i. Brief introduction to Mexico’s Tax legislation.
As set forth in article 21 section IV of the Political Constitution of the United Mexican States, it is the obligation of Mexicans to contribute to public spending; Consequently, the federation's Tax code establishes that any natural or legal person that possesses a source of wealth within national territory is bound to said contributions under the terms of article 1 of the same code. Furthermore, said tax code in its article 2, differentiates contributions in its sections I and II in taxes and social contributions, Where the former refers to those tax burdens related to obtaining profits, added value and burdens directly related to specific economic activities; and the latter consist of contributions where a person is replaced by the State in the fulfillment of obligations established by law in the matter of social security or to the people who benefit in special form by services of social security provided by the State.
Standart tax olbigations are income tax and VAT including, where applicable, their respective withholdings. Mexico’s tax authorities in recent years had implemented several electronic instances where all invoicing must comply with Tax code regulations stated on Articles 29 and 29-A which trigger both revenue recognition as well as expense deductibility; therefore its mandatory to fulfill this requirement, the lack of compliance with this regulation will result in the application of sanctions by tax authorities.
It is very important to mention all expenses in order to be deductible from the taxable income must comply with the principles stated on Article 27 of Income Tax Law; one of the more important sections (Section III) states that expenses must be:
“Be covered by a tax receipt and that payments whose amount exceeds $2,000.00 are made by electronic funds transfer from accounts opened in the name of the taxpayer in institutions that make up the financial system and the entities that for this purpose, authorize the Bank of Mexico; nominative check of the taxpayer account, credit card, debit card, services, or so-called prepaid cards authorized by the Tax Administration Service.”
Based on the above all expenditures above $2,000.00 MXN (~100 USD) must be paid via wire transfer or nominative checks from the account of the taxpayer intending to deduct said expenditure. Mexico has a clear segregation between statutory and tax accounting where all taxpayers need to reconcile between these different sets of accounting books, therefore even though there may be losses at statutory level, they may not be reflected within tax accounting.
i. Income Tax
In article 1 of the income tax law, the following persons are defined as subject to this tax:
a. Residents in Mexico, with respect to all their income, whatever the location of the source of wealth where they come from.
b. Residents abroad who have a permanent establishment in the country, with respect to the income attributable to said permanent establishment.
c. Residents abroad, regarding income from sources of wealth located in national territory, when they do not have a permanent establishment in the country, or when having it, said income is not attributable to it.
a. Tax Rate
According to Income tax law Article 9; the rate of said tax it’s equal to 30% over taxable income.
b. Calculation
Income tax for legal entities, is calculated based on annualized results and is subject to the provisions of Title II of said law. As cited in article 9, the application of the rate for this tax will be made over the taxable profits which will be obtained by decreasing from the total cumulative income obtained during the year, the deductions authorized by said Title plus employees profits share paid in the year (in the terms of Article 123 of the Political Constitution of the United Mexican States), additionally the taxable profits will be reduced, if applicable, by the outstanding tax losses from previous exercises (not going back for more than 5 years).
As previously mentioned, statutory and tax accounting presents several differences, therefore the reconciliation between both must be performed as follows:
a. Monthly advance payments
Regardless of the annual income tax calculation, all taxpayers subject to Income tax must pay on monthly basis a partial payment on behalf of the annual burden, consequently Tax legislation mandates to calculate a profitability index based on the previous 12 month fiscal year. In the event the previous year did not provide a profitability index, the taxpayer must apply the latest by which this index had been determined, without that exercise being older than five years to the one for which advance payments must be made.
i. Value added tax (VAT)
a. Rate
Article 1 from Value added tax Law expresses that all natural individuals and legal entities are subject to this tax whenever they perform any of the following activities:
a. Alienate goods,
b. Provide independent services,
c. Grant the temporary use or enjoyment of goods,
d. Import goods or services.
