The tax-writing committee of the Chamber of Deputies released its changes to the public on 17 October 2013.
Read an initial KPMG report about the federal government’s original tax reform package: TaxNewsFlash-Americas: Mexico - Proposed tax reform 2014 would repeal IETU
The Chamber of Deputies approved a revised version of the federal government’s original tax reform proposals—changes that would mainly affect foreign investment and related-party transactions. These changes are described below.
Because the legislative process is still ongoing, it is possible that additional changes could still be made.
Application of benefits of tax treaties
The proposal concerning application of tax treaty benefits generally remains the same.
Thus, as proposed concerning transactions between related parties, the tax authorities may request that a foreign taxpayer (residing abroad) 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 documentation considered necessary for this purpose.
This provision 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.
Limitations on deductions
As originally proposed, the provision concerning a limitation on deductibility of expenses would be summarized as follows:
- Payments of expenses made to related-party residents (either in Mexico or abroad) for which the income is not taxable, or it is taxable at an effective rate that is less than 75% of what would have been paid in Mexico, would not be deductible.
The revised proposal, after changes made by the Chamber of Deputies, would effectively retain language under current law, summarized as follows:
- Payments of expenses to persons, legal entities, trusts, partnerships, investment funds, as well as 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 / amount that would have been agreed to in comparable transactions between independent parties.
The original proposal also would have applied to payments made by the taxpayer if such payments would have been deductible if made by a related party (whether a resident of Mexico or a foreign country). The revised proposal from the Chamber of Deputies clarifies that this limitation would not apply when the related party that could deduct the payment receives the income generated by the Mexican taxpayer either in the same tax year or the following tax year.
This proposal would affect true “double dip” structures, as well as potentially apply to payments made from Mexican subsidiaries to their parent companies when treated as fiscally transparent, although this does not seem to be the objective of the legislation—i.e., to affect permanent establishments and limited liability companies.
Limits on specific payments
An additional section would be added to the non-deductibility provision to limit specific payments.
In general, the measure would provide that payments made to a foreign entity that controls or is controlled by the taxpayer, with respect to payments of interest or royalties or payments for technical assistance, and that fall under any of the following circumstances, would not be deductible:
- 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” would be 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 favor of any person and, when appropriate, any part of a payment.
This measure would likely affect hybrid entities and instruments. However, the proposal could also potentially apply to payments made by Mexican subsidiaries to their parent companies when treated as fiscally transparent entities. Still, it does not seem to be an objective of the legislation to affect permanent establishments or limited liability companies, in general.
Additional corporate income tax on dividends
The initial proposal for tax reform includes an additional 10% corporate income tax, which would be payable on the total distribution of profits and dividends (without gross-up) made to foreign shareholders by a distributing 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 excess amount.
The Camber of Deputies’ revised proposal would clarify that this additional 10% tax would be treated as a withholding tax with respect to foreign residents, and would be payable by the Mexican company by a date that is the 17th day of the month following the date of payment, along with the Mexican company’s monthly estimated tax payment.
Because the revised proposal would treat this amount as a withholding tax, it appears that applicable income tax treaties could limit or reduce the withholding rate, and the foreign resident could possibly claim a tax credit for the amount of tax withheld if allowed by the domestic law of the recipient’s country of residence or if allowed by the applicable tax treaty.
A “grandfather rule” has been added to the proposal, to clarify that this additional 10% tax would apply only to profits generated as of 1 January 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.
Capital gains on publicly trade shares
A “grandfather provision” has been added to the proposal, to allow taxpayers to consider as the tax basis of shares being sold the average of the last 22-days’ closing prices of 2013, instead of the regular tax basis methodology—potentially granting a step up on such tax basis.
Prudent taxpayers would compare both procedures so that they consider applying the procedure that would provide a greater amount of tax basis.
With respect to the maquiladoras tax regime, the definition of “maquiladora operation” would be incorporated into a provision of the income tax law. This would be substantially similar to the definition under the current IMMEX decree, but would include a new requirement that the total revenue for the maquila’s productive activity would have to be be obtained exclusively from the maquiladora activity.
Additionally, only two transfer pricing methods would be available for maquiladoras—a safe harbor method and a possibility of an advance pricing agreement (APA) from the tax administration.
The revised proposal, approved by the Chamber of Deputies, would repeal the possibility of deducting pre-operative expenses in one tax year related to mining concessions exploration.
For more information, contact a tax professional with KPMG’s Mexico tax center:
Jose Manuel Ramírez
+1 212 872 6541
Or contact a tax professional with the KPMG member firm in Mexico:
+5 255 524 68300
+5 281 812 21818