On Nov. 18, 2015, reforms to the Mexican Income Tax Law (MITL), Tax Code, Excise Tax and Federal Income Law for 2016 (collectively, the Tax Reform) were published in the Federal Gazette. The Tax Reform reestablishes measures to promote savings and increase incentives for doing business in Mexico, some of which were eliminated in the tax reform of 2014. In this Client Alert, we describe some relevant aspects of the Tax Reform.
Tax Reforms for the Energy Sector:
- In December 2013, the energy sector in Mexico was opened to national and international investors, triggering a need for financing, either via debt or equity, for energy producers. The means of financing could be restricted by thin capitalization rules. Thin capitalization rules provide that any interest payments to a related party outside Mexico are generally not deductible if the debt to equity ratio is greater than 3 to 1. Before 2014, this threshold was not applicable to interest from any incurred debt used to invest in the production of electric energy. However, during 2014 and 2015 no such exception applied. Now, the Tax Reform is reinstating this benefit so that companies in Mexico solely involved in these kinds of projects may be funded with 100% debt and deduct all interest payments to a foreign shareholder without being subject to thin capitalization thresholds. This new rule will apply retroactively to debt incurred in 2014 and 2015, thus any taxpayer in the energy industry that was subject to the limitation will have the right to compensate the tax paid in those two years against any payable taxes.
- Taxpayers who carry out investments in renewable energy equipment and who use renewable energy in their operations, specifically, solar, wind, hydro, geothermal energy, and biomass fuel equipment, are eligible to obtain a 100% upfront deduction for the cost of new investment in equipment. This upfront deduction allows the taxpayer to reduce its current tax bill or defer the payment of taxes using the tax losses triggered by such deduction. However, if because of such tax losses no taxes are paid by the taxpayer, the taxpayer would not have an After-taxed-profits Account (CUFIN – Cuenta de Utilidad Fiscal Neta). In general terms, the CUFIN is equal to a Mexican entity’s net taxable income, less income tax paid, less certain nondeductible items. A CUFIN balance is relevant because dividends not paid out of the CUFIN are subject to the general corporate tax rate of 30% at the distributing entity level in Mexico, and dividends coming from such account are not subject to such corporate tax, but only to a 10% withholding tax applicable on certain shareholders. Taxpayers investing in renewable energy, generally, do not have a CUFIN balance from where they could pay dividends free of the 30% corporate tax to its shareholders on early stages of their operations because at those stages the sum of tax losses allows them not to pay any income taxes. Under the Tax Reform, dividends paid by Mexican subsidiaries “exclusively” engaged in the production of renewable energy may be exempt from the corporate tax if the dividends, instead of being paid out from the CUFIN, are paid out from a specific account called “Profit Account for Investment in Renewable Energy” (CUTINER – Cuenta de Utilidad por Inversión en Energías Renovables). Taxpayers are deemed to be “exclusively” engaged in the production of renewable energy if their income derived from those activities represents at least 90% of their total income. The CUTINER is calculated based on a taxable income amount considering a 5% depreciation percentage and a fictional tax amount, which are determined only for purposes of the CUTINER. In that regard, the CUTINER is an account that will allow the taxpayers to distribute dividends free of the 30% corporate tax when no CUFIN could have been generated. It will exist only until the total of tax losses carried forward by the taxpayer exceeds the amount of her net taxable income. When the taxpayer´s profits reach an amount enough to generate a net taxable income higher than the tax losses, the CUTINER will no longer be usable and the taxpayer shall start using a CUFIN account. If dividends are paid out of the CUTINER to individuals and foreign tax resident shareholders, the 10% withholding tax will, however, still be applicable.
- Investment Trusts for Venture Capital (FICAPs) are tax transparent entities with certain withholding obligations developed to promote investments in shares issued by nonpublic Mexican companies. FICAPs have not been very appealing for investors because of burdensome requirements and limitations, e.g., the FICAP time limit of 10 years. Since, the development of the energy sector in Mexico has become a priority for the current Administration, the Executive decided to make FICAPs a more suitable vehicle for foreign and national investors. The Tax Reform is eliminating the current life cap of 10 years for these trusts, so that energy projects in Mexico with duration periods longer than 10 years can use this vehicle.
