SPACs: A new financial instrument available in Mexico
During 2017 and 2018 the Mexican Stock Exchange witnessed the placement of securities issued by the first two Mexican special purpose acquisition companies (SPACs). Alberto Alvarez and Moisés Gutiérrez of Chevez, Ruiz, Zamarripa y Cia., address some aspects of the operation of said companies, as well as the tax implications that could arise for investors as a result of participating in a Mexican SPAC.
The first Mexican SPAC was issued to a company in the oil and gas sector
What is a SPAC?
In accordance with the U.S. Security and Exchange Commission, a SPAC is a company specifically created to pool funds in order to finance a merger or acquisition opportunity within a set time frame, of which identification is usually pending.
SPACs are vehicles that are very common in the American and Canadian markets. In the US, for example, there have been 291 SPACs listed since 2003, 155 of which have successfully completed an acquisition.
Such companies raise funds by means of an initial public offering (IPO) through an authorised stock exchange. Units are then issued by the SPAC. These units generally consist of shares of common stock and warrants to purchase common stock in the future. Each warrant may be exercisable for a full share of common stock or for fractions of such common stock at a price set in the corresponding prospectus.
The SPAC is a blank cheque company at the time of the IPO, since it does not have any type of business operation nor assets. Investors participating in the IPO basically rely on the experience and track record of the SPAC's management team, who should have enough knowledge to find an attractive acquisition target and, at a later stage, complete an acquisition through a business combination that could be a merger, share or asset purchase, reorganisation or any other type of transaction.
The industry sectors where the SPAC may invest are typically listed in the prospectus and depend on the background and skills of the management team.
While the management team is searching for the acquisition target, the proceeds from the IPO issued by the SPAC are deposited into a trust or escrow account. Once the account is funded, the management team normally has up to 24 months to identify and acquire an operating business.
If the SPAC does not complete an acquisition within such time frame, the vehicle must be liquidated and the proceeds obtained through the IPO should be returned to the investors or shareholders.
SPACs in Mexico
As opposed to other jurisdictions, Mexico does not have a specific regulation for all the aspects concerning the public listing and management of a SPAC. Instead, SPACs are seen in Mexico as investment vehicles brought from other jurisdictions which are being adapted through slight changes to the Mexican tax and legal framework.
Despite the lack of specific regulation, SPACs are starting to become a viable investment vehicle in Mexico mainly based on the success they have had in other countries and the flexibility they offer to investors.
The first Mexican SPAC was issued back in August 2017 by Vista Oil & Gas S.A.B. de C.V. (Vista Oil & Gas) and was listed on the Mexican Stock Exchange. This first vehicle was launched with the intention of raising funds to acquire one or more companies engaged in the energy sector in four countries: Mexico, Colombia, Argentina and Brazil.
The main difference between Mexican SPACs and their American counterparts is the fact that one third of the resources obtained through the IPO will be registered and recognised as a capital increase
Half of the portfolio of this Mexican SPAC was listed in Mexico through the Mexican Stock Exchange, while the remaining 50% was listed on international markets in accordance with the applicable regulations. Vista Oil & Gas IPO expected to raise around $11.7 billion Mexican pesos ($650 million). The management team of this Mexican SPAC has up to 24 months to identify and participate in a business combination.
Recently, in March 2018, Promecap Acquisition Company, S.A.B. de C.V. (Promecap) listed the second SPAC on the Mexican Stock Exchange. The purpose of this vehicle, as stated in the prospectus, is to invest resources in family-owned companies, private equity and public companies engaged in fast-growing sectors.
In this case, 79.02% of the portfolio was listed in Mexico, while the remaining 20.98% was listed on international markets, in accordance with the applicable regulations. Promecap expected to raise around $5.6 billion pesos. The management team of this Mexican SPAC has up to 24 months to identify and participate in a business combination as well.
To preserve the investment made by the participants in the IPO during the 24-month period to achieve a business combination, the terms for both Mexican SPACs provide that all the proceeds derived from the IPO will remain invested in US Treasury bills. This way, in the event the SPAC is not successful and has to be liquidated, investors can recover their investment tackling foreign exchange effects with the security to obtain minimum yield on their investment.
After the success of the first two Mexican SPACs quoted on the Mexican Stock Exchange, it is expected that in the following years more companies will explore the option of SPAC IPOs.
Structuring a SPAC in Mexico
Both, the Vista Oil & Gas and Promecap SPACs issued units, which consist of a share and a warrant. Each component is listed under separate ticker symbols. The two SPACs provide that three warrants should be exercised to purchase in the future one share of the relevant SPAC.
This is somehow similar to the structure and functioning of the SPACs listed on the stock exchange markets in the United States; however, we have noticed a significant difference between the operation of SPACs in Mexico from those in the US.
The main difference between Mexican SPACs and their American counterparts is the fact that one third of the resources obtained through the IPO will be registered and recognised as a capital increase. Shares of common stock will be issued in exchange. Two thirds of such resources will be registered and recognised by the SPAC as a contribution for future capital increases, which shall be capitalised in case a business combination is accomplished.
Contributions for future capital increases are treated as debt for Mexican tax purposes which eases any form of reimbursement in a potential scenario in which the SPAC is not successful and funds should eventually be reimbursed to investors that participated in the IPO.
