Source: Cuatrecasas
Introduction
The taxation landscape of Mexico is characterised by a comprehensive framework that encompasses various taxes, including corporate income tax (CIT), value added tax (VAT) and special excise taxes. Corporate tax planning in Mexico involves navigating a complex system of regulations and compliance requirements, with a standard corporate income tax rate of 30 per cent. Recent developments in Mexican taxation have been influenced by global trends towards greater transparency and anti-avoidance measures. The country has implemented the Organisation for Economic Co-operation and Development (OECD)’s Base Erosion and Profit Shifting (BEPS) recommendations, including transfer pricing documentation and country-by-country reporting.
Additionally, Mexico has introduced measures to combat tax evasion, such as the mandatory disclosure of aggressive tax planning schemes and the use of electronic invoicing to enhance tax collection efficiency. Trends indicate a continued focus on aligning with international tax standards and increasing the use of technology in tax administration.
Entity selection and business operations
In the context of Mexican taxation, the selection of an entity type is a critical aspect of tax planning for businesses. The primary forms of business organisations in Mexico include corporations,1 partnerships and branches of foreign companies (permanent establishments – PEs). Each of these entities is subject to different tax treatments, which can significantly impact the overall tax burden on the business and its shareholders, partners and members.
Corporations in Mexico are subject to CIT over their taxable income, which must be recognised on an accrual basis. Moreover, dividends distributed to other Mexican tax resident entity are exempt from income tax; nevertheless, any dividends distributed to individual shareholders are subject to an additional income tax. Similarly, partnerships are taxed in the same manner as corporations; however, their income recognition is based on a cash flow basis.
Additionally, a branch operating in Mexico will be taxed solely on its Mexican source income, whereas a Mexican subsidiary is subject to taxation on its worldwide income. Importantly, any remittances distributed from the branch to the parent entity are subject to a 10 per cent withholding in Mexico. Historically, branches of foreign corporations have been uncommon in Mexico.
The Mexican tax system does not recognise transparency for entities, meaning that CIT must be paid at the entity level rather than by individual owners or shareholders.2 This approach contrasts with the treatment of certain legal structures, such as trusts and passive Mexican joint ventures, where transparency is acknowledged and tax obligations are considered at the level of the beneficiaries. Consequently, entities operating in Mexico are required to fulfil their CIT obligations independently, ensuring that tax is levied directly on the entity’s income rather than being distributed among the stakeholders. This distinction underscores the importance of understanding the specific tax treatment applicable to different organisational forms within the Mexican tax framework.
Domestic income tax
Mexico adheres to the principle of worldwide income taxation, which mandates that its tax residents, whether individuals or legal entities, must recognise and pay income tax over all income, irrespective of its source. Conversely, non-Mexican tax residents and their PEs situated within the country are subject to taxation solely on income from Mexican sources of wealth and on income generated from their economic activities conducted within the country.
According to Article 9 of the Federal Tax Code (the FTC), a legal entity is considered tax resident in Mexico when it has its main business administration or its effective place of management in the country. Therefore, if the main business administration or the effective management headquarters of the subsidiary is in Mexico, it would be considered a resident entity in Mexico for tax purposes.
As a general rule, resident legal entities in Mexico are required to report all of their income, regardless of its source, and apply the general tax rate of 30 per cent on their taxable income3 to determine the corresponding income tax.4 Additionally, Article 16 of the Mexican Income Tax Law (the MITL) sets forth that taxable income encompasses all income received in cash, goods, services, credit or any other form by legal entities during the fiscal year, including income from their PEs abroad. However, it is important to note that certain items, such as capital contributions, asset revaluations, and dividends distributed by other resident legal entities in Mexico, are considered non-taxable income.
International tax
As mentioned above, Mexican tax resident corporations are subject to tax over their worldwide income. This means that any foreign source income should be included as taxable income under the CIT. To mitigate the risk of double taxation, Mexico has established a network of tax treaties with various countries. These treaties often include provisions for the crediting of foreign taxes paid against Mexican tax liabilities, thereby preventing or limiting double taxation. Additionally, Mexico adheres to the principles of the OECD Model Tax Convention, which provides guidelines for the allocation of taxing rights between countries.
