation to receive such donations. They are limited to 7% of the annual taxable profits.
When employing handicapped persons, the income tax generated by that individual is deductible for the employer.
The real estate business may create a fideicomiso (FIBRA). No provisional income tax payments shall be due during the taxable year. Several tax deferrals are available for the companies involved in the real estate business through a FIBRA.
Taxpayers may invest in cinematographic, theatrical and other performing arts projects and receive a credit versus their income tax for the amount invested. This may not exceed 10% their annual income tax.
Normally, land is deductible when sold. Real estate developers may deduct acquired land that will be developed in order to sell houses or apartments.
Co-operative societies which are formed only of individuals may be treated as a transparent entity and thus the individuals may be taxed individually.
Investments in specialised sports facilities are creditable versus the annual income tax, as expenses in training high-level athletes. It is limited to 10% of the annual income tax.
30% of investments made in equipment to feed electricity to electrical vehicles shall be creditable versus the annual income tax.
Certain businesses, such as farm and other primary industries, may immediately deduct investments made in their businesses and not by annually depreciating their value.
The general rule is that losses may be carried forward 10 years. They are to be adjusted by inflation. Certain losses can only be offset versus future profits of the same kind; ie losses for the alienation of shares may only be offset versus future profits generated from selling shares.
There are no general limits imposed on the deduction of interest. Only interest generated between related parties are subject to thin capitalisation rules (3 debt to 1 capital ratio).
Consolidation is optional for qualifying related groups of companies. It is not widely used, because the benefits are marginal and short-lived.
Each company assesses its tax as if no consolidation exists and then the holding company calculates a consolidated tax return. Subsidiaries pay the tax to their holding company. Companies are only allowed to lose during three years. If a losing company generates a loss on the fourth year, the consolidated effect for the losses must be reversed by the holding company.
If no consolidation is opted for, then individual losses may only be carried forward by the company incurring the loss.
Losses may not be transmitted by merger. If a company merges into another company that has a loss, the losses may only be subtracted from future profits generated in the same line of business.
Alienation of land and shares is taxed by deducting their cost from its selling price. The cost is adjusted for inflation. Losses from the alienation of shares may only be carried forward 10 years versus future profits from the alienation of shares.
Value-added tax is payable for the alienation of goods, the rendering of services, the rent of property or the importation of goods.
A special consumption tax applies to the alienation of cigars, gasoline, alcoholic and energising beverages, fertilisers and other goods. It also applies to certain services, such as telecommunication services.
Incorporated businesses are not subject to any other notable taxes.
Most closely held local businesses operate in corporate form, although there is widespread evasion of taxes in Mexico, which tends to involve operation as individuals.
No provision prevents individual professionals from incorporating a company and providing services through it at the lower corporate tax rate. But upon receiving profits in the form of dividends or fees, then they will pay the difference of the higher tax rates applicable to individuals.
No rules prevent closely held corporations from accumulating earnings for investment purposes.
Individuals must accrue dividends to their tax base. They do so by multiplying the dividend by 1.4286. The individual is entitled to credit the income tax paid by the corporation paying the dividends, proportional to his shares. Additionally, the individual taxpayer is liable to pay a 10% withholding tax on the dividends.
An individual that sells shares must accrue to his income tax base the difference between the price of sale and the cost of the shares. The cost of the shares is adjusted by inflation.
Taxation for individuals on dividends from and on gain on the sale of shares is the same as that mentioned in the section above.
a) Interest is subject to different withholding tax rates in the absence of tax treaties, as follows:
b) Dividends are subject to a 10% withholding tax.
c) Royalties are taxed as follows:
Many international companies set up holding companies in the Netherlands, Luxembourg and Switzerland to invest in Mexico. This is especially true for United States multinationals, as they can benefit from the check-the-box regime.
Local tax authorities will challenge the use of treaty country entities by non-treaty country residents in the absence of a sound business reason – other than tax benefits – to triangulate the investment through the tax treaty country.
