Overview of Mexicos tax system regarding U.S. Business and commercial activities in Mexico

Overview of Mexico’s tax system

regarding U.S. Business and commercial activities in Mexico

Agenda Doing business or commercial activities in Mexico.

Direct transactions by US resident. Permanent Establishment (Branch). Mexican Subsidiary.

Tax Losses. Mandatory Employee Profit Sharing. Profit distribution (Dividends) tax structure. Sale of Shares. Thin Capitalization rules. Asset Tax. Value Added Tax.

Alternatives for Doing Business in Mexico

Foreign Co.

Branch USCO Inc.

MexCo, SA or SRL

USA

MEX

B

C

Foreign Resident for tax purposes

A

Structure of operations for Income Tax in Mexico

• All individuals and corporations are subject to pay income tax in Mexico, under the following circumstances:

– If they are residents in Mexico, obligation to pay income tax includes all revenue, even if sourced out of Mexico.

Structure of operations for Income Tax in Mexico

– Foreign residents with Permanent Establishments (PE) in Mexico, are subject to pay for the income that is attributable to that PE.

– Foreign residents whose revenue is sourced in Mexico, only if:• Do not have a PE in Mexico, or they have a

PE but that revenue is not attributable to such PE.

“Alternative A”Foreign Resident for Mexican tax purposes

Foreign residents that have no PE in Mexico will be subject to pay in Mexico for all revenue received in cash, goods or services, as long as those revenues are sourced within Mexico.

Payment method and due date. Payment of the Income Tax is ussually aplicable thru a

withholding method, and the tax has to be paid either on payment date or on the due date of payment, whichever is first.


Withholding payment It’s ussually done by the Mexican resident who

performs the payment, or by the foreign resident if payment is done thru a PE in Mexico.

On some cases, payment might be due directly from the foreign resident.


Type of income for Foreign residents Salaries and professional fees. Lease of goods. Sale of real estate. Sale of shares. Dividends. Interest. Financial Lease. Royalties and Technical Assistance. Construction. Artists and athletes.

Subsidiary vs. PE Mexican Subsidiary

Worldwide income is taxable Transfer pricing rules Reduced liability exposure (SA, SRL)

Permanent establishment (Branch) Only taxable on attributable income Payments to parent company non-deductible “Corporate veil” easily broken, liability for USCO. Not for “Maquila” purposes.

“Alternative B”Permanent Establishment

• Any fixed place of business, where full or partial business activities are performed.

• Among others, the following are usually considered PE’s :– Branch, agency, office, factories, workshops,any

place for extraction or exploration of metals

• Foreign Residents that operate thru a person different that an independent agent.– Are considered a PE, especially if this person has

power of attorney to act in behalf of the US resident.

• When the Non Resident operates thru an independent agent, it will be considered a PE if the agent meets the following criteria:– The agent does not operate under its ordinary scope of

activities.

– The agent has in existence good and merchandise which he delivers on behalf of the foreign resident.

– Assumes risk that belong to the foreign resident.

– It is subject to detailed instructions and control from the Foreign resident.

– Receives pay, without taking into consideration the end result of the activities


• Construction services– Applies to building, demolition, instalation,

instalation, projection and supervision activities. – PE is considered when the Foreign resident operates

in Mexico more than 183 days (consecutive or no) in a 12 month period.


• The ITL does not consider a PE under the following circumstances:– The use of facilities with the objective of

exhibiting or storing goods or merchandise.– The purchasing of goods or merchandise to send to

foreign land.– Preparatory or auxiliary activities– The use of bonded warehouses.


“Alternative C”Mexican Subsidiary

S.A. de C.V. S.R.L.Partners Minimum 2,

unlimited maximumMinimum 2, maximum of 50

Equity Minimum $50,000 Pesos

Minimum $3,000 Pesos

US Tax benefit

None US preferential tax treatment as

“flow thru structures”

Type of corporate structureTax treatment is the same for Mexican purposes

General Mexico Income tax Issues

• Corporations and Permanent Establishments are taxed by the determination of the net taxable income, which is determined by the income less the deductible expenses for the year.

