Contributed By Jáuregui y Del Valle, S.C.
In Mexico, businesses generally adopt a corporate form. There is a range of alternatives, including the Soceidad Anónima and the Sociedad de Responsabilidad Limitada, which are the most commonly used and have no substantial tax regime differences between them. The particular needs and goals of each business will determine the appropriate type of corporation to form.
Groups of professionals or individuals that engage in civil activities mostly involving the rendering professional services may opt to form a non-stock civil entity (Sociedad Civil or SC), which is highly common between lawyers, architects, doctors, accountants, etc.
Corporations are taxed as separate legal entities from their shareholders, and must file an annual income tax return and monthly advance payments in account for the annual tax return.
In corporations, the shareholders are only liable for the amount of their contributions to the corporation; this is known as the “corporate veil”.
The main tax difference between a non-stock SC and a business corporation is that, in SC, profits are taxed on a cash flow basis, while in a commerce corporation they are taxed on an accrual basis.
There are no transparent entities in Mexico as seen in other jurisdictions per se; as a general rule, Mexican provisions do not attribute tax residency to contracts or other disregarded legal vehicles like trusts. However, asociaciones en participación (similar to joint ventures) are deemed to be Mexican residents for tax purposes if, among other factors, they carry out business activities in Mexico.
Fideicomisos are known in other countries as trusts, and have a certain grade of “transparency” with no legal personality. For tax purposes, trusts are deemed to be “tax transparent legal figures” with no tax residency – they are considered as passive subjects in tax obligations carried out by members/controlling persons (ie, the settlors or beneficiaries). However, if the members of a fideicomiso engage in business activities through the fideicomiso, the trustee, pursuant to some provisions that are primarily applicable to corporations, will have to determine the tax result or tax loss of the business activities each year, and will comply with other tax obligations on behalf of its members, such as filing advance payments. Furthermore, the beneficiaries must accumulate earnings or losses obtained through business fideicomisos, with their annual tax returns crediting any provisional payments made by the trustee during the corresponding fiscal year.
This type of entity is commonly used when structuring hedge funds, real estate funds, etc.
Mexican Law provides that any corporation that has its main administration or effective management seat located in Mexico will be deemed a Mexican resident for tax purposes. In this respect, the main administration or the effective management is considered to be in Mexico when the day-to-day decisions of control, direction, management or operation of the incorporated business and its activities are taken within Mexican territory.
Transparent entities are not considered residents in Mexico for tax purposes.
Regardless of whether the incorporated business is owned directly by individuals or corporations or through transparent entities, corporations are taxed at a 30% income tax rate over taxable income, which is calculated by offsetting the net income (broadly, gross income less deductible income-related expenses), with tax loss carry forwards from the previous ten years.
The taxable income of a corporation is usually calculated by subtracting the income-related authorised deductions and the employee’s profit sharing paid from the gross income of the relevant fiscal year.
As a general rule for corporations, taxable income is calculated on an accrual basis, whereby income and expense items are included in taxable income or taxable expense as they are earned or incurred, rather than when they are received or paid.
Profits of SC and individuals are taxed on a receipt or cash flow basis, recognising income and deductions when money is received or paid.
Federal law provides a special tax regime to incentivise technology investments; it consists of a tax credit equal to 30% of the expenditure and investment made during the relevant tax year in technology research or development (R&D). Such credit can be offset against the income tax charged in the same relevant tax year. If the income tax charged in the relevant tax year is lower than the tax credit obtained as a result of the tax relief, the taxpayer may credit the resulting difference against income tax they are due to pay in the following ten years.
The above-mentioned tax credit will not exceed MXN1.50 billion collectively between all the taxpayers willing to obtain the benefit, and MXN50 million individually per taxpayer on an annual basis.
There are no particular incentives for patent box investments.
Financial and tax incentives are used in Mexico to attract local or foreign investment capital to certain activities or particular areas in the country, as follows:
In order to apply these tax incentives, taxpayers have to comply with certain special rules.
Tax incentives are also given to trusts that invest in venture capital in Mexico; to certain legal entities engaged in the primary sector activity (eg, agriculture, cattle and fishing); to corporations with less than MXN5 million of income, which are eligible to be taxed on a receipt or cash flow basis; and to taxpayers investing in power supply equipment for electric vehicles, among others.
Moreover, special temporary incentives are issued by the federal government, such as tax relief in the Northern Mexican border consisting of benefits in income tax and value added tax, and the payment of interest.
