On September 8th, 2019 the Mexican President presented to the Mexican Congress the 2020 economic legislative package; this amended certain tax provisions, among others, the Mexican Income Tax Law (MITL). This Tax Reform was published on the Mexican Official Gazette in December 2019 and entered into force (in general terms) on January 1st, 2020.
As part of these measures, the MITL incorporate, among others, the following deduction limitations.
a) Payment to low tax jurisdictions
The approved anti-tax haven provision establishes that payments carried out directly or indirectly to related parties subject to low taxation or through structured agreement shall not be considered as deductible for Mexican Corporate Income Tax (CIT) purposes.
For these purposes, according to the MITL, low taxed jurisdictions are those that are subject to an income tax lower than 75% of the tax rate that would be payable in Mexico (i.e. 30% for legal entities) regarding the same transaction (i.e. 22.5% over same taxable income).
Moreover, the MITL also establishes that a structured agreement is anywhere the Mexican taxpayer or any related party participates, and the amount paid is linked to payments made to preferential tax regimes that benefits the Mexican taxpayer or any related party, or when it may be concluded that such agreement was executed for such purposes, based on the facts or circumstances.
Considering the above, it is important to keep in mind that this rule would be applicable to all deductible payments for Mexican CIT purposes (e.g., raw materials, inventories, interests, royalties, technical assistance, services, among others).
Notwithstanding, further regulations are expected to be issued by the Mexican Tax Authorities in order to clarify the scope and application of this rule.
On the other hand, in case of indirect payments to preferential tax regimes, this rule will be applicable to payments made to related parties that are not considered as low taxed from Mexican tax purposes, but the final beneficiary of the payments shall be another related party that actually is located in a low taxed jurisdiction for Mexican tax purposes.
For these purposes, there is a presumption of payments carried out indirectly to a tax haven, if the second payment (i.e., the one made to a low taxed jurisdiction) is deducted for tax purposes and is equal to or higher than 20% of the first payment made from Mexican source (by the Mexican taxpayer). In this case, an amount equivalent to the deductible payment made by the recipient that is considered income subject to a preferential tax regime shall not be deductible.
The aforementioned will apply to payments carried out between companies of the same group and also through structured agreements. In this sense, according to the MITL, two members are considered to be within the same group whenever one of them holds effective control over the other or whenever a third party holds effective control upon both.
In this case (i.e., indirect payment), the non-deductible amount for Mexican tax purposes would be equal to the total amount paid by the direct recipient to the second related party located in a low taxed jurisdiction.
However, it is important to keep in mind that the corresponding payment shall be considered deductible as long as the recipient (in a low taxed jurisdiction) obtain income from entrepreneurial activities (business activities). In this sense, the foreign resident should prove that has the necessary personnel and assets to carry out its business activities, as well to demonstrate that it was incorporated and has its effective place of business (management) located in a country that has in force a broad tax exchange of information agreement with Mexico (“substance test”).
Finally, regarding the payments made to low taxed jurisdictions, there are the following exceptions in the application of the aforementioned rule:
- When a structure agreement is in place, the “substance test” exemption will not applicable, when the income derived from the business activity is attributed to a exempted related party getting benefit from it, or the income is attributable to a PE or a branch of the Group, that it is also exempted.
- When the transaction is subject to a “hybrid” treatment (by the entity or by the transaction per se),that results in a deductible payment in Mexico, and in non-tax payment (whether partial or total) in the foreign jurisdiction where the foreign entity is located; however, this would not be applicable, whenever the recipient of payment is a member or shareholder of the Mexican taxpayer, and such members or shareholders include on their gross income all the items of income earned by the Mexican taxpayer proportionally to their participation and provided that they are not considered income subject to a preferential tax regime (i.e. a “check the box” mechanism);
- The MTA shall issue general rules to govern the interaction of the application of this new provision in the case of indirect payments to low tax jurisdictions (or through structured agreements), with rules similar to those in place in foreign law that disallow the deduction of payments made to preferential tax regimes or by reason that they are subject to hybrid mechanisms; however, such rules have not been published as of today.
- The antitax-haven rule would not apply in the proportion in which payment is subject to tax indirectly by reason of the application of the new article 4-B of the MITL (income from transparent vehicles and foreign vehicles); whenever the abroad payment is subject to a 40% withholding tax rate according to the MITL, or when the payment is subject to Mexican CFC (REFIPRES from its acronym in Spanish) or any other similar foreign law provisions (as could be US CFC), under the terms set forth in the general rules issued by the MTA (be aware that as of the publication of this flash, the applicable general rules have not been published, and are currently analyzed by the MTA, thus, foreign CFC rules cannot be considered today as an exemption to the application of the Mexican antitax-haven provision, until the general rules are published). These exemptions shall not be applicable in the case of payments carried out through hybrid mechanism, in which the fifth paragraph will be applicable.
- According to the reform carried out to the Mexican “CFC” section, the tax-haven analysis should be carried out transaction by transaction and not at the entity level.
Finally, be aware that even when this provision tries to be aligned with the BEPS action plan 2 of the OECD, and BEPS Pillar 2, it has important differences with both reports that should be further analyzed and considered by Multinational groups. Moreover, it should be further analyzed if the analysis should be carried out and not at the entity level or by each transaction.
b) Limitation on interest deduction
As part of the amendments of the MITL, an interest expense deduction limitation was also approved, in which the year´s net interest shall be only deductible up to an amount equal to the 30% of the adjusted tax profit.
In this regard, this provision shall only be applicable to taxpayers whose accrued interests from their debts that exceeds MXN 20 million. In this regard, this threshold shall be determined considering all interest of all the entities and permanent establishments of foreign residents that are members of the same group or that are related parties.
On the other hand, it is relevant mention that the following debts will be excluded from this provision:
- Debts contracted to finance public infrastructure works
- Debts contracted to finance constructions in real estate located within Mexico
- Debts contracted to finance the land construction where constructions are going to be carried out
- Debts contracted to finance projects to explore, extract, transport, store or distribute oil and solid, liquid or gas hydrocarbons
- Debts contracted to finance other extractive industry projects
- Debts contracted to finance projects to generate, transmit or store electricity or water
- Public debt yields
Notwithstanding the above, it is established that this provision will not be applicable to the members of the financial system engaged in these operations as part of its business purpose.
Additionally, it is allowed to determine the deductible interest limitation by the taxpayer in a consolidated basis (applicable in case of companies within to the same group).
Be aware that even in cases where the taxpayer does not obtain a tax profit, or when a tax loss is obtained, the adjusted tax profit must be determined. Moreover, when the adjusted tax profit result is equal to zero or a negative number, the total amount of payable interest shall be considered as non-deductible.
The amount resulting from the aforementioned calculation will have to be reduced from the net interest amount in order to determine the non-deductible amount. In this regard, in the event that a part of such interest cannot be deduct in the corresponding fiscal year, it may deduct within the following 10 years.
It is important to mention that this provision will only be applicable when the non-deductible interests determined pursuant to this provision are greater than those determined according to the thin-capitalization provision.
Be aware that other tax implications may arise in the computation of CIT and value added tax provisions, such should be further analyzed as consequence of applying this new provision.
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As always, the staff of the Tax & Legal Practice of KPMG in Mexico is at your service to analyze in detail the effect the application of the above provisions may have on your business.