September 17, 2021
Mexico's 2022 economic proposal focuses on eliminating loopholes
If enacted, the proposal would impose additional reporting requirements on certain taxpayers, modify the thin capitalization rules and require taxpayers to have a valid business purpose for restructurings, mergers and spin-offs. Taxpayers should continue to monitor the progress of the proposal through Congress.
Mexico's Economic Proposal for 2022 (the Proposal), which includes the Revenue Law, Government spending budget and a tax reform package, focuses on increasing tax collection by eliminating loopholes in legislation where there are perceived abuses by taxpayers. The Proposal also would grant the Mexican tax authorities (SAT per its acronym in Spanish) additional collection tools and powers in the audit process to effectively challenge the substance of transactions by requiring business purpose and to look to preceding or subsequent transactions. The Proposal does not include any new taxes or rate increases. For a summarized version, please see Tax Alert 2021-1643.
Mexico's Congress still has to debate and vote on the Proposal, which could change as it moves through the legislative process.
Once Congress approves the Proposal (no later than November 15, 2021), it will be sent to the President for his signature and published in the Mexican Federal Official Gazette. The Proposal will become law on the date of publication and should generally be effective January 1, 2022.
The Proposal would expand the definition of back-to-back loans to include any related-party debt that lacks business purpose. As such, interest payments on any related-party loan or transaction would be recharacterized as dividends, if the financing transaction is deemed to lack a business reason. Mexican legislation, however, does not define the term "business reason."
Thin capitalization rules
Mexico currently has a three-to-one debt-to-equity ratio limitation for determining deductible related-party interest paid to nonresidents. An option is available for taxpayers to use either book or tax equity to calculate the limitation on the deduction of interest. The Proposal would modify the thin capitalization rules to make these two calculations more consistent. Specifically, the Proposal would require taxpayers to include net operating losses (NOLs), in addition to paid-in capital and previously taxed earnings, when the tax-equity option is elected to calculate their limitation on interest deductions. Losses are currently not included in the tax equity calculation. To the extent book and tax equity differ by more than 20% for purposes of the thin capitalization rules, the Proposal would only allow taxpayers to use the tax-equity option if there is a business purpose for the difference and other requirements are met.
The Proposal also would require taxpayers to have an agreement with the government to carry out certain activities, such as infrastructure and electricity, to exclude debt from those activities from their thin capitalization calculation.
Non-regulated Special Purpose Financial Institutions (SOFOMs)
SOFOMs are companies dedicated to financing activities and are included in the definition of financial institutions for income tax purposes in Mexico, if certain requirements are met. These entities have historically been used by many multinational entities to set up financing structures.
The proposal would eliminate the current exemption for SOFOMs from the thin capitalization limitations on interest deductions for loans entered into with related parties, when the activities of the SOFOM are predominantly related-party transactions.
The Proposal also would eliminate the current 4.9% withholding rate applicable to interest paid on loans by a SOFOM to a foreign related party when (i) the foreign related party is the beneficial owner of more than 5% of the interest paid by the SOFOM and (ii) the foreign related party owns, directly or indirectly, more than 10% of the debtors' shares or is more than 20% owned, directly or indirectly, by the debtor.
Domestic restructuring, spin-offs and mergers
Currently, domestic restructurings, mergers and spin-offs are treated as tax free to the extent certain formal requirements are met. The Proposal would require taxpayers to have a valid business purpose for these transactions to be treated as tax free, in addition to the current requirements.
Mergers and spin-offs would also be subject to additional reporting and scrutiny by the SAT if a relevant transaction, as defined in the Proposal, occurs within five years, before or after, the reorganization. Relevant transactions would include the following:
In addition, the Proposal would change the definition of a spin-off to refer to the transfer of capital stock (capital social), instead of capital equity (capital contable). This provision aligns with other changes that disallow the creation of capital accounts as a result of a split-up.
The Proposal would expand the current limitations for the allocation of NOLs resulting from a spin-off, to require that the losses may only be transferred between entities that carry on the same business activity.
Additionally, regarding the existing restrictions on the use of NOLs when there is a change in control, the Proposal would expand on the current assumptions for determining when there is a direct or indirect change in the control of a company. Under the Proposal, a direct or indirect change in control would occur when (i) there is a change in the holders of the direct or indirect rights to make decisions in shareholders' assemblies, or to change members of the Board of Directors, or (ii) a company and its shareholders stop consolidating their financial statements after a merger.
