Mexico: Mexican Tax Reform Update – October 2013

On October 17, the Mexican Congress modified the proposed tax reform that was prepared by the executive branch (led by President Enrique Peña Nieto) and forwarded to Congress on September 8. The executive branch's tax proposal had met with opposition from conservatives in Congress and many in the global business community who expressed concern that the adverse tax impact on multinationals and domestic corporations would negatively affect Mexico's investment climate. Many of the corporate tax increases proposed by the executive branch were removed in the tax reform legislation prepared by Congress.

The two houses of the Mexican Congress (i.e., the Chamber of Deputies and the Senate) will debate provisions of the tax reform package during the next few days, and the reform is expected to be approved—either in its current form or with amendments—by October 31. Notable provisions are described below, including tax rate changes, flat tax repeal, VAT reform, and other provisions affecting the popular maquila program, foreign residents, and Mexican individuals and companies.

Income Tax

The main income tax proposals are as follows:

New Dividend Tax. An income tax will be imposed on any dividend received by individual Mexican residents and corporate and individual nonresidents from a distributing Mexican company. Dividends distributed to Mexican corporate shareholders will be exempt. The dividend tax will be imposed at the shareholder level (unlike the executive branch proposal to impose the tax at the distributing company level). The tax rate will be 10 percent of the gross dividend amount, subject to reduction pursuant to one of the 56 double tax treaties Mexico has in force. The tax is imposed only on profits generated after 2013. The tax is collected through a withholding regime imposed on the distributing company.

Corporate Tax Rate. The corporate tax rate, which was scheduled to be reduced to 29 percent in 2014 and 28 percent in 2015 and future years, will remain at 30 percent (as proposed by the executive branch).

Individual Tax Rate. The individual tax rate will be increased from 30 percent to 35 percent. This increase goes beyond the more modest proposed increase to 32 percent by the executive branch.

Treaty Benefits. In related party transactions, foreign residents claiming treaty benefits may be asked to appoint a Mexican resident as their legal representative that will furnish a written declaration under oath stating that the relevant transaction is in fact taxable in the foreign country, including the foreign legal provisions that generate such double taxation. The legal representative will be jointly liable for unpaid taxes of the foreign resident.

Foreign Tax Credit. A new foreign tax credit system will be introduced on a per-country basket basis. The system will allow, in some cases, an indirect tax credit when Mexican taxpayers receive dividends from foreign companies.

Fringe Benefits Deduction Limitation. The deduction for nontaxable fringe benefits provided to employees, such as the savings fund, grocery coupons, etc., will be limited to 41 percent of the cost of said benefits paid to the employees.

Immediate Deduction of Investments. The immediate expensing of certain investments will be disallowed, as originally proposed by the executive branch.

Deduction of Deemed Costs for Real Estate Developers. This deduction, which had been proposed to be eliminated by the executive branch, will remain in effect.

Deduction for Insurance Companies. This deduction, which had been proposed to be eliminated by the executive branch, will remain in effect.

Sustainable Energy Accelerated Deduction. This 100 percent deduction allowable for these investments, which had been proposed to be eliminated by the executive branch, will remain in effect.

Foreign Related Party Deductions. An executive branch proposal—to prohibit the deductibility of payments to foreign related parties when income derived from those payments is taxed abroad at a tax rate less than 22.5 percent—will be substituted with a new prohibition to deduct payments to hybrid entities not subject to income tax in their country of residence or establishment. Additionally, payments made by Mexican taxpayers to foreign related parties will not be deductible if those payments are also deductible in the foreign country.

Capital Gains Derived from Sales Through the Mexican Stock Market. Individuals who are tax resident in Mexico and foreign tax residents will no longer be entitled to the tax exemption on capital gains derived from sales through the Mexican Stock Market. As proposed by the executive branch, a 10 percent capital gains withholding tax will be imposed, to be withheld and remitted by the intermediaries trading the stock through the Stock Market.

Maquila Definition. The executive branch proposal to limit the definition of "maquila" to exporters of 90 percent of their sales is rejected. However, in order for existing permanent establishment protection and other favorable tax rules to apply, the maquila must derive all of its income from designated maquila operations. In addition, new requirements will be introduced as to which entity must own the equipment used by the maquila in its manufacturing operations.

Shelter Maquila. The period in which a shelter maquila is allowed to pay reduced income taxes under the regime will be broadened from three to four years.

Consolidation Regime. The current tax consolidation will be eliminated (as proposed by the executive branch) and replaced with a similar regime (so-called "integration regime"), which is similar to the consolidation regime. A significant difference will be that the consolidation regime allowed a five-year tax deferral, and this new integration regime will limit deferral to no more than three years.

Flat Tax Elimination

The 17.5 percent flat tax, which is an alternative cash basis tax, will be eliminated.

Value Added Tax

Border Region. The current 11 percent tax rate applicable in the border area will be increased to 16 percent.

Tax Exemptions. The proposal by the executive branch to eliminate the tax exemptions for mortgage interest, sales of personal residences, and tuition for private schools will be rejected, and these exemptions will remain in effect.

Maquila Regime. The proposal by the executive branch to impose a 16 percent VAT on the sale of maquila-produced goods located in Mexico between foreign residents or between a foreign resident and a maquila will be rejected. The 0 percent VAT tax rate for these transactions will remain in effect.

The proposal of the executive branch to eliminate the exemption applicable to a maquila's importation of goods will likewise be rejected. Instead, the VAT will be technically imposed on maquilas for goods that are imported for use in maquila production, but the tax would be eliminated by a 100 percent tax credit; accordingly, there will be no cash VAT imposed on these transactions. In order to be eligible for the credit, each maquila will have to be certified by the tax authorities beginning in 2015 according to rules that will be published once the VAT reform is enacted.

Excise Tax

Junk Food. A five percent excise tax will be imposed on the sale of high-caloric food. This is a new tax and was not included in the executive branch proposal.

Fuel and Pesticides. An excise tax will be imposed on fuels and pesticides.

Soft Drinks. A tax of one Mexican peso per liter of soft drinks will be imposed, as proposed by the executive branch.

Mining Fee

A fee for mining rights will be charged at the rate of 7.5 percent of net profits of mining companies, as proposed by the executive branch.

Next Steps

The Mexican Congress will debate the provisions of the Tax Reform package during the next days, and the reform is expected to be approved (either in its current form or with amendments) by October 31.

Jones Day has highly experienced international taxation practitioners who can assist in any matter that may arise on the subject.

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.

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