Mexico - Taxation of cross-border mergers and acquisitions
Taxation of cross-border mergers and acquisitions for Mexico.
Taxation of cross-border mergers and acquisitions for Mexico.
Mexico has been massively affected by the COVID-19 pandemic since mid-March 2020. Analysts indicate that the Mexican economy downturn about 8.5 percent in 2020 — its worst year since the Great Depression. The mergers and acquisitions (M&A) market has suffered the same turbulence, reflecting a 7 percent decrease in the number of operations and a 27 percent drop in reported deal value, in 2019.
Financial service targets led the transactions, with a 2 percent increase in the number of the operations, while technology ranked second, despite a 13 percent decrease versus year 2019. Internet deals were up 18 percent and ranked third, followed by real estate transactions, despite a 53 percent decrease in number compared to those made in 2019.
Furthermore, according to expert analysis, since the last quarter of 2020, U.S. companies have performed most of the acquisitions in Mexican companies and, with respect to venture capital, technology companies are the most attractive to investors.
While the outlook for 2021 is uncertain globally, in recent months we noticed that the market has begun to change. We have seen investors doing the analysis to identify opportunities, take advantage of strategic alliances in future operations, consolidate their markets in some sectors, and even expand business areas in terms of sectors and strategic geographies. In this sense, the experts forecast an active year for the Mexican M&A market.
The 2020 tax reform did not introduce material changes, likely due to the COVID-19 pandemic. However, the recent developments affecting M&A transactions include the following.
Amendments to the recently enacted Mexican General Anti-avoidance Rule (GAAR)
A portion of this rule has been amended to expressly include the possibility of giving criminal effects to the conclusions reached through the application of the GAAR in those cases where the tax authorities do not agree with the strength of the business reasons argued by the taxpayer. Note that through the application of this provision, the effects that taxpayers are giving to their operations may be ignored for tax purposes only, albeit without prejudice to the criminal investigations that may arise in relation to the commission of criminal offenses.
As such, in terms of the GAAR, legal transactions lacking business reasons and generating direct or indirect tax benefits to the taxpayer will have the same tax effects as those corresponding to the transactions that would otherwise have been carried out to obtain the economic benefit reasonably expected by the taxpayer.
Mexican Mandatory Disclosure Rules
Mexico tax reform enacted at the beginning of 2020 has implemented rules in order to disclose certain transactions in accordance to the OECD BEPS report and the DAC 6 (EU Directive on cross-border tax arrangements) in the European Union, which mainly include any plan, project, proposal, advice, instruction, or external recommendation made expressly or tacitly, with respect to an arrangement that can, directly or indirectly, generate a tax benefit in Mexico, which must be filed to the Mexican Tax Authorities within 30 business days of a reporting event occurring, starting 1 January 1 2021.
In first instance, the tax advisors are obliged to report the transactions; however, there are certain situations in which the obligation will be for the taxpayer (i.e. the taxpayer prefers to report the transaction directly, when there is a legal restriction to the tax advisor, when the tax advisor did not comply with the obligation to report, among others).
The hallmarks that the Mexican provisions consider as reportable are 14; nevertheless, the most relevant from an M&A perspective are the following:
- legal acts that allow tax losses to be transferred
- treaty benefits when the foreign resident is not subject to taxation in its state of residence or is able to apply a preferential tax rate
- transactions between related parties (i.e. transfer of intangible assets which are hard to value; transfer of assets from a restructure that reduces the 20 percent of the operating profit, etc.)
- avoid applying 10 percent withholding tax on dividends
- when there are tax losses whose term for being carried forward to offset tax profits is about to expire; and transactions are executed to earn tax profits that may be reduced by such tax losses; and such transactions generate an authorized deduction to the taxpayer that sustained such losses or a related party.
