Mexico's Congress recently approved tax measures that will affect investments made by foreign entities in Mexico, including changes to the application of tax treaty benefits to related party transactions, limitations on certain deductions and the introduction of withholding tax on dividends. To complete enactment procedures, the president must sign the bill and it must be published in the official gazette.
For an in-depth discussion of these changes approved by Congress on October 31, 2013, see "Tax Reform 2014" [PDF 397KB], a new publication prepared by KPMG Mexico.
In September, Mexico's Congress was presented with an economic package for 2014 that included, among other changes, various proposals to limit deductions, impose additional corporate income tax on profits or dividends distributed to foreign shareholders and implement anti-abuse rules. In late October, the Senate approved the tax reform provisions, following the passing of a revised version of the package by the congressional committee earlier that month.
Application of benefits of tax treaties
The package includes a measure that could affect the application of income tax treaty benefits (i.e., reduced withholding tax rates) when the income is not taxed in the other treaty-partner country. The measure specifically applies to tax treaty benefits for transactions between related parties and provides that the tax authorities may ask a foreign taxpayer (residing abroad) to prove the existence of "legal" double taxation through a statement, made under oath and signed by the taxpayer's legal representative.
This sworn statement must represent that income subject to tax in Mexico, and for which the taxpayer plans to apply income tax treaty benefits, is also subject to tax in the country of the income recipient's residence. With the sworn statement, the taxpayer's legal representative must include the applicable legal provisions, as well as the necessary documentation.
It is not clear whether this measure could deny the reduction of withholding tax on dividends paid by Mexican companies to Canadian companies under the treaty where those dividends are essentially not taxed in Canada under the Canadian foreign affiliate rules. A similar concern may exist where dividends are paid to countries with participation exemption regimes.
Limitations on certain deductions
The tax reform package provides an arm's-length rule for deductible expenses that is effectively similar to the current transfer pricing laws for arm's length prices. The measure provides that payments of expenses to persons, legal entities, trusts, partnerships, investment funds, and any other legal vehicle whose income is subject to preferential tax treatment would not be deductible unless the taxpayer demonstrates that the price or the amount of the consideration is equal to the price or amount that would have been agreed to in comparable transactions between independent parties.
Limits on certain non-arm's length specific payments
Mexico has added an additional measure to the non-deductibility provision to limit specific payments including certain interest, royalty or technical assistance payments made to a foreign entity that controls or is controlled by the taxpayer. Generally, the payments are not deductible where:
- The entity receiving the payment is transparent (this limitation would not apply if the shareholders or partners are subject to income tax for the amount of income received and the amount is equal to the consideration that would have been agreed in comparable transactions by independent parties)
- The payment is "non-existent" for tax purposes in the country or territory where the foreign entity is located
- The foreign entity does not consider the payment as taxable income in accordance with applicable tax provisions.
"Control" is defined as when a party has effective control or administration over another party, to the degree that the controlling party could decide the time for the delivery or distribution of income, profits or dividends, either directly or by proxy.
"Payments" include an amount accrued in favour of any person and, when appropriate, any part of a payment.
This measure may affect payments made by Mexican companies to a parent company that is a hybrid entity or where the parent company is not subject to tax on the income because of a hybrid instrument.
Withholding tax on dividends
The package includes the introduction of a 10% withholding tax on the distribution of profits made to foreign shareholders by a Mexican entity—regardless of the CUFIN (net profits account) balance, and in addition to the standard 30% rate of corporate income tax on the grossed-up amount of the distribution exceeding the CUFIN balance. This 10% withholding tax would be payable by the Mexican company by the 17th day of the month following the date of the distribution, along with the Mexican company's monthly estimated tax payment.
A "grandfather rule" has also been added to clarify that this 10% withholding tax would apply only to profits generated as of January 1, 2014.
Note that, with respect to permanent establishments (PE), the tax would remain an additional 10% tax payable by the PE on the distribution of dividends or profits.
Mexican subsidiaries of Canadian companies may want to consider making a dividend distribution before the year-end.
Mexico's Congress has approved specific rules to counter the use of "tax invoices" when such invoices are not appropriately used and represent a "malpractice" by the taxpayer (an earlier anti-abuse rule was rejected during the legislative process).
The tax reform package:
- Keeps the corporate tax rate at 30% (i.e., it will not be decreased)
- Repeals the IETU (Mexico's single rate business tax)
- Introduces a new regime providing for a 10% tax rate on capital gains realized for publicly traded shares, provided certain requirements are satisfied – if the foreign resident cannot meet these requirements a 35% tax rate applies
- Makes changes to revenue requirements and limitation on transfer pricing methodologies under the Maquiladoras tax regime
- Revises the mining tax proposal that repeals the possibility of deducting pre-operating expenses in one tax year, and instead applies the standard rules allowing a 10% deduction per year
- Introduces a special mining fee of 7.5% applied to the positive difference between the revenues from the sale of mining products less deductions allowed under the income tax law and an extraordinary mining fee of 0.5% of the revenues from the sale of gold, silver and platinum
- Repeals the current tax consolidation system and replaces it with another optional regime that provides a tax deferment period of three years (from five years)
- Makes various reforms to the tax compliance system including:
- Mandatory digital invoice requirements for expenses to be deductible
- A requirement to upload financial records and information to a centralized system each month
- An online "tax mailbox" from which taxpayers will receive their tax correspondence.
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We can help
Your KPMG adviser can help you assess the effect of these important changes on your corporate structure and your international tax planning. For more details on Mexico's tax reform and its potential impact, contact your KPMG adviser.
Information is current to November 15, 2013. The information contained in this TaxNewsFlash-Canada is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour 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 upon such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's National Tax Centre at 416.777.8500.
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