The tax will be calculated by applying to the values indicated by this Law, the rate of 16%. The tax on value added in no case will be considered part of these values and taxpayer shall transfer said tax, expressly and separately, to the persons who acquire the goods, use them or enjoy them temporarily, or receive the services. It will be understood by transfer of the tax the collection or charge that the taxpayer must make to said persons of an amount equivalent to the tax established in this Law, even when retained in the terms of Articles 1-A or 3, third paragraph thereof.
a. Debits and credits
As cited on paragraph 2 of the introduction to Mexican tax legislation, the trigger for revenue recognition for both Income tax and VAT is the invoice issuance, however the main difference between those taxes, resides in the cash flow management, due to the fact that for income tax purposes every income must be acknowledged as such on the moments it is billed; nonetheless for VAT purposes as stated on article 1 of said law, the enforceability of said tax is executed at the time of collection; consequently in order to recognized credits before payable taxation, it’s mandatory to comply with:
1. Expenses must be backed up with the proper invoice
2. Expenses (if above 100 usd) must have been paid via wire transfer or nominative check.
b. Monthly payment calculation
VAT is caused on a monthly basis, so monthly payments are considered as final and the calculation is made by subtracting the creditable tax effectively paid to third parties to the total transferred and effectively collected tax from third parties regardless if they are related or unrelated parties.
In the event the creditable tax amount is higher than the transferred tax, it is possible to apply the tax credit to the payables over the following periods.
c. Tax included at revenues.
Article 7 Bis of the Federal Consumer Protection Law establishes that all retail transactions must include within the offered prices of the products and services must include VAT; therefore, whenever FLG Servicios de Mexico withholds service fees over the loans granted to customers must split from its total withholding of service fees both VAT and actual revenues.
i. Withholding Taxes
a. Salaries & wages, Rents professional fees
Mexican tax legislation, provides some criteria that require legal entities to withhold taxes over operations with individuals and/or residents abroad; these assumptions are contained both in the law of income tax and VAT.
Whenever a legal entity does business with a individual, the former must withhold a 10% for Income tax and 2/3 of the creditable VAT, regardless the kind of services provided, which could be either the temporary usage of a property (rent agreements) or professional services rendered. Regarding salaries and wages paid to employees, the employer has the mandate to withhold whatever income tax is caused by the employee; nonetheless, in this case there will be no VAT involved.
Whenever a legal entity withholds taxes to a third party, it must pay those withheld taxes to the tax authority on the 17th of the following month.
a. Payments to abroad parties
Whenever a resident on national territory does business with residents abroad, there is a mandate to withhold income tax as stated on Article 1 of Income tax law, therefore every payment made to abroad parties must act in consequence. There are different criteria for these withholdings, and it may vary from country to country depending on the international treaties Mexico is part of.
In terms of Income Tax Law Article 4, the benefits of treaties to avoid double taxation will only be applicable to taxpayers who prove to be residents in the country in question and comply with the provisions of the treaty itself and of the other procedural provisions contained in said Law; moreover, in cases where treaties to avoid double taxation establish lower withholding rates than those indicated in this Law, the rates established in said treaties may be applied directly by the retainer; In the event that the retainer applies rates higher than those indicated in the treaties, the resident abroad will have the right to request a refund for the corresponding difference.
i. Transfer pricing
a. General overview
Mexico’s general criteria to determine if transactions are hold by related parties submits itself to Article 9 of OCDE Model Tax Convention on Income and Capital, where it considers that whenever a legal entity or individual of a contracting state participates directly or indirectly over management, control or capital of another legal entity in a different contracting state; Income tax law abides to the aforementioned criteria in Article 179.
Transfer pricing comparability is a self-qualification analysis in Mexico, that even though is not mandatory to file it before tax authorities, is extremely important to have it, as far as it may allow the deduction of such transactions for Income tax purposes; this Comparability analysis, as adopted on Income tax law Article 179, requires that transactions between related parties comply with principles of market value and arm’s length, otherwise the tax administration reserves the right to determine both income and approved deductions based over price value if such transactions would had been held with a non-related party.
a. Thin capitalisation rules*
Rules adopted by Mexican government, in order to prevent the excessive debt with related parties and to prevent the shift of taxable profits abroad, includes rules over capitalisation where the deduction of financing charges is limited based on the relation between equity and total debt.
General rule is interest expense over debt exceeding 3 times the registered equity will not be deductible. Calculation for these purposes is based on the value of the equity (common stock), compared to the total debt with related parties; where the latter should not be higher than 3 times the former. Whenever this happens, it is necessary to calculate a “interest factor” which will be the debt in excess (total debt with related parties minus 3 times registered equity) divided by total debt with related parties. This index will be applied to the total accrued interest and the result will be considered as non- deductible interest expenditures
* On the federal revenues law proposed before congress for 2020, there is a major change regarding thin capitalisation, which I'll review in a different article whenever it is approved or modified.
Comments