When it comes to repatriating overseas earnings, Mexican tax law offers several strategies to optimise tax efficiency. One common approach is the use of foreign tax credits, which allow taxpayers to offset taxes paid abroad against their Mexican tax obligations. However, this credit is typically limited to the amount of Mexican tax incurred on the foreign-source portion of the company’s worldwide taxable income. Generally, this calculation must be performed on a country-by-country basis.
However, we note that the rules regarding tax credits for foreign corporate income tax are subject to capital ownership requirements stemming from direct or indirect ownership.
Another strategy involves the deferral of income recognition until the earnings are repatriated, which can be beneficial if the foreign jurisdiction has a lower tax rate (note that such strategy may work only if the foreign jurisdiction does not fall under the Mexican Preferential Tax Regime rules5). Furthermore, the use of holding companies in jurisdictions with favourable tax treaties can also be an effective planning tool.
Mexico has established anti-deferral rules concerning income obtained through foreign entities or legal figures, as well as income derived from entities subject to jurisdictions with income tax rates lower than 75 per cent of the rate that would be applicable in Mexico. As a result, residents in Mexico are required to report income at the time it is received. This regulatory framework ensures that income is taxed in a timely manner, preventing the deferral of tax liabilities and aligning with international tax compliance standards.
Activities and tax incentives
Mexico offers a range of tax incentives aimed at fostering economic growth and encouraging investment in various sectors. These incentives are designed to support businesses in specific regions and industries, providing financial benefits and tax relief to qualifying entities.
Special rules apply to factories6 operating under a toll manufacturing regime, offering tax benefits to companies involved in manufacturing and assembly operations, particularly those that export a significant portion of their products. Although less common than in the past, federal incentives are available for national cinematographic and theatrical productions, investments in high-performance sports, electric vehicle power feeders, technology and research and development projects, the real estate investment trust regime, risk capital, and hiring the elderly or people with disabilities, or both.
Additionally, a tax credit is available for companies’ purchasing diesel or biodiesel fuel for specific activities. Taxpayers operating in the ‘northern border region’ and the ‘southern border region’ may be eligible for tax incentives, including an income tax credit and a reduced VAT rate. In the southern border region, the city of Chetumal benefits from additional exemptions from general import tax and customs clearance processing fees. To qualify, taxpayers must file a request with the tax authorities by 31 March of each fiscal year. Qualifying projects involving capital expenditure investment and job creation may benefit from discretionary grants provided by state and municipal authorities, aimed at supporting local economic development and attracting investment to specific areas.
Since 12 October 2023, companies in export industries that relocate part of their production closer to their markets (a strategy known as ‘nearshoring’), as well as key sectors of the film and audiovisual industry that promote the export of creative content, may benefit from an immediate deduction of their investment in new fixed assets and an additional deduction for training expenses.
Capitalisation requirements
Identifying and determining the most efficient way to contribute resources to a legal entity are crucial, as the manner of such contributions can have varying tax effects, particularly when repatriating resources abroad. These tax effects need to be analysed based on several factors, including the nature of the operation, the search for capital return and the origin of the funds.
Capital contributions
As a general rule, contributions made by shareholders to the capital of a legal entity, as well as reimbursements to shareholders, do not have tax effects, provided that no profits are distributed through such reimbursements. In this context, capital contributions made by shareholders in favour of the company are recorded under the capital contribution account.
Debt funding
Conversely, funding resources through debt between companies does not affect the company’s capital but can impact the entity’s operation. Generally, interest payments are deductible for the debtor resident in Mexico. However, the deduction of interest is subject to several restrictions as outlined in Articles 11 and 28 of the MITL, among other limitations over authorised deductions.
Restrictions on interest deductions
The following restrictions over interest payments are included under Mexican tax law:
- Interest treated as a dividend: interest arising from debts where the lender is deemed to have control over the Mexican entity, such as through involvement in administration, entitlement to profits or the ability to demand repayment on a specific date, will be considered a dividend distribution.
- Arm’s-length basis: interest must be agreed upon on an arm’s-length basis.
- Back-to-back rules: interest derived from a back-to-back structured loan will be considered nondeductible and recharacterised as a dividend.
- Non-deduction of payments to preferential tax regime entities: payments made to related parties (directly or through structured arrangements) are not deductible if the income of the counterparty is subject to a preferential tax regime.