Furthermore, on 18 November 18 2020, the Mexican Tax Authorities issued general rules to provide guidance on the filing of the report, as well as the supporting documentation that must be included as part of the report. Although quite extensive, the genera rules do not set forth the long-expected economic thresholds per scheme that would trigger the report. Since there is no threshold, all schemes need to be disclosed, regardless of the amount involved in the scheme. These guidelines are intended to provide an itemized description of requirements that the corresponding report needs to satisfy. Also, several annexes were published for the filing of the information requested.
In February 2020, the Mexican Tax Authorities issued additional guidance establishing a threshold of 100 million Mexican pesos (MXN) (approximately 5 million US Dollars (US$)) of tax benefit derived from the specific transaction to be subject to disclosure.
Payments to low tax jurisdictions or hybrid mechanisms
One of the most relevant changes in 2020 comes from the new restriction to consider as deductible expense, those payments made to related parties that are residents of low tax jurisdiction, or in cases of a hybrid mismatch. It is deemed that the foreign resident is subject to low taxation when its effective tax rate is lower than the 75 percent of the Mexican Corporate Income Tax; it means less than 22.5 percent.
This limitation extends its reach to those cases where the payments are made to a foreign resident that is not necessarily subject to a low taxation, but this payment is afterwards distributed to a related party that is subject to a low-tax jurisdiction or a hybrid mechanism.
There is an exception to these payments, and this limitation will not be applicable in the cases where the payment derives from business activities. For these purposes, the taxpayer must sustain that the receiver has enough personnel and assets to carry out its business activities (‘substance test’). Although the payments of royalties, leasing or interests qualify as passive income, these could qualify for the exception if the substance test is met.
Groups investing in Mexico should revise their current holding structure, acquisition vehicles, and include the effects of this new restriction when modeling as this provision may affect the tax costs and available profits for distribution.
Proposed reform to outsourcing services legal frame
On 12 November 2020, the Executive issued the initiative to reform the Federal Labor Law, Social Security Law, the Law of the Institute of the National Housing Fund for Workers, as well as the Federal Tax Code, Income Tax Law and the Value Added Tax Law, which intends to prohibit the subcontracting regime and regulate the contracting of specialized services or the execution of specialized works and the employment agencies. Initially, the entry into force of the reform was scheduled on 1 January 2021, but due to the relevance, requisites and the impacts in the productive sectors, on 9 December 2020, a tripartite agreement was signed involving the business sector, the labor sector and the Executive, to postpone the discussion of the reform until February 2021, and it is envisaged that within a term not exceeding 30 days it will be discussed and, if applicable, approved.
In this sense, the amendments to the Federal Labor Law, Social Security Law, Law of the Institute of the National Housing Fund for Workers include the following:
- The initiative proposes to prohibit the subcontracting of personnel, which consists of an individual or legal entity providing or making available their own personnel for the benefit of another party.
- On the other hand, the specialized services, understood as the execution of specialized labor, which are not part of the corporate purpose or the economic activity of the beneficiary of such services, would be considered allowed, provided that the suppliers obtain an authorization from the Ministry of Labor and Social Welfare (STPS), which will be valid for 3 years and it may be denied or revoked when the legal requirements are not met.
If the suppliers of the specialized services do not comply with labor and social security obligations, the beneficiaries would be jointly and severally liable for the labor obligations and social security contributions that would have been made by the workers with whom the specialized service is provided.
The individuals or legal entities that provide specialized services are required to report service contracts and to submit the information about the services provided before the social security authorities on a quarterly basis.
- Regarding the employment agencies, which are individuals or legal entities that are involved in the hiring, recruitment, selection, training, training process, among other services, would be allowed and in no case shall it be considered an employer.
The initiative to reform the Federal Labor Law also proposes that the assets of the company or establishment must be transferred to the substitute employer for the employer substitution to take effect. With regards to the Law of the Institute of the National Housing Fund for Workers, the term of joint and several liability of the substituted employer is reduced from 2 years to 6 months.
Considering the above, it is proposed to add an article in the Federal Tax Code that establishes that the payments for subcontracting personnel will not trigger a deduction or credit for Income Tax (IT) and value-added tax (VAT) purposes, respectively. Neither will tax effects be given to services in which personnel are provided in the following cases:
- when the workers that the contractor makes available to the contracting party originally were workers of the contracting party and had been transferred to the contractor.
