Acquisitions (from the buyer’s perspective)

Tax treatment of different acquisitions

What are the differences in tax treatment between an acquisition of stock in a company and the acquisition of business assets and liabilities?

On a day-to-day basis, the acquisition of stock is one of the most frequently used alternatives to gain control of a target company. From a tax perspective, the acquisition of stock has many virtues; among them, the fact that the sale of stock in a company is generally not subject to value added tax or that tax attributes of the target company are included in the acquisition thereof.

As mentioned above, the acquisition of stock includes tax attributes. However, it should be noted that tax liabilities prior to the transfer of the business are also included therein, thus outlining the paramount importance of conducting thorough accounting, legal and tax due diligence. (For further details, see question 9.)

Notwithstanding the foregoing, certain aspects must be taken into account when opting for this alternative. For instance, in some cases where certain tax requirements are not met, tax consequences for a non-resident purchaser could be triggered. Income tax could be triggered in operations in which non-residents acquire stock issued by a Mexican resident when tax authorities determine that the market value thereof exceeds the purchase price by more than 10 per cent.

A common alternative to the acquisition of a target company via stock purchase is the acquisition of the business assets thereof. In general terms, this option consists of the purchase of the assets that are essential for the operation of the target company. In a sense, this alternative enables the acquirer to handpick the assets that are considered valuable and discard other items deemed as a burden for the business in question.

Moreover, tax authorities may permit certain authorised deductions in connection with the calculation of income tax due for the acquisition of the business assets. Nevertheless, it is important to point out that pursuant to applicable Mexican tax laws, goodwill may not be deducted.

Unlike acquisition of stock, the general rule is for acquisitions of business assets to be subject to value added tax, and, whenever real estate is involved in the operation at hand, federal and local taxes thereupon could be triggered.

Furthermore, in an asset deal, in terms of article 26(iv) of the Federal Tax Code, the acquirer could be jointly liable for contributions generated prior to the acquisition of the ongoing business for up to the value of the business itself (the full price paid for all the assets).

Step-up in basis

In what circumstances does a purchaser get a step-up in basis in the business assets of the target company? Can goodwill and other intangibles be depreciated for tax purposes in the event of the purchase of those assets, and the purchase of stock in a company owning those assets?

In connection with the acquisition of stock, no step-up in basis is considered regarding assets of the target company; in general terms, the step-up in basis only occurs concerning the price paid for the purchased stock. (The tax basis of the assets remains the same, thus, no step-up in basis could be deemed to exist.)

With reference to the acquisition of business assets, the basis for the acquisition will be the amount effectively paid therefor and allocated to each asset; hence, a step-up in the basis thereof could be considered.

Additionally, in the latter, both fixed assets and intangibles may be deducted through the straight-line method, bearing in mind that goodwill, among other items, may not be deducted for income tax purposes.

Other items, such as investments in fixed assets, cost and deferred charges, preoperative expenses, technical assistance and royalties may be deducted in the percentage set forth in the corresponding provisions for each item.

Domicile of acquisition company

Is it preferable for an acquisition to be executed by an acquisition company established in or out of your jurisdiction?

There are numerous aspects that must be carefully analysed in order to decide whether to acquire a target company directly (as a non-resident) or indirectly by means of a (Mexican) resident company.

In a stock deal, in cases where the purchase of the target company is made by the non-resident by means of a Mexican entity, the cost of the acquisition will be generated at the level of the first (ie, due to a capital increase in the resident company used for the purchase) and, indirectly, at the target company’s level. From a tax standpoint, tax consequences deriving therefrom could be either adverse or beneficial depending on several factors (such as the target company’s financial position in the relevant tax year).

Should the non-resident decide to perform the acquisition of the target company on its own, tax treaties executed by Mexico ought to be kept in mind given that certain benefits pertaining to the distribution of profits, capital gains, payments on interests, etc, from the target company to the purchaser could apply depending on the applicable tax treaty.

