Highlights

  • Government measures around the world instituted due to the COVID-19 crisis may create several consequences for taxpayers both at domestic and cross-border levels.
  • Mexican taxpayers should continue paying their taxes as normal and should expect no assistance or grace period from the Mexican tax authorities. However, alternatives could still be used to ameliorate any possible impact.

These unusual times have called for unprecedented measures. Governments all over the world have been forced to ban travel, place strict quarantine requirements and grant tax benefits of some sort in an effort to alleviate the impact of the upcoming economic crisis. Also, businesses and entrepreneurs have been forced to shut down operations, extend or negotiate payments and even reduce their labor force.

Some of these measures and exceptional circumstances will raise tax effects at a domestic level and at a cross-border level. In this alert, we will cover some of the most important considerations for businesses and individuals who are facing some of these circumstances.

As opposed to the fondness shown by the Mexican Government following all Organisation for Economic Co-operation and Development (OECD) recommendations when implementing the most recent tax reform, there is no intention from the current administration to adopt any suggestion of the OECD to grant taxpayers relief in order to avoid a bigger fall in the Mexican economy. Mexican taxpayers should continue paying their taxes as normal and should expect no assistance or grace period from the Mexican tax authorities. As such, some of the considerations that Mexican businesses and individuals should have in mind are the following:

1) Foreign Employees in Mexico

Some workers have been forced to stay in Mexico for larger than expected either because of travel bans or because they were laid off due to current limited resources of their employers. As a result, some will be unable to physically go back to their original country of employment to perform their duties and will be obligated to stay in Mexico and telework.

In general, employees of a foreign tax resident will not be subject to tax in Mexico if they do not stay more than 183 days in Mexico and if they are paid by a foreign employer with no establishment of any kind in Mexico.

Considering this lock-down and a potential impediment of the employees to return to their countries, they could end up exceeding the 183 days threshold and thus be levied with an income tax in Mexico.

Regardless of the foreign tax credit the employee may have access to in his/her country of residence, this could represent a liquidity issue for the employee since he/she could end up being obligated to pay taxes in both countries: Mexico and his/her country of residence.

In Mexico, salaries will be exempt on approximately the first US$5,500 but subject to a 15 percent tax rate on income below approximately US$43,500 and a 30 percent rate on income above approximately US$43,500.

In this case, the OECD Secretariat's general view is that the income of the employee should continue to be taxed as it was prior to the COVID-19 crisis. That is, the employee should be taxed in the country where he/she used to exercise the greater part of his/her employment.

Since we do not expect the Mexican authorities addressing these issues the same way, it is important for employers and employees to start looking for options to ameliorate any tax contingencies and any double-taxation scenarios.

2) Directors or Officers Locked in a Foreign Country

Mexico, as many other countries in the world, adopted the rule that companies that are residents of Mexico for tax purposes are subject to tax in Mexico over their worldwide income.

Many countries deem companies to be residents for tax purposes in the country where they have their place of effective management.

The effective management is generally performed by directors and officers of a company. So, what happens if you are a foreign company but your officers either voluntarily or unintentionally are now located in Mexico or in a foreign country that defines tax residency the same way? Or alternatively, what happens if a Mexican company has its directors or officers in another country?

Small periods of time should not be an issue, but the longer the quarantine lasts or the more directors or officers decide to remain in other countries, the more reasons tax authorities from Mexico and other countries will have to make an argument for taxation. Take, for example, the case of France, where the country recently announced flight restrictions to people outside the Schengen Area until September 2020 or until further notice.

Although this at first glance should not represent a risk in practice, some government officials have informally commented on these scenarios. With that in mind, the most conservative position is to mitigate any risk in this regard.

In this respect, the OECD has encouraged countries to work together to alleviate these kind of unplanned tax implications and potential new burdens. However, as mentioned, it is unlikely Mexico will follow such recommendations.

3) Mexican Individuals or Employees Located in the United States or Abroad

Mexican individuals who are non-U.S. citizens or green card holders who spend more than 183 days in any given year in the U.S. and a certain amount of time in the previous two years will be deemed to be tax residents of the U.S. for federal income tax purposes, and thus subject to tax in that country over their worldwide income. They will also be subject to a broad scope of Internal Revenue Service (IRS) and U.S. Treasury reporting requirements. This will be true unless a U.S. domestic exception applies or a double income tax treaty between the corresponding country and the U.S. provides otherwise.

Generally, under the double income tax treaty between Mexico and the U.S., Mexican individuals with closer connections to Mexico will be ultimately considered tax residents of Mexico. However, a Mexican individual who will try to claim such treaty to avoid being deemed as a tax resident of the U.S. is obligated to file certain forms to the IRS, such as Form 1040NR or 8833, among others.

In this regard, the OECD Secretariat has issued guidance and suggested that countries adopt a position in the sense that under bilateral tax treaties, the tax residence should not change due to such temporary dislocation.

We will need to wait and see whether the IRS eases these rules in line with such OECD recommendations. But in the meantime, it is important that cross-border workers or individuals stranded in the U.S. thoroughly analyze their situation and carefully plan in order to mitigate troublesome tax consequences.