The major transfer pricing issue for inbound investors operating through a local corporation has to do with the fact that under the Income Tax Law, there is an obligation to primarily use the comparable uncontrolled price method to determine transfer pricing, which imposes the burden to find comparable uncontrolled transactions; this may prove a daunting task in cases where the services or goods involved are unique, such as patented medicines or specialised services, as the tax administration frequently invokes uncontrolled transactions that are not quite applicable. Thus, finding comparable uncontrolled transactions should be a priority for any company operating in Mexico. If no such transactions are available, then justification for this fact must be thoroughly backed by evidence, and arguments should be available to the taxpayer in order to present them to the Tax Administration in order to justify the application of a different transfer pricing method.
Local tax authorities do not, as a general principle, challenge the use of related party limited risk distribution arrangements for the sale of goods or provision of services locally. It depends if the prices are within the comparable uncontrolled transactions prices used by the tax authority.
As mentioned above, the Income Tax Law sets forth the obligation to use primarily the comparable uncontrolled transactions method. Other than that, the Income Tax Law remits to the OECD Transfer Pricing Guidelines for Multinational Corporations and Tax Administration as amended from time to time by the OECD.
Compensating adjustments are allowed and made when transfer pricing claims are settled, especially in the presence of double taxation conventions.
Filing MAPs is uncommon in Mexico.
Local branches of non-local corporations are not taxed differently to local subsidiaries of non-local corporations because the basis of taxation is residence, not nationality of the investment.
The sale of stock in local corporations by a non-resident is subject to a 25% withholding tax on the consideration received without any deduction. If the non-resident has a legal representative in Mexico, he may opt to apply a tariff on the profit derived from the sale of the stock, which might be as high as 35%.
Most treaties that Mexico has entered into do not include a capital gains clause. Whether or not the sale of stock falls within the meaning of "business profits" is debatable, but this should be the preferred view. If the sale of stock fell within the meaning of “other income” for treaty purposes, most Mexican double taxation conventions allow for the resident country to tax the income without limitation.
In a spin-off, 50% of the voting stock of the companies involved should remain the same for a period of three years (one year prior to the spin-off and two following this event). Should this limit change, then the spin-off is considered a taxable event. This is the same for national and overseas groups.
Formulas are not used to determine the income of foreign-owned local affiliates selling goods or providing services. All subsidiaries are taxed the same.
The Income Tax Law provides that pro rata management and administrative expenses paid to a foreign resident (either related or not) are non-deductible. The Tax Court has held this provision to be in breach of the nondiscrimination clause of double taxation conventions though, and the deduction has been allowed to the taxpayers involved in litigation.
Thin capitalisation rules are set forth in the Income Tax Law. Interest that derives from debt that exceeds three times the amount of the accounting capital of a corporation is nondeductible when the debt is owed to a foreign-resident related party.
Interest recharacterisation as dividends is a matter of much concern in Mexico. The Tax Administration has used its power to recharacterise interest as dividend as leverage to negotiate with taxpayers, since if this rules applies, there is a double effect, as interest will be deemed nondeductible and since a dividend is deemed to have been paid, then the paying company has to pay income tax on that distribution (unless they have a positive balance in their after-tax account). The law provides for the recharacterisation of interest as dividends in the following cases:
The foreign income of local corporations is accruable to the tax base as any other item of income.
Dividends from foreign subsidiaries of local corporations are accrued as any other item of income. But if the local corporation owns 10% or more of the foreign subsidiary, then it has the right to credit the income tax withheld by the foreign country and also the income tax paid at corporate level by the foreign subsidiary. This credit is also available if a foreign subsidiary of the direct subsidiary distributes dividends that eventually reach the Mexican resident.
Intangibles developed by local corporations can be used by non-local subsidiaries without incurring local corporate tax. The transfer of intangibles developed in Mexico should be done at arm’s length prices. Failure to comply with this requirement makes any payment made by the local company to the foreign related party non-deductible.
