The Situation: A Tax Treaty developed to avoid double taxation, negotiated between Mexico and Spain in late 2015, was just recently published in the official gazettes of both nations. The new protocols are effective September 27, 2017.
The Result: The most significant changes relate to withholding tax rates and the exemption from capital gains taxes in certain instances.
Looking Ahead: The changes should incentivize investment activities in both countries.
On December 17, 2015, Mexico and Spain signed a Protocol to their Convention for the Avoidance of Double Taxation and the Prevention of Fraud and Fiscal Evasion ("Tax Treaty"). The action amended the nations' respective legal provisions substantively. It took nearly two years for both countries to publish the protocol in their official gazettes: July 7, 2017, for Spain and August 18, 2017, for Mexico. The protocol will enter into force in both countries on September 27, 2017.
It is worth mentioning that the Tax Treaty was designated by both countries as a Covered Tax Agreement under the Multilateral Convention to implement tax treaty related measures under the BEPS Project ("MLI"). The amended Tax Treaty incorporates some of the MLI features such as Purpose of the Covered Tax Agreement, Prevention of Treaty Abuse, and real estate related capital gains from alienation of shares.
The most relevant changes include:
- Paragraph 2 of Article 10 of the Tax Treaty is replaced by a new second paragraph that establishes a 10 percent withholding tax on dividends payments (that mirrors the withholding tax on dividends pursuant to Mexican domestic law), but also provides an exemption from such withholding tax if the recipient of the dividends owns at least 10 percent of the equity of the payor or is a pension fund.
- Paragraph 2 of Article 11 of the Tax Treaty is replaced and introduces a withholding tax rate of 4.9 percent on (i) interest payments to financial institutions and insurance companies, and (ii) coupon payments on listed bonds. Furthermore, all other interests payments are subject to the 10 percent withholding tax rate, which represents an important benefit considering that Mexican domestic law provides for a general 35 percent withholding tax rate. Lastly, pension funds are tax exempt on interest income.
- Paragraph 3 of Article 13 of the Tax Treaty previously exempted from tax any capital gains from the sale of shares of companies in the source state if the selling shareholder disposed its entire shareholding so long as that interest represented less than 25 percent of the total equity of the company. The protocol now replaces that provision with a new paragraph 3, which allows the source state to tax net gains on the transfer of shares at a maximum rate of 10 percent, regardless of the equity holding percentage. However, capital gains arising from the sale of shares can only be subject to tax in the transferor's tax jurisdiction when (i) the transferor is any of the following: a financial institution, an insurance company, a pension fund; or (ii) the relevant shares are regularly listed on an stock exchange (except for Spanish REITs). New conditions have been introduced for internal group restructurings, so that the gain can only become subject to tax in the transferor's tax jurisdiction.
The changes brought by the protocol to the Tax Treaty are very welcome as the they provide more certainty to transactions entered into by tax residents of both Spain and Mexico, brings the Tax Treaty closer to the more widely applied tax treatment by the international community and will incentivize investments in both jurisdictions (particularly, for certain type of investors such as financial institutions and pension funds). Moreover, it will allow the Spanish holding companies (known as Entidades de Tenencia de Valores Extranjeras or "ETVEs") to become a potential European holding structure for investments into Mexico.
Two Key Takeaways
- The Mexico-Spain Tax Treaty was designated by both countries as a Covered Tax Agreement under the Multilateral Convention. Certain elements of the Multilateral Convention were incorporated into the Treaty, including Purpose of the Covered Tax Agreement, Prevention of Treaty Abuse, and real estate related capital gains from alienation of shares.
- The Mexico-Spain Treaty brings affected transactions into line with more widely applied tax conventions put in place by the international community.