- when the workers provided or made available by the contractor cover all the principal activities of the contracting party.
It is clarified that subcontracting is not considered to be the provision of specialized services or the execution of specialized works that are not part of the corporate purpose or the economic activity of the contracting party, provided that the contractor has the abovementioned authorization from the STPS.
In this context, to take the deduction and/or credit of specialized services or specialized labor, they should obtain from the contractor information such as: i) a copy of the valid authorization as a provider of specialized services; ii) the electronic invoicing (CFDIs) of the payments to the workers that provided the service and the proof of payment issued by the bank of the withholding income tax return; iii) proof of social security payment of the employer and the contributions to the national housing fund; and iv) a copy of the VAT monthly return and the payment of the VAT.
The current obligation to withhold 6 percent VAT on the provision of personnel will be abrogated.
Finally, the proposal also considers as tax fraud, any schemes that simulates the provision of specialized services, specialized labor or the subcontracting of personnel. For the Federal Tax Code purposes, the contracting party would be jointly and severally liable for the contributions that would have been made by the workers with whom the subcontracting service is provided.
The discussion of this initiative has been delayed until February 2021, but there are no doubts about the imminent approval of the reform.
Asset purchase or share purchase
An acquisition in Mexico can take the form of an asset deal or a share deal.
According to the Mexican tax rules, on a business acquisition, the seller and buyer share jointly in liabilities incurred by the business during the 5 years leading up to the acquisition.
Mexican laws do not define the term ‘business’. According to the tax authorities, a sale of a business occurs when a company sells or otherwise disposes of the assets and liabilities that were used to develop the core business of a company. Another indication that a transfer of a business has occurred is the simultaneous transfer of employees to the company acquiring the assets and liabilities. This joint liability is limited to the purchase price paid for the assets.
If the acquisition of assets is properly planned and reviewed by tax and legal advisors, the transfer of a potential tax risk can be mitigated. By contrast, on a purchase of shares, the historical liabilities remain with the company acquired.
Some of the tax considerations relevant to each method are discussed later in the report, and their respective advantages are summarized at the end of the report.
Purchase of assets
An acquisition of assets increases the cost of the transaction, because the transaction is normally subject to VAT. When the buyer is a Mexican resident, this additional cost may be refunded. In addition, tax for the transfer of real estate property may apply. From a tax perspective, however, the acquisition of assets preserves the tax basis for the buyer and may result in a reduced tax basis for corporate income tax purposes.
For tax purposes, it is necessary to apportion the total consideration among the assets acquired. It is generally advisable for the purchase agreement to specify the allocation, which is normally accepted for tax purposes provided it is commercially justifiable. The Mexican rules are very formal and, in addition to the contract, require proper invoices supporting the acquisition of assets and detailing the amount of the VAT triggered on the acquisition.
Goodwill purchased from a third party is not deductible for tax purposes in Mexico. According to the criteria used by the tax authorities, goodwill is the excess paid for the assets over their real value, nominal value or fair market value.
For tax purposes, depreciation of acquired tangible and intangible assets must employ the straight-line depreciation method at the maximum rates specified for each asset in Mexican income tax law. Among others, applicable rates are as follows:
- 5 percent for buildings
- 10 percent for office furniture and equipment
- 25 percent for automobiles, buses, trucks, tractors and trailers
- 30 percent for personal desktop or portable computers, servers, printers, optic readers, digitizers and computer networking hubs.
There are special rules for cars and certain intangible assets, such as royalties.
In the case of a sale of assets in Mexico, the tax attributes of the company (i.e. tax losses and tax credits) are not transferred to the acquirer of the assets.
As previously mentioned, the purchase of assets (goods) is subject to VAT. The general VAT rate is 16 percent.
Purchase of shares
The purchase of a target company’s shares does not represent a deduction for corporate income tax. In a share deal, no VAT is applicable.