In an asset deal, if the acquiring entity resides abroad, a permanent establishment could be deemed to exist in cases where a non-resident acquires the essential assets directly and continues the operation thereof. Accordingly, the non-resident could be taxed over Mexican-sourced income and, in cases where a permanent establishment is deemed to exist, over income attributable thereto as well.

Regardless of the foregoing, other options such as special purpose vehicles could be considered in order to perform a tax-efficient acquisition, reducing exposure to liabilities.

Company mergers and share exchanges

Are company mergers or share exchanges common forms of acquisition?

From a tax perspective, mergers (provided that both of the parties involved are Mexican residents for tax purposes) tend to be more efficient than share exchanges. The foregoing is the case, given that mergers may be treated as tax-free transactions, provided that certain requirements are met. In that sense, it is common that mergers do not cause income tax or value added tax. (Exceptions may apply.)

Likewise, tax attributes of the merged company may be passed down to the surviving company. (Certain exceptions such as net operating losses may apply).

Pursuant to applicable Mexican tax laws, share exchanges are a tax-efficient alternative only to corporate restructures of entities of the same group, as any share exchanges could be considered as a double sale with the corresponding tax consequences (a taxable transaction for both parties).

Tax benefits in issuing stock

Is there a tax benefit to the acquirer in issuing stock as consideration rather than cash?

From a corporate standpoint, the issuance of stock by the acquirer as consideration could prove to be a convenient strategy. Likewise, the convenience thereof could lie in cases where the acquirer has a cash shortage or cash flow-related complications.

Nonetheless, in general terms no tax benefit is included in the applicable Mexican tax laws with regard to this alternative. Thus, even in cases where the purchaser issuing the stock might not trigger tax consequences, the recipient thereof could in fact have to face tax repercussions similar to a cash deal.

Transaction taxes

Are documentary taxes payable on the acquisition of stock or business assets and, if so, what are the rates and who is accountable? Are any other transaction taxes payable?

Mexican tax laws do not contain documentary taxes such as stamp duties in connection with the acquisition of stock or business assets. However, value added tax is due in the performance, either by individuals or legal entities, of certain activities. In this regard, and as mentioned in question 1, value added tax could be payable concerning asset operations (ie, asset purchase agreements) in which business assets are acquired (certain exceptions, such as account receivables, may apply).

According to the Mexican value added tax law, the general tax rate is of 16 per cent. The sale of certain goods may be subject to a rate of zero per cent or even exempted from the tax at hand.

In connection with operations and transactions carried out after the acquisition of a target company by means of an asset purchase agreement, distinguishing between activities subject to a zero per cent value added tax rate and those that are exempted thereof is vital given that, while the first may allow the crediting of paid value added tax, the latter do not give rise to such benefit.

In recent years, tax authorities have assumed an aggressive position towards value added tax refund claims, slowing down refund procedures, whereby legal action is often necessary in order to obtain a favourable resolution. The foregoing should be kept in mind due to the cashflow implications that could derive therefrom.

It is important to point out that even though the transfer of land (not including the transfer of other properties contained therein, that is, only the value of the soil) might be deemed as a value added tax-free operation, whenever real estate is involved in the acquisition of business assets, local taxes may be due (ie, transfer tax).

Net operating losses, other tax attributes and insolvency proceedings

Are net operating losses, tax credits or other types of deferred tax asset subject to any limitations after a change of control of the target or in any other circumstances? If not, are there techniques for preserving them? Are acquisitions or reorganisations of bankrupt or insolvent companies subject to any special rules or tax regimes?

Whenever the amount of authorised deductions exceeds the amount of taxable income, tax losses will be deemed to exist. Such losses may be used to reduce the taxable profit for the subsequent 10 tax years, until fully amortised. However, when in a given year a taxpayer fails to carry forward tax loss carry-forwards, even though such taxpayer could have done so, said taxpayer shall forfeit the right to do so in subsequent years, for up to the amount that could have been carried forward.