Nonresident capital gains
The Proposal would modify certain provisions related to the authorization to defer income tax for capital gains in corporate reorganizations carried out by nonresidents. Under current provisions, nonresident shareholders may request a ruling to approve the transfer of shares in a Mexican entity with the payment of the deferred income tax due when the shares leave the group. This ruling is an indefinite gain recognition agreement. The Proposal would allow the SAT to cancel the deferral authorization, if, based on the information provided, it is concluded that the reorganization lacks a business purpose or that the exchange of the shares related to the reorganization resulted in income subject to a preferential tax regime, as defined by Mexican rules. Once the deferral authorization is cancelled, capital gains tax would be triggered.
The Proposal would deem the shares subject to the deferral ruling to be transferred out of the corporate group and payment of the corresponding capital gains tax would be triggered, if the issuer entity and the acquiring entity stop consolidating their financial statements.
In addition, the Proposal would include additional information reporting provisions for relevant transactions, as defined in the Proposal, carried out by the taxpayers within five years, before or after the authorized date of the corporate reorganization.
The Proposal also would modify the requirements nonresidents must satisfy for electing to be taxed on capital gains on a net gain basis at a 35% rate. Specifically, the Proposal would require nonresidents to show they have complied with the transfer pricing rules. For these purposes, the registered public accountant would have to include the transfer pricing supporting documentation in the tax audit report.
Also, the Proposal would require the Mexican entity (issuer of the shares being transferred) to notify the SAT about transfers of its shares between foreign residents. Failure to notify could result in the Mexican entity becoming jointly liable for any tax due by the foreign residents.
The Proposal would include additional obligations for Mexican legal representatives of nonresidents appointed for specific compliance related to Mexican-sourced income. For example, the Proposal would require a legal representative to voluntarily assume joint and several liability up to the amount of any tax liability due by the nonresidents, and demonstrate it has sufficient assets to cover possible assessments. This provision is not exclusive to capital gains income.
Maquiladora transfer pricing rules
The Proposal would eliminate the option for maquiladoras to request an advanced pricing agreement (APA) to comply with maquiladora transfer pricing rules. The Proposal also would repeal the APA option for nonresidents operating through "shelter" companies. Without this alternative, as of 2022, maquiladoras would only be able to apply the "safe harbor" methodology, which requires taxable income in Mexico to be the greater of: i) 6.5% of total costs incurred by the maquiladora or ii) 6.9% of the total value of the assets used in the maquiladora operation (including the average value of inventory and machinery and equipment owned by the maquila principal).
Additionally, the Proposal would eliminate the need to file an annual notice informing the SAT of the application of the safe harbor methodology (which was considered an administrative burden) as this information should already be disclosed in the annual maquila informative tax return (DIEMSE).
Transactions involving the usufruct on immovable goods
The Proposal would establish that the usufruct on immovable goods is to be depreciated as a fixed asset at the annual rate of 5%, instead of the 15% rate typically applicable. In addition, the Proposal would trigger income recognition for the holder of an asset that is separated from its usufruct on the date the usufruct returns to the holder.
Mexican controlled foreign corporation regime (CFC)
The Proposal would clarify certain aspects of the computation for determining whether a CFC is subject to a preferential tax regime (REFIPRE) by excluding the annual inflationary adjustment and the foreign exchange fluctuation from the CFC taxable income determination.
Foreign tax credits
The Proposal would establish the order in which the foreign tax credit (FTC) would be applied in the annual income tax return, stating that the FTC would be creditable after considering the credit corresponding to the monthly advanced income tax payments. Mexican companies with foreign-source income may be affected by this new rule, since the estimated income tax payments may result in an overpayment of income tax on domestic-source income, thus reducing the ability to efficiently use the foreign tax credits. The foreign tax credits, if not used on the return, are subject to certain limitations and cannot be refunded, whereas an overpayment of estimated income tax on domestic-source income could be refunded or otherwise credited.
Value-added tax (VAT)
VAT credit on the importation of goods
The Proposal would clarify that VAT credits for the importation of goods would only apply if the import documentation (pedimentos) is issued in the name of the taxpayer claiming the credit, thereby making it more costly for the taxpayer to use a third party for importing goods into Mexico.
Disallowance of VAT credits for activities carried out outside of Mexico
The Proposal includes provisions on the allocation of activities between taxable and non-taxable activities, including activities performed outside of Mexico, for purposes of calculating the amount of credits that may be taken for input VAT. These rules would eliminate the ability of taxpayers to credit any VAT paid on the acquisition of goods, services, imports, etc. related to activities carried out abroad.
