MEXICO: An Introduction to Tax: Non-contentious

Nearshoring 

Nearshoring is the strategy whereby a company transfers part of its production to third parties who, despite being located abroad, are established in nearby destinations with a similar time zone. This practice arises as a response to offshoring, which, in order to reduce costs, seeks suppliers in other destinations to make production processes more efficient.

Mexico’s strategic position, the COVID-19 pandemic and other geopolitical and economic problems have made Mexico an attractive country for foreign investment.

For the past few years, investments in Mexico have increased. Foreign companies have announced their interest in establishing operations in Mexico due to the relocation of the supply chain, which is the major reason for nearshoring. Mexico has various legal structures that an investor may adopt to carry on a business, such as the incorporation of a Mexican subsidiary (taxed at the 30% rate), establishing a branch, or having operations through a trust.

Mexico also has programmes that promote the import, manufacture and export of goods, such as the IMMEX Program, which allows the temporary importation of goods without payment of the general import tax and other taxes (eg, value-added tax), and PROSEC, which allows producers of certain goods to import at a preferential rate.

Mexico has several good locations for setting up manufacturing facilities (eg, Tijuana, Chihuahua and Guadalajara). Under local law, the states are able to grant tax incentives by reducing or exempting payment of the 2% local wages tax for a certain number of years, or through reimbursement of expenses relating to public services such as the interconnection of water and sewage services, or of expenses relating to training programmes for employees.

Alienation of Shares by Non-tax Residents: How to Access Preferential Tax Treatment

For the alienation of shares issued by a Mexican resident company or by a non-Mexican tax resident that is considered to have its source of wealth in Mexico, being the corresponding income taxable under the Mexican Income Tax Law, the corresponding tax is determined by applying the 25% rate to the total consideration agreed. However, if certain requirements are complied with, non-tax residents may apply the 35% rate on the gain obtained on the transaction.

One of the most complex requirements is the appointment of a legal representative in Mexico by the non-resident selling party, who shall take joint and several liability with the taxpayer regarding the income tax payable and generally, the compliance with tax obligations. In this regard, an additional requirement was introduced in the tax regulations: the appointed representative shall have enough assets to cover the income tax due in case the taxpayer fails to comply with its tax obligations. If a legal entity is appointed as legal representative, the following shall be observed: (i) the amount of taxes due by the non-resident seller shall not exceed 10% of the paid-in capital of the legal representative; and (ii) the legal entity appointed as representative shall not have incurred a tax loss in the last two fiscal years.

In this regard and in order to make it easier for the appointed representative to guarantee tax compliance, the tax authority recently established the option to offer as guarantee of the tax payment a letter of credit issued by a banking institution that covers at least the tax payable by the non-resident, which may replace the requirement for the appointed representative to have paid-in capital of at least 10% of the tax due.

The above requirements become problematic in practice when guaranteeing large amounts, and the situation becomes even more complex for transactions that are tax exempt under a double tax convention, or in cases where no gain derives from the sale transaction. This is because the amount of tax due: (i) is the basis for determining the paid-in capital that an entity to be appointed as legal representative needs to have; and (ii) is the amount for which the letter of credit shall be issued, and which shall serve as a guarantee of compliance with the tax obligations of the selling party. To date, the Mexican tax authorities have not issued a criterion on this matter or an alternative mechanism through which the appointed representative may guarantee compliance with tax obligations, nor have they stated if the mentioned requirements are mandatory.

Digital Economy – Tax Rules in Mexico

For the past few decades, we have been living in an era where purchasing a product online involves a seamless yet complex digital process, often spanning multiple countries – from marketing in the United States, production in China and data servers in Finland, to consumers in Mexico. This digital landscape presents significant challenges for tax authorities worldwide.

Traditional tax systems, based on physical presence, have struggled to adapt to a world where significant revenue can be generated without any physical manifestation in a taxing jurisdiction. The OECD has been at the forefront of addressing these challenges through its BEPS (Base Erosion and Profit Shifting) Project, particularly focusing on the unique issues posed by the digital economy. The OECD under Action 1 of the BEPS Project, which addresses “Tax Challenges Arising From Digitalization”, has been working to prevent double or multiple taxation and to allocate taxing rights more effectively in the digital world, specifically through a two-pillar solution proposed in 2019, known as Pillar One and Pillar Two, aiming to create a more coherent and fair international tax framework.

BEPS Pillar One seeks to expand taxing rights to market jurisdictions where users and consumers are located. Pillar Two, on the other hand, introduces the Global Anti-Base Erosion (GloBE) rules, aiming to ensure that all internationally operating businesses pay a minimum level of tax, regardless of where they are headquartered or operate. This pillar is designed to address situations where profits might otherwise be subject to no taxation or very low taxation, providing jurisdictions with the right to tax profits that are undertaxed.

As a member of the OECD, Mexico is committed to following BEPS recommendations and measures and has addressed the challenges of the digital economy identified under Action 1. Before 2020, Mexico lacked regulations to tax foreign residents providing digital services within its borders. This regulatory gap meant that significant revenue generated by international digital service providers went untaxed, creating an imbalance in the taxation landscape.

In 2020 Mexico launched a new legal framework aimed at regulating the provision of digital services within the country’s jurisdiction, applying the taxation principles set by the OECD for digital commerce (neutrality, efficiency, certainty, simplicity, effectiveness, fairness and flexibility), particularly neutrality, which advocates for tax systems that treat all forms of commerce equitably, whether conducted online or offline, to create a fair competition between digital commerce and traditional commerce.

This framework marked a significant shift in aligning Mexico’s tax system with global standards, ensuring that both Mexican and foreign residents who offer digital services pay income tax and value-added tax, where applicable.

The implementation of the new tax framework in 2020 was a pivotal moment. By extending tax obligations to foreign digital service providers, Mexico aimed to increase its tax revenues and create more equal taxation for all businesses operating within its economy.

New rules were incorporated into both the Mexican Income Tax Law and the Value Added Tax Law, specifically targeting the provision of goods and services through digital platforms. The Mexican Income Tax Law now includes provisions to tax income obtained by Mexican resident individuals who sell goods or provide services via the internet. This includes activities conducted through digital platforms, computer applications, and similar means provided by third-party intermediaries. A simplified mechanism that allows taxpayers to efficiently comply with tax obligations was introduced.

On the other hand, the Value Added Tax Law was amended to address the taxation of digital services provided from abroad by non-tax residents to users in Mexican territory. Under the new rules, VAT is charged at the general rate of 16% on the provision of digital services when the service recipients are located in Mexico. These new rules also tax intermediary services provided by non-tax residents without a permanent establishment in Mexico. By doing so, Mexico ensures that foreign digital service providers are also subject to VAT, closing the previous loophole that allowed these entities to operate untaxed.

The VAT Law establishes a set of obligations which must be observed by non-resident service providers and intermediaries, including the obligation to register with the Mexican tax authorities as withholding agents, charge and collect VAT together with the price of the digital services and deliver it to the tax authorities on a monthly basis, and issue electronic invoices (except when acting through an intermediary). Non-resident providers are also obliged to provide the tax authority with information regarding the number of services or transactions carried out each month, as well as the kind of services and prices charged, indicating the number of users per service. Non-resident intermediaries must also file informative returns providing general information about clients who provide goods and services through digital platforms. The above enables the tax authorities to identify digital services providers and at the same time, verify compliance with tax obligations.