Rules provide for a kind of relief for losses incurred, by carrying over the loss to offset it against net income in future years (carry forward). The tax losses may be carried forward up to ten years from their determination. The amount of the losses will be adjusted for inflation.
No carry back rules apply.
Special rules apply for mergers and changes of control.
First, under the current legislation, local corporations have a limitation on the deduction of interest paid to foreign related parties equivalent to a debt-equity ratio of 3:1; interest that exceeds such ratio will be considered non-deductible.
Interest derived from loans contracted by financial institutions and interest derived from debt contracted for construction activities, the operation or maintenance of productive infrastructure related to strategic activities or the production of electricity are excluded from this limitation.
Second, another limitation to the deduction of net interests (the difference between interest earned and interest payable) was recently introduced, whereby taxpayers are only allowed to deduct net interest up to 30% of their “EBITDA”. Any amount of interest exceeding such limitation may be deducted by the taxpayer in the following ten years (subject to the same limitation), and any remaining difference would be deemed a non-deductible expense.
The aforementioned limitation would only apply to interest accrued during the taxable year that exceeds MXN20 million. This amount would be prorated between companies that are part of a corporate group or related parties.
This limitation does not apply when the debt generating the interest is raised to finance the construction of real property located in Mexico. Also, this limitation will only apply when the amount of non-deductible interest determined under this rule is higher than that determined under the first limitation, in which case the first limitation will not apply.
Subject to special rules, certain groups of corporations may seek authorisation from the tax authority to apply the optional regime for consolidated groups of corporations.
Within the regime, a company of the group will add the taxable profit and subtract the tax losses of the group to determine the group’s income tax. The group may defer the income tax for up to three years.
Companies with tax losses generated before they could otherwise qualify for this regime are not eligible for the optional regime for consolidated groups of corporations.
The disposition of real property, land, fixed assets, securities, shares, ownership interests or governmental certificates, among others, may result in a capital gain for the seller.
Corporations are taxed on the positive difference between the tax basis of the relevant asset, adjusted for inflation, and the transaction price.
As a general rule, tax on capital gains is triggered when the asset is sold, at a 30% rate over net gain.
Foreign residents who sell shares issued by Mexican companies are subject to a 25% tax on the gross proceeds from the sale, without any deductions. There is an option for foreign residents with a local representative in Mexico to determine income tax for the sale by applying a 35% rate on the net gain.
Mexico has an extensive tax treaty network, whereby tax reliefs are granted on international capital gains.
Value Added Tax or VAT is levied on the sale of goods, the rendering of independent services, the leasing of property, and the importation of goods and services. The general VAT rate ranges between 0% and 16%, and is levied on the final consumer. It is refundable when the VAT paid is greater than the VAT collected, not credited and paid in excess, and it is taxed on a receipt/cash flow basis. Moreover, VAT is creditable against VAT collected, with taxpayers paying the difference between the VAT paid and VAT collected.
Special Production and Services Tax (IEPS, for its acronym in Spanish) is levied on the sale of specific goods and the rendering of specific services, mainly those that cause social or individual damage, or the consumption of which by the population causes an additional cost for the government (ie, tobacco, alcohol, etc).
Real estate owners are subject to real estate property tax at progressive rates, depending on the value of the property.
Individuals and corporations are subject to the payment of real estate acquisition tax when acquiring real estate in Mexico. The tax is based on tariffs set by local authorities at a rate over the value of the property, based on a valuation carried out by an expert; depending on the location of the property, the rate is between 2% and 6% over the value of the acquired property.
Incorporated businesses are not subject to any other notable taxes.
Most closely held local businesses operate in corporate form. It is not common for an individual to operate directly in a non-corporate form.
The corporate tax rate is 30%, and individuals are subject to a progressive rate that goes up to 35%. There are no particular provisions that prevent individual professionals (eg, architects, engineers, consultants, accountants) from earning income at corporate rates through corporations. On the contrary, it is a common practice for professionals to form an SC.
There are no rules that prevent closely held corporations from accumulating earnings for investment purposes.
Dividends paid by closely held corporations to shareholders (with funds not arising from the “net after-tax profit account”, or CUFIN for its acronym in Spanish) must be multiplied by a factor of 1.4286 and the result thereof levied with general Mexican income tax at a rate of 30% at a corporate level, meaning that the tax would be levied on the corporation and not the shareholder. However, if the shareholders are individuals or foreign residents (individuals and corporations), the dividend will be subject to withholding tax at a rate of 10%.