Compliance for nonresidents rendering digital services in Mexico
The Proposal would require foreign digital service providers to submit VAT information returns monthly, instead of quarterly. This provision is consistent with the form of the monthly return. The Proposal would sanction foreign digital service providers that fail to file information returns and pay taxes for three or more consecutive months.
VAT on leasing of goods
The Proposal would subject the leasing of goods to Mexican VAT, regardless of the place where the goods are delivered (i.e., Mexico or abroad). Currently, leasing transactions are subject to VAT in Mexico only when the leased goods are delivered within the Mexican territory.
0% VAT rate applicable to certain products
In line with recent federal court rulings, the Proposal would clarify that the 0% VAT rate applies to food products intended for both human and animal consumption. The Proposal also would impose the 0% VAT rate on feminine hygiene products.
Other amendments on compliance and audit procedure
The Proposal would establish that taxpayers may not lose their Mexican tax resident status for five years, unless tax residency can be demonstrated in another country not considered a preferential tax regime. If Mexico has entered into an information exchange agreement with the relevant country and that agreement allows for assistance in the collection and remittance of taxes, this provision would not apply.
Cancellation and restriction of Digital Stamp Certificates (CSDs, by its Spanish acronym)
The Proposal would modify the current procedure to cancel CSDs required to issue invoices. The Proposal also would clarify the procedure for rebooting a cancelled CSD or obtaining a new one. The cancellation of the CSD is an enforcement tool typically applied by the SAT in cases of deemed incompliance by Mexican taxpayers (i.e., missed tax returns, transactions with black-listed companies, mismatch in records, non-locatable tax domicile).
Joint and several liability
Currently, joint and several liability applies to the acquirers of going concerns. The Proposal would create several assumptions for deeming a going concern as acquired even if title is not formally transferred. Specifically, the Proposal would deem a going concern as acquired when there is an identical continuation of certain elements (assets, liabilities, members of the board, shareholders, suppliers, tax domicile, employees, copyright, etc.).
The Proposal also would impose joint and several liability for up to the amount of the tax liability on any Mexican legal representatives appointed by foreign residents.
Obligation for certain taxpayers to file an annual tax report
The Proposal would reinstate the requirement that taxpayers have their financial statements audited by a registered public accountant and file an annual tax report (Dictamen Fiscal) if they recorded gross income of at least MXN $876,171,996.50 (approximately USD $45 million) on their tax returns or if the company is publicly traded. Taxpayers have been relieved of this obligation in recent years.
Obligation of CPAs to report on potential tax criminal offenses
The Proposal would require certified public accountants (CPAs) to report to the SAT any conduct by the audited taxpayer, identified as a result of the preparation of the annual tax report, that may constitute the commission of a tax criminal offense. It is also would hold CPAs who fail to report these situations criminally liable for concealing the potential tax offense.
Common Reporting Standard/Foreign Account Tax Compliance Act
The Proposal would (i) incorporate into Mexico's domestic legislation the international covenants assumed by Mexico regarding the exchange of information, (ii) strengthen compliance, and (iii) provide enforcement tools for financial institution reporting obligations.
In addition, the Proposal would require companies, trustees, other entities and legal vehicles (e.g., partnerships) to obtain and keep information on their ultimate beneficial owner in an accurate and updated manner. It also would grant new verification powers to the SAT for auditing these persons.
Simulation of legal acts for tax purposes
The Proposal would authorize the SAT to determine the simulation of legal acts in related-party transactions exclusively for tax purposes and determine upon audit the outstanding tax liability amount according to the true nature of the transaction. While the process for determining the simulation of related-party transactions is already contained in the Mexican Income Tax Law, the Proposal would allow the SAT to determine simulation from a procedural perspective at the Federal Tax Code level. This provision would close the loophole for certain challenges to this process that had been raised in the past.
Tax offense for simulating labor relations
In line with the recent Mexican outsourcing reform under which the subcontracting of labor is banned in Mexico, the Proposal would add, as an aggravating circumstance to the committing of tax fraud, the false treatment of employees as independent contractors for tax purposes. The Proposal also would add, as an aggravating circumstance to tax fraud, obtaining any tax benefit from payments that violate anti-corruption laws.
Oil and gas
The Proposal would modify the current tax compliance framework applicable to oil and gas companies. According to the Proposal, the modifications are aimed at tackling black market practices.