The government-owned central bank, Banco de México, is responsible for establishing monetary policies, although it is autonomous from the government. The Foreign Investment Commission (Comisión Nacional de Inversión Extranjera) and its Executive Secretary are responsible for administering the controls on foreign investment and authorizing specific investments where required. The Foreign Investment Commission is the central authority that approves foreign investment in new or existing companies where required under the law.
The Foreign Investment Law (Ley de Inversión Extranjera) establishes a National Register of Foreign Investment (Registro Nacional de Inversiones Extranjeras), which is maintained by the Secretariat of Economy (Secretaría de Economía).
The Mexican government trend is toward deregulation in the foreign investment, foreign trade, and financial sectors, and toward stricter regulation in ecological protection, urban development, consumer protection, and intellectual property rights.
Mexico has some monopolies viewed as in the national interest (e.g. the petroleum sector and postal service), but the country has been on a reform path for a number of years, privatizing, deregulating, and cutting back the role of government, and these reforms have encouraged competitiveness in all sectors.
Mexico has many laws to protect investors, such as the competition law, price controls, securities market regulation, consumer protection, imported merchandise standards, food and drugs registration, environmental provisions, e-commerce legislation, mining rights, patent and trademark protection, and copyright privacy.
Foreign companies wishing to engage in commerce in Mexico on a regular basis, in activities in which there are no foreign investment restrictions, must obtain prior authorization from the Secretariat of Economy to register a Mexican branch in the Public Register of Commerce (Registro Público de la Propiedad y del Comercio).
EXPORTING TO MEXICO
Mexico constitutes an excellent potential customer for exporters, with its developing economy and population of over 112 million. It lies in a strategic geographical location for international trade, sharing borders with the US, while facing Europe and Asia, and representing easy entry to the rest of Latin America.
Mexico’s commercial conditions provide an excellent business and investment opportunity. It is a member of the World Trade Organization (WTO), the Asia-Pacific Economic Cooperation Mechanism (APEC), and the Organization for Economic Cooperation and Development (OECD).
Mexico has signed 12 free trade agreements (FTAs), which provide preferential duty rates on foreign trade operations with 44 countries. These FTAs include: NAFTA; the European Union; the European Free Trade Association (Iceland, Norway, Switzerland, and Liechtenstein); Japan; Chile; Israel; Honduras, Guatemala and El Salvador; Colombia; Uruguay; Costa Rica; Bolivia; and Nicaragua.
General Import Duty rates range from 0% to 35%, but most imports fall within the range of 3% to 20% (exceptionally, certain food products, shoes, and textiles pay higher duties). Temporary imports are exempt from customs duties (except for fixed assets) and VAT payments, if conditions are met.
TAX SYSTEM
Resident taxpayers (corporate and individual) are subject to Mexican taxation on their worldwide income, while non-residents are taxed on Mexico-sourced income only.
Corporate income is taxed at the entity level, so after-tax earnings may be distributed to shareholders with no further tax charge for the distributing entity and no income tax withholding regardless of the tax residence of the recipient.
There are no capital duties on share contributions, nor stamp duties.
It is important for investors to be aware of the profit sharing obligation for Mexican entities, equal to 10% of taxable income, which is payable each year to employees. Known as PTU, this payment is deductible for corporate tax purposes.
The concept of form traditionally prevails, however substance is becoming increasingly important.
A great competitive advantage of the Mexican tax system is that Mexico has over 43 tax treaties in effect, with many more in negotiation.
CORPORATE TAX
Mexican entities are taxed with income tax and potentially flat tax, both federal taxes. The corporate income tax rate for the calendar years 2011 and 2012 is 30%. Beginning in 2013, the rate will drop to 29% and then to 28% in 2014. A preferential rate applicable to taxpayers engaged exclusively in agriculture, livestock farming, fishing, and forestry is currently 22.5%.
Provisions to recognize the effects of inflation for tax purposes in the areas of monetary assets and liabilities (annual monetary adjustment) and depreciable assets are provided in the income tax law, even though recent inflation rates have been decreasing.
Dividends paid from the After Tax Earnings Account (CUFIN) are not subject to further Mexican taxation. However, dividends paid in excess of CUFIN are taxed at the corporate level at an effective rate of 42.86%. This tax may be credited by the distributing company against its corporate income tax liability in the same year or in the following two years.
Income tax losses can be carried forward for 10 years (with no carrybacks) and are updated for inflation.