4) Unpaid Credits

Under certain circumstances, taxpayers may deduct unpaid debts from borrowers. This will be the case, for example, when it is notorious the practical impossibility to collect payment on that credit or when the credit has expired, whichever happens first.

There are special rules around the application of this deduction. In this case, it is important to consider these rules before deciding on taking such deduction.

5) Getting a Loan?

Due to reduced cash flows, some companies may be searching for additional resources. Loans, either from a bank, a third party or a related party could be good options to address any liquidity issues.

However, it is important to bear in mind some interest deduction and tax withholding rules before obtaining a loan in order to determine the real cost of borrowing the funds. In case of intercompany loans, interests paid to a related company in a country with a preferential tax regime (e.g., one with tax rates below 22.5 percent) will generally not be deductible unless the income derives from the recipient's business activity.

Similarly, interests coming from loans granted by foreign related parties that exceed a 3:1 equity to debt ratio will not be deductible under thin capitalization rules.

On top of those limits, companies highly leveraged in which annual accrued interest exceeds MX$20 million are not able to deduct the "net interests" that surpass 30 percent of the "adjusted tax profits," as such terms are defined in the Mexican Income Tax Law (MITL). Any interest not deducted in any given year because of this limitation can be carried forward for up to 10 years. Finally, the loan amounts are to be invested for the purpose of the borrower´s business to be deductible.

On the other hand, if a Mexican resident obtains a loan from abroad, it also will be important to consider any withholding taxes applicable. This is relevant, since it is generally the case that under contractual agreements, the debtors will have to gross-up the interest payment in order for the lender to receive what it had received had no such withholding tax applied.

The withholding tax rates will vary depending on the quality and tax residence of the lender. Interest payments will generally be subject to a small 4.9 percent withholding tax rate in Mexico if they are paid to a foreign bank or are paid with respect to publicly traded securities in Mexico and securities publicly traded abroad through banks and stockbroking firms in a country with which Mexico has a tax treaty. Other interest payments, however, could be subject to a 15 percent or even a 35 percent withholding tax rate in Mexico. In these latter cases, a tax treaty with the foreign country could provide for a reduced rate.

Moreover, certain interest payments will be subject to Value Added Tax (VAT) in Mexico.

6) Should Your Patrimony Stay Home?

People have started reviewing opportunities abroad as a way to protect their patrimony and secure the value of their money.

Hence, understanding the tax consequences of having an account (checking, investment or otherwise) in another country or an offshore structure is vital if there is an intention of sending any patrimony overseas. Harsh implications could derive if one does not fulfill tax obligations with respect to such holdings abroad.

Things like automatic exchanges of information and inadvertent income such as exchange gains and anti-deferral regimes could severely hinder any benefit of having part of one's patrimony abroad. It is of utmost importance to plan in advance and to know exactly what would be the implications from a Mexican tax perspective in order to avoid unfavorable results.

7) Home Office Deduction

Individuals with commercial and professional activities, in addition to certain expenditures, are able to deduct the proportional part of their houses used as an office.

If they are paying rent, the deduction will correspond to certain percentage of the rent. If they own the house, the deduction will regard to part of the investment depreciation rate of the construction. In addition, they will be able to expense the proportion of the real property tax and other local contributions. Under certain circumstances, it will be worth looking into this alternative.

8) Tax Tribunal Activities

On April 13, 2020, the Mexican Government decided to extend the suspension of all tax litigation and tribunal activities until May 5, 2020. According to the decree, only "urgent" matters will continue to be processed and litigated. One important urgent activity mentioned in the decree, given the potential current cash difficulties, has to do with bank account freezes. As such, it should be noted that a constitutional appeal could still be filed against these kinds of practices commonly used by Mexican tax authorities.

9) Frequently Asked Questions (FAQs)

  • a) Can an individual defer the payment of income taxes due in April?

Generally, yes. As long as individuals file their tax returns before April 30, 2020, they will have up to six months to pay the tax. Please note, however, that interest will apply.

  • b) Can I reduce the amounts of monthly tax payments?

Yes. Monthly income tax payments in Mexico (pagos provisionales) are calculated by applying to the corresponding monthly income a factor (coeficiente de utilidad) obtained based on previous year profits. When a taxpayer considers that such a factor is greater than the one it should apply in 2020, it could solicit Mexican tax authorities to use a different factor as of July 2020.

  • c) Are there any tax consequences if my landlord forgives my rental payments?

Lessees, either entities or individuals, will have to recognize forgiven rents as taxable income so long as they correspond to accrued but unpaid rents. If the rent, however, is not yet due, it should not be considered income for Mexican tax purposes. In this respect, it is important to review the corresponding lease agreements to determine the rental terms and possibilities to avoid recognition.

  • d) What happens if I do not pay my taxes on time?

Sanctions fees, surcharges and inflation adjustments could apply, although if payment is spontaneously done later, without a preliminary approach by the tax authorities, the sanctions fees will not apply.

The sanction fees could hover around US$650 and US$1,500 for late payments.

The authorities, however, could qualify such lack of payment as tax fraud with all the consequences that that entails.

  • e) Is it possible to deduct investments and expenses made in our facilities to face the COVID-19 crisis?

At first, yes. But, it is important to consider that such expenses should be related with the business purpose of the taxpayer and must be necessary to pursue its business goals and continue operations.