These exemptions are generally extended to intermediate
entities or vehicles, but are subject to limitations that
should be carefully analysed when structuring an investment to
avoid jeopardising its tax-free treatment.
In order to attract foreign capital and promote inbound
investments in Mexico, a presidential decree was issued in
March 1992 granting an income tax exemption for investments
made by FPFs. The FPF exemptions, as originally introduced,
granted a full withholding tax exemption on any type of
Mexican-sourced income derived from investments made by FPFs in
the country; provided such funds were exempt from income tax in
their country and applied for their registry annually to the
Mexican tax authorities.
This withholding tax exemption was incorporated into the
Mexican Income Tax Law (MITL) later that year, with the
intention of providing further certainty to the FPF tax
Evolution of FPF rules through the years
Since their enactment, the FPF rules have been revised to
extend their application to intermediate entities or vehicles
through which FPFs route their investments, and limit their
scope mainly with respect to: (i) the number of intermediary
corporate layers allowed for FPF investments; (ii) the types of
income subject to the exemption; and (iii) the minimum holding
period of the income-producing assets.
Initially, to preserve the tax-free nature of investments
made by FPFs through intermediaries, FPF exemptions were
extended in 1995, through administrative tax rules, to foreign
investment funds owned by FPFs; these also had to be registered
with the Mexican tax authorities (this exemption was later also
extended to intermediate foreign entities in 2002 through
administrative tax rules). This exemption only applied in
proportion to the participation of the FPF in the foreign
investment funds or entities, regardless of the corporate
levels of the investment structure.
These provisions were then amended in 1998 to limit the
exemption only to interest, rental income and capital gains
derived from the sale of shares and real property located in
Mexico, to the extent that the FPFs were the beneficial owners
of such income and the real property had been leased for at
least one year prior to its sale. These rules expressly
excluded variable rental income from the exemption, which
became relevant for commercial leases as it is common practice
for such agreements to include a variable consideration based
on the income obtained by the tenants.
A big change followed in 1999, when a new provision was
included to grant a corporate tax exemption to Mexican entities
in which FPFs were shareholders, in proportion to the
participation of the FPFs in these entities. This is one of the
few examples under Mexican tax law of a Mexican entity being
granted a corporate tax exemption.
The FPF tax regime remained substantially unchanged until
2014, when a new MITL was published eliminating the FPF
registry in Mexico and increasing the lock-up rental period
from one to four years. The holding period was increased to
four years in order to mirror the rules governing Mexican real
estate investment trusts (FIBRAS).
Where do we stand today?
The latest amendments to the FPF tax regime came in late
2015, generating much concern amongst those FPFs already
investing in Mexico, as they:
(i) introduced limitations on the levels of entities or
vehicles allowed to be interposed within FPF investments, which
in most cases resulted in having to restructure existing
(ii) created income tests at the level of the intermediary
foreign entities or vehicles, putting at risk the exemptions of
such entities or vehicles if, for instance, they were also used
to invest in other countries; and
(iii) limited the exemption on interest income, and the
deduction of such expenses for Mexican borrowers, only to
interest derived from loans granted directly by FPF.
As of today, the MITL provides that FPFs are exempt from
income tax on interest, capital gains and income from granting
the temporary use or enjoyment of real estate property in
Mexico that has been leased for at least four years (Qualifying
Income). In general terms, the FPF exemptions are currently
granted at the following levels:
(i) Withholding tax exemption on Qualifying Income
(including interest) obtained directly by FPFs;
(ii) Withholding tax exemption on Qualifying Income (excluding
interest) obtained directly by foreign legal entities or
foreign investment funds in which FPFs participate directly
(only one level of foreign entities or foreign investment funds
(iii) Corporate tax exemption on Qualifying Income obtained by
Mexican entities in which FPFs participate directly (only one
level of intermediate Mexican entities allowed). This exemption
was rounded out with a withholding tax exemption on dividends
distributed by such entities from Qualifying Income; and
(iv) Corporate tax exemption on Qualifying Income obtained by
Mexican entities in which foreign legal entities owned by FPFs
participate directly (only one level of intermediate foreign
entities allowed). This exemption was also rounded out with a
withholding tax exemption on dividends distributed by such
entities from Qualifying Income, but in this case the dividends
have to actually reach the pension funds in order for the
exemption to apply.
What are the main challenges faced by FPFs investing in
One of the most significant challenges for FPFs has been to
achieve tax-free treatment along their investment structures.
This has not been easy considering the limitations on the
number of corporate layers allowed and the Qualifying Income
tests at the level of intermediary entities or vehicles.
These limitations tend to take centre stage when negotiating
co-investments or joint venture structures, as FPFs generally
have very low flexibility as they are required to ensure that
any intermediate vehicle or entity will not put their
exemptions at risk. It is common for joint venture partners to
each have to set up sophisticated structures on top of their
joint-venture vehicles to satisfy their particular
While there is no one-size-fits-all structure, the most
common joint venture vehicles for FPFs have proven to be
certain types of foreign investment funds which can be
disregarded for the purposes of the corporate-layer
limitations, or agreements governed under local law that lack
legal personality and can achieve tax transparency. However, as
is often the case, the devil is in the detail in such
structures, as those vehicles may be deemed to have lost their
lack of personality or their tax transparent status if not
properly set up, putting the FPF exemptions at risk.
It is also relevant to consider that since the exemptions
for intermediate entities or vehicles are granted in proportion
to the participation of the FPF, if these are ever diluted, the
exemption is generally lost in that percentage.
Another practical issue generally arises if FPFs invest
simultaneously in several projects, as projects generating
non-Qualifying Income may contaminate other projects if not
routed through an appropriate structure, therefore jeopardising
the exemptions for all projects. This usually results in having
to create complex structures to segregate project risks and
protect projects generating Qualifying Income.
FPF financing structures have also proven to be
head-scratchers. The challenge has been to create financing
structures for FPFs to fund Mexican projects, while maintaining
local FPF exemptions on interest income and allowing the
Mexican project companies to claim the deduction of the
expenses associated with such financing.
As touched on earlier, the latest amendments to the FPF
rules introduced new requirements for such purposes, which
basically limited the FPF exemption on interest income, and the
deduction of such expenses for Mexican borrowers, only to
interest derived from loans granted directly by FPFs. In
practice, it is rarely the case that FPFs grant financing
directly to project companies, so advisors often have to come
up with new and exciting ways to channel the funds to the
project companies while also being able to reap the
While this tax regime remains very attractive, FPFs should
be mindful of the rules that limit their exemptions and
carefully review their structures as they pursue their
investments in Mexico, in order to preserve the tax free nature
of their investments.
This article was written by Oscar A. López Velarde,
Santiago Díaz Rivera Bravo and Daniela Iñigo
Arroyo of Ritch, Mueller, Heather y Nicolau, S.C.
Oscar A. López Velarde
Santiago Díaz Rivera Bravo
Daniela Iñigo Arroyo (email@example.com)
Ritch, Mueller, Heather y Nicolau, S.C.