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Mexico's proposed 2020 tax reform

INSIGHT ARTICLE  | 

Early September 2019, Mexico’s Office of the Presidency released a proposed bill containing a 2020 tax reform package (the Package). The 2020 Package includes significant changes to the country’s international tax regime. Mexico’s House of Deputies will review the package by Oct. 20, 2019. If approved, the House will then send the package to the Senate for final passage.

Several proposals in the Package could have a significant impact for U.S. companies operating in Mexico. The following summarizes a few key proposed changes contained in the Package:

  • Permanent establishment. The definition of permanent establishment is expanded to include instances where a foreign resident acts in Mexico through an agent that has a “principal role” in concluding contracts, or that is a related party.
  • Foreign fiscally transparent entities. For the first time in Mexico, rules are proposed to tax foreign fiscally transparent entities with Mexico-attributed income, in a manner similar to the way the U.S. taxes foreign partnerships under section 864(c) of the U.S. Internal Revenue Code and related regulations.
  • Payments to related parties. Proposed rules would limit the deduction of payments to related parties that are subject to a preferential tax regime (i.e. that has an effective tax rate of 22.5% or less).
  • Limitation on deduction of interest. The package proposes an EBIDTA-based mechanism to determine the amount of deductible interest expense to which a Mexican taxpayer is entitled. In general, the interest will be limited to an amount equal to 30% EBIDTA, as determined under special rules.
  • Digital economy and e-commerce. A new chapter has been added to the income tax law with the purpose of regulating the digital economy and e-commerce activities. Special mechanisms are proposed to tax activities carried out through mobile applications.

    Additionally, changes in value-added tax (VAT) law are included in the package to ensure VAT compliance in e-commerce activities. These changes would require that, in certain cases, foreign residents that carry out business in Mexico through digital platforms to collect and remit the VAT.
  • Shelter maquiladoras. The four-year holiday to avoid permanent establishment taxation for foreign companies operating in Mexico through a shelter maquiladora (independent contractor) would be repealed. Thus, under this rule foreign companies that hire a shelter maquiladora will be subject to Mexican tax beginning day one. Foreign companies that, at the time, of enactment of this change are still in the four-year holiday will have it revoked automatically under the proposals.
  • Business purpose of transactions. The Package adds stringent requirements to consider whether a transaction has a business purpose. Showing lack of business purpose can provide the Mexican taxing authorities a basis to re-characterize or disregard the transaction for tax purposes. An important factor in determining whether there is business purpose in a transaction is significance of the economic benefits of the transaction compared to its tax savings. If the tax benefits exceed economic benefits, the transaction may be deemed to lack a business purpose.
  • Reportable transactions. Taxpayers and/or their tax advisors are required to file a report with the Servicio de Administración Tributaria (SAT) on certain “reportable transactions”. An actual list of reportable transactions is yet to be published. However, a reportable transaction is one that features one or more of the following factors:
    • Impairs the exchange of information between the SAT and their competent counterparts in foreign countries. This includes exchange of information under FATCA or CRS, or under treaties for the exchange of tax information to which Mexico is a signatory.
    • Avoids Mexico’s anti-deferral rules.
    • Allows for the transfer of net operating losses to entities that did not generate such losses.
    • Accomplishes a corporate reorganization where there is no compensation for the property, functions or risks thereof reassigned.
    • Results in a weak set of comparables for transfer pricing purposes.
    • Involves the disposition of intangibles that are difficult to appraise.

A technical committee comprised of tax subject matter experts from the SAT will be charged with identifying reportable transactions.

  • Tax advisor. Individuals and entities that provide Mexican tax advice to domestic or foreign taxpayers are required to register with the SAT. In addition, they will be required to disclose to the SAT the reportable transactions with respect to which they provide advice.

If these amendments are approved, companies with complex tax structures and transactions, and their tax advisors will have to assess the reporting requirements with respect to these structures and transactions. Most provisions of the 2020 Package, if approved, would become effective for tax years that begin on or after Jan. 1, 2020.

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