Mexico: Non-deduction of payments to low-tax jurisdictions and limitation on interest deductions
Mexico: Non-deduction of payments
The 2020 tax reform includes measures disallowing deductions of payments made to related parties in low-tax jurisdictions and limiting certain interest deductions. These measures have an effective date of 1 January 2020.
The 2020 tax reform was part of the 2020 economic legislative package, presented to the Mexican Congress in September 2019. Read TaxNewsFlash
Payment to low-tax jurisdictions
The “anti-tax haven provision” establishes that payments made directly or indirectly to related parties subject to “low taxation” or through a structured agreement are not deductible for Mexican corporate income tax purposes.
For these purposes, according to Mexico’s income tax law, “low-tax jurisdictions” are those that provide for income taxation that is lower than 75% of the tax rate that would be payable in Mexico (30% for legal entities) regarding the same transaction (that is, 22.5% over same taxable income). Moreover, Mexico’s income tax law also establishes that a “structured agreement” is any agreement in which a Mexican taxpayer or any related-party participates, and the amount paid is linked to payments made to parties located in jurisdictions having a preferential tax regime 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 and circumstances.
Considering these rules, it is important to keep in mind that this treatment would apply for Mexican corporate income tax purposes, to all deductible payments made for raw materials, inventories, interests, royalties, technical assistance, services, etc.
Regulations providing guidance to clarify the scope and application of these rules are expected to be issued by the Mexican tax authorities.
Application of rules to indirect payments
Concerning “indirect payments” made to parties in jurisdictions having preferential tax regimes, the Mexican rules also apply even when the payments are made to related parties that are not considered to be “low taxed” from Mexican tax perspectives when the final beneficiary of the payments is another related party that actually is located in a low-tax jurisdiction (as determined under the Mexican tax law).
For these purposes, there is a presumption that payments are made indirectly to a tax haven jurisdiction when the second payment (i.e., the one made to a low-tax jurisdiction) is deducted for tax purposes and is equal to or greater than 20% of the first payment made from the Mexican source (by the Mexican taxpayer). In this case, an amount equivalent to the deductible payment made by the ultimate recipient is considered to be income subject to a preferential tax regime and is not deductible for Mexican income tax purposes.
This treatment will apply to payments made between companies of the same corporate group and also will apply to payments made through structured agreements. According to provisions of Mexican income tax law, two members of a corporate group 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 over both. In this situation of indirect payment, the non-deductible amount for Mexican tax purposes is equal to the total amount paid by the direct recipient to the second related party located in the low-tax jurisdiction.
However, it is important to note that the corresponding payment will be considered to be deductible as long as the recipient (in a low-tax jurisdiction) obtains income from entrepreneurial activities (business activities). In this sense, the foreign resident must prove that it has the requisite personnel and assets to carry out its business activities, as well as it must 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 (referred to as the “substance test”).
Finally, regarding the payments made to low-tax jurisdictions, there are the exceptions in the application of the rule:
- When a structure agreement is in place, the “substance test” exemption will not apply when the income derived from the business activity is attributed to an exempted related party receiving benefit pursuant to the agreement or when the income is attributable to a permanent establishment or a branch of the corporate group, that it is also exempt.
- When the transaction is subject to “hybrid” treatment (by the entity or by the transaction, per se) that results in a deductible payment in Mexico, but in a non-taxable payment (whether partial or total) in the foreign jurisdiction where the foreign entity is located. However, this treatment will not apply whenever the recipient of the payment is a member or shareholder of the Mexican taxpayer, and such member or shareholder includes on gross income all the items of income earned by the Mexican taxpayer proportionally to the member’s or shareholder’s participation and provided that it is not considered to be income subject to a preferential tax regime (a “check the box” mechanism).
- The Mexican tax authorities are to issue general rules as guidance concerning the interaction of the application of this rule in situations of indirect payments to low-tax jurisdictions (or through structured agreements). The guidance is to be similar to that in place in foreign law that disallows the deduction of payments made to preferential tax regimes or by reason that they are subject to hybrid mechanisms; however, the Mexican tax authorities have yet to issue these rules (as of 23 March 2020).
- The anti-tax haven rule will not apply with regard to the portion of the payment that is subject to tax indirectly by reason of the application of the new article 4-B of the Mexican income tax law (income from transparent vehicles and foreign vehicles). Whenever the foreign-made payment is subject to a withholding tax rate of 40% (according to rules under the Mexican income tax law), or when the payment is subject to Mexican controlled foreign corporation (CFC or “REFIPRES” from the acronym in Spanish) or any other similar foreign law provisions (such as U.S. CFC rules), under the terms of the general rules of the Mexican tax authorities. This guidance is currently being considered by the Mexican tax authorities but not yet published as of 23 March 2020; thus, foreign CFC rules cannot currently be considered to be an exemption to the application of the Mexican anti-tax haven provision, until the general rules are published. These exemptions will not be applicable in instances when payments are made through hybrid mechanisms (in which the following item will apply).
- According to the reform of CFC provisions of Mexican income tax law, the tax-haven analysis is to be conducted on a transaction-by-transaction basis and not at the entity level.
Note that even while this rule appears to be aligned with the OECD’s base erosion and profit shifting (BEPS) Action 2 recommendations and BEPS Pillar 2, there are significant differences between Mexico’s treatment and that of the BEPS items, and multinational groups need to consider further analyzing these differences—with inquiry to whether this analysis is appropriate at the entity level or by each transaction.
Limitation on interest deduction
As part of the 2020 tax reform amendments to Mexico’s income tax law, an interest expense deduction limitation was enacted and provides a year´s net interest is only deductible up to an amount equal to 30% of the adjusted tax profit.
In this regard, this provision is only applicable for taxpayers having accrued interest from their debts that exceeds $20 million pesos. This threshold is determined considering all interest accruals of all entities and permanent establishments of foreign residents that are members of the same group or that are related parties.
Interest related to certain debts are excluded from this interest deduction limitation 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 when 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
The interest deduction limitation provision will not apply to members of the financial system engaged in these operations as part of its business purpose.
The rules allow a taxpayer to determine application of the deductible interest limitation on a consolidated basis (applicable for companies within to the same group).
Even in instances when the taxpayer does not realize a taxable profit, or when a tax loss is recognized, the adjusted tax profit must be determined for purposes of these rules. Moreover, even when the adjusted tax profit result is equal to zero or a negative number, the total amount of payable interest can be non-deductible.
The amount resulting from the calculation will have to be reduced, that is subtracted, 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 deducted in the corresponding tax year, it may be carried forward and deducted over the following 10 years.
This provision will only apply when the non-deductible interest amounts, as determined under this provision, are greater than those determined according to the thin capitalization provision. There may be other tax implications arising from the computation of corporate income tax and value added tax provisions, and may require further analysis as a consequence of applying this new limitation on interest deduction provision.
For more information, contact a tax professional with the KPMG member firm in Mexico:
Armando Lara Yaffar | +52 (55) 5246 8374 | email@example.com
Alfredo Cobix | +52 (55) 5246 8727 | firstname.lastname@example.org
The KPMG name and logo are trademarks used under license by the independent member firms of the KPMG global organization. KPMG International Limited is a private English company limited by guarantee and does not provide services to clients. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's Federal Tax Legislative and Regulatory Services Group at: + 1 202 533 4366, 1801 K Street NW, Washington, DC 20006.