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Tax issues in international M&A in Mexico

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International mergers and acquisitions (M&A) involve special considerations, including when it comes to tax, as Mario Castillo and David Adame of Copper Wolf explain.

M&A involving at least one Mexican company with at least one foreign company must be carefully studied to be carried out successfully. This is because the deals involve the application of different legal systems, as well as different legal and tax effects.

This article examines the legal and tax aspects of international M&A from the perspective of the Mexican legal system.

General legal effects of international M&A

Most of the time, the terms ‘merger’ and ‘acquisition’ are used interchangeably and sometimes even synonymously. However, there are substantial differences in their definitions.

In his book Wall Street Words: An A to Z Guide to Investment terms for today’s Investor, David L Scott defines a merger as a combination of two or more companies in which the assets, liabilities and capital of the selling company are absorbed by the acquiring company. An acquisition is the purchase of an asset, such as a plant, a division, or even an entire company.

It follows that in a merger there is a legal union between two or more commercial companies that together form a single company (which may or may not be new), while in acquisitions there are two separate legal entities.

The basic elements of a merger are:

  1. The merging company, which is the surviving element of the merger. This is either a new entity or, when there is no new entity, one of the companies that decided to merge; and

  2. The merged company, which is the element that ceases to exist because it will form an integral part of the merging company.

Article 222 of the Mexican General Law of Commercial Companies establishes that the merger must be decided by the supreme body of each of the companies that wishes to be part of the merger. Therefore, the resolutions adopted in the minutes of the meeting must include all the details of the merger and be accompanied by the merger agreement entered into between the merging company and the merged company or companies.

Where two or more companies plan to merge under Mexican law, it is important to consider compliance with the requirements and deadlines established by the legal provisions.

Two types of mergers

In Mexico, there are two types of mergers, depending on when a merger takes effect: successive and instantaneous. This is important because, under Mexican law, it is essential to specify who will be responsible for the liabilities of the merged companies. The timing of the merger depends on this requirement.

In Mexico, compliance with requirements can be more important than the substance of the transaction.

In a successive merger, the merger cannot take effect until three months after its registration in the Public Registry of Commerce. However, a merger is instantaneous when it takes effect at the moment of its registration in the Public Registry of Commerce. In both cases certain assumptions and requirements must be met.

An acquisition is the purchase of an asset, such as an industrial plant, a division or even an entire company. Generally speaking, there are two ways to make an acquisition: a share deal and an asset deal.

In the sale and purchase of shares, the buyer acquires a legal entity, which will have an independent life from the purchasing company and will not form a unit as in the case of a merger. In contrast, in an asset deal, the assets are transferred directly to the person making the purchase.

International M&A

Returning to Scott’s definition of M&A, an international merger is one in which at least one of the companies participating in the merger has a different nationality from the others. An international acquisition is one in which the seller and buyer of an asset are of different nationalities.

Two articles in Mexican law are essential for understanding the application of the national legal framework in transactions between Mexicans and foreigners: articles 12 and 2736 of the Federal Civil Code.

Articles 12 and 2736 establish that, as a general rule, Mexican national law will apply when either the persons are in Mexican territory, or the acts or facts have occurred in Mexican territory and the parties have voluntarily submitted to Mexico’s laws. In the latter case, the parties decide which law to apply.

In an international merger, the merger must comply with the formalities required by each of the legal systems of the companies involved. For example, if a Mexican company merges with a US company, the formalities of each of the companies, according to the laws of Mexico and the United States, must be respected when approving the merger.

However, in an acquisition, the jurisdiction to which the parties have chosen to submit shall prevail, except in certain special cases.

As stated above, in a merger the merged companies cease to exist. Therefore, the merged companies will be extinguished in accordance with the formalities of the country of incorporation.

However, the merging company will be governed according to the country of its incorporation. In this sense, it is important to analyse whether a foreign legal entity is recognised as a legal person in both countries.

In Mexico, article 2736 of the Federal Civil Code recognises the capacity to be the holder of rights and obligations regarding the operation, transformation, dissolution, liquidation, and merger of foreign private legal entities. This article also establishes that a private foreign company will be governed in accordance with the foreign law used for its incorporation.

However, in an acquisition, the law that the contracting parties choose to submit to shall be used, unless the transaction is prohibited by any provision of the country in which the transaction took place.

Therefore, if the transaction is carried out in Mexico, the parties must verify that its operation does not contravene any Mexican regulatory provisions.

Having established the basic notions of M&A, it is necessary to consider the tax aspects of a merger involving a Mexican company and a foreign company.

Tax effects of an international merger in Mexico

As mentioned above, a merger involves two or more companies with different roles: the merging and the merged company. This section looks at the tax effects for a Mexican company participating in an international merger, in the roles of both merged and merging company.

Mexican company as a merged company

By virtue of the merger, the assets of the merged company are transferred to the assets of the merging company. This implies a transfer of assets for tax purposes, which corresponds precisely to the transfer of the merged company’s assets.

The gain derived from this disposal is taxable income in accordance with section IV of article 18 of the Income Tax Law. Article 18 establishes that the gain derived from the merger of companies is considered taxable income.

However, article 14 of the Federal Tax Code (Código Fiscal de la Federación, CFF) states that a disposal is understood as a merger of companies, except in the cases referred to in article 14-B of the CFF.

Article 14-B of the CFF states that in the case of a merger, it is considered that there is no alienation, provided that certain requirements are met. These requirements include the filing of the merger notice referred to in the CFF Regulations; that the merging company carries out the same activities as the merged company during a minimum period of one year immediately following the effective date of the merger (with some exceptions); and that the merging company files the tax returns for the fiscal year and information returns corresponding to the merged company.

