February 02, 2005 | By Keith Martin in Washington, DC

MEXICO has started collecting a 25% withholding tax on certain payments by Mexican companies to  foreigners.

Local lawyers advise that the tax is probably unconstitutional, but anyone paying it must file a separate court action within 15 days to have any hope of getting his money back.

Fees for services or rents paid by Mexican companies to foreigners in other countries that have tax treaties with Mexico are usually immune from withholding taxes if the foreign company receiving the payments has
no “permanent establishment” in Mexico. However, a new law enacted on November 13 purports to override these treaty provisions. 

The law would subject to such payments to withholding taxes at as much as a 25% rate. Ordinarily, a US company that must pay income taxes to another country would receive a credit to use against its US taxes.
However, some of the withholding taxes in this case will not be creditable in the US. For example, where withholding taxes are collected on fees paid to a construction contractor, no foreign tax credit could be
claimed to the extent the fees are for work performed physically in the United States.

Foreign tax credits can only be claimed for taxes paid to another country on “foreign source income.” In this case, the income would be considered from a US source. The new Mexican law may ultimately be found to be unconstitutional. However, taxpayers must challenge it promptly in separate court actions to get their money back, according to Jose Ibarra, a tax lawyer with the firm Chevez, Ruiz, Zamarripa y Cia in
Mexico City. 

“Considering that residents of Mexico that make such payments will probably take the safe position of making tax withholdings based on local law provisions, without regard to any treaty, thus not risking a challenge by the tax authorities, it will be up to the nonresidents to take their case to a mutual agreement procedure or to the Mexican constitutional courts within 15 working days from the date in which they suffer the ‘undue’ withholding for the first time,” Ibarra said.