- The variable tax rate for gasoline and other fuels depending on Pemex costs and performance currently established on the Mexican Excise Tax Law is replaced by a fixed fee, applicable to producers and importers of gasoline and other fuels.
Reforms toward BEPS implementation
- The Base Erosion and Profit Shifting Action program of the OECD (BEPS) was endorsed by the G20 in July 2013 and approved by its leaders in November 2015. It addresses the shifting of profits to low or no-tax jurisdictions to ensure that profits are taxed where economic activities are performed and where value is created, while at the same time standardizes tax compliance requirements. Mexico, as an active member and fully aligned to the OECD´s project, once again is taking the lead as one of the first countries to adopt OECD recommendations under BEPS. On that front, the Tax Reform establishes that (i) entities with taxable income of more than approximately US$37 million and publicly traded companies, (ii) entities part of an “integrated group” of companies, (iii) public companies, and (iv) foreign tax resident entities with permanent establishments in Mexico, having operations with related parties, must all file three new information tax returns: a master file, a local file and, in cases of “holding” or “appointed” companies in Mexico, a country-by-country reporting. The tax returns will require, in general, information regarding their organizational structure, description of the business, intangibles owned, financial and tax positions (including APAs, rulings), and their per country activities.
- In the same line of BEPS, as a measure against tax avoidance and evasion, the OECD was asked by the G20 to develop a standard to exchange financial information. This gave rise to a Multilateral Competent Authority Agreement on Automatic Exchange of Financial Account Information (CAA) that has been signed by 78 jurisdictions and to a Common Reporting Standard (CRS). Together, they place on jurisdictions an obligation to obtain information from their financial institutions and automatically exchange that information with other jurisdictions. The CRS sets out the financial account information to be exchanged, the financial institutions required to report, the different types of reportable accounts and taxpayers covered, as well as common due diligence procedures to be followed by financial institutions. In this regard, the Tax Reform will require Mexican financial institutions to disclose to the Mexican Tax Authorities data on account holders and beneficiaries resident in a country that is a signatory of the CAA, so as to facilitate international exchange of information with other revenue agencies. In general terms, the financial institutions must identify “reportable accounts” as defined in the CRS and file the information with the Mexican Tax Authorities every June 30, starting June 30, 2017.
- The adoption of these anti-avoidance measures will bring about immediate results for the Mexican Tax Authorities with the enforcement of a temporary repatriation program. Generally, Mexican tax residents with investments in low tax jurisdictions, as defined under the MITL, are required to (i) recognize any passive income obtained therein regardless of any profit distributions or repatriation of their investments, (ii) pay any taxes due on a yearly basis at a 30% rate, and (iii) file certain tax information returns. Noncompliance with those requirements may trigger fees, surcharges, and even criminal sanctions. Following other OECD members, like Belgium, France, Germany and the UK, Mexico will enact a temporary repatriation program under which taxpayers may become tax compliant with respect to any undisclosed investments in foreign jurisdictions prior to December 2014, without facing sanctions, surcharges, or fees. However, the program will be available only if the Mexican taxpayer invests such repatriated income in certain areas, such as fixed assets, technology or pending debts and the amount of said investments is not reduced for a period of three years and fulfills some additional requirements. This voluntary disclosure program is expected to last until July 2016. Taxpayers being subject to a tax audit or a pending litigation with the tax authorities may not use these benefits. The program, however, does not provide a discount on tax rates, does not provide a means to pay the tax anonymously, and does not take into consideration the risks of liquidating foreign currency positions to invest inpesos, which may limit the benefits afforded under the program.