Tax indemnities and warranties
In a share acquisition, the buyer takes over the target company together with all related liabilities, including contingent liabilities. Therefore, the buyer normally requires more extensive indemnities and warranties than in the case of an asset acquisition. The alternative approach, to inject the seller’s business into a newly formed subsidiary, does not work in most cases because of the joint tax liability for the transfer of a business under Mexican law.
A full due diligence investigation is essential in a share deal. When significant sums are identified as potential tax contingencies as a result of the due diligence exercise, it is common for the buyer to require the establishment of an escrow amount from which the seller can draw on an agreed schedule.
The Mexican tax authorities are entitled to examine and assess additional taxes for any year, at any time within a 5-year period commencing on the day after taxes were due or tax returns were filed, including amended returns. If the taxpayer has deducted tax losses from taxable profits, the tax authorities are entitled to examine and assess the information relating to the losses, regardless of how they were generated, for up to 5 years after the amortization of the loss.
After a change in control, the losses of an entity acquired can only be used against income from the same line of business that generated the losses. The carry forward period is 10 years.
Crystallization of tax charges
Since tax authorities may claim joint liability of the buyer for unpaid taxes in the last 5 years, it is essential to obtain an appropriate indemnity from the seller in addition to the escrow amount.
Choice of acquisition vehicle
Several potential acquisition vehicles are available to a foreign buyer, and tax factors often influence the choice. There is no capital duty in Mexico.
Local holding company
A Mexican holding company is typically used where the buyer wishes to carry out an asset deal. In a share deal, however, changes introduced in the 2014 tax reform have reduced the ability to push down debt to the Mexican holding vehicle.
Foreign parent company
A foreign parent company is commonly used in a share deal. International corporations completing a stock or asset purchase through a foreign vehicle should evaluate:
- participation exemption regulations in foreign countries\
- interest deduction in foreign countries
- goodwill deduction
- passive income accrual
- controlled foreign company (CFC) rules
- entity classification for foreign tax purposes
- exit strategies
- debt pushdown to Mexico.
Exit strategies that exempt Mexican corporate income tax withholding on any capital gain derived from the transfer of Mexican operations include:
- completing the transaction with a subsidiary in a country with which Mexico has signed a tax treaty providing exemption from capital gains tax on the sale of shares (e.g. France, Italy)
- setting up an intermediate holding company in a foreign country that can be sold, so that no transfer of Mexican shares occurs. In this case, the Mexican shares should not derive, directly or indirectly, more than 50 percent of their value from real property located in Mexico. If they do, the transfer is taxable in Mexico, unless the Belgium or Luxembourg treaty applies.
Non-resident intermediate holding company
If the foreign country taxes capital gains and dividends received from overseas, an intermediate holding company resident in another territory could be used to defer this tax and perhaps take advantage of a more favorable tax treaty with Mexico. However, the buyer should be aware that many Mexican treaties contain treaty-shopping provisions that may restrict the ability to structure a deal in a way designed solely to obtain tax benefits.
A branch is not used as a vehicle of acquisition in Mexico due to several tax inefficiencies.
A joint venture may be used for the acquisition. In Mexico, the joint venture is only available at the corporate level, with the joint venture partners holding shares in a Mexican company. Mexican rules do not distinguish between a joint venture vehicle and a Mexican holding company for tax purposes.
Choice of acquisition funding
As of 2005, Mexican tax law applies thin capitalization rules such that interest paid to foreign related parties that results in indebtedness exceeding a ratio of 3:1 to their stockholders’ equity is not deductible for corporate income tax purposes.
Foreign investment may be financed with debt or equity at the investor’s discretion. Some issues that should be considered when evaluating the form of the investment are discussed below.
The most important benefit of financing through debt instead of equity is the interest deductibility for corporate income tax purposes in Mexico.
Debt considerations for corporate income tax purposes include the following.
- Interest payments made on ‘back-to-back loans’, as defined under Mexican tax law, may be treated as dividend distributions.