When there is a change in the partners or shareholders that control a company with pending tax loss carry-forwards and the sum of the company’s income in the preceding three years is less than the amount, updated for inflation, of those losses at the end of the last year before the change of partners or shareholders, such company may carry forward losses only to offset tax profits corresponding to the same type of business activities in which the losses were sustained.

Lastly, it should be noted that concerning mergers, the surviving companies are not entitled to use the losses generated by the merged companies and that losses of the surviving companies may only be used against gains generated as a result of the same type of business activities that gave rise to the losses prior to the merger.

According to Mexican tax laws, no special rules or preferential tax regimes apply for the acquisition of target companies subject to insolvency or bankruptcy procedures. However, taxpayers subject to such procedures may reduce debts remitted by their creditors (following the procedure set forth by the applicable laws) from pending losses in the relevant tax year in which the debt remittance took place. In cases where the amount corresponding to the remitted debts is greater than the pending losses, the differences therefrom should not be considered as accruable income unless the debts in question were originated by transactions between related parties.

Interest relief

Does an acquisition company get interest relief for borrowings to acquire the target? Are there restrictions on deductibility generally or where the lender is foreign, a related party, or both? In particular, are there capitalisation rules that prevent the pushdown of excessive debt?

Mexican tax authorities and laws have assumed an aggressive position towards items related to or classified as interest payments. In that sense, in order for such payments to be deductible, certain requirements must be complied with. Therefore, thin capitalisation, transfer pricing and back-to-back rules, among other requisites, ought to be observed for such purposes. As outlined hereunder, the deductibility thereof is heavily conditioned.

Bearing the foregoing in mind, interest payments on borrowings obtained by a Mexican resident in order to acquire a target company could be deductible for income tax purposes provided that the lender’s corporate purpose includes acquiring, holding and transferring stock of other companies.

Concerning the deduction of interest payments between resident companies and foreign related parties, certain thin capitalisation rules ought to be abided by. Resident companies may only be entitled to deduct such payments as long as the total amount of debt contracted does not exceed three times the company’s net worth. In cases where such debt-to-net-equity ratio is not complied with, interest payments would not be deductible for income tax purposes.

In connection with the above-mentioned, it is important to point out that companies engaged in specific industries (ie, the financial system and certain activities related to the country’s strategic sectors) may be permitted to have higher debt-to-net-equity ratios, provided that the tax authorities grant them an authorisation therefore.

Moreover, with regard to the applicable transfer pricing rules, corporate entities entering into transactions with non-resident related parties must determine their accruable income and authorised deductions bearing in mind that the price and other compensation for such transactions are equal to the amount that would have been paid to independent parties on an arm’s-length basis.

Concerning back-to-back rules, yields on credits between related parties could receive the same treatment as if they were dividends.

Interest derived from foreign taxpayers is subject to income tax via withholding; nonetheless, non-resident parties should keep in mind that tax treaties entered into by Mexico could provide them with reduced withholding rates applicable thereto.

According to Mexican tax laws, debt pushdown is not an allowed practice. That being said, some operations between related parties could be deemed as debt pushdown operations. In this regard, tax authorities, considering that no business motives are involved in such transactions, have denied the deduction of interest.

Protections for acquisitions

What forms of protection are generally sought for stock and business asset acquisitions? How are they documented? How are any payments made following a claim under a warranty or indemnity treated from a tax perspective? Are they subject to withholding taxes or taxable in the hands of the recipient? Is tax indemnity insurance common in your jurisdiction?

As outlined in question 1, any tax liability prior to the acquisition of stock in the target company remains therewith after the transaction takes place.

Consequently, adequate representations and warranties in the negotiation proceedings are of paramount importance in order to minimise or avoid any potential tax liabilities or contingencies, to enable the acquirer (and in some cases even the target company) to seek indemnity, as well as to ensure that the seller’s indemnities are backed up by collateral.