A tax consolidation regime exists in Mexico whereby individual entity losses can be used against profits in other group entities. For tax consolidation, group holding entities must have two shareholders (like any Mexican entity) and any foreign shareholders must be resident in a country with which Mexico has a broad exchange of information agreement, or hold less than 50% of the voting shares of the holding entity. Note that a 2010 tax reform limits the deferral benefits, obtained through consolidation, to five years.
Thin capitalization rules establish a 3:1 debt to equity ratio, disallowing excess interest charges.
Note that all inter-company transactions are closely scrutinized and are subject to contemporaneous documentation requirements to support inter-company prices.
Specific rules are applicable for the recognition of non-remitted income arising from investments in preferential tax regimes.
Mexico does not recognize transparency for any foreign corporations.
Since 2008, Mexican entities are not only subject to income tax, but also flat tax, an alternative business tax covered later in this article.
Double taxation relief is available by way of (limited) credit for foreign taxes paid.
Tax returns for income tax or flat tax are due annually by March 31 and are based on a calendar year. Provisional payments of the applicable tax are made monthly by the 17th day of the month following that for which the tax is calculated.
TAXATION OF FOREIGN COMPANIES
Mexican tax law follows the OECD model treaty definition of a permanent establishment (PE). Mexican branches of foreign entities (i.e. PEs) are generally subject to the same tax rules as Mexican entities, with some exceptions. For example, branches may deduct pro-rata allocations of home office expenses, provided certain requirements are complied with, but may not deduct remittances to their home offices, even when such remittances are classified as royalties, fees, commissions, services, or interest.
In general terms, distributions to the head office, either in cash or in kind from branches or other PEs, are subject to the statutory corporate tax rate on the grossed-up distribution, unless the remittance is made from the capital remittances account or CURECA.
Mexican-sourced income that is not connected with the conduct of business through a PE is generally subject to specific withholding tax rates, although tax treaties reduce or eliminate withholding taxes in some cases.
It is important to analyze whether activities performed by a foreign company may generate a PE in Mexico. For example, sales people or agents with authority to execute contracts can constitute a taxable PE. Goods held in bonded warehouses within Mexico do not constitute a PE. The Mexican customer is considered the importer at the time goods are released from the warehouse. Liaison or representative offices can operate tax-free in certain circumstances. However, if they employ local personnel, they are subject to normal payroll obligations.
TAX DEPRECIATION RATES
Key maximum applicable rates of depreciation or amortization for income tax purposes, on a straight-line basis:
Pre-operating expenses 10%
Fixed assets normally used by a business enterprise:
•Buildings and other construction 5%
•Furniture and office equipment 10%
•Personal desktop and laptop computers,servers, printers 30%
•Cars, buses, cargo trucks, tractors, trailers,forklifts 25%
•Equipment for research and product
development 35%
•Tools 35%
Machinery and equipment for:
•the manufacture of motorvehicles and parts 8%
•the construction industry 25%
•agriculture, livestock farming,forestry or fishing 25%
•restaurants 20%
Other activities 10%
Accelerated depreciation rates are available for many assets, in the form of an immediate deduction equivalent to the present value of the deduction stream, and this option can mean deductions at rates as high as 92%.
MAQUILA REGIME
A key attraction of the Mexican tax system is the maquila (or IMMEX) regime whereby foreign businesses can manufacture, transform or assemble goods in Mexico with significantly reduced (or indefinitely deferred) tax charges, provided that they meet specific conditions, in obtaining authorization for the regime from the Mexican authorities.
Key benefits include PE protection for the foreign principal, effective reduction of corporate tax rates, transfer pricing options limiting taxable profits in Mexico, importation of raw materials and fixed assets without paying VAT or customs duties (in most cases), and zero rate VAT on the “exported” maquila service provided to the principal.
TAXATION OF SHAREHOLDERS
Dividends paid to individuals and residents abroad are not subject to any withholding tax where they are not in excess of the after-tax earnings account (CUFIN).
Intercompany dividends are not included in the taxable income of the recipient, but must be included in the mandatory profit sharing base. When dividends are paid to domestic individual shareholders, such income is taxable for those shareholders on a grossed-up basis, although a proportional credit is available for their portion of the income tax incurred by the distributing entity, thus achieving single-level taxation of distributed corporate profits.
Non-residents are subject to withholding taxes on most Mexican-sourced interest, royalty, service, and technical assistance income at rates varying from 4.9% to 40%, depending on several factors. For taxable gains on disposals, the non-resident investor pays tax at a rate of 25% of the gross sale proceeds or can elect to pay 30% of the net gain, if complying with certain procedures.
