United States-Mexico Tax Treaty
The world’s most populous Spanish-speaking nation. Mexico is a Federation comprised of 32 states, being Mexico City the capital of the country. The government of Mexico is divided in three branches: the Legislative Branch in the form of a bicameral legislature comprised of a Senate of the Republic (Cámara de Senadores) and the Chamber of Deputies (Cámara de Diputados); the Executive Branch, with a President as the head of State; and a Judicial Branch, headed by the Supreme Court of Justice.
Mexico is one of the top economic partners of the U.S. which has allowed the creatin of integrated chains of supply among U.S. and Mexican businesses. Mexico and the U.S. have signed and ratified the United States, Mexico, and Canada Agreement- USMCA, which is a revised version of the former North American Free Trade Agreement- NAFTA. Under the USMCA, there are multiple protections for the investors from the North American region as well as import/export rules that require regional content inclusions in goods manufactured in the region.
Mexico is also a top touristic destination around the world, and specially for U.S. individuals. Consequently, there is a high degree of investments in real property from U.S. persons that may be relevant for U.S. tax and reporting purposes.
U.S.-Mexico Tax Treaty
The following are the current taxes in Mexico:
Income tax (Impuesto sobre la Renta)
Mexico imposes income tax on tax residents, nonresidents with permanent establishments (PE) located in Mexico and nonresidents with income attributable to Mexican sources.
Tax residents are subject to worldwide taxation, meaning that the tax resident pays income tax on income obtained from all sources and jurisdictions. The tax rates applicable to tax residents are 30% (corporate tax rate) and can go up to 35% for individuals.
Nonresidents with a permanent establishment in Mexico are taxed only for the income attributable to the permanent establishment. Mexico follows the traditional concept of PE, and any fixed place of business through which business or independent services of an enterprise are wholly or partly carried on. Preliminary or auxiliary activities are not considered to constitute a PE. It must be highlighted that under the most recent developments of the Base Erosion and Profit Shifting Project (BEPS) carried by the Organization for the Economic Cooperation and Development (OECD), Mexico has updated its traditional definition of PE to include situations where the auxiliary activities are part of a cohesive transaction. In these cases, a PE is deemed to exist. If a nonresident has a PE under Mexican law, such PE is subject to taxation under the applicable tax rates for tax residents.
Nonresidents with income attributable to Mexican sources. If a nonresident obtains income from source within Mexico and has no PE therein, the nonresident is subject to withholdings on such income. Examples of income from sources located in Mexico are wages, royalties, dividends, payments received for technical assistance, capital gains (meaning sales from property located within Mexico), etc. Income received from those sources is usually subject to various withholdings rates. As discussed below, such withholding rates can be reduced under the applicable tax treaty.
Mexico provides specific tax benefits for assembling or manufacturing operations carried through a Maquiladora. The main tax benefit of operating a maquiladora is to prevent the creation of a PE for the activities carried by the maquiladora. This allows U.S. companies to generate income not subject to taxation under Mexican law which can be repatriated to other jurisdictions.
Under a relevant tax reform implemented in 2020, Mexico has incorporated provisions to prevent the use of anti-hybrid mechanisms. Additional rules pertaining to payments made to related parties subject to a “preferential tax regime” are non-deductible. Notably, this includes payments to related parties in the United States that are subject to the “foreign-derived intangible income” (FDII) regime. New provisions are also included to limit certain interest deductions, which cannot exceed 30% of adjusted fiscal profit.
In addition, new tax legislation target income obtained through foreign tax-transparent entities or other investment vehicles for private equity funds.
Perhaps most notably, the 2020 tax reform implemented the economic substance rule, the “step-transaction” doctrine and the ability to re-characterize certain actions or legal acts that are deemed to lack “business reason.”
Value Added Tax- VAT (Impuesto al Valor Agregado- IVA)
Mexico imposes a VAT on sales, leases or services provided to final consumers. The statutory tax rate is 16%. There is a preferential tax rate of 8% applicable only to States located in the border with the U.S.
VAT is also applicable to transactions carried through digital platforms. Moreover, providers of digital services that do not have a PE located in Mexico must register with the Mexican tax authorities and although they are not subject to income tax or VAT, must charge VAT on services provided to Mexican consumers. Failure to meet such requirements will lead to a shut-down from the Mexican market.
Social Security Taxes
Mexico imposes mandatory employer contributions to support multiple social benefits. For example, there is a mandatory employer contribution whose rate depends on the risk of the job performed by the employee. Other contributions are for maternity, sickness, incapacity, death, and retirement. Finally, there is an additional 5% contribution for housing of the employee. All these contributions are payable to the Mexican Institute of Social Security (Instituto Mexicano del Seguro Social- IMSS). The employee is also required to make contributions for such concepts.
Additionally, and not properly a tax, there is a mandatory profit sharing with employees in the amount of 10% of the net taxable income of a business entity.
Tax Treaty with the U.S.
Mexico is one of the few jurisdictions that has a tax treaty with the U.S. in the Latin American region. The relevant documents are the following:
- Convention Between the Government of the United States of America and the Government of the United Mexican States for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, together with a related Protocol, signed at Washington on September 18, 1992
- Technical Explanation of the Convention and Protocol between the United States and Mexico signed on September 18, 1992
- Second Additional Protocol That Modifies the Convention Between the Government of the United States of America and the Government of the United Mexican States for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income
- Technical Explanation of the Protocol between the United States and Mexico, signed on November 26, 2002, (the “Protocol”) amending the Convention between the United States of America and the United Mexican States for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, signed on September 18, 1992
Subject to the Limitations on Benefits Clause (LOB), the tax treaty between Mexico and the U.S. provides for multiple tax benefits, specifically as for the determination of a PE, reduced withholding tax rates, and exemption of certain types of income such as business profits.
Currency. Mexican peso (MXN)
Common Legal Entities. Corporation (SA), limited liability company (SRL) and branches.
Tax Authorities. Servicio de Administración Tributaria (SAT or Tax Administration Service)
Tax Treaties. Mexico is a party 59 tax treaties, and is a signatory to the OECD’s MLI.
Corporate Income Tax Rate. 30%
Individual Tax Rate. Up to 35%
Corporate Capital Gains Tax Rate. Mexico does not provide for special tax treatment with respect to capital gains.
Individual Capital Gains Tax Rate. 10% where applicable.
Residence. An individual is deemed a tax resident if she/he maintains a permanent home in Mexico. Mexican nationals are deemed tax residents, subject to the permanent home and center-of-vital-interests test.
Interest. 35%, generally.
Transfer Pricing. Mexico employs transfer pricing rules that largely adhere to OECD guidelines, generally utilizing the comparable uncontrolled price (CUP) method or the cost plus and resale price methods
CFC Rules. Yes, Mexico provides for a controlled foreign company (CFC) regime for certain “controlled” entities with significant passive income that is subject to low rates relative to Mexico’s statutory rate.
Inheritance/estate tax. No.
Taxpayers with interests in assets located in Mexico or income sourced in Mexico may have important reporting obligations, including the following forms:
- Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations,
- Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business,
- Form 8938,
- Form 3520, Reporting Transactions with Foreign Trusts and the Receipt of Foreign Gifts,
- Form 3520A, Information Return of Foreign Trusts With a U.S. Owner, and
Other forms and reporting obligations may apply.
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