COVID times has brought us tough changes in our lives, and tax reform is one of them. In the U.S., the CARES Act provided relief to multiple sectors of the economy to alleviate the impact of the pandemic. However, the perspectives of tax reform in other jurisdictions are quite different, mainly considering the impact of COVID in public finances. Mexico is aimed in that direction.
Earlier November of this year, the Mexican Senate approved multiple tax amendments that aim to strengthen the revenue-collection capacity of the tax authorities, but more importantly, intend to regulate certain business activities, such as those provided by Digital Service Providers (DSP) with no tax residence in Mexico.
In the following lines, we will discuss how DSPs will be subject to harsh regulations in Mexico as consequence of the newly approved tax reform which may lead to a “shut-down” of their operations.
Subjects and Compliance Rules
Multiple DSPs provide remote digital services to Mexican based customers. Such providers usually are not tax residents therein, nor they have a permanent establishment (PE) in that jurisdiction.
Under rules enacted by the Mexican government for 2020, DSPs with no PE in Mexico that provide digital services to customers therein are subject to certain compliance rules, including:
- The registration of the DSP with the Mexican tax authorities.
- Charge Value Added Tax (VAT) at the normal tax rate of 16% on the services provided to customers.
- Generate monthly reports detailing the number of transactions or services provided to Mexican customers. Such reports are submitted quarterly to the Mexican tax authorities.
- Issue electronic invoices to each of their customers.
- Appoint a legal representative in Mexico to receive notices and verification requests from the tax authorities.
- Request electronic signature under the Mexican tax laws.
The type of businesses that are subject to this compliance rules are those that provide:
- Downloads or access to images, video, movies, text, information, audio, music, games, bets, or any type of media or digital content.
- Multiplayer games, which certainly includes MMORPG (massively multiplayer online role-playing game).
- Online news, weather information, or traffic information.
- Marketplaces among sellers/buyers.
- Online clubs and dating websites or apps.
- Online learning or testing.
DSPs that fall within the mentioned categories and that comply with the registration rules described, are included in a list of registered companies, which is published by the tax authorities. Up to the publication of this article around 47 companies are already registered in Mexico, including the following:
As an additional note, it must be added that the registration or the appointment of the legal representative does not create a PE because of an exemption provided specifically for these types of businesses.
Non-compliance consequences: Shut-down access to Mexican market
Until 2020, failure to comply with the above rules did not brought any relevant penalty, except those provided by the Mexican Tax Code, which basically included failure-to-file penalties.
However, under the new tax legislation for 2021, failure to comply with these rules will brought severe consequences to providers of digital services, being the final consequence the ¨shut-down¨ of the access of the DSP to the Mexican market.
The specific process to verify compliance of the provider is as follows: Upon discovery of compliance failure by a DSP, the tax authorities will issue a letter to the provider, explaining the failure. Such letter is published in the Official Federal Registrar in case the provider fails to register before the tax authorities, fails to appoint a legal representative in Mexico or fails to request its electronic signature. In the remaining cases, the letter will be sent to the appointed legal representative.
Once the letter has been issued, the DSP has 15 days to answer such letter and may request an extension for additional five days to respond. The extension is automatic if requested within the original response period.
The tax authorities have a period of 15 days to evaluate the response of the DSP and will issue a determination that is published in the Official Federal Registrar. If the authorities consider that the provider has fail to comply with its obligations, it will order the temporary block of the company to the Mexican market.
The order to temporarily “shut-down” operations of a provider is sent to the telecommunications companies operating in Mexico, which have a period of five days to execute the order. Moreover, the tax authorities will periodically issue a list of blocked companies. If the provider complies with all the obligations after the “shut-down” it will have to request market access to the tax authorities.
Considerations and plan of action
The new penalties for non-Mexican based digital services providers are severe and can produce the interruption of ongoing operations in the Mexican market. Considering that some relevant companies are already registered with the Mexican tax authorities, it is clear that additional participants in the Mexican market with no presence therein will start the registration as soon as possible.
These new changes will bring challenges to medium businesses and startups that are just beginning to expand their operations beyond the U.S. market. Administrative costs to comply and retaining foreign counsel will put pressure on costs of the operation. From our experience, it is advisable to register with the tax authorities to prevent unexpected risks in the near future, bearing in mind that the Mexican government is heavily pressured to obtain more revenue. Advice from U.S. counsel with expertise in foreign jurisdictions should be sought to ease the transition to a new market.
International & Offshore Tax Compliance Attorneys
Freeman Law represents clients in the Dallas-Fort Worth area, the United States, and internationally. Schedule a consultation or call (214) 984-3410 to discuss your tax concerns.