- Thin capitalisation rule: debts incurred from non-Mexican tax residents who are related parties must not exceed a 3:1 debt-to-equity ratio. If this ratio is exceeded, the interest deduction will be disallowed. However, we note that debts incurred for the construction, operation or maintenance of productive infrastructure linked to strategic areas, or for the generation of electricity, are excluded from the application of thin capitalisation rules.
- Earning stripping rule: this rule sets forth that net interest expense, defined as the excess of accrued interest expense over accrued interest income, should be disallowed if it exceeds 30 per cent of the adjusted taxable income (equivalent to the earnings before interest, taxes, depreciation and amortisation metric for tax purposes). This rule applies only to interest amounts exceeding 20 million Mexican pesos. Disallowed interest may be carried forward under the same rules that apply to net operating losses. In the case of group entities, the calculation is performed on a group basis. Nondeductible expenses under this rule may be carried forward for up to 10 fiscal years.
In conclusion, the method of contributing resources to a legal entity must be carefully considered to optimise tax implications, particularly in the context of repatriating resources abroad. Both capital contributions and debt funding have specific tax considerations that must be meticulously analysed to ensure compliance and tax efficiency.
Common ownership: group structures and intercompany transactions
In the context of Mexican tax legislation, tax planning for structures involving related parties presents several critical issues that must be carefully navigated to ensure compliance and optimise tax efficiency. One of the primary concerns is the adherence to transfer pricing regulations, requiring that transactions between related parties be conducted at arm’s length.
This means that the prices charged in these transactions should be comparable to those that would be charged between independent parties under similar circumstances. Failure to comply with these regulations can result in significant adjustments and penalties. Additionally, the use of related party structures often necessitates thorough documentation to substantiate the arm’s-length nature of transactions, including detailed transfer pricing studies and intercompany agreements. Another key issue is the potential for double taxation, which can arise if income is not properly allocated between jurisdictions. To mitigate this risk, it is essential to use tax treaties and other mechanisms in order to avoid double taxation.
Furthermore, the Mexican tax authorities have increased scrutiny on the use of related party structures to shift profits and erode the tax base, making it imperative for companies to ensure that their tax planning strategies are robust and defensible. Overall, effective tax planning in related party structures requires a comprehensive understanding of the relevant regulations, meticulous documentation and proactive measures to address potential risks.
Ownership structure of related parties
Under Mexican tax legislation, several tax planning considerations arise from the jurisdiction’s rules related to tax grouping and loss sharing, controlled foreign corporations (CFCs) and tiered partnerships. First, Mexico does not allow for tax grouping or consolidated tax returns, which means that each entity within a corporate group must file its own tax return and cannot share losses with other group members. This necessitates careful planning to optimise the tax position of each entity individually.
Second, the CFC rules in Mexico (or Mexican Preferential Tax Regime Rules) require Mexican taxpayers to include in their taxable income certain types of passive income earned by their foreign subsidiaries, even if such income has not been distributed. This can lead to increased tax liabilities and necessitates strategic planning to manage the timing and nature of income recognition.
Third, tiered partnerships, where partnerships hold interests in other partnerships, can present complex tax challenges. The income and losses from these partnerships must be carefully tracked and reported, and the structure can impact the overall tax burden due to the potential for multiple layers of taxation (also, such type of structure is commonly reviewed and scrutinised by the Mexican tax authorities). Therefore, it is crucial for taxpayers to consider these factors and seek appropriate tax planning strategies to mitigate adverse tax consequences and ensure compliance with Mexican tax laws.
Domestic intercompany transactions
Under Mexican tax legislation, there are several limitations and opportunities for owners of related parties. One significant opportunity is the ability to make deductible related-party payments, which can reduce overall net income. However, these deductions are subject to strict transfer pricing rules to ensure that transactions between related parties are conducted at arm’s length (such as supported with documentation that evidence the materiality and existence of the operation).
Additionally, while Mexico does not have a participation exemption, dividends distributed between Mexican tax resident entities are exempt from CIT. However, there are limitations on the availability of losses generated from related-party transactions. Specifically, losses from transactions between related parties may be scrutinised to prevent tax avoidance schemes.
Furthermore, Mexico has implemented measures to counteract BEPS. These measures include restrictions on the deductibility of interest and other payments to related parties in low-tax jurisdictions (as mentioned in the interest deduction restrictions above).
