Mexico 2014 income tax reform: Considerations for the financial sector
Karina Pérez and Alejandro Ortega of PwC analyse Mexico’s recently reformed tax code and related administrative regulations, focusing on those provisions that taxpayers in the financial sector need to be acutely aware of.
Though income tax regulations are expected to be issued shortly and administrative regulations have just been issued on June 6 2014, the 2014 Income Tax Law means there is already plenty for financial sector taxpayers to contend with.
Corporate tax and tax on distributions
The new Income Tax Law which repealed the 2013 Income Tax Law maintains the 30% corporate income tax rate, eliminating the scheduled reductions to 29% and 28% for 2014 and 2015, respectively. The withholding tax applicable to non-residents that refers to the maximum rate applicable to individuals of 30% was replaced by a 35% rate. An additional 10% withholding tax on dividends paid to individuals resident in Mexico and non-resident shareholders was introduced. This additional withholding tax is equally applicable to distributions made by branches to their head offices.
Withholding tax on interest paid abroad
There is no change in the 4.9% income tax withholding rate applicable to interest paid to foreign banks resident in countries that have signed a tax treaty with Mexico. Tax residency certification is required for Mexican interest payers to apply this reduced rate.
Treaty relief for non-resident taxpayers is available provided domestic and treaty requirements are met. One relevant aspect of the reforms is that for treaty relief the tax administration may require certain documentation to prove that double taxation arises with respect to transactions between related parties (that is, a declaration under oath). Administrative regulations contain some exceptions to this rule. Considering that this provision is not intended to override tax treaties, it would be desirable that tax authorities issue additional regulations in this regard to clarify that this rule would be enforceable only if a treaty contains a similar rule. However, tax authorities would still have the power to request this information.
It should be noted that some Mexican treaties contain specific exclusion clauses that have an impact on the financial sector that should be taken into account when applying a treaty. These features are common in the Mexican treaty network and particularly in the most recently signed treaties.
Limitations for deductions
Limitations for deductions concerning technical assistance, interest and royalty payments between related parties when a Mexican resident controls or is controlled by a related party were introduced. This limitation applies in the following cases: a) when and to the extent that the recipient is a transparent entity whose owner or owners are not subject to tax in its jurisdiction; b) the recipient country of tax residence considers the payment to be disregarded; or c) the recipient does not include the payment as part of its taxable income under its jurisdiction's rules.
The deduction of payments is not allowed when made to tax haven jurisdictions (as defined in the Income Tax Law), unless supported by transfer pricing documentation. Further, the law does not allow the deduction of expenses that are also deducted by another related party, unless the corresponding income is included in the related entity's taxable income in the same or in a subsequent tax year.
These measures are intended to limit undue tax erosion of the Mexican tax base pursuant to the OECD initiative on base erosion and profit shifting (BEPS).
Other limitations for deductions were introduced which have important impact, such as limitations (at 53%) for tax exempt salaries and benefits, as well as for contributions to pension and retirement plans. If the employer reduces the employee's benefit package, then the deduction for tax exempt salaries and benefits will be limited to 47%.
Some taxpayers have considered that some of these limitations go against constitutional provisions and therefore have filed injunctions before the Mexican courts.
The reform eliminates the option to depreciate certain assets on an accelerated basis. The 100% rate deduction remains for investments on certain machinery and equipment for limited cases.
The new law repeals the provision that allows companies to defer income recognition on installment sales.
Real estate investment companies
The tax reform eliminates the special tax treatment for real estate investment companies (REICs or SIBRAS for its acronym in Spanish) and increases from one to four years the minimum leasing period to apply the exemption applicable to pension funds on the sale of real estate or shares representing such real estate.
Registry for foreign financial institutions and funds
The Tax Administration Service will no longer hold a register for foreign financial institutions (FFIs, such as banks, pension and retirement funds, investment banks and non-bank banks), a former requirement to apply income tax exemption or a low withholding rate for interest.
Although this was meant to simplify tax obligations, this measure may give rise to uncertainty regarding documentation that is needed to apply such exemption or rate that may be required under a tax review. In some instances a written confirmation from the tax authorities may be desirable to avoid controversies. Further, the elimination of this registry may give rise to an increase in the administrative burden regarding the documentation to be provided to each of the withholding agents by financial institutions. As a result administrative regulations to minimise these burdens would be desirable.