Individuals must accrue the income generated by dividends, and may credit the taxes paid by the corporation that distributed the dividend against the due tax calculated in their annual tax return.
Non-residents may invoke tax treaty relief for the 10% withholding tax.
As for taxes triggered on the sale of shares in closely held corporations, individuals are taxed on the net gain over the cost of the shares, adjusted for inflation.
Individuals are subject to a withholding tax on dividends from and gain on the sale of shares in publicly traded corporations, at a rate of 10%.
Different withholding tax rates apply for inbound investments, depending on the activity:
However, these withholding rates are subject to treaty relief or exemptions when an income tax treaty is invoked; the amount of the relief varies depending on the foreigner's country of residence.
Mexico has an extensive tax treaty network whereby investors may achieve physically transparent effects and/or tax relief for the equity and/or debt investments conducted in Mexico.
The primary tax treaty countries used in Mexico are the USA, the UK, the Netherlands, Luxembourg, Switzerland and Canada.
Non-treaty country residents are not subject to tax treaty benefits, the use of which will be challenged by local tax authorities.
Mexican taxpayers who enter into transactions with related parties must charge or pay the prices that would be agreed between independent parties in comparable transactions – ie, the arm’s length principle. The taxpayers are required to prepare and update documentation supporting the value of the transaction.
A significant transfer pricing issue presented for inbound investors operating through a local corporation is the challenge by the tax authorities to the transfer pricing study in which related party considerations are determined.
Local tax authorities do not challenge the use of related party limited risk distribution arrangements for the sale of goods or the provision of services locally. Local authorities focus on transfer pricing rules, and the transactions are carried out on an arm’s length basis.
Local transfer pricing rules and their enforcement follow the OECD standards.
When the tax authorities settle a transfer pricing claim in a negative way, it is likely that adjustments will have to be made to the taxable income of the taxpayer, because most negative transfer pricing claims result in a ruling against the deductibility of the transaction, directly affecting the tax result calculation.
Local branches of non-local corporations are considered as Mexican residents for tax purposes, and are consequently taxed solely as local taxpayers.
Capital gains of non-residents on the sale of stock issued by a Mexican resident or stock where 50% or more of the book value is represented directly or indirectly by real property located in Mexican territory are taxed at a 25% withholding rate over the gross value of the transaction, without any deductions. If the non-resident appoints a legal representative in Mexico and complies with certain requirements, the transaction may be taxed with 35% over the net gain.
See also 2.7 Capital Gains Taxation.
If the sale of shares forms part of an international group’s restructure, the shares may be assigned without triggering income tax, as long as certain conditions provided by statute are met and the shares remains within the control of the group.
There are no formulas to determine the income of foreign-owned local affiliates selling goods or providing services. However, the compensation for such transactions has to be calculated based on a transfer pricing study.
Payments by local affiliates to non-local affiliates are deductible – for example, payments for management and administrative expenses incurred by the non-local affiliate are deductible as long as the compensation is within the arm’s length principle.
Interest paid by a Mexican tax resident (eg, a foreign-owned local affiliate) to foreign related parties (eg, a non-local affiliate) is not deductible when it derives from amounts of debt that exceed three times its equity capital in a 3:1 ratio. As a result of this disproportionate debt/equity ratio, the exceeding debt may be recharacterised as equity, resulting in a disallowance of the interest deduction and taxation of the funds as dividends. This is known as “thin capitalisation”.
Also, other scenarios provide that interest is deemed a dividend when, among other factors, foreign companies grant loans to Mexican legal entities or permanent establishments of foreigners, if:
Local corporations are taxed over their worldwide income, regardless of the source of the income.
This is not applicable, as foreign income is taxable in Mexico.
Dividends received by local corporations from foreign subsidiaries are considered as taxable income. However, if the local corporation holds 10% or more of the capital stock of the foreign subsidiary for at least six months prior to the dividend being paid, it has the right to credit the income tax withheld together with the corporate tax paid by the foreign subsidiary abroad against the Mexican tax. This credit is also available if a second level foreign subsidiary of the direct subsidiary distributes dividends that eventually reach the Mexican resident.
Foreign subsidiaries are able to use intangibles developed by Mexican corporations, provided the transaction complies with the arm’s-length principles. If intangibles developed in Mexico are transferred to a foreign resident, such transfer must also comply with the arm’s-length rules in order for an eventual royalty payment made by the Mexican resident to the foreign resident to be deductible.
