December 12, 2004 | By Keith Martin in Washington, DC

MEXICO will not allow Mexican companies to deduct interest paid on debt if the companies are too “thinly capitalized.” 

This was one of a series of tax law changes that the Mexican Congress passed on November 13. They are expected to take effect on January 1.

“For the first time, the income tax law will include a limitation on the deduction of interest due on debt based on adequate capital levels,” José Ibarra with the law firm Chevez, Ruiz, Zamarripa y Cia reported from Mexico City. Companies will not be allowed to deduct interest paid on “excess” debt — that is debt
exceeding a 3-to-1 debt-equity ratio. Only loans from related parties or from foreign lenders are taken into account. However, there are still other uncertainties about how to calculate debt, according to Ibarra.

The law has a transition rule for companies that already exceed the permitted ratio. They have five years to comply, but must reduce their debts each year in “equal proportionate parts.” Ibarra said that companies that have trouble complying may be able to avoid the restrictions by entering into advanced pricing
agreements with the Mexican tax authorities.

Financial institutions are exempted from the new limits, but the exemption may be subject to constitutional challenge. 

The new law also limits deductions for amounts paid to companies in tax havens. Mexico has had a tax havens list in the past.

The list this year has almost 100 jurisdictions on it. However, starting in January, the list will be replaced with a general principle that payments to a jurisdiction where the actual tax on the payments is less than 75% of the tax that would have been paid in Mexico will be considered made to a tax haven.