Deduction of contingency reserves
The option to deduct contingency reserves for banking institutions has been eliminated and currently banks are allowed to deduct bad debts once they are not collectable from a legal standpoint pursuant to the Income Tax Law to the extent that these bad debts were not previously deducted under the rules applicable to the deduction of contingency reserves. From a legal standpoint, bad debts would be considered uncollectable when such debts are considered as such pursuant to the National Banking and Securities Commission rules.
Transitory provisions are included in the law in this regard. These rules provide that banks will continue to recognise taxable income from the decrease of the balance of contingency reserves as of December 31 2013. Such transitory provisions also provide that where the deduction for bad debt in the corresponding year is lower than 2.5% of the contingency reserve average balance of that year and limited to the amount of such difference, the deduction would be allowed for the remaining balance of the contingency reserves as of December 31 2013. In cases where the remaining balance of the contingency reserves as of December 31 2013 has been fully deducted, banks have the right to deduct write-offs, rebates, waivers and discounts on loan portfolios and losses from the sale of such portfolios, as well as losses arising from foreclosure. Administrative regulations establish another procedure applicable to this deduction.
This item of the reform applicable to banks was under the review of the tax authorities and as a result of this review new regulations were issued in this regard.
In accordance with such new regulations, beginning 2014, an option is available for the banking institutions as a transition rule to deduct bad debts generated in 2014 in lieu of applying the transitory provisions mentioned above. For these purposes, such regulations provide that the deduction of losses of bad debts arising in 2014, including writ-offs, rebates, waivers, discounts of loan portfolios and losses from the sale of such portfolios, as well as losses arising from foreclosure, may be deducted within certain limits and considerations, provided that the amount of these items is equal to the remaining accounting balance of the contingency reserve as of December 31 2013 considering the annual limit of 2.5% of the annual average balance of the loan portfolio.
While the above procedure is completed, banking institutions are allowed to deduct every year the excess of contingency reserves that has not been deducted as of December 31 2013, considering for this purpose the limitation of 2.5% mentioned above.
Additionally, banking institutions would have to compare the balances of the contingency reserves of December 31 2013 and 2012 against the balance of such reserves of the following years to determine a potential taxable income when the final balance is lower than the previous balance; the reference to 2012 is unclear.
For insurance and bonding companies the reserves deduction was maintained.
Withholding tax on publicly traded shares
The new law imposes on individuals (both those resident in Mexico and also non-residents) a 10% tax on capital gains derived from the sale of shares issued by Mexican residents, of shares issued by foreign companies or of instruments that represent such shares, or share indexes, to the extent that they are publicly offered on the Mexican recognised stock exchanges. The income tax is calculated on each transaction, applying the 10% rate on the gain and the intermediary shall determine the profit and respective tax, without deducting losses.
Income tax withheld is considered a definitive payment pursuant to the law. The gain shall be the difference between the purchase price (closing quote on the day of the transfer) and the average acquisition price during the holding period.
An exemption is available for treaty residents and the intermediary will not be obliged to withhold the tax as long as the taxpayer provides a sworn statement that he is a resident in a treaty country, as well as his tax registration number issued by the competent authorities. If the taxpayer does not provide this information to the intermediary, the intermediary would be obliged to withhold the 10% tax. Administrative regulations provide an optional waiver for the intermediaries to make the 10% withholding, provided that the account holder delivers a sworn statement to the intermediaries that he is a treaty resident.
It is uncertain whether such sworn statements would relieve the taxpayer from meeting treaty application requirements to be entitled to the exemption. In this regard, it would be desirable that tax authorities issue some guidance stating that the taxpayer is relieved from meeting treaty benefit requirements to facilitate the application of this exemption.
The 10% rate is not applicable where shares are not considered as publicly placed or where the shares are purchased outside the authorised stock exchanges or when the securities are not considered as publicly traded. Also, this rate would not apply if, in a period of 24 months, a person or group of persons sells 10% or more of the fully paid shares of the legal issuing entity, through one transaction or more than one simultaneous or successive transaction. This exclusion also applies to transactions on such securities markets conducted as listing operations or protected cross trades, regardless of how such operations are labelled, which prevent sellers from accepting more competitive bids than those they receive before and during the period in which the shares are offered for sale, even if the National Banking and Securities Commission has classified such transactions as agreed in a stock exchange. In these cases the maximum rate of 35% would apply on the gain derived and no deduction of losses is applicable.