- The Mexican borrower may be subject to inflationary income resulting from the loss on the purchase value or the Mexican currency.
- The Mexican borrower may deduct any foreign exchange losses on the principal and interest components.
- Transfer pricing rules apply. Any interest that exceeds arm’s length interest in intercompany transactions is treated as a dividend distribution and is non-deductible.
Deductibility of interest
Mexico’s thin capitalization rules require taxpayers to maintain a debt-to-equity ratio of 3:1. The ratio includes all interest-bearing debt. The equity is determined according to Mexican generally accepted accounting principles (GAAP) and excludes the income or loss of the same year (e.g. equity is calculated as the sum of accounting capital at the beginning and end of the relevant year divided by two). Interest paid in excess of the ratio is disallowed for income tax purposes.
When such interest is paid to a lender abroad, such non-deductible interest is still subject to withholding tax (WHT).
Moreover, interest paid to a foreign controlling or controlled entity from Mexico is not deductible where:
- the foreign entity is transparent for tax purposes and its members are not subject to income tax in their country
- the payment is non-existent for that foreign entity, or
- the interest revenue is not taxable for the foreign entity.
Under Mexican domestic tax legislation, all taxpayers are required to price their transactions with related parties on an arm’s length basis. When transactions are carried out with foreign-based related parties, taxpayers must also prepare and maintain documentation that supports the arm’s length price by identifying related parties and disclosing information about the functions, risks and assets associated with each type of transaction performed with related parties.
As part of the tax reform in force commencing 2020 and based on the final report of Action 4 — BEPS, to avoid multinational groups being indebted to its subsidiaries, and considering that this report establishes limitations for interest deduction that are more effective than the thin capitalization rules, it is proposed that the net interest deduction (accrued interests in favor and accrued interest charged) cannot be greater than 30 percent of the taxable income adjusted. If the interest cannot be deducted in that fiscal year, these can be deducted in a 3-year period, if specific requirements are met.
This disposition will be applicable to the deductible interest commencing in the fiscal year 2020, no matter the debts for which the interest is incurred, derived from prior fiscal years.
There is an exception for the first US$20,000,000 accrued interest; however, this amount is at the group level.
Withholding tax on debt and methods to reduce or eliminate it
Interest is considered to be Mexican source where the capital is placed or invested in Mexico or where the party paying the interest is a Mexican resident or a non-resident with a permanent establishment.
WHT rates applicable to interest paid vary depending on the foreign beneficiary, the borrower domiciled in Mexico and the purpose of the loan.
WHT rates are as follows.
- A 4.9 percent WHT rate may apply in the case of loans or other credit payable by Mexican financial institutions, as well as loans placed through banks in a country with which Mexico has a tax treaty.
- The WHT rate is 10 percent for finance entities owned by foreign governments and foreign banks, including foreign investment banks and non-bank banks, provided they are the effective beneficiaries of the interest and provided they submit to the Mexican tax authorities the information required under the general rules on financing granted to Mexican residents. Non-bank banks should also comply with the requirements established by the tax authorities relating to placement percentages and deposits received.
- The WHT rate is 21 percent for foreign suppliers who sell machinery and equipment forming part of the acquirer’s fixed assets.
- The WHT rate is 21 percent for financing to acquire machinery and equipment and in general to supply working capital, provided these circumstances are mentioned in the agreement.
- The WHT rate is 35 percent for other interest (e.g. loans granted by foreign-related parties). This rate may increase to 40 percent as discussed below.
Payments of interest by a Mexican resident to a foreign-related party subject to a preferential tax regime (tax haven) are subject to 40 percent WHT. Despite the above rates, tax treaty rates should be observed. As noted in the table at the end of this report, the highest tax treaty rates for general interest payments are 15 percent and 10 percent, depending on the terms negotiated with each country and whether the treaty includes a most-favored-nation clause.
Withholding is triggered when payment is made or when interest is due, whichever occurs first.