• One Federal Corporate Income Tax rate

– 2006 – 29% – 2007 – 28%– No state income tax

• Previous year losses may be reduced.

Tax Losses

Possibility to carry forward for 10 years No carry back.

Possibility of adjusting with inflation. First year with Index rate from July to December Following years from December to June of the year

of amortization.

Tax loss Inflation Adjustment

TAX LOSS 2004 $256,829.00

1st. Adjustment

December 2004July 2004

ADJUSTED TAX LOSS 263,372.00

2nd. Adjustment

June 2005December 2005

ADJUSTED TAX LOSS $267,618.00

Mandatory Profit Sharing Mandatory 10% employee profit sharing. 1 year holiday. No inflation accounting. Dividends received counts as income (not for

IT). Tax losses may not be carried forward. Not a tax, which means no FTC in most

countries.

Total revenue. ( - ) Allowed Deductions.

---------------------Taxable Profit

( - ) Paid Profit Sharing (*)Paid Profit Sharing (*) ( - ) Previous Years Tax

Losses ----------------------- (= ) Net taxable income

Mandatory Profit Sharing (2006)

(*) Starting in 2006

In 2005 considered a deductible expense if amount paid exceeds exempt taxable employee benefits.

Sale Of Shares

US CoSale of SharesSale of Shares

Mex Co

Shares

100% US Co

Sale Of Shares

• Withholding of 25% over gross sale price ór 29% over profit if foreign resident appoints a legal representative In Mexico, and the transaction is audited by an independent CPA.

• Cost basis is determined by– Original cost

– (+) Inflation adjustment

– (-) Tax losses incurred

– (+/-) Difference in balance of the NAPTA account

• Under Mexican income tax law, profit distributions are only taxed once at the corporate level.

• Profits distributions include not only dividend payments but also reimbursement of shares due to corporate capital reductions or a company’s liquidation.

Profit Distribution

Net taxable Income

(-) Income tax paid

(-) Non deductible expenses

(-) Non deductible profit sharing

(=)Net After Profit Account

Net After Tax Profit Account (“NATPA”)

Net After Profit Account

(+) Received Dividends

(-) Distributed Dividends fron NATPA account

(=) Accumulative Net After Profit Account

Accumulative Net After Tax Profit

Account (“NATPA”)

Profit Distribution

• If Dividend comes from NAPTA no Income Tax is paid.

• If payment exceeds NAPTA or there is no balance in this account, corporation pays the Income tax for such distribution in accordance with these factors:

Year Factor Rate

2006 1.4085 29%

2007 1.3889 28%

• If Income Tax is paid for profit distribution, the amount paid is fully creditable versus the corporate Income Tax of the corporation.

• This credit is allowed in the year of the profit distribution or the following two years.

• No inflation adjustment is allowed.

Profit Distribution

Example: Company Corona-Tequila,S.A. de C.V. distributed dividends on june 30th 2005, for the amount of $ 650,000.00, at that date NAPTA account had an adjusted balance of $500,000.

Total dividend distribution on June 2005: $ 650,000.00

-Adjusted balance of the NAPTA account at the

Date of distribution: $ 500,000.00

Distributed Dividends that exceed the NAPTA account: $ 150,000.00

NAPTA balance after distribution: $ 0.00

Profit Distribution-Example

Determination of Income Tax due for the distributed dividends that exceed the NAPTA balance:

Dividendss that exceed the balance of NAPTA: $ 150,000.00

(X) Gross up factor: 1.4085

=Result: $ 211,275.00

(X) Income Tax corporate rate: 30%

=Income tax payable for profit distribution(*): $ 63,382.50

Profit Distribution-Example

(*) This tax is fully creditable for the Income Tax of the corporation for 2005, 2006 or 2007

Thin Capitalization rules

US Co

Mex Sub

Capital? Debt?

Debt vs. Equity Since 2005, “Thin capitalization” rules, limit of 3 to 1

ratio for Debt versus equity. Debt.