Overall, while there are opportunities for tax planning through related-party transactions, these are balanced by stringent regulations to prevent abuse and ensure fair taxation.
International intercompany transactions
Under Mexican income tax law, there are several limitations and regulations regarding the shifting of income to low-tax jurisdictions and the generation of deductions in high-tax jurisdictions. Notably, principal payments between related parties are not taxable, which provides some flexibility in structuring intercompany financing. However, interest payments to non-Mexican tax-related parties are subject to stringent thin capitalisation rules, which limit the amount of deductible interest to avoid excessive debt financing. Additionally, payments made to related parties located within preferential tax regimes are generally non-deductible, further curbing tax avoidance strategies.
In terms of withholding taxes, Mexico imposes withholding on interest payments to foreign entities, with reduced rates such as the 4.9 per cent rate are potentially available. However, this reduced rate may be rejected if the interest is paid to related parties, ensuring that the benefits of lower withholding rates are not exploited through intra-group transactions.
Furthermore, international transfer pricing rules have evolved to align with the OECD’s BEPS initiatives, requiring that transactions between related parties be conducted at arm’s length and adequately documented to reflect economic reality.
Third-party transactions
When structuring transactions involving third parties under Mexican tax law, several tax planning considerations must be taken into account to ensure compliance and optimise tax efficiency. First, it is essential to understand the nature of the transaction and the specific tax implications for each party involved. This includes analysing the type of income generated, such as capital gains, dividends or interest, and the corresponding tax rates applicable to each and the tax regime applicable to the involved parties (e.g., Mexican tax resident individual, legal entity or a non-Mexican tax resident).
Additionally, the use of tax treaties between Mexico and other countries can significantly impact the withholding tax rates on cross-border payments, potentially reducing the overall tax burden. Another critical aspect is the application of transfer pricing rules, which require that transactions between related parties be conducted at arm’s length.
Furthermore, the choice of legal entity and its tax regime, whether it be a corporation, partnership or trust, can influence the tax treatment of the transaction (specifically, whether it is classified as a pass-through entity, a legal figure or an opaque entity). By carefully evaluating these factors, taxpayers can effectively plan and structure their transactions to achieve optimal tax outcomes while ensuring compliance with Mexican tax regulations.
Sales of shares or assets for cash
Under Mexican tax law, capital gains realised by Mexican tax resident corporations are treated as ordinary income and are subject to the standard corporate tax rate of 30 per cent. However, losses incurred from the sale of shares are limited in their deductibility and can only be used to offset gains from the sale of shares.
Mexican tax resident corporations are subject to taxation on capital gains. This implies that the tax cost basis of the acquired shares can be deducted from the sales price of these assets. The tax cost basis of the shares is calculated by adding the acquisition cost to the undistributed profits and then subtracting any pending fiscal losses.
For nonresidents, the tax rate on gross income from the sale of shares is 25 per cent. Alternatively, a 35 per cent tax rate applies to net income (where the tax cost basis of the shares can be considered) if specific conditions are met.7 We note that depending on the tax residence of the seller, reduced tax rates over capital gains may be applicable.8
Additionally, capital gains from the sale of publicly traded shares by individuals or non-Mexican residents are taxed at a rate of 10 per cent. When determining the deductible basis for the sale of real estate, fixed assets and shares, the law allows for the indexation of the original cost to account for inflation.
Indirect taxes
The standard VAT rate in Mexico is 16 per cent, while a reduced rate of zero per cent applies to certain transactions. VAT is levied on the sale of goods, leasing and the provision of services, as well as on imports. A zero per cent rate applies to the transfer of certain goods (food, medicine and other items) as well as to the exportation of goods and services, with some exceptions. An 8 per cent rate applies to taxpayers operating through establishments in the northern and southern border regions that meet certain requirements. However, the reduced rate does not apply to the importation of goods, the transfer of immovable property and the transfer of intangibles.
The VAT return must be submitted monthly, within the first 17 days of the following month. VAT paid for expenses and investments made during a business’ pre-operational period is either creditable on the VAT return for the month the taxpayer begins business operations or submitted for refund during the month following the VAT payment, based on an estimation of future activities.