Checklist for debt funding
- It is difficult to implement debt pushdown strategies in Mexico.
- To identify the optimal amount of debt to be allocated to Mexico, it is necessary to carry out projections for corporate income tax.
- The use of bank debt may avoid thin capitalization and transfer pricing problems, but back-to-back loan restrictions may apply.
- Maximum WHT applies on interest payments to non-Mexican entities unless a lower rate applies under a relevant tax treaty.
When incorporating a new company, there is no capital duty in Mexico. However, Public Registry recording obligations may apply. According to Mexican income tax law, the income obtained by the corporation from capital increases is not taxable, but such increases of capital in Mexican or foreign currency must be reported with a detailed return filed within 15 days of the receipt of the capital. Transfers of goods to the capital of another company are taxed as sales, and corporate tax may be triggered on gains derived from the transfers.
No currency restrictions apply in Mexico, so capital contributions and repatriations can be achieved in foreign currency. However, from Mexican legal and tax standpoints, once the capital contribution in foreign currency is made, it is converted into Mexican currency. Therefore, if the Mexican currency suffers a substantial devaluation, the foreign investor may suffer a loss in foreign currency terms.
Capital repatriations in the form of share redemptions are not subject to exit capital duties and can be effected tax-free for the shareholder up to the amount of contributed capital per share. However, when a profit is determined from a capital redemption that exceeds the capital contributions account balance (CUCA by its Spanish acronym), the additional 10 percent tax applies where the profit was not generated before 1 January 2014.
In an alienation of shares or security instruments representing the ownership of property, the source of wealth is deemed to be located in Mexico where the issuing entity resides in the country or where more than half the accounting value of said shares or security instruments is derived directly or indirectly from real property located in the country. Income tax would be assessed at 25 percent on the gross amount without any deduction, or 35 percent on the gain. The latter treatment is only applicable where certain requirements are met, such as where the non-resident (seller) has a representative in Mexico, the non-resident’s income is not subject to a preferential tax regime and the non-resident files an audit prepared by a certified public accountant (CPA) with the tax authorities. In the case of a related-party transaction, the CPA must report the market value of the alienated shares in the audit. The buyer must make the withholding if it is a resident or a non-resident with a permanent establishment in Mexico. Otherwise, the taxpayer must submit the applicable tax by a return filed with the authorized offices within 15 days of the receipt of the income.
According to Mexican tax provisions, a domestic merger may be carried out tax-free where the following conditions are met.
- The surviving company files a notice of the merger with the tax authorities no later than 1 month following the date on which the merger is approved by the shareholders.
- Following the merger, the surviving company continues to carry out the activities that it and the merging companies carried out before the merger for a period of at least 1 year following the date on which the merger was completed.
- The surviving company files all tax and information returns on behalf of the merging companies for the fiscal year in which the merger is completed, including payment of any tax liability at the date of the merger.
- Finally, reorganizations may be carried out on a tax-free basis in certain cases; however, further analysis of the details of the reorganization is required.
Concerns of the seller
The tax position of the seller can significantly influence the results of the transaction. As discussed previously, in certain circumstances, the seller may prefer to realize part of the value of their investment as income by means of a pre-sale dividend, if the company has a sufficient balance in its pre-2014 net after-tax earnings account.
Many companies in Mexico are family businesses. The disposal of the shares of such businesses is commonly taxed at an individual rather than a corporate level. This is important because the seller generally looks to pay reduced taxes on the transaction and may propose arrangements that could cause tax contingencies for the company being acquired. Therefore, it is advisable at the outset of the process to identify the transaction structure proposed by the seller in order to evaluate its tax implications and reduce potential delays.