Interest deduction in Mexico Inflationary “gain” reduces interest deduction Loans denominated in US Dlls and record exchange losses

to hopefully offset impact of inflationary gain. 4.9 W/H tax on interest paid to US banking institutions. 15% W/H tax on interest paid to US residents other than

banking institutions.

Debt vs. EquityOct Nov Dec Total

Debt Balance 7,500 8,000 11,500 27,000

# months 3

Average 9,000

Inflation 3%

Inflation Gain (taxable) 270

Interest deduction* 156 160 230 546

NET EFFECT (TAX) -276

* Interest rate 25%

Debt vs. Equity Equity

Inflation adjustment on equity added (capital increase) to stock basis.

No W/H tax on dividends to the extent of NAPTA (Fiscal Net Income Account).

Investment can be repatriated as a reimbursement of investment without any tax implication.

Only if original contribution is higher than equity at the time of reimbursement

If not deemed a profit distribution.

Debt vs. Equity Equity, treatment of sale

Any change of ownership is subject to tax. Election to net gain taxation upon prior consent

from Tax Authorities. Stock basis step-up for undistributed earnings and

step-down for losses.

Thin Capital Rules• Interest paid will not be deductible if company

falls under thin capitalization criteria.• A company is considered thinly capitalized when

the liabilities exceed 3 times the amount of equity. – If any of the liabilities come from a related entity.

– If the interest bearing liability comes from non related foreign resident but the company has other related entities in Mexico it has to comply witht he three to one ratio, in order to fully deduct the interest paid.

Thin Capital RulesIf debtor is… …and loan comes from…

…then thin capital

rule……….

Mexican without RE's Mexican non RE of debtor Non applicable

Mexican with RE's Mexican RE of debtor applicable

Mexican without RE's Foreign Resident not RE of debtor

Non applicable

Mexican with RE's Foreign Resident not RE of debtor

applicable

Mexican with RE's Foreign Resident RE of debtor

applicable

Thin Capital RulesDetermination of Excess of Liabilities over equity

Yearly Average of liabilities ( Equity

(Beg. Balance + Ending Balance) x 3 2

)-

Final Monthly balance# of months of the year

Non deductible

interest

Accruedannual interest

Annualdebts

average

Excess of

debts

Thin Capital Rules

x =

Thin Capital RulesYearly average of accounts payable

(ending balance of each month of the year

divided by the number of months)

2,500,000$

Minus: Average Equity for the year

Beginning equity 500,000

Ending equity 600,000 / 2 = 550,000

Three times the amount of equity 550,000 X 3 = 1,650,000

Excess of liabilities (3 to 1 ratio) 850,000

Thin Capital RulesExcess of liabilities 850,000

Average liabilities 2,500,000

Interest rate 5.00%

Interest that correspond to the year 125,000 = 0.0500

Average liabilities 2,500,000

Factor to apply to excess liabilities 0.0500

Non deductible interest 42,500

Thin Capital RulesAs a tax reform for 2006, the following account payables are not included in the yearly average:

• To distribute dividends• To reduce the stock• To sell assets• To engage in new credits• To transmit the majority of the shares• That allows the loan company to

participate in the determination of the best use of funds.

- Option for application in 2005

Credit subject to terms that limit the capacity of the debtor

Tax on Assets

• An alternative minimum tax– 3 year carry back, 10 year carry forward

• 1.8% average assets less certain debts– Since 2005 debt with banks and nonresidents is reduced

• 4 year holiday– Except for leasing

– Interrupted upon mergers, spin offs and transformation

Value Added Tax

15% imposed on Sale of goods Services Leasing Imports

0% on exports (direct & indirect) enabling the tax to be refunded or offset against other taxes.

10% on the border region.

Value Added Tax

Service Provider

USCOUSCO

Mex Co

Shares

Supplier

VAT PAYABLE 0VAT PAYABLE 0VAT CREDITABLE 150VAT CREDITABLE 150 FAVORABLE FAVORABLE BALANCE 150BALANCE 150

Export 0%

VAT Paid 100 VAT Paid 50

USA

MEX

Documents

Overview of Mexicos tax system regarding U.S. Business and commercial activities in Mexico