The two houses of the Mexican Congress (the Chamber of Deputies and the Senate) last week passed a tax reform measure which now awaits President Enrique Peña Nieto’s signature. The legislation is significantly different than the President’s controversial tax overhaul proposal forwarded to Congress on September 8. If signed by the President, as expected, the new tax rules will be effective on January 1, 2014, except as noted below.
The tax reform measure is very similar to the reform measure passed by the Chamber of Deputies and forwarded to the Senate on October 17, which was the subject of a Jones Day Alert dated October 18. Set forth below is a summary of the significant changes included in the reform package as well as a description of material proposals by the executive branch which were rejected or modified by Congress.
Federal Tax Code
New “tax mailbox” process. A new procedure will be established, known as the “tax mailbox”, to facilitate and expedite communications between the tax authorities and taxpayers and to allow electronic reviews and tax audits. According to the transitory provisions, the tax mailbox will be available for legal entities on June 30, 2014 and for individuals on January 1, 2015.
Tax reports (dictámenes fiscales). Under current law, companies are obligated to file tax reports prepared by their external auditors, which gives them the benefit of not being audited by the tax authorities until the external auditor is questioned about the tax report. Congress modified the rule to give some companies the option to choose whether or not to file such tax reports, with the continued benefit to delay tax audits. This is more advantageous than the rejected executive proposal, which would have eliminated the opportunity to file such tax reports.
Joint liability for partners and shareholders. Each partner and shareholder having control in the decision making of a Mexican legal entity will be jointly responsible for unpaid taxes and will be required to post a bond or otherwise guarantee tax credits under litigation, according to their percentage share ownership in the legal entity. This new rule is less restrictive than the executive proposal to impose strict liability on all shareholders for the tax liabilities of their legal entities.
Reduced period to challenge tax credits in an administrative appeal. The term to file an administrative appeal to challenge tax credits was reduced from 45 business days to 30 business days. This is less restrictive than the executive proposed 15 business day term. Taxpayers remain entitled to alternatively challenge tax credit determinations directly before the Tax and Administrative Court without first filing an administrative appeal.
Negotiated settlement of tax credit disputes. Taxpayers will be given the option to negotiate directly with the tax authorities, with the participation of the Taxpayer National Ombudsman, to resolve disputes regarding tax credits and amicably terminate tax audits without issuing a tax assessment.
Rejected substance over form provision. Congress rejected the executive proposal to empower the tax authorities to review, under a substance over form approach, transactions in which Mexican taxes were not triggered.
New dividend tax. An income tax will be imposed on any dividend received by individual Mexican residents and corporate and individual non-residents 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% 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% in 2014 and 28% in 2015 and future years, will remain at 30%.
Individual and withholding tax rates. The individual tax rate will be increased from 30% to 35%. This increase goes beyond the more modest proposed increase to 32% by the executive branch. Also, all items of Mexican source payments to non-residents will be subject to withholding at 35% unless the rate is reduced by Mexican law or by tax treaty.
Treaty benefits. Foreign residents claiming treaty benefits will be obligated to appoint a Mexican tax resident as its legal representative in order to file either an informative tax return or a tax report related to the Mexican source payment received by such residents. In addition, the tax authorities may require foreign residents to describe its related party transactions and, through its local legal representative, furnish a written declaration under oath stating that its related party transactions will be taxable in the foreign country and describing the specific foreign legal provisions generating such foreign 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.
Exempted wages and some fringe benefits deduction limitation. The deduction for nontaxable wages and certain nontaxable benefits provided to employees, such as the savings fund, will be limited to 53% of the cost of such nontaxable wages and benefits. Moreover, if the number of different types of nontaxable benefits of the previous tax year are reduced in the following tax year (for example, a company eliminates its savings fund), then the deduction will be limited to 47% instead of 53%. This may be an incentive for companies to reduce different types of nontaxable benefits provided to employees.
Accelerated depreciation of assets. The immediate expensing of certain investments will be disallowed, as originally proposed by the executive branch.
Repeal of deductibility of pre-operating expenses for mines. The allowance of deducting pre-operating expenses for mining companies was eliminated; however, this elimination will enter into force until January 1, 2015. Additional rules impacting the mining industry are discussed below.
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% deduction allowable for these investments, which had been proposed to be eliminated by the executive branch, will remain in effect.
Restricted deductibility of payments to hybrid entities. Payments to related and unrelated hybrid entities will not be deductible unless the payment is proven to be arm’s length.
Additional restricted deductibility on foreign related party payments. In addition to the above-described restricted deductibility of payments to hybrid entities, two additional rules will disallow related party deductions. First, technical assistance, interest or royalty payments will be nondeductible when paid to a foreign entity controlled or controlling the Mexican entity if (x) the foreign related party has “pass-through” tax treatment, its shareholders or partners are not taxed in the same jurisdiction and the payment was not agreed on an arm’s length basis; (y) the foreign related party considers the payment to be disaggregated; or (z) the foreign related party does not consider the payment to be taxable income. Second, related party payments that are also deducted by another related party will be nondeductible.
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% capital gain 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% of their sales is rejected. However, in order for existing permanent establishment protection and other favorable tax rules to apply, themaquila must derive all of its income from designated maquila operations. In addition, new requirements will be introduced as to which entity much 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 3 to 4 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 5 year tax deferral and this new integration regime will limit deferral to no more than 3 years.
Real Estate Investment Companies. The Congress approved the proposal of the executive branch, eliminating the special tax treatment granted to Real Estate Investment Companies (known as SIBRA for its Spanish acronym). Henceforth, the SIBRA status (that allowed to defer income tax on contributed real estate and allowed not to file monthly tax returns) will not be available anymore.
Flat Tax Elimination
The 17.5% flat tax, which is an alternative cash basis income tax, will be eliminated.
Value Added Tax
Border region. The current 11% tax rate applicable in the border area will be increased to 16%.
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% 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% 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 inmaquila production, but the tax would be eliminated by a 100% 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.
Junk food. An 8% excise tax will be imposed on the sale of high caloric food. This new tax was not included in the executive branch proposal and is higher than the 5% rate originally proposed by the Chamber of Deputies.
Fuel and pesticides. An environmental 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.
The proposed fee for mining rights was approved by the Congress. The fee will be charged at the rate of 7.5% of net profits of mining companies.
An additional mining fee equal to 0.5% of gross earnings from the sale of gold, silver and platinum was approved.
President Nieto is expected to sign the tax reform measure into law after which the new tax rules will enter into force on January 1, 2014, except for provisions having a delayed effective date.