Disposals by non-residents of Mexican shares traded widely and publicly in the Mexican or some foreign stock exchanges is generally tax exempt for disposals of less than 10% participations.
A reorganization of Mexican entities of the horizontal type, i.e. a consolidation of two entities or a spin-off of one entity into two or more other entities, can be essentially tax-free (except for the special tax on the acquisition of real property if immovable property is transferred). For non-Mexican entities involved in a reorganization of ownership in Mexican entities, an authorization can be granted for the deferral of taxes.
Tax treaties may reduce or eliminate income tax withholding for nonresidents and the treaty provisions should be analyzed accordingly, depending on the country of residence of the individual receiving Mexican-sourced income.
TAXATION OF TRUSTS & ESTATES
Mexican trusts generally may only be created with domestic banks as trustees. In addition, insurance, bonding, and brokerage companies can create trusts for specified purposes. Generally, trusts are not taxable entities; they act as conduits of income to beneficiaries.
Trusts have frequently been used to hold real property in the border zones and coastlines, where ownership by foreigners has been prohibited or otherwise limited. However, the foreign investment law now permits direct foreign investment in non-residential property if certain requirements are met, making trust vehicles unnecessary.
Investors should be aware of various tax incentives for trustees and beneficiaries who participate in Mexican Real Estate Investment Trusts (FIBRAS) and entities (SIBRAS) and investment options should be evaluated.
It is important to know that when business activities of a non-resident are carried out through a trust, a PE is deemed to exist for tax purposes, although applicable tax treaty provisions should be reviewed to determine if this rule is overridden.
ALTERNATIVE FLAT RATE BUSINESS TAX
Since 2008, a flat rate business tax (IETU) applies to most income from the disposal of goods, independent services, and the leasing of goods, on a cash flow basis. The current flat tax rate is 17.5%. Specific payments, such as royalties between related parties and interest, are not allowable for flat tax.
Flat tax is payable to the extent it exceeds the income tax liability for the period.
Flat tax also has an accounting impact on deferred taxes reported in the financial statements. If the entity expects to pay flat tax in excess of income tax in future years, financial statements will present the deferred tax calculated on this basis.
Foreign residents with PEs are subject to flat tax solely in respect of the income attributable to the PE in Mexico.
It is important to consider that flat tax does not contribute to the after-tax earnings account (CUFIN), so it does not help increase tax-free earnings to distribute to shareholders.
Salaries and wages, employer contributions to the social security system, and non-taxable employee benefits are not included within taxable income and are non-deductible under the flat tax legislation. Nevertheless, the employer can obtain a flat tax credit on “taxable” wages paid and social security contributions made, which is generally equivalent to deducting these two items.
Flat tax credits (excess of expenses over income, multiplied by the flat tax rate) are available to carry forward against any flat tax liability for 10 years.
Investors should ensure they model the potential flat tax effects in any Mexican tax planning.
VALUE-ADDED TAX
VAT is payable monthly at the general rate of 16% on the sale of goods and services, as well as on lease payments and imports of goods and services. In the border zones, an 11% VAT rate generally applies. Some transactions are subject to the zero rate and other transactions are exempt. All exports are subject to the zero rate.
Credit against the VAT liability (which may result in an overpayment to carry forward or application for a refund) may be taken for VAT paid on all imports and purchases. Such credit may not be taken in proportion to revenues that are exempt from VAT or for VAT paid in goods and services that do not represent deductible expenses under the income tax law.
OTHER INDIRECT TAXES
There are various other taxes in Mexican law. A tax is levied on the transfer of real property and the rights thereto; excise tax (IEPS) is levied on certain items (e.g. alcoholic beverages, cigarettes, gasoline), often at substantial rates; and there are various state and municipal taxes, generally at much lower rates than federal contributions.
As we have seen, Mexico is a very attractive country for doing business and we have presented some key issues that investors should consider when looking for a country in which to locate their investments. Mexico has many competitive advantages, in terms of both its commercial environment and tax incentives that can be explored and exploited with the assistance of competent professional advisors.
It is always important to obtain the best support in your business ventures, and PwC Mexico, with more than a century of accumulated experience in Mexico, is the leading professional services organization in the country, providing a full range of business advisory services.
© The Business Year
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
TBY would like to thank PwC Mexico for compiling this analysis.