Trademarks: Tax implications in the U.S. & Mexico
Approximately 30% of the global market is related to intellectual property. While intangible goods cannot be touched or seen, they are all too real. For companies around the world, one of the most important intangible assets for trading are Trademarks.
In practice, owners of Trademarks often generate income by licensing their trademarks to other parties. The owner is referred to as a "licensor." The other party, referred to as the "licensee," pays "royalties" to the licensor for use of the Trademark.
Investors often come to Mexico seeking out foundational legal advice concerning the incorporation of a Mexican company. But they should not overlook tax planning in connection with their Trademarks. However, the failure to engage in proper tax planning with respect to intangibles may leave much on the table. Indeed, royalty payments are often an alternative to repatriating capital.
This article provides a general overview of the tax implications in connection with cross-border use of Trademarks and their implications for U.S. tax residents investing in Mexico.
Trademark royalties paid to a U.S. investor – Mexican tax implications
Under the Mexican Income Tax Law (IT Law), non-Mexican resident individuals and legal entities with a permanent establishment (PE) in Mexico are subject to income tax ("IT") with respect to income that is attributable to the PE. U.S. tax residents are also subject to tax on Mexican source income.
Royalties include payments for, among other things, the temporary use of trademarks, trade names, patents, certificates of invention or improvement, copyrights of literary, artistic, or scientific works under the Federal Fiscal Code (FFC) 1.
Notably, income from royalty payments, technical assistance, or publicity is deemed to be from Mexican source income if (1) the goods or rights for which the royalties or technical assistance are paid are used in Mexico or (2) the amounts are paid by a Mexican resident or by a foreign resident with a PE in Mexico.
Generally, the tax is calculated by applying the applicable withholding rate (25% or 35%) to the gross income. The payor is required to withhold the corresponding amount. Royalties paid for the use of trademarks are subject to a 35% tax rate 2.
Withholding rates may be reduced under the Mexico-U.S. tax treaty if certain requirements are met. The withholding party may apply the reduced tax rate, if it is applicable. However, if the withholding party applies a higher tax rate, the foreign resident may request a refund. Additionally, the withholding party is required to issue a digital tax invoice to the foreign resident.
Under the Mexican Value Added Tax Law (VAT Law), individuals and legal entities are required to pay VAT at a 16% rate if such persons carry out the following activities in national territory: (i) transfer goods; (ii) provide independent services; (iii) grant temporary use or enjoyment of goods and (iv) import services and/or goods.
The use of intangible goods that are provided by foreign residents in Mexican territory is deemed to be the import of goods.
In the case of the import of intangible goods, the importer (taxpayer of the VAT) is entitled to a credit against the import VAT. In certain cases, the import VAT would not impact the importer.
Additionally, if a Mexican subsidiary is incorporated, certain restrictions may apply to the royalty payments made to its U.S. Holding, as new deduction restrictions were included in the Mexican tax provisions, regarding payments made to tax havens.
Generally, from a Mexican tax perspective, a country with a corporate tax rate of less than 22.5% may be considered a tax haven (a country or jurisdiction with low-rate taxes or no corporate taxes). In such a case, payments made by a Mexican company to a Company whose tax rate is less than 22.5% or it is a transparent vehicle, royalty payments may be restricted or would have to comply with an additional tax burden.
Moreover, transactions carried out between related parties are required to be at fair market value and supported by a transfer pricing study from the U.S. and Mexican sides.
As such, a U.S. tax resident licensor (with a corporate tax rate of 22%) must pay a 35% withholding tax in Mexico on the income received from royalties for licensing a Trademark to a Mexican subsidiary at fair market value. However, if the U.S. tax resident licensor complies with the U.S.-Mexico tax treaty, it would be subject to a 10% withholding tax. Additionally, Licensee (Mexican subsidiary) may deduct royalty payments from its taxes if certain requirements are met. This reflects tax symmetry.
We recommend performing due diligence and a thorough tax analysis before deciding which vehicle or jurisdiction will own the Trademarks, and from which vehicle and jurisdiction the licensor will receive royalty payments, as various tax implications may be triggered for the licensor in the U.S. and the licensee in Mexico, respectively. Additionally, the economic tax burden may be reduced for the taxpayers.
Trademark royalties obtained from Mexico – U.S. tax implications
Generally, royalties paid for the use of property in the U.S. are U.S. source income, and royalties for the use of property outside the U.S. are foreign-source income. The place in which the intangible property is used is the situs of the economic activity giving rise to the income, regardless of the place at which the intangible property was developed. For example, if a Trademark is used in the U.S., the income is U.S. sourced. Residence or nationality of the payor or recipient of royalties does not affect the U.S. sourcing rules.
A royalty payment is related to the use of a valuable right. Royalty income includes the amounts paid for the use of or for the privilege of using patents, copyrights, secret processes, formulas, goodwill, trademarks, trade brands, franchises, and other property.
Royalties received from a controlled foreign corporation (CFC) by U.S. shareholders are treated as having the same character as that of the income from the CFC. Generally, income received by a U.S. resident is treated as passive income. However, if the royalties received from a CFC are business income, then they are treated as general limitation income received by the U.S. shareholders and not as passive income.
Payments of U.S. source "fixed and determinable annual or periodic" (FDAP) income, for example, royalties paid to foreign residents are subject to U.S. withholding tax at a 30% rate, unless a reduced rate of withholding or exempt rate is claimed under an income tax treaty. Payment of royalties should be reported on Form 1042-S.
1. Article 15-B of the Federal Fiscal Code
2. Article 167 of the IT Law
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.