Private Wealth 2019

Last Updated January 04, 2019

Contributed By Deloitte

Trends and Developments


Authors



Deloitte private wealth team in Mexico is comprised of two partners and two senior managers (lawyers and accountants). Expertise covers the regularization of taxpayers that held offshore structures the determination of the tax effects of such investments and the filing of the corresponding tax returns. Further expertise includes the filing of informative tax returns and legal and tax effects opinions of current offshore structures.

Tax Consequences of Offshore Structures Located in Preferential Tax Regimes (REFIPRES) Under the Mexican Income Tax Law (MITL)

Mexican taxpayers with offshore structures should be aware of the tax consequences that arise from having a foreign entity or vehicle in a preferential tax regime.

It is not illegal to have an offshore structure, but it is illegal not to timely report and pay the corresponding Mexican income taxes derived from those structures, as well as not filing the informative tax return.

Tax Systems

Every country has its own tax rules that govern the tax treatment of its residents operating abroad and foreign taxpayers operating in that country. In general, there are two kind of systems to tax income. In a worldwide income tax system, all income earned by such country’s tax residents is subject to taxation, even if the income is generated in a foreign country. In a territorial tax system, a country only taxes its tax residents on the income earned within that country.

Mexican tax residents are required to pay income tax on a worldwide basis. This obligation includes, considering as a taxable item, income derived from preferential tax regimes earned through foreign entities or vehicles that are transparent for tax purposes, even if such income has not been distributed.

Income is broadly defined to include “all income received in cash, in kind, services, credits or in any other form (ie, foreign exchange gain is taxed as interest income) obtained during the tax year.

For better understanding, it is important to mention that in 2005 Mexico introduced a new comprehensive controlled foreign companies legislation (CFC) under which resident companies and individuals are obligated to anticipate the recognition of their offshore income as taxable income in Mexico even if not distributed, if they hold a direct or indirect investment interest in a foreign entity or vehicle that is subject to a preferential tax regime or is pass-through (fiscally transparent) for tax purposes.

Income is considered subject to a preferential tax regime if derived from jurisdictions where the income is not taxed, or taxed less than 75% of the income tax that would otherwise be levied in Mexico that is, less than 22.5% in case an investor is a Mexican company and 26.25% in case of a Mexican resident individual).

For computing the 75% of minimum taxation, taxpayers must consider the effective tax levied as a result of any statutory, regulatory or administrative provisions, rulings, clearance, refunds, credits or any other procedures.

The MITL establishes certain exceptions to the CFC regime:

  • Active trade or business exception: Meaning revenue earned through foreign legal vehicles or entities, comes from active trade or business instead of from passive income. If more than 20% of an entity’s or vehicle’s total income comes from passive income, this exception does not apply. Passive income includes interests; dividends; royalties; capital gains (sale of shares, securities, intangibles and certain derivative instruments); commissions and mediation fees (agency); revenue from the sale of goods not physically located in the entity’s or vehicle’s jurisdiction (only if Mexico is the source of the recipient country); income from services rendered outside of such jurisdiction (only if a Mexican claims the deduction); and revenue from the disposition of real estate, granting the temporary use or enjoyment of goods and free income.
  • Royalties exception: As a second exception, CFC rules do not apply to royalties received by foreign legal vehicles or entities paid in exchange of a licence to use a patent or industrial secrets (trade marks and software are not included) provided that:
    1. intangibles were created and developed in that jurisdiction (not in Mexico) or were purchased at fair market value;
    2. royalties must not generate an authorised deduction for a Mexican tax resident;
    3. royalties meet arm's length standards; and
    4. accounting records of the foreign legal entity or vehicle are kept and an informative tax returns (mentioned in Article 178 of the MITL) is filed in February each fiscal year.
  • Lack of control exception: If a Mexican taxpayer does not have an average participation on the foreign legal entity or vehicle that grants him effective corporate or administrative control, to an extent that would allow the Mexican resident to decide when to distribute income, profits or dividends, either directly or through a third party, then he will only have to accrue income derived therefrom until it is effectively distributed to him.
  • De minimis income exception: Resident individuals will not be obligated to anticipate the recognition of income in preferential tax regimes or pass-through entities and vehicles, when it does not exceed the amount of MXN160,000.00 (approximately USD8,274.00) per fiscal year.

If any of the above exceptions apply to a Mexican investor participating in a foreign entity or vehicle in a preferential tax regime, such investor should not have to recognise the income generated by such entity or vehicle until it actually receives a redemption.