This is since the repayment of contributions for future capital increases is only deemed for Mexican tax purposes as a repayment of debt and not as a capital reimbursement which may be a taxable event as mentioned below.
In case a capital reimbursement occurs, a negative financial and cash flow impact could be generated in the SPAC considering that a capital reimbursement may be taxable in Mexico at the level of the SPAC. This would occur if the SPAC has accounting profits in its books that have not been subject to taxation in Mexico when the capital reimbursement is carried out.
If profits are being distributed via a capital redemption, from a tax perspective it would be considered that a dividend is being paid. In such a case, additional taxation would be imposed on the investor considering that dividends are subject to a 10% income tax rate, which could be reduced if the investor resides in certain jurisdictions where a tax treaty has been entered into with Mexico.
Mexican income tax treatment for a SPAC
As of today, Mexico does not have a specific tax regime for SPACs listed on the Mexican Stock Exchange and therefore, the general tax regime provided in the Mexican Income Tax Law would be applicable for the SPAC as a Mexican-resident entity, as well as for its investors, depending on their specific tax regime.
In this regard, the Mexican SPACs would be treated as any other regular corporation for Mexican tax purposes; this means it would be obliged to recognise every taxable income as accrued, including the foreign exchange effects from holding investments through an escrow account in US Treasury bills and the inflationary effect derived from the contributions for future capital increases, and would be entitled to deduct strictly necessary expenses provided formal requirements are met.
The Mexican corporate income tax is imposed at a 30% rate over the taxable profit and should there be any net operating losses pending to be used, these may be carried forward for 10 years.
The government should enact specific regulations to provide legal certainty to investors, as has happened in other jurisdictions
On the other hand, the tax regime that would be applicable to the investors will depend on the type of income received from the SPACs that could be capital reimbursements and dividends (as mentioned before) and capital gains from the sale of shares.
Regarding capital gains from the sale of shares, the Mexican Income Tax Law establishes different tax regimes considering several elements, such as the characteristic of the seller of the shares (Mexican individuals, Mexican corporations and foreign residents), the fact that those shares were purchased and sold via a stock exchange and the level of interest participation being sold.
In general terms, shares issued by a Mexican entity quoted in a recognised stock exchange are subject to a 10% income tax on the gain obtained provided: i) those shares are purchased and sold in the stock exchange, and ii) the interest participation being sold in one or more successive or simultaneous sales within a 24-month term does not represent control over the entity or more than 10% of the shares of such entity.
In the event those shares are not purchased on the stock exchange, the 10% income tax regime described above may still be applicable provided that not more than 1% of the shares issued by the entity are sold in one or more successive or simultaneous sales within a 24-month term.
Failure to comply with the above would cause the investor to be subject to the maximum income tax rate applicable, which could be up to 35% in the case of Mexican individuals.
However, it should be noted that in the case of foreign-resident investors, provided they reside in a country with which Mexico has entered into a tax treaty and evidence of such situation via a tax residence certificate is provided to Mexican custody, any capital gains obtained thereon may be exempt from income tax in Mexico.
Considering the above, this special tax regime granted to Mexican individual investors and foreign residents could encourage these types of investors to invest in units issued by a Mexican SPAC, rather than in shares issued by a Mexican private company which could be purchased via a private equity fund, since the tax regime would be completely different on capital gains obtained on an exit event.
Special purpose acquisition companies are new investment vehicles in the Mexican Stock Exchange that are attractive for public investors, since they provide various financial and tax advantages. Their complete success will have to be tested based on the track record they will have when completing business combinations through M&A processes.
In the meantime, to further promote the use of these types of vehicles, the government should enact specific regulations to provide legal certainty to investors, as has happened in other jurisdictions such as the US.
From a tax standpoint, additional specific measures would encourage even more investment through this type of vehicle, such as a tax-exempt period for the SPAC granted up to the moment where the first business combination is performed and a more favourable tax regime for Mexican investors, such as the case of foreign investors residing in treaty countries.
Alberto Álvarez Flores
Chevez, Ruiz, Zamarripa y Cia.
Av. Vasco de Quiroga 2121
4° Piso, Peña Blanca Santa Fe
CP01210 Mexico City
Tel: +52 (55) 5261-5679
Alberto Álvarez has been a partner at Chevez, Ruiz, Zamarripa since 2015. With more than 10 years of experience, he is specialised in high-level tax consulting for clients primarily in the private equity and real estate sectors.
He obtained a bachelor's degree in public accounting from the Instituto Tecnológico Autónomo de México (ITAM) and a diploma in corporate assessment from the same institution.
He obtained his master's degree in tax law from the Universidad Panamericana (UP).
He is a member of the Mexican Institute of Public Accountants (IMCP) and of the College of Chartered Accountants in Mexico (CCPM).
Moisés Gutiérrez Morales
Chevez, Ruiz, Zamarripa y Cia.
Av. Vaso de Quiroga 2121
4° Piso, Peña Blanca Santa Fe
CP 01210 Mexico City
Tel: +52 (55) 5261-5664
Moisés Gutiérrez joined Chevez, Ruiz, Zamarripa in 2013 and was promoted to associate in 2017. He is specialised in tax advisory services providing advice on federal Mexican and international taxes to corporate and individual clients.
He obtained a bachelor's degree in public accounting from the Universidad Panamericana (UP) and he is attending the master's degree in tax law at the same university.
He is a member of the College of Chartered Accountants in Mexico (CCPM).