International developments and local responses
Mexico has concluded over 60 tax treaties with various countries to avoid double taxation and prevent tax evasion (such as the United States, the United Kingdom, Germany, Spain and France). These treaties are designed to facilitate cross-border trade and investment by providing clarity on tax obligations and reducing the risk of double taxation for individuals and businesses operating in multiple jurisdictions.
The Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (BEPS MLI) came into effect for Mexico on 1 July 2023. This convention introduces several significant modifications to existing tax treaties. These include changes to the criteria and rules for recognising a PE, adjustments to the conditions under which reduced tax rates on dividends apply, and revisions to the requirements for reduced tax rates on capital gains. Additionally, the convention implements a principal purpose test to prevent treaty abuse. These modifications are designed to enhance the integrity of the international tax system and curb tax avoidance strategies.
Finally, we note that the Double Taxation Treaty between Germany and Mexico has recently been amended with respect to dividend distributions and the ownership requirements necessary to qualify for the reduced tax rate.
Year in review
In recent years, tax planning in Mexico has faced several significant, controversial and interesting issues that have captured the attention of both tax professionals and businesses. One of the most notable issues is the implementation of the General Anti-Avoidance Rule, which allows tax authorities to recharacterise transactions that lack a valid business purpose and are primarily aimed at obtaining a tax benefit.
Additionally, Mexican tax legislation now includes a reportable schemes regime. Under this regime, tax advisors are required to disclose aggressive tax planning transactions to the Mexican tax authorities.
Special considerations
Outlook and conclusions
Mexico’s corporate taxation framework is characterised by a comprehensive and evolving system that aligns with international standards and addresses the complexities of modern business operations. The standard corporate income tax rate of 30 per cent and the VAT rate of 16 per cent form the backbone of the tax regime, with specific provisions for different types of entities, including corporations, partnerships and branches of foreign companies.
Recent developments, such as the implementation of the OECD’s BEPS recommendations and the introduction of anti-avoidance measures, reflect Mexico’s commitment to enhancing transparency and combating tax evasion. The adoption of digitalisation in tax processes and increased cooperation with international tax authorities further underscores this commitment.
Entity selection and business operations in Mexico require careful consideration of the tax implications, as different organisational forms are subject to varying tax treatments. The principle of worldwide income taxation mandates that Mexican tax residents recognise and pay income tax on all income, regardless of its source, while non-residents are taxed only on Mexican-source income.
International tax considerations, including the use of tax treaties and foreign tax credits, play a crucial role in mitigating double taxation and optimising tax efficiency. Mexico’s anti-deferral rules ensure timely taxation of income obtained through foreign entities, aligning with global tax compliance standards.
Tax incentives offered by Mexico aim to foster economic growth and investment in specific sectors, providing financial benefits and tax relief to qualifying entities. These incentives, along with capitalisation requirements and restrictions on interest deductions, highlight the importance of strategic tax planning.
The complexities of common ownership, group structures and intercompany transactions necessitate adherence to transfer pricing regulations and meticulous documentation to ensure compliance and avoid double taxation. The scrutiny of related party structures by Mexican tax authorities emphasises the need for robust and defensible tax planning strategies.
Third-party transactions, including the sale of shares or assets, are subject to specific tax treatments, with capital gains taxed as ordinary income for Mexican tax residents and varying rates for non-residents. The application of indirect taxes, such as VAT, further adds to the intricacies of the tax landscape.
Mexico’s extensive network of tax treaties and recent adoption of the BEPS MLI demonstrate its proactive approach to international tax developments. These treaties facilitate cross-border trade and investment while preventing tax evasion and ensuring fair taxation.
Overall, Mexico’s corporate tax environment is dynamic and multifaceted, requiring businesses to stay informed and adapt to ongoing changes. Effective tax planning and compliance are essential for optimising tax outcomes and contributing to the country’s economic growth.
Symbiosis focuses its efforts in terms of export promotion, assistance with direct investment, and internationalization of Canadian companies. With deep cultural and business ties with the region and an understanding of the challenges presented to Canadian clients doing business in Mexico. Our team is positioned to timely and efficiently assist clients in providing counsel and the legal tools to assist in their positioning in Mexico. For further information, please contact us or book a call/video conference with a member of our team, it would be our pleasure to meet you and talk about your project.
