Mexican Tax Laws Change | Norton Rose Fulbright
By José Ibarra and Heléna Klumpp
Mexican tax reforms that took effect on January 1 will have a direct effect on the overall tax cost of doing business in Mexico. The following is a discussion of the major provisions that will affect investors in Mexican projects.
The corporate income tax rate remains 35% in 2002. However, that rate will drop 1% each year until it reaches 32% in 2005.
The reform bill eliminated a taxpayer’s election to defer 5% of its income tax by retaining distributable profits. (The deferred portion was paid when such profits were eventually distributed.)
Two changes will affect the tax cost of distributing earnings from Mexican corporations.
Mexican companies are required to maintain special “CUFIN” (cuenta de utilidad fiscal neta) accounts. Generally speaking, the balances in these accounts represent profits that have already been taxed at the regular corporate tax rate. Distributions from a CUFIN account to Mexican resident entities are not subject to further taxation. If a company makes a dividend to a Mexican resident entity but has no earnings in its CUFIN account from which to pay the dividend, then the dividend is subject to a 35% “equalization tax.” The tax is computed on the amount of the dividend “grossed up” by a multiple of 1.5385 to account for income taxes that should have been paid at the corporate level on those profits.
Before the new tax reforms, a dividend paid to an individual or a nonresident shareholder out of a CUFIN account was subject to a 5% withholding tax, but one had first to “gross up” the dividend by 1.5385 before applying the withholding tax. The result was the withholding tax was effectively 7.69% of the actual dividend paid. (Critics charged that the gross-up violates tax treaties limiting dividend withholding taxes to 5%.) If a company made a dividend to a nonresident but had no earnings in its CUFIN account from which to pay the dividend, then the dividend was subject to the same 35% equalization tax as on dividends paid to residents, plus the 5% withholding tax.
The new tax reforms eliminated the withholding tax on distributions made out of CUFIN accounts.
They also changed the way CUFIN accounts are maintained. A company computes its CUFIN account balance by adding its taxable profits and subtracting its tax liability and non-deductible expenses. Prior to the reform bill, a company could never have a negative balance in its CUFIN account. Now, if a company’s tax liability and non-deductible expenses exceed taxable profits, it will create a negative account balance. The negative amount (adjusted for inflation) must be used to offset any future positive earnings in the CUFIN account. Requiring taxpayers to make a reduction of future CUFIN balances could drastically reduce a company’s ability to pay tax-free dividends. To somewhat counterbalance the effect of this provision, a company will now be permitted to carry forward for three years as a credit the amount of equalization tax that is paid on any distribution exceeding CUFIN earnings.
Expensing For Investments
New investments in certain fixed assets may now be recovered with a one-time, present-value deduction in the year immediately following the tax year in which the asset is first used. For the past three years, investments were required to be depreciated on a straight-line basis. For example, an investment in a building that was made in 2000 had to be recovered at the rate of 5% over 20 years. Now such an investment may be recovered through a one-time deduction at 57% of its total value in the year after the asset was placed in service. The 57% represents the present value of the depreciation deduction to which the owner would have otherwise been entitled, discounted at a 6% rate. The statute requires use of this discount rate. Assets located in Mexico’s three largest cities — Mexico City, Guadalajara and Monterrey — must meet additional requirements to qualify for the immediate deduction.
Mexican tax laws allow related companies to consolidate their profits and losses on a limited basis for income tax purposes. Since 1999, members of a controlled group have only been permitted to report 60% of their tax items on a consolidated basis. The remaining 40% must be reported by each company individually. Until last month, special rules applied to companies considered “pure holding companies,” which are companies that derive at least 80% of their gross income from transactions with their subsidiaries. These companies were permitted to consolidate 100% of their profits and losses with 60% of those of their subsidiaries.
The new tax reforms place pure holding companies on the same footing as regular consolidated groups: only 60% of their tax items may be consolidated with the rest of the group’s 60%. The other 40% of the holding company’s income must be reported separately. This change will hit hardest the group structures in which interest-bearing debt was incurred at the holding company level and income-producing assets were kept in lower-tier companies. Previously 100% of the interest could be used to offset 60% of the subsidiaries’ income. Now 40% of the interest deduction must be taken at the holding company level, where there may be no income against which to use it.
A en P Interests
The reform bill affects the way a sale of an interest in an asociacion en participacion will be viewed for tax purposes. An asociacion en participacion, or “A en P,” is similar to a US partnership in that it is considered transparent for Mexican tax purposes. Previously, upon the sale of an interest in an A en P, the purchaser was deemed to acquire directly the assets and liabilities of the A en P. The purchase price was allocated among the A en P’s assets and it stepped up the buyer’s basis in those assets for Mexican tax purposes. Now the sale of an interest in an A en P is treated exactly like the sale of shares in a corporation: the total value is assigned to the interest itself, with no possibility to increase the tax basis of the underlying assets. This means that the buyer of an interest will not see its purchase price reflected in larger depreciation deductions or smaller gains on sale of the underlying assets.
Three changes will affect the way companies account for and pay value-added taxes and income taxes.
First, value-added taxes, or “VAT,” must now be computed on a cash method — not accrual. This means that the tax liability arises when sales of goods or services are actually paid. Correspondingly, VAT amounts may only be credited when VAT has actually been paid to vendors and suppliers. Under prior law, the provision of goods or services (or the invoicing of either), as opposed to the payment for them, gave rise to VAT liability.
Second, all corporate taxpayers must now make advance payments for tax each month. Under prior law, taxpayers with gross receipts under a minimum threshold were permitted to make advance basis on a quarterly basis. Such distinctions were eliminated as of January 1.
Finally, inflationary gains or losses must now be computed once each year using the monthly average of liabilities and financial assets, instead of on a monthly basis and using daily averages as in prior years.