Company law and accounting
Legal entities may be organized in various forms under Mexican law:
- Sociedad en nombre colectivo — the usual general partnership form
- Sociedad en comandita simple — a limited partnership with some general partners (having unlimited liability) and some limited liability partners; its capital is represented by social interests
- Sociedad en comandita por acciones — a limited liability stock partnership with some general partners (having unlimited liability) and some limited liability partners; its capital is represented by shares
- Sociedad de Responsabilidad Limitada (S. de R.L.) — a partnership with limited liability for all its members; its capital is represented by social interests
- Sociedad Anónima (S.A.) — an entity similar to a US corporation in which all members have limited liability; its capital is represented by shares
- Sociedad Anónima Promotora de Inversión (SAPI) — a type of entity for investors organized in general terms as an S.A. but exempt from certain restrictions, which gives shareholders additional rights; it is recommended for joint venture projects and entities that may become publicly listed companies, since it is regulated by the Securities Market Law
- Sociedad de Acciones Simplificada (SAS) — the latest type of entity constituted by one or more individuals who are only obliged to pay their contributions represented in shares; the total annual income of this entity may not exceed MXN5 million. Its capital is represented by common shares.
General partnerships lack limited liability, so foreign investors do not often use them. Although an S de R.L. is treated in the same way as any other commercial entity for Mexican tax purposes, it may be treated for US tax purposes as an eligible entity for partnership status; as such, its US partners, whether corporate or individual, benefit from the pass-through taxation rules.
The S.A. is the most common entity used by foreign investors in Mexico, and discussions in the rest of this report focus on the S.A. Both an S.A. and an S. de R.L. may be incorporated as variable capital (de capital variable) entities, which enables the capital to be increased or decreased by simple shareholders’ or partners’ resolutions, without further formalities. The shareholders may redeem their contributions to the variable capital without any special formalities, but they cannot withdraw their contributions of the fixed capital, which must be maintained at the minimum level established in the By-Laws.
M&A in Mexico should be accounted for according to the Mexican financial reporting standards (FRS), which generally are consistent with International Financial Reporting Standards (IFRS). There are some differences, however, which include the following.
- Under IFRS, if the value of net assets acquired exceeds consideration and any retained minority interest, a gain is recognized. Mexican FRS does not allow the recognition of any gain until intangible and fixed asset values are adjusted to zero.
- Under Mexican FRS, the seller’s contingent liabilities are recognized when payment is deemed to be probable and the amount can be reasonably estimated. Under IFRS, the seller’s contingent liabilities are recognized if fair value can be reasonably estimated.
- Under IFRS, when an entity obtains control through a series of acquisitions (step acquisitions), it should revalue any previously held equity interests at its acquisition-date fair value and record any gain or loss through the operating statement. New guidance for Mexican FRS does not allow the recognition of any gain or loss when control is obtained through step acquisitions.
If the buyer owns other Mexican companies, the target company can be included in the Mexican tax group if certain requirements are met. Among others, the Mexican holding company should own, directly or indirectly, more than
80 percent of the voting shares of the target company. In no case can more than 80 percent of the Mexican holding company’s voting shares be held by another or other companies, unless the latter are residents of a country with which Mexico has a treaty that includes a broad information exchange clause.
The new grouping regime does not allow the inclusion of entities with non-operating losses, and the tax deferment period is reduced to 3 years.
Mexico’s income tax law requires all taxpayers that execute transactions with related parties to undertake a transfer pricing study to demonstrate that their transfer prices honor the arm’s length principle.
There are no advantages under Mexican tax law for a dual resident company.
Foreign investments of a local target company
Mexico, in common with other countries, has established anti-tax haven provisions to close a loophole that both Mexican and foreign investors had used to allocate income to tax havens and so reduce their Mexican taxable income. The legislation is designed to prevent Mexican taxpayers from deferring Mexican income taxes by using preferential tax regimes or tax havens. Currently, the anti-tax haven provisions encompass all types of investments by a Mexican resident, both direct and indirect.
The definition of tax haven or preferential tax regime has been amended to include any regime where taxes paid are less than 75 percent of the amount that would be paid in Mexico. Income accrual does not apply where:
- income is derived from activities other than interest, dividends, royalties, gains on the sale of shares, real property, or the temporary use or enjoyment of real property, and
- the country in which the investment is located has a current treaty for the broad exchange of information with Mexico.