Likewise, regarding the acquisition of business assets, the purchaser could be jointly liable for taxes due by the seller of the ongoing business prior to the transaction, for up to the value of the business. In addition, other liabilities must be taken into account, for example, labour liabilities.

Based on the foregoing, it is essential to conduct exhaustive accounting, corporate and tax due diligence in order to verify the target’s tax compliance, identify potential liabilities and, consequently, establish strategic vantage points in the negotiation proceedings.

The purchaser (or the target company) could be entitled to seek indemnity from the seller in cases where tax authorities determine the existence of liabilities or that tax due was not duly paid prior to the acquisition. In this respect, it should be noted that pursuant to the Federal Tax Code, the statute of limitations regarding tax authorities’ auditing powers is five years, although certain exceptions may apply, in which the statute of limitations is 10 years.

In general terms, resident companies or permanent establishments that receive indemnity-related payments ought to accrue such items for income tax purposes. Concerning non-residents, income tax due should be determined over the total amount of indemnities or damages paid by resident companies or permanent establishments located in Mexican territory.

Regarding forms of protection generally sought for stock and business assets acquisitions, the most common mechanism used by the purchasing party is to deposit a percentage of the purchase price in an escrow account for a certain period of time in order to cover the seller’s indemnity obligations. Tax indemnity insurance is available in Mexico, but is not commonly used.

Post-acquisition planning

Restructuring

What post-acquisition restructuring, if any, is typically carried out and why?

Evidently, and due to a multiplicity of factors, companies have different needs. As a result, post-acquisition restructuring should be treated as custom-made operations undertaken to implement the most tax-efficient structures and to address the relevant company’s needs and interests.

In consideration of the foregoing, some of the most common means of post-acquisition restructuring consists of mergers or spin-offs (which could be treated as tax-neutral operations, under certain circumstances) or debt refinancing.

In some cases, Mexican entities involved in complex structures could opt to migrate foreign holding companies into the country as a means of restructuring.

Spin-offs

Can tax-neutral spin-offs of businesses be executed and, if so, can the net operating losses of the spun-off business be preserved? Is it possible to achieve a spin-off without triggering transfer taxes?

Tax-neutral spin-offs may be executed in Mexico, provided that holders of at least 51 per cent of the voting stock in the existing and new companies remain the same (that is, their participation in the capital stock of the existing and new companies must be proportional to the voting share they had or have in the existing and new companies for a year before the transaction and two years thereafter).

Concerning monetary spin-offs, more than 51 per cent of the substantial monetary assets may neither be transferred to the new companies nor retained by the existing one in order for the operation to be deemed as tax-neutral. Failing to comply with the preceding requisite could give rise to a tax treatment in which a capital reduction and the transfer of property over such assets would be deemed to have taken place and, as a result, both income and value added tax could be payable.

Regarding tax loss, if the original company primarily conducted commercial activities, the tax loss carry-forwards pending for offsetting tax profits shall be divided between the original company and the companies spun-off in proportion to the division of the total value of inventories and accounts receivable related to the commercial activities of the original company. Other tax attributes are also divided between the entities.

Notwithstanding the above, local taxes may still be payable in cases where real estate is transferred, varying on the state in which the operation takes place.

Migration of residence

Is it possible to migrate the residence of the acquisition company or target company from your jurisdiction without tax consequences?

Pursuant to applicable Mexican tax laws, the migration of residence of a target company in Mexico is not possible without triggering tax consequences. Should a resident corporate entity change its tax residence to another country, a liquidation for tax purposes would be deemed to exist and income tax could be due as if an arm’s-length sale of assets had occurred. Therefore, the deemed transfer of assets (and the corresponding deemed distribution in favour of the shareholders) could be subject to taxation.

Interest and dividend payments

Are interest and dividend payments made out of your jurisdiction subject to withholding taxes and, if so, at what rates? Are there domestic exemptions from these withholdings or are they treaty-dependent?