- The current dividends regime under the MITL provides for a 10% withholding tax levied on foreign tax residents and Mexican individual shareholders. Individual shareholders tax residents in Mexico receiving dividends issued by Mexican entities will be eligible for a tax credit applicable against such 10% withholding tax, so long as any profit generated during tax years 2014, 2015, and 2016 is reinvested by the company issuing the dividends. The amount of tax credit available will differ depending on the year in which the dividends are distributed. If the dividends are distributed in 2017, the credit will be equal to 1% of the distributed amount; in 2018, it will be 2%, and in 2019, it will be 5%. Entities whose shares are not publicly traded on the Mexican Stock Exchange must elect to make a tax report of their financial statements to use this benefit.
- The withholding interest tax rate of 4.9% applicable under domestic law to interest payments to foreign financial institutions, investment banks and non-bank banks- that has, until now, been confirmed on an annual basis by the Congress, will remain for 2016. This time, however, the 4.9% was established in transitory provisions of the MITL. This gives it an indefinite duration and reduces the uncertainty of its application in upcoming years. The rate applies provided the foreign financial institutions, investment banks and non-bank banks are the effective beneficiaries of the interest, reside in a country with which Mexico has double tax treaty and other requirements are met.
- The world of deductions shrank significantly in Mexico after the passage of the 2014 amendments to the MITL. Corporations that invested in capital assets used in areas outside of Guadalajara, Monterrey, or Mexico City were previously able to elect an initial upfront deduction equal to a percentage of the total cost of an asset. The depreciation percentages ranged from 43% to 92% depending on the type of asset. After 2014, this upfront deduction was no longer available. Instead, Mexico started following the general straight-line method of depreciation for all fixed assets. The Tax Reform includes a temporary provision whereby certain taxpayers will be able to take an upfront deduction on their new fixed assets at depreciation percentages between 43% to 95% depending on the kind of asset and the year of the investment. The taxpayers eligible to benefit from this provision are (i) Mexican resident individuals and corporations with income of less than 100 million pesos (approx. US$5.9 million), (ii) taxpayers investing in construction and expansion of transportation infrastructure, and (iii) taxpayers investing in the hydrocarbon´s sector (except upstream) and in equipment for the creation and distribution of energy. This provision will be in force only during the last four months of 2015, 2016 and 2017.
- Individuals receiving interest payments from financial institutions in Mexico were subject to a fixed withholding tax rate of 0.60%. Starting in 2016, this fixed rate is replaced by a rate determinable on a yearly basis depending on the economic yields observed in the markets. Based on these market projections, the rate for 2016 will be 0.50%.
- Starting in 2016, the deductibility of welfare payments to non-unionized employees will no longer be capped at an amount equal to 10 times the annual minimum wage of the employee. However, other limitations on the deductibility of these payments will still apply (e.g., the deductions of payments that represent tax-exempt income for employees – only 53% or 47% deductible).
- Low income individuals subject to the Incorporation Tax Regime (RIF-Régimen de Incorporación Fiscal) will have the option to pay the Value Added Tax (VAT) at lower rates in transactions with the general public. Instead of being subject to a 16% general VAT rate, they could pay VAT at rates from 8% to 0% depending on their business activities. Additionally, taxpayers with an annual income below $300,000 pesos will benefit from a 100% discount on any VAT payable during the time they remain subject to the RIF.
- Exports of high-caloric foods are currently exempt from excise taxes. When a transaction is exempt as opposed to subject to a rate of 0%, the exporter is generally not able to get a credit for any excise tax previously transferred to him in Mexico. Under the new rules, the exemption is replaced by a tax rate of 0% , which will enable exporters to get an excise tax credit on the exportation of such goods.
With the intent to remedy some potential unconstitutional aspects of electronic tax audits, the Tax Code now gives a right to taxpayers to first review, and provide evidence against, any tax assessed by the Mexican Tax Authorities as a result of electronic tax audits. Despite of these amendments, the constitutionality of electronic audits is still challengeable. Additionally, taxpayers will also now be notified of their right to attend the corresponding local office of the Tax Authority to receive information about the facts and omissions of their ordinary and electronic audits.