The new tax reform for the tax year 2020 was published in in the Federal Official Gazette of Mexico, amending provisions of the Income Tax Law, the Value-added Tax (VAT) Law and the Federal Tax Code, among other laws, on December 9, 2019. Some of the main amendments are briefly detailed below.
Income Tax Law
Concept of Permanent Establishment
In order to reflect the recent changes to the definition of permanent establishment (PE) included in in the Organization for Economic Co-operation and Development’s (OECD) Base Erosion and Profit Sharing (BEPS) project, the reform broadens the concept included in the Income Tax Law.
The most important addition to the PE definition refer to activities carried out by nonresidents through a person different from an agent of an independent status; also, a new provision was included aimed at preventing a group of related parties from fragmenting a business operation into minor operations in order to avoid having a PE in the country.
Combat Hybrid Mechanisms (or Hybrid Mismatches)
Although the tax legislation already contains measures against hybrid mechanisms or mismatches (i.e. cases where an expense deduction is authorized by the Mexican tax legislation and the correlative income is tax exempted or not subject to tax abroad), the Mexican government has acknowledged that these measures have not been effective, and that the most recent recommendations of the OECD to combat this practice need to be included in our tax legislation.
Based on the above, the reform considers as a non-deductible expense, payments made by a Mexican tax resident to a related party directly or through a “structured agreement” (under which the consideration to be paid involves payments to entities subject to preferential tax regimes which benefit the Mexican taxpayer or its related parties).
Limits for Interest Payment Deductions
Although Mexican law already contains measures which limit the deduction of interests between related parties, such as thin capitalization rules, the Mexican government deemed it necessary to include new rules regarding interest payments made not only to related parties but also to independent parties.
Under the new rule, any amounts exceeding 30% of the adjusted tax EBITDA (earnings before interest, taxes, depreciation, and amortization) of a legal entity will not be deductible for tax purposes. This limitation is only applicable when the amount of the interest payments made by a Mexican resident entity and its Mexican-resident related parties exceeds in the aggregate 20 million pesos ($1 million).
Carryforward of non-deductible interest is permitted for the following 10 fiscal years taking into consideration the limit established by the rule. It is worth noting that certain interest payments are excluded from the deduction limit rule, such as interest on loans obtained to finance public infrastructure works and real estate developments located in Mexico, as well as interest paid on loans taken to finance projects in the extractive industries, and those derived from public debt instruments.
Corporate groups are allowed to calculate the adjusted tax profit on a consolidated basis, in the terms that will be later established in the Miscellaneous Tax Regulations.
Services and Sale of Goods through the Internet, Technological Platforms, etc.
Following the administrative rules published in 2019, and confirming the intention of the Mexican government to implement new mechanisms to ensure tax compliance by Mexican resident individuals who participate in the business models of the digital economy, new withholding rules are included in the Income Tax Law.
Under the new regime, companies providing digital platform services (regardless of whether they are residents in Mexico or residents abroad) are obliged to withhold income tax to Mexican resident individuals who obtain income through such digital platforms.
Formal obligations are established both for the taxpayers (individuals) and for the legal entities obliged to make the tax withholding, including nonresidents who do not have a PE in Mexico.
Elimination of Private Infrastructure and Real Estate Trusts (Private “Fibras”)
Given that the Mexican government considers that taxpayers have taken advantage of the tax regime applicable to private infrastructure and real estate trusts, the reform eliminates this regime from the Mexican legal system.
Payments Made to Tax Transparent Foreign Entities and Vehicles
Although the current Mexican legislation recognizes tax transparency of entities that are not deemed as taxpayers in other countries allocating income to the members of such entities and vehicles, it has been considered necessary to establish a new rule that simplifies the collection of taxes that ultimately correspond to the members of transparent entities and vehicles, either Mexican tax residents or nonresidents.
For these purposes, a new provision is included in the Income Tax Law applicable to foreign fiscally transparent legal entities and vehicles (such as trusts and partnerships) who obtain Mexican sourced income, in order to disregard their tax transparent status thus being subject to tax under the rules applicable to resident legal entities or to nonresident legal entities, as the case may be.
An exception to the above rule was included regarding tax transparent vehicles that manage private equity funds invested in Mexican legal entities, subject to the compliance of certain requirements, i.e. that the transparent vehicle and its members are tax residents in a jurisdiction with which Mexico has entered into an exchange of information agreement considered as “broad” by the Mexican tax authorities.