Dividends paid by resident companies are not subject to corporate taxation as long as they are paid out of the after-tax earnings and profits account that already has been subject to taxation. Should that not be the case, the entity paying dividends will be required to pay tax on the distribution of untaxed profits.

In addition, dividends paid to non-residents, whether individuals or legal entities, as well as to resident individuals, would be subject to an additional 10 per cent withholding tax. In some cases, Mexican individuals receiving dividends could have an additional tax burden of up to 5 per cent.

Yields on credits as well as debt claims could be classified as interests in accordance with Mexican tax laws, and as such, taxed when capital is invested in Mexico or when a resident or a non-resident with a permanent establishment in Mexico makes such payments.

In accordance to the foregoing, and in consideration of the debt’s nature, the corresponding withholding rate could range from 4.9 per cent up to 40 per cent.

Non-resident parties should always bear in mind that tax treaties entered into by Mexico could provide them with relief regarding tax payable on interest and dividend payments made out of the country, such as lower withholding rates or the possibility to credit or deduct in their jurisdiction Mexican tax effectively paid.

Tax-efficient extraction of profits

What other tax-efficient means are adopted for extracting profits from your jurisdiction?

Until recently, interest, royalty and service-related payments were commonly used by taxpayers to erode the taxable base of their operations.

Therefore, in order to address certain practices through which taxpayers were abusively extracting profits from the country (for instance, by way of abuse of tax treaties), tax authorities established more rigorous thin capitalisation and transfer pricing rules. It is worth mentioning that the Organisation for Economic Co-operation and Development has been developing base erosion and profit shifting programmes to address such matters.

As a result of the foregoing, the Mexican income tax law establishes limitations to the deductibility of interest deriving from excessive indebtedness of taxpayers with non-resident related parties in order to control operating debt margins. In that sense, debt arising from credits subject to distribution of dividends, sale of business assets, transfer of control and reduction of capital, among others, should be taken into account in order to determine the debt-to-net equity ratio referred to in question 8.

Concerning transactions between related parties, transfer-pricing provisions ought to be abided by. Consequently, regarding transactions between a resident taxpayer and a non-resident related party, the first should determine its accruable income and authorised deductions bearing in mind that the price and compensation for such transactions must be equal to that which would have been paid to an independent party (arm’s-length principle).

Disposals (from the seller’s perspective)

Disposals

How are disposals most commonly carried out - a disposal of the business assets, the stock in the local company or stock in the foreign holding company?

Concerning disposals, non-residents may prefer disposing of the target’s stock, as tax treaties entered into by Mexico could provide them with certain benefits.

In addition, from the seller’s perspective, it is essential to consider the cost of acquisition of the shares in the target company. In cases where the cost of shares is deemed high, it could be convenient to dispose of the target’s stock, given that such cost could be deducted from the sale price in order to calculate income tax due.

Alternatively, in cases where the cost of shares is low, the seller could prefer to dispose of the target’s assets.

Concerning transactions in which a company that holds stock in a target company whose assets are then sold to a third party, tax consequences triggered when the assets are transferred and when profits deriving therefrom are later distributed to the seller should be kept in mind.

Disposals of stock

Where the disposal is of stock in the local company by a non-resident company, will gains on disposal be exempt from tax? Are there special rules dealing with the disposal of stock in real-property, energy and natural-resource companies?

Income deriving from the disposal of stock issued by a resident company could be subject to taxation at a rate of 25 per cent over the gross amount of the consideration corresponding thereto, when in the hands of a non-resident seller. Nevertheless, provided that certain requirements are met, non-residents could opt to calculate income tax due at a rate of 35 per cent over the capital gain in question (with the possibility to deduct the cost of the shares), that is, on a net basis. However, in order for the latter alternative to be available, non-residents must designate a representative in the country in charge of complying with several obligations, such as remitting the corresponding tax.