Therefore, if Mexican taxpayers receive income from a preferential tax regime, they are required to:

  • consider it as accrual income for the fiscal year in which the foreign entity or vehicle obtains it;
  • keep the information of the investments subject to preferential tax returns available for the tax authorities, including bank or investment statements;
  • keep tax and accounting records as required by MITL (and pay the tax upon the annual return on a separate basis);
  • file the informative return in February each year, reporting any income that is subject to preferential tax regimes, or income earned through foreign entities or vehicles subject to such regime, in the preceding year.

Informative Returns for Black-Listed Jurisdictions

On 14 July 2016, the Mexican Tax Authorities repealed Rule 3.19.11 of the Mexican General Tax Rules which stated the possibility of not filing the informative return for taxpayers that had investments in jurisdictions that qualified as a preferential tax regime, if such jurisdiction had a Broad Exchange of Information Agreement in place with Mexico.

Therefore, Mexican taxpayers must file an informative return in February each year disclosing:

  • income obtained during the preceding calendar year from a jurisdiction that qualifies as a preferential tax regime;
  • any sort of income arising in a listed jurisdiction (MITL, XLII Transitory Article); and
  • taxpayers conducting transactions through foreign vehicles or legal entities transparent for tax purposes.

In order to be required to file an informative return it is necessary that the foreign legal entity or transparent vehicle located in the blacklisted jurisdiction obtains income in the relevant fiscal year or conducted transactions through that transparent entity/vehicle; otherwise, if there is no income or transaction carried out in the fiscal year, there is no reporting requirement. Unfortunately, no court precedents have been issued regarding this matter or the Mexican internal revenue service regulations.

Finally, failure to file the informative tax return for more than three months of its due date (thus, in May, an extension can be granted under the General Tax Rules) or filing incomplete information could lead to consequences of three months to three years of imprisonment and fines.

Repatriation Decree 2017 (Effective on 2019)

On 18 January 2017 a decree for repatriation of funds kept outside Mexico by Mexican companies, individuals and permanent establishments (prior to 1 January 2017) was published in the Federal Official Gazette.

This decree granted the following incentives:

  • a tax rate of 8% on the total amounts repatriated into Mexico;
  • consider their formal tax obligations as duly complied with (ie, informative tax returns); and
  • avoid incurring tax penalties and surcharges.

To apply the benefit, taxpayers must invest the repatriated funds only in the investments described in the decree and maintain such investments for at least two years. The benefit was available until 19 October 2017.

Even if the decree encouraged non-compliant Mexican taxpayers to return their investments, the decree is a tax incentive not a tax amnesty (as the repatriations schemes of 1995 or 2009). Therefore, it is important that taxpayers keep in mind that the Mexican tax authorities could review if tax obligations have been duly fulfilled.

Conclusion

It is important to mention that many of the offshore structures were created before the USA created FATCA (Foreign Account Tax Compliance Act) with the OECD subsequently creating common reporting standards (CRS). We now live in a different world, where financial institutions are required to annually report to their local tax authorities the account information of foreign taxpayers, information that is later (automatically) exchanged among countries (the first exchange of information from Mexico to USA occurred in September 2015, as agreed in the Intergovernmental Agreement [IGA]) and to other countries (under CRS).This situation may lead Mexican tax authorities to investigate when, how and for how much time these assets have been residing offshore.

In this context, any undeclared assets allocated many years ago to these offshore structures may become re-assessed against higher tax rates, penalties plus interest, and may even be subject to prosecution as tax evasion is a criminal offence in Mexico.

It is strongly advised that Mexican taxpayers with offshore structures in preferential tax regimes regularise their current structures and recognise any income that has been generated, such as: i) interests (including FX gain); ii) capital gains; and iii) dividends, and comply with their formal obligations to file an informative tax returns.

Deloitte

Paseo de la Reforma 505
p. 28
Colonia Cuauhtémoc
06500
Ciudad de México
México

+52 (55) 5080 6478

rambravo@deloittemx.com www.deloitte.com/mx

Authors



Deloitte private wealth team in Mexico is comprised of two partners and two senior managers (lawyers and accountants). Expertise covers the regularization of taxpayers that held offshore structures the determination of the tax effects of such investments and the filing of the corresponding tax returns. Further expertise includes the filing of informative tax returns and legal and tax effects opinions of current offshore structures.

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