Income from a foreign source that is subject to a WHT reduction or exemption under a tax treaty executed with Mexico is disregarded for income tax purposes. This treatment does not apply to legal entities incorporated abroad that are not taxpayers or that are deemed transparent for tax purposes.
Direct and indirect Mexican investors in preferential tax regimes are obliged to recognize the income on a current basis and file an annual information return on their business and their investment activities in such jurisdictions.
Limitations for payments abroad
In 2020, new limitations to payments made to foreign-related parties or through a structure settlement were introduced; such payments cannot be deductible when the income is subject to preferential tax regimes, disregarding the possibility to deduct if this payment was made at market value
Furthermore, it is established that the tax transparency will not be recognized in Mexico for entities that are not subject to taxes, but only their partners or shareholders.
The ‘credit’ of the tax paid indirectly in distribution of dividends or profits is denied, when such dividends or profits were deducted by the payer or if the tax is credited in some other country, except when the income referred is considered taxable.
Renewable energy industry
Mexican Income Tax Law allows the deduction of 100 percent of machinery and equipment for energy generation from renewable sources or cogeneration systems of efficient electricity, provided the machinery and equipment are used for at least 5 years immediately following the year in which the deduction is claimed.
In a measure that aims to attract investment in renewable energy projects in Mexico, entities that are eligible for this deduction are able to distribute tax-free dividends against future profits through the creation of a ‘green net after-tax profit account’ (CUFIN verde).
Obtaining tax treaty relief
In the case of transactions with related parties, the tax authority is now authorized to require formal documentation from the non-resident to show that there is double taxation on the income for which a treaty benefit is being applied.
The documentation must specify the applicable provisions of foreign law and include any other documentation that may be deemed necessary.
Comparison of asset and share purchases
Advantages of an asset purchase
- Any VAT paid may be refunded if the buyer is a Mexican resident.
- A step-up in the tax basis of fixed assets and intangible property is allowed for income tax purposes.
- There is no transfer of seller’s liabilities, except in the case of an acquisition of the overall trade or business. However, strategies are available that avoid this contingency.
- The vehicle can be properly designed from the beginning, including exit strategies.
Disadvantages of an asset purchase
- Time required for setting up the vehicle to complete the asset purchase.
- Employees transferred typically demand seniority recognition from the new employer unless they receive a severance payment from the old employer.
- Property transfer taxes may apply.
- Goodwill paid is not tax-deductible.
- VAT may increase the cost of the transaction in certain circumstances.
Advantages of a share purchase
- Less time-consuming process.
- Usually more attractive to the seller, both commercially and from a tax perspective (because the disposal may be exempt), so the price may be lower.
- Transfer of tax loss carry forwards and other tax credits is allowed.
- No real estate transfer tax.
- The acquisition of shares is not subject to VAT.
Disadvantages of a share purchase
- Buyer effectively becomes liable for any claims or previous liabilities of the entity, including tax (i.e. there is a joint liability for unpaid taxes over the previous 5 years).
- No income tax deduction for the purchase price.
- Deferred tax liabilities are acquired.
- Possibly more difficult to finance tax-efficiently.
KPMG in Mexico
Dosal S.C. Manuel Avila
Camacho #176 Col.
T: +52 55 5246 8727
Dosal S.C. Manuel Avila
Camacho #176 Col.
T: +52 55 5246 8659
This country document does not include COVID-19 tax measures and government reliefs announced by the Mexican government. Please refer below to the KPMG link for referring jurisdictional tax measures and government reliefs in response to COVID-19.
Click here — COVID-19 tax measures and government reliefs
This country document is updated as of 1 January 2021.
Brindamos a nuestros clientes una extensa gama de servicios legales para que cumplan sus obligaciones fiscales estatales, federales e internacionales.
Brindamos a nuestros clientes una extensa gama de servicios legales para que cumplan sus obligaciones fiscales estatales, federales e internacionales.