Under Mexican Law, local corporations are bound to pay income tax over income received by a foreign subsidiary or controlled foreign entity that is exempt from paying income tax in its country of origin or when the foreign effective income tax is lower than 75% of the tax rate that would have applied to the income in Mexico. In this case, the local corporation shall determine the income tax on the income obtained by the foreign entity in proportion to its participation therein.
This rule is not applicable to foreign subsidiaries that carry on business activities abroad, except when more than 20% of the subsidiary’s income is represented by passive income.
CFC rules are also not applicable where the local corporation has no effective control over the foreign subsidiary or its management.
Mexican law does not provide rules related to the substance of non-local affiliates.
Local corporations are taxed on gains on the sale of shares in their affiliates, whether they are local or foreign, by reducing the average cost per share as determined under the Mexican Income Tax Law’s provisions from the purchase price per share.
However, if the sale of shares forms part of an international group’s restructure, the shares may be assigned without triggering income tax, as long as certain conditions provided by statute are met.
In the recently approved tax reform, a general anti-avoidance rule was included. Under this new rule, tax authorities will be entitled to deny tax benefits or even reclassify transactions and arrangements in those cases where taxpayers are not able to prove any commercial substance.
There are no regular routine audit cycles in Mexico.
Mexican Tax Law currently in force includes regulations regarding reporting standards for Mexican corporations that form part of multinational groups. This obligation includes the filing of master and country-by-country reports.
Also, provisions based on the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations are included in domestic tax law.
As part of the recently approved tax reform, rules based on BEPS actions recommended by OECD were included in Mexican domestic law. These new rules include the new limitation in the deduction of interests (see also 2.5 Imposed Limits on Deduction of Interest), a general anti-avoidance rule (see also 7.1 Overarching Anti-avoidance Provisions), rules to prevent the use of harmful tax practices by using transparent and hybrid vehicles (see also 9.6 Proposals for Dealing with Hybrid Instruments), and mandatory disclosure rules for tax consultants.
As a member of the OECD, the Mexican government is in line with the BEPS initiative and recommendations. A recently approved tax reform included several provisions that follow OECD’s recommendations in the final reports to BEPS action 4 (Limiting Base Erosion Involving Interest Deductions and Other Financial Payments), action 5 (Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance) and action 12 (Mandatory Disclosure Rules).
With these reforms, the Mexican Tax Administration Service seeks to raise the collection of taxes by limiting Mexican taxpayers’ ability to implement tax avoidance strategies and structures.
In recent years, the Mexican authorities have become interested in international tax, and particularly in ways to prevent tax avoidance by Mexican taxpayers; consequently, its influence will be present in the implementation of the BEPS recommendations.
Traditionally, the Mexican government has not been interested in having a comprehensive competitive tax policy. On the contrary, the Mexican tax authorities continuously try to enforce provisions to increase taxpayers’ burden and to stop tax evasion, which is a main concern in the country.
This is not applicable, as the Mexican tax system is not considered a competitive tax system.
In the past, the Mexican tax authorities have tried to tax hybrid instruments without consideration for their legal and tax nature in their jurisdiction. These practices have been reviewed by Federal Courts, which determined the illegality of such practices and ordered tax authorities to recognise the tax and legal nature of hybrid instruments pursuant to the law of their formation.
However, the recently approved tax reform considers hybrid instruments as taxpayers for Mexican purposes when their main place of management is deemed to be located in Mexico.
This is not applicable, as Mexico has a worldwide income regime.
This is not applicable, as Mexico does not have a territorial tax regime.
The tax reform recently approved in the Mexican Congress includes a provision by which the tax authorities will be entitled to consider transactions or legal acts as non-existent, or to recharacterise them, when they lack commercial substance and are only executed to obtain a tax benefit.
The OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations and its amendments have been adopted into Mexican Law, so no major change is expected. Also, the taxation of profits from intellectual property is already covered by Mexican legislation, so no change is expected on that matter either.
The Mexican government is in favour of transparency and the proposal for country-by-country reporting, which has already been included in domestic legislation.
The tax reform recently approved in the Mexican Congress taxes transactions and profits generated by digital economy businesses operating inside and outside the country with income and value added tax.
See 9.12 Taxation of Digital Economy Businesses.
Please see 6.4 Use of Intangibles.
There are no further general comments about the BEPS process.