Contributed By Deloitte
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.
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:
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:
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:
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:
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.
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.