Thus, to the extent that the requirements set forth in article 14-B of the CFF are met, it would be considered that there is no disposal by virtue of a merger.

However, article 14-B of the CFF establishes that its provisions only apply to mergers of companies resident in Mexican territory and where the company created as a result of the merger is also a resident of Mexican territory.

Thus, since in this case the merging company is not a tax resident in Mexico but a foreign resident, the exception of article 14-B of the CFF would not apply. Therefore the gain derived from the sale of assets that occurs as a result of the merger would be considered taxable income.

By virtue of the merger, therefore, the tax effect of the disposal of the assets and liabilities of the merged Mexican company must be considered. The tax cost and the price thereof must be compared and any income tax applicable to the gain thus obtained must be paid.

Since it is a merger, there is no consideration and therefore there is no sale price as such. In this case, a market appraisal may be relevant to provide certainty in determining the price for tax purposes.

It is important to clarify that there are no specific provisions and/or procedures applicable to international mergers under Mexican law, but this analysis is believed to be the appropriate path to follow in these cases.

Another provision within the Mexican legislation that could be similar to the tax effects of the international merger is the liquidation process due to a change of tax residence.

In accordance with article 12 of the Income Tax Law, a Mexican corporation is deemed to be liquidated when it ceases to be a resident of Mexico. For these purposes, the Mexican company must consider all of its assets as disposed of and their market value as of the date of the transaction; when this value is not known, an appraisal will be made by a person authorised by the Mexican tax authority.

The tax effect is practically the same in the liquidation of companies due to a change of residence as in the disposal of assets due to merger, which leads to the conclusion that this is the best path to follow to determine the tax effect of the merged company.

Finally, if the merger is part of a restructuring of companies belonging to a group, the Mexican tax authority may authorise the deferral of the payment of the tax derived from the gain on the disposal if certain requirements are met, in accordance with article 161 of the Income Tax Law.

Compliance with tax obligations

As stated in the doctrine of commercial law, by virtue of the merger agreement, the merged company loses its legal personality. The merging company is the only one that subsists now, with only one equity.

This makes the merging company, if applicable, the only possible taxpayer of any tax obligation for income tax purposes, or the only party that could comply with tax obligations subsequent to the extinction of the merged company, such as the corresponding notice to the tax authorities of such a situation.

Under Mexican law, it is essential to specify who will be responsible for the liabilities of the merged companies.

When the Mexican corporation ceases to exist, the Mexican tax obligation to cancel the Federal Taxpayers Registry (RFC) of the corporation must be complied with.

Mexican tax regulations establish that the notice of cancellation of the RFC due to the merger of companies must be filed by the legal representative of the merging company. Therefore, the foreign company must file the notice of cancellation of the RFC of the Mexican company derived from the merger.

In cases where no operations or assets are kept in Mexico, some Mexican tax authorities require that the cancellation of the RFC of the Mexican merged company must be made through the procedure of initiation of liquidation and cancellation in the RFC due to total liquidation of the assets, to comply with the requirements.

However, when the merging company maintains fixed assets and operations in Mexico, this process is simpler. It will be considered that the foreign company has a permanent establishment in Mexico, so it would have to be registered. Through this permanent establishment, the commercial operation in Mexico and the process of cancellation of the RFC of the merged company would be carried out.

Mexican company as a merging company

The tax effect in Mexico when a foreign company merges into a Mexican company, as such, does not give rise to a direct payment of income tax in Mexico. Such a transaction is considered an acquisition by incorporation.

However, the tax effect of the transfer of assets by merger to the Mexican company should not be taken lightly just because the merger itself does not generate a tax liability.

With respect to this type of merger, since it is considered an acquisition in Mexico, it is important to review the transfer of tax attributes and costs that the foreign company may have and the manner in which its tax value may be recognised in Mexico.

Failure properly to recognise these tax values in the Mexican company could result in taxable income in excess of the company’s financial margins. This would result in higher tax payments than would otherwise be due.

Therefore, it is important to determine an appropriate strategy to recognise for tax purposes the value of inventories, shares, fixed assets, accounts receivable, etc., in order to match them with the income obtained in the merging company and avoid excessive tax disbursements.

Other aspects to take into account would be the transfer of profits from previous years and capital contributions from the foreign company to the Mexican company, since these could be considered within the tax attributes of the Mexican company and could be used in the future to provide resources to the company’s shareholders.

Finally, an analysis of the payment of indirect taxes in Mexico must also be considered, since, if applicable, the introduction into the country of certain fixed assets could cause the payment of value added tax at customs upon importation.

Conclusion: growth through M&A

The need for growth has made it common for operations involving companies from several countries to take place in today’s globalised world.

Once the organic growth of companies stagnates, they need to grow outside their sphere of control and seek synergies with other companies through M&A. In many cases, this involves companies of different nationalities.

In the particular case of international mergers involving Mexico, this country is still very formalistic in certain aspects. This means that compliance with requirements can be more important than the substance of the transaction, which complicates and delays the processes.

Therefore, a thorough analysis is recommended of the effects that an international merger involving a Mexican company could have. This includes being very careful to have and comply with all the formal requirements and taking into consideration the time it could take to perfect the merger in the country.

Given that an international merger is a very complex operation, since it involves various legal and tax regulations of at least two countries, it is of utmost importance to have experts in the application of the laws of both jurisdictions to analyse fully the effects that the merger may cause.

In addition, other regulatory requirements must be considered. These include filing notices and obtaining authorisations from certain authorities.

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