The recently issued administrative regulations that deal with the application of this new capital gains tax clarify the treatment of American Depository Receipts (ADRs) with underlying Mexican shares.
Pursuant to these new regulations, the exemption provided for publicly traded Mexican shares is extended to ADRs. Further, pursuant to such regulations taxpayers are no longer obliged to file the declaration under oath or their tax identification number to the Mexican intermediaries to obtain such exemption provided that some requirements are met. The wording of this new rule can be interpreted in the sense that this benefit only applies to taxpayers that are treaty residents, although this may not be the intention of this rule and leaves open other questions regarding its application.
In the case of over-the-counter transactions the applicable withholding rates are 35% on the gain if certain requirements are met or 25% on a gross basis.
The new regulations also introduce the procedure to determine the cost of acquisition of shares or securities where its custody and administration corresponds to a different intermediary than that who participated in its alienation.
Tax treaty relief is available where relevant conditions are met. Very few Mexican treaties exempt gains from the sale of shares; most of the Mexican treaties exempt gains derived from the sale of shares that represent a participation of less than 25% of the capital of a Mexican company.
The value added tax law maintains the exemption applicable to mortgage interest.
Flat tax and tax on cash deposits
The tax reform package repeals the flat tax and tax on cash deposits.
These changes in force from the beginning of 2014 have a significant impact on the industry, especially on companies with affiliates or other investments in Mexico. As mentioned above, there are some administrative regulations and income tax regulations that are expected to be issued shortly which will provide positive clarifications in some relevant areas.
Tel: +52 55 52 63 57 34
Karina Pérez is the leading partner for Mexico of the tax financial services practice. She joined PricewaterhouseCoopers in February 2008. Karina was the former leading partner for Mexico and Latin America for the Tax Controversy and Dispute Resolution practice. In this capacity she successfully resolved disputes in different industries, such as in the financial, consumer products, pharmaceutical, telecommunications, and energy sectors, among others. She has practised in the area of international taxation for more than 25 years.
Before working at the firm she worked at the Mexican Central Bank. After that she occupied for 17 years different relevant positions at the Mexican Treasury Department and Tax Administration Service. In that capacity she was engaged in important projects related to the banking and capital markets area, as well as in asset management, real estate and other matters related to the financial sector. She negotiated 44 of the treaties and protocols entered into by Mexico with its major commercial partners (for example, US, Canada, UK, Spain, France, Italy, Germany, Switzerland, Belgium, Luxembourg, Netherlands, Russia, India, China, Singapore, Malaysia, Netherlands, Brazil, Chile, and Venezuela). She also was involved in the negotiation and implementation of exchange of information agreements and has been in involved in FATCA projects in Mexico and its regulation.
As a tax official she worked on proposed tax legislation, administrative rules and regulations. She was also responsible for issuing private rulings for international transactions and was the competent authority in several mutual agreement procedures for treaty interpretation. As part of her functions she issued technical and operational guidelines applicable to the Large Taxpayers Division of the Tax Administration Service, including those applicable to the financial sector. In this role she was also responsible for the registry of foreign banks, pension funds and exempt organisations and placement of bond reporting obligations. Being a tax official she served for many years as a delegate for Mexico in different working groups at the OECD (for example, the Committee of Fiscal Affairs, Working Group No.1, Treaties and Related Issues, Harmful Tax Competition).
She graduated as a lawyer from the Escuela Libre de Derecho.
Alejandro Ortega Quintanar
Tel: +52 55 52 63 61 57
Alejandro Ortega is acting partner of the Financial Services Tax practice in Mexico. He has practised in the area of financial sector international taxation for more than 20 years. Before joining PwC he worked in BBVA Bancomer, S.A., GE Capital Bank, S.A. and also at other Big 4 firms. He graduated as an accountant from Instituto P0litécnico Nacional and he has a master in finance from Universidad Nacional Autónoma de México. He is also a member of Colegio de Contadores Públicos de México.