Controlled foreign corporations provisions exist in Mexico. Any related subsidiary or controlled foreign entity paying income tax in a foreign country, at a tax rate lower than 75% of the tax rate applicable in Mexico, is subject to CFC rules. The local company shall pay the Income Tax on the profits generated by the CFC as assessed under Mexican law, in proportion to its participation in the foreign subsidiary/entity.
CFC provisions do not apply when the foreign subsidiary/entity is carrying out a business in the foreign country, but not if 20% of the income it generates comes from passive income (dividends, interest, royalties, alienation of shares and/or derivative operations).
No rules related to the substance of non-local affiliates exist.
Local corporations are taxed on gain on the sale of shares in non-local affiliates the same way that the sale of shares in local affiliates is taxed, which is that taxpayers shall reduce from the price obtained for each share, the average cost per share as determined by the Income Tax Law.
If the profits derived from the sale of shares of the non-local affiliates are subject to CFC rules (not directly sold, but through other foreign entities subject to CFC rules), and the shares are sold between related parties, the taxpayer may opt not to apply CFC rules if they comply with the following requirements:
There is no general anti-avoidance provision in Mexico. Nevertheless, the Tax Administration has developed a doctrine in which it will disregard any transaction for tax purposes if the taxpayer does not provide evidence that it was made with a business reason. The Administrative Tax Court has upheld this doctrine in several cases.
There are no regular audit cycles in Mexico. But the tax authority tends to audit large corporations annually. In these audits, it is advisable not only to be counselled by an accountant, but also by a lawyer, since any evidence not filed before the tax authority is non-admissible in litigation before the courts.
In relation to transfer pricing, the Income Tax Law incorporates the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations into domestic law as changed from time to time by the OECD, so the changes introduced in these guidelines were automatically introduced in Mexico.
The Federal Fiscal Code has already implemented the OECD reporting standards for Mexican multinational corporations, which includes the master report and a country-by-country report each taxable year.
Mexico has been in favour of the BEPS initiative from the onset and positively implements and enforces the action plans. On top of the reporting standards, Mexico has also implemented the Automatic Exchange of Information OECD initiative and has already exchanged information with many countries. The tax administration is seeking to end tax avoidance schemes used by Mexican taxpayers.
International tax does not have a high public profile in Mexico, but is rather a matter for specialists and large corporations. There are few academics in universities with enough experience in the subject and only the IFA Mexico Branch and a commission of the Accountants Bar routinely study international tax issues, so the influence will be low.
Mexico does not have a comprehensive competitive tax policy. On the contrary, the country constantly seeks to tax multinationals more heavily because there is a generalised tax evasion problem in the country. It is estimated that 60% of the economy is informal in Mexico, so the government must rely on large established companies to finance taxation.
The only major tax advantage that Mexico offers is that there is no tax on inheritance, though this has little influence in corporate taxation.
There are some tax regimes that are favourable to foreign investors, such as the maquiladora provisions, where a company that sends goods to be transformed in Mexico is not deemed to have a permanent establishment; but, as mentioned, there is no coherent competitive tax policy.
Mexico tends to tax hybrid instruments without consideration for the tax treatment granted by the foreign tax regime, maximising taxation and creating double taxation. If the BEPS proposals are implemented, then it can actually be beneficial for the taxpayers who might get relief in cases where double taxation is caused by the different treatment received in Mexico and abroad.
Mexico is not a territorial tax regime.
No impact is expected from LOB or anti-avoidance rules.
Changes in transfer pricing have not had a significant impact in Mexico. Taxation of profits from intellectual property is an issue that the tax administration has addressed several years ago, so no radical change is expected.
We are in favour of the proposal for transparency. This reporting in addition to the automatic exchange of information should be a good deterrent and means to combat international tax avoidance and evasion.
There is draft legislation that targets the digital economy, but it is poorly worded since it only taxes Mexican residents, thus foreign over-the-top businesses doing business in Mexico will not be taxed.