While the disposal of stock listed on the Mexican Stock Exchange, as well as other recognised markets, may be subject to a 10 per cent tax rate, no special rules are included in Mexican tax laws concerning the disposal of stock in companies related to the energy and natural resources industries.

In pursuance of some of the tax treaties entered into by Mexico, taxation on capital gains deriving from the transfer of stock could be limited or avoided (such as in cases where the non-resident seller has a minority participation in the Mexican entity, or simply due to the non-resident’s jurisdiction).

Moreover, the disposal of stock issued by non-resident companies, 50 per cent or more of whose value derives from real estate located within the country, could be subject to taxation. In such cases, tax treaties may provide relief from taxation, assuming that certain conditions are met (eg, that real estate properties located in the country are used in the performance of its activities).

Avoiding and deferring tax

If a gain is taxable on the disposal either of the shares in the local company or of the business assets by the local company, are there any methods for deferring or avoiding the tax?

Mergers, spin-offs and corporate reorganisation in connection with the disposal of stock or business assets may result in tax-neutral (or at least tax-efficient (deferral)) operations that may manage to change or even avoid taxation, as mentioned throughout this chapter.

In this regard, tax authorities may authorise the deferral of income tax payable over profits deriving from the disposal, by a non-resident of stock in a Mexican company, between companies belonging to the same corporate group (concerning stock-for-stock transactions). Income tax corresponding to the profits obtained from such a disposal of stock would be payable within 15 days of a second transaction or disposal by means of which the stock in question ceases to belong to any of the companies from the corporate group takes place.

Update and trends

Key developments of the past year

Are there any emerging trends or hot topics in the law of tax on inbound investment?

Key developments of the past year18 Are there any emerging trends or hot topics in the law of tax on inbound investment?Northern Border Region tax incentives

The Decree granting tax incentives to taxpayers in the Mexican Northern Border Region (the Decree) entered into force on 1 January 2019 and will remain in effect during 2019 and 2020. The Decree’s purpose is to establish mechanisms to strengthen the economy of taxpayers of the northern border of the country, enhance and increase investment, encourage productivity and contribute to the creation of sources of employment. The Decree includes a tax incentive that allows Mexican taxpayers (both individuals and legal entities) and foreign residents with a permanent establishment in Mexico to pay two-thirds of the income tax applicable to the income obtained from activities carried out in the Border Region. Regarding value added tax (VAT), the Decree provides a tax incentive applicable to Mexican taxpayers that consists of granting a tax credit equivalent to 50 per cent of the VAT rate, so that the applicable rate to such taxpayers would be 8 per cent.

Taxpayers that plan to benefit from the tax incentives for income tax and VAT must comply with a series of requirements. The requirements applicable to the income tax incentive differ from the requirements applicable to the VAT incentive, so that there could be taxpayers who will be able to apply the income tax incentive but not the VAT incentive, and vice versa.

Elimination of the right to universal offset of taxes

Under the Federal Revenue Law for 2019, the right to universal offset of taxes (ie, the possibility of offsetting different type of taxes, such as income tax against VAT) was eliminated, so taxpayers may only offset favourable tax balances against due taxes when both refer to the same tax. The right to universal offset of taxes had been in force since 2014. The elimination of this right will affect companies’ cashflows; any favourable tax balance arising after December 2018 that cannot be offset against the same type of tax can be requested to the tax authority via the usual processes established for tax refunds.

Base erosion and profit shifting (BEPS) actions

The Multilateral Instrument to Implement Tax Treaty-Related Measures to Prevent Base Erosion and Profit Shifting (MLI) was signed by Mexico on 7 June 2017. Certain BEPS measures had already been included as a result of the 2014 tax reform (for example, anti-hybrid rules, interest deduction, controlled foreign corporation rules and transfer pricing rules); additional actions have not yet been implemented in domestic legislation. However, it is expected that Mexico will implement certain additional BEPS recommendations, such as measures regarding the digital economy.