The Mexican Congress in late October 2019 passed tax reform legislation for 2020.
In general, the tax reform measures reflect changes to certain provisions of Mexico’s income tax law, the value added tax (VAT), the excise tax law, and the Federal Fiscal Code.
The tax reform measures generally are effective 1 January 2020, but certain provisions have a specific effective date.
The following discussion provides details about certain of the tax reform provisions.
Payments to foreign related parties subject to preferential tax regime
With an intention to harmonize the income tax law provisions with recommendations of the OECD’s base erosion and profit shifting (BEPS) project regarding hybrid mechanisms, there are provisions to disallow payments made to certain related parties residing abroad.
Beginning from 2020, payments made to related parties (or made through a structured agreement) will not be deductible when the income is subject to what is described as a “preferential tax regime”—thus, leaving aside the possibility of deducting the payment if it is made at an arm’s length value. Any payment made to a resident of a country that has an applicable rate of tax with respect to that income below 22.5% will not be deductible in Mexico. This would include payments to related parties in the United States that are subject to the reduced rate under the “foreign-derived intangible income” (FDII) regime of 13.125%. There may be similar situations with regard to payments made into other countries.
The rate of income tax in Mexico is not increased if the tax base is “expanded” by these rules limiting the deduction of interest.
Effective 2020, the deduction of “net interest” (interest accrued with regard to a liability less interest accrued in a credit) cannot exceed 30% of the adjusted fiscal profit. If the interest expense cannot be deducted in a given year, it can carried forward and deducted over the following 10 years.
The calculation of this 30% is applicable to separate members of a taxpayer group, but there is an option to apply it at the group level in 2020, according to expected-to-be-issued guidance.
The “adjusted fiscal profit” is the amount of fiscal profit plus accrued interest expenses and less deductions for investments—a kind of fiscal EBITDA (earnings before interest, tax, depreciation and amortization). In the event the result at the end of the year is a tax loss, the net interest expense will not be deductible and will be subject to the carryforward rule. There is an exception for the first MX $ 20 million (note this amount is at the group level).
Foreign transparent vehicles and private equity funds
Certain provisions were added by the tax reform legislation to establish new rules for taxing the income obtained by or through foreign tax-transparent entities or certain legal entities or investment vehicles for private equity funds.
Transparent or investment funds entities will be treated as “opaque” for Mexican tax purposes. If the place of administration or effective place of management is located in Mexico, then these entities will be taxed as Mexican tax resident entities. They will be subject to income tax under the corresponding regime for corporations, not-for-profit organizations, foreign residents, or preferential tax regimes (as applicable). This provision does not apply when there is an income tax treaty between Mexico and the country of residence of the entity is in force and contains provisions that provide for the tax treatment of a transparent entity or legal entity. These rules will be effective 1 January 2021.
Another provision that has been included in the income tax law is intended to regulate the tax treatment of income obtained by Mexican residents or permanent establishments (PEs) in Mexico from foreign residents via foreign transparent entities or certain legal entities. In this situation, Mexican residents and PEs would be subject to taxation from the income received from the foreign entity. If these entities are subject to income tax under any of the regimes of an income tax law, then such income tax paid may be claimed and credited to the Mexican resident taxpayer.
Nevertheless, legal investment funds entities will not be treated as opaque if there is a tax incentive in the income tax law that addresses their situation and is only applicable with regard to private equity investments. Investments made through foreign investment vehicles without a legal personality and considered as transparent for tax purposes abroad and that invest in Mexican legal entities will be considered to be transparent and taxed on the income (in the hands of the beneficiaries). The tax incentive will only apply to income derived from interest, dividends, capital gains, and the use of immovable property. This tax incentive will be available and apply as long as the transparent investment vehicle complies with the following requirements:
If the above requirements are not satisfied, the investment vehicle will not treated as transparent for tax purpose in the proportion to the participation of the members that do not satisfy the above requirements, and the investment vehicle will be treated as a corporation for Mexican tax purposes according to this percentage.
These measures are effective in 2021.
Digital services taxation
The tax reform legislation recognizes an opportunity to establish measures aimed at increasing efficiency in the collection of tax with regard to transactions that are conducted via digital platforms or websites located outside Mexico.
There are new rules, thus, for service providers, users of the electronic services, and intermediaries that connect providers of goods or services to purchasers and users through an online platform. The subject services include downloads or access to images, movies, text, information, video, audio, music, games (including gambling), other multimedia content, multiplayer environments, mobile tones, online news, traffic information, weather forecasts and statistics, online clubs, dating websites, long-distance teaching or testing.
The download or access to books, newspapers and electronic journal is not included in the digital services tax.
In case of digital services provided by foreign residents having no PE in Mexico, it will be considered that the services are provided within the Mexican territory if any of the following items are met:
These items will be considered to be digital services when they are rendered by the use of an app through a digital format via the internet if a consideration for the services is charged.
The obligations of the digital services providers that are foreign residents having no PE in Mexico include requirements that they must:
Moreover, in instances of individuals do not obtain income greater than MX $300,000 during year preceding the year related to the activities conducted via the intermediaries platforms (note this is not the same as the year for salaries and interest), there is an election to treat the withholding as a final, definitive payment. If this option is elected, it is binding for a five-year period.
Note that the fulfilment of these obligations by the foreign resident will not trigger a PE in Mexico.
These measures generally are effective 1 June 2020.
Characterization of acts, economic substance rule
Probably the tax reform change that may generate more legal uncertainty for taxpayers is the one related to the possibility of the tax administration to re-characterize or consider certain legal acts when the acts lack "business reason" and generate a tax benefit—an economic substance rule.
For these purposes, it is considered that there is no business purpose or no economic substance when the economic benefit, present or future, is less than the tax benefit.
In addition, it is presumed (unless proven otherwise) that a series of legal acts lack economic substance when the economic benefit could have been achieved through the performance of a fewer number of legal acts and the tax effect of these would have been more burdensome.
Another reform measure concerns the inclusion of a new chapter in the Federal Fiscal Code concerning the disclosure of reportable transactions.
This new chapter requires tax advisors to present information to the tax authorities regarding transactions or operations in which they are involved. These types of requirements for reportable transactions are present in the laws of other countries, but with smaller and limited scope—they apply to only certain international transactions or operations and not to domestic transactions, as is the case with Mexico.
Read a November 2019 presentation [PDF 489 KB] about the tax reform legislation in Mexico
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