Fiscally Transparent Foreign Entities
Under the tax regime applicable before January 1, 2020, Mexican tax residents who obtained income through fiscally transparent foreign entities and vehicles or through legal entities with income subject to preferential tax regimes, as a general rule, were obliged to pay income tax on the income derived by the foreign entities or vehicles, even if the corresponding income had not been distributed by the same; in certain cases an informative return regarding the investments made through these foreign vehicles and entities should be filed.
This tax treatment had certain exceptions under which tax deferral was authorized, i.e. cases where the foreign entity carried out business activities and its passive income did not exceed 20% of its total annual income, as well as cases where the taxpayer lacked control over the entity’s management.
Under the new rules, applicable as of January 1, 2020, a differentiated tax treatment is established between:
- income obtained through fiscally transparent entities; and
- income obtained through controlled foreign entities who do not have a transparent status abroad and whose income is subject to a preferential tax regime.
As a general rule, in both cases, income derived by the foreign entity or vehicle shall be taxable for the Mexican taxpayers, even if the same has not been distributed to them, proportionally to their participation in the entity or vehicle.
Tax deferral may be applicable in certain cases where the taxpayers lack significant control regarding income obtained through controlled foreign entities; no tax deferral is allowed regarding income obtained through tax transparent vehicles.
Value-added Tax Law
Digital Services by Non-tax Residents
The reform also includes several changes and additions to VAT in the area of the digital economy, in order to comply with the recommendations issued by the OECD and increase revenue from indirect taxes.
Among the most relevant changes, the reform establishes that regarding digital services provided by nonresidents who do not have an establishment in Mexico, the service shall be deemed to be provided within national territory and thus taxable for VAT purposes when the recipient of the service is located in Mexico. In these cases, the nonresident who provides the service through a digital platform shall charge the corresponding VAT to the service recipient and shall pay such tax before the Mexican authorities, regardless of whether the nonresident has a PE in Mexico or not.
Federal Tax Code
Tax Invoices for Nonexistent Transactions
Although the current legislation already includes measures against the sale of tax invoices connected to nonexistent operations, the current administration has considered it necessary to include more severe measures against this illegal practice.
Among the most important changes, the reform enables the tax authority to deny the use of the electronic signature (used for purposes of complying with a number of tax obligations) in some specific cases, and to increase the number of cases in which the authority may render digital seal certificates (which enable taxpayers to issue tax invoices) null and void.
These measures are complemented by the criminal tax reform that was approved by the Mexican Congress during earlier months, intended to increase the penalties imposed onto those who sell or use tax invoices in connection with nonexistent operations.
General Anti-Abuse Rule
Although Mexican legislation currently contains measures against tax simulation, it has been deemed necessary to include a new general anti-abuse rule to combat this problem more effectively and comply with the recommendations made by the OECD.
Under the new rule, legal acts that lack a business reason but generate a direct or indirect tax benefit to the taxpayer may be reclassified by the tax authorities in order to assign the tax consequences that correspond to the acts that would have been performed to obtain the economic benefit reasonably expected by the taxpayer.
Disclosure of Reportable Schemes
In order to increase fiscal transparency, and following the recommendations made by the OECD, a new reporting obligation applicable to tax advisers and taxpayers was included in the Federal Tax Code.
In accordance with the reform, tax advisers are required to register before the tax authorities and disclose certain general and personalized schemes designed for their clients, as defined under Mexican law.
For these purposes, a “reportable scheme” is deemed as any scheme that generates or may generate, directly or indirectly, a tax benefit in Mexico to the extent that it complies with any of the features established by law, while “tax adviser” includes any individual or corporation resident in Mexico or resident abroad with a PE in Mexico that in the ordinary course of their activities are responsible for or involved in the design, marketing, organization, implementation or administration of a reportable scheme, or the person who makes available a reportable scheme for implementation by a third party.
It is expected that the amendments and new provisions included in the 2020 tax reform will be clarified and further developed under the rules of the Miscellaneous Tax Regulations to be issued by the Executive Branch.
Jorge San Martín is a Partner and Elsa Sánchez-Urtiz is an Associate at SMPS Legal, Mexico.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.