BLOOMBERG TAX INTERNATIONAL FORUM
The tax overhaul in Mexico is intended to improve revenue collection and provide strengthened legal tools for the tax authorities. José Carlos Silva and Jorge Ramón Galland Ríos look at the provisions in the reform with a focus on those which address BEPS-related measures and tax evasion.
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A consensus has existed among tax specialists in Mexico for a considerable time now on the necessity of enacting a thorough tax overhaul to:
- address economic growth through investment enhancement;
- extend the number of active taxpayers through combating the informal economy; and
- promote wealth distribution in an effort to reduce economic inequality.
Despite the fact that it has been more than six years since the last substantial tax reform, international integration based on capital mobility, and harmonization of tax frameworks to address profit shifting away from the situs where real economic activity and value creation takes place, are still part of Mexico's tax policy.
Mexico's tax-to-GDP ratio (16.1% for 2019) is dead last—ranked 36th out of 36—when compared with the OECD average (34.3%). As a consequence of the low tax revenue statistics for the country, Mexico has been enforcing domestic reforms developed in the context of the Organization for Economic Co-operation and Development (OECD)/G-20 Base Erosion and Profit Shifting (BEPS) Project. The latest development, the tax reform published in the Federal Official Gazette on December 9, 2019, the so-called 2020 Tax Reform, is no exception to this trend.
The tax bill that will be analyzed here was originally proposed by the Executive Branch and approved by Congress in October 2019. The Legislative Intent Explanation document states that the purpose behind its enactment is to address tax avoidance and evasion—as well as to strengthen revenue collection by adding and developing tools, stemming from the BEPS Project, for exercise by the tax authorities—without levying new taxes.
This article will provide a brief survey of some of these measures, dividing them into two main subject areas: BEPS, and tax evasion.
The obligations set out in this recent tax overhaul for regulating certain aspects of the digital economy do not embrace measures from the BEPS Project's Action 1. The legal framework implemented for digital platforms does not levy any income taxes on their profits, but rather intends to collect revenue from individuals carrying out business activities through such digital platforms, under already existing taxes, by means of withholding obligations.
However, value-added tax (VAT) of 16% is enforced on the consideration received by nonresident digital platforms. Several withholding, administrative and data sharing obligations are also established for digital platforms.
Anti-hybrid Mismatch Arrangements
Drawing from Action 2 of the BEPS Project, a new connotation is given to the concept of pass-through foreign entities and/or vehicles. With this new set of rules, tax transparency or "pass through treatment" will be disallowed for Mexican tax purposes and will be now subject to the same rules as "opaque" legal entities. This will be achieved by taking into consideration the effective place of management: if within Mexico, foreign entities/vehicles will be subject to worldwide taxation; if managed outside the country, such entities/vehicles will be subject to pay taxes on Mexican-sourced income.
However, there is no relief for Mexican residents holding a participation in such foreign entities/vehicles, and they must therefore recognize the income derived therefrom, even before profits are distributed. A tax credit is allowed to avoid domestic and foreign double or multilayer taxation.
Furthermore, legal tools are introduced for the tax authorities to neutralize the effects of hybrid mechanisms, based on the tax symmetry doctrine: payment deductibility to related parties will be disallowed if either the related party or the same taxpayer can also claim a deduction on the same payment in a different jurisdiction. Likewise, the deduction of payments made under structured arrangements or related parties will be disallowed if the recipient's income is subject to a low-tax regime.
Controlled Foreign Corporation Rules
The concept of "effective control" over a controlled foreign corporation (CFC) is amended. Whenever taxpayers have 50% or more of any rights to vote, veto, or to decide when profits are distributed, they will be deemed to have effective control of the corporation. Effective control will also be presumed if the CFC has 50% or more of its business activities sourced in Mexico, and if the taxpayer has a right to more than 50% of the assets or profits of the CFC in case of liquidation or a capital reimbursement, at any time during the year.
Interest Expense Deduction Limit
Based on the BEPS Project Action 4, a new limit for interest expense deductibility is included in the 2020 Tax Reform. The deductibility of interest payments is further constricted by disallowing any net interest in excess of 30% of the taxpayer's adjusted tax earnings before interest, taxes, depreciation and amortization (EBITDA). A 10-year carry forward will be applicable to those payments that are not taken during a specific tax year. Furthermore, a de minimis exception is provided by the regime (roughly $1 million of interest is allowed without limitation) as well as certain exemptions regarding specific debt-driven industries related to energy and water projects.
Both the OECD's Multilateral Instrument (MLI) and BEPS Action 7, had a direct influence on the tax bill. The term "permanent establishment" provided in the Mexican Income Tax Law now addresses splitting-up contracts and fragmentation of activities.
Activities that qualify under the preparatory or auxiliary exception but that may be considered as forming part of a comprehensive and coherent business will create a permanent establishment in Mexico. Additionally, independent agents concluding agreements for a nonresident on a regular basis, or that have a main role in the conclusion of such, will also be deemed to create a permanent establishment in the country.
Mandatory Disclosure Rules
New obligations are included for both tax advisers and taxpayers concerning the mandatory disclosure of tax planning arrangements. Stemming from the BEPS Action 12 recommendations, any arrangement or scheme that generates a direct or indirect tax benefit in Mexico to the taxpayer will have to be reported by either the tax adviser or taxpayer.
An index of broadly sketched schemes is provided to define reportable tax planning arrangements in this new regime, which includes harsh penalties for non-compliance. Although reporting will be initiated in 2021, it is important to emphasize that this set of rules could apply retroactively to taxpayers, and is thus something to monitor closely as regulations and forms are published.
Tax Evasion Measures
General Anti-Avoidance Rule (GAAR)
For the first time, Mexico's tax legal framework will include a general anti-avoidance rule (GAAR). The basis of the incorporation of this new rule is to grant the tax authorities the power to assess different tax consequences to those claimed by taxpayers. The rules grant the tax authorities the right to recharacterize any legal act that generates a direct or indirect tax benefit for a taxpayer and that lacks business reasons.
Likewise, under this new set of rules, the tax authorities may deem that no business reasons exist when the economic benefit obtained was attainable in a lower number of acts with other tax consequences, or whenever the expected economic benefit is lower than the tax benefit obtained.
Taxpayers may initiate legal remedies to combat the recharacterization and prove otherwise.
Criminal Tax Reforms
In a controversial move, under the Federal Tax Code, tax fraud will be dealt with under the same rules applicable to organized crime. The issuance and illegal trade of digital invoices is included and could result in a criminal process in which the seizure of assets belonging to the taxpayer may be applicable, as well as imprisonment. A similar treatment is applied to fraudulent outsourcing schemes.
VAT Withholding on Certain Services, Including Personnel Outsourcing
The rendering of independent services by a third party is an issue that is also addressed by this tax reform. A third party that places personnel at the client's disposal, regardless of the legal form of the contract, where the service is rendered, or who directs the personnel, will carry a 6% VAT withholding on the consideration paid for these services. Non-compliant withholding agents shall not be able to take either the corresponding income tax deduction or VAT credit related to the payments made for the outsourcing services.
To Sum Up
As explained above, the tax reform did not include a tax increase in the form of new taxes or higher rates. Its main purpose was to strengthen revenue collection and provide the authorities with powerful legal tools to combat tax evasion.
However, the 2020 tax reform is a game changer in many aspects of the law—particularly in the relationship between taxpayers, their advisers and the tax administration. Despite the fact that a more comprehensive and exhaustive tax reform is still needed for the challenges that lie ahead for Mexico, this seems to be a good opportunity for taxpayers to plan and pave the way ahead for new horizons in the Mexican tax arena.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
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