Mexico’s approval of the MLI set to increase the administrative tax burden
With the MLI expected to enter into force in Mexico in 2023, Jorge Díaz Carvajal of Escalante & Asociados considers the impact on the country’s existing DTAs and taxpayers.
On October 12 2022, the Mexican Senate finally approved the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting adopted by the OECD in 2016 and signed by Mexico in 2017, under the framework of the work performed on BEPS.
On November 22 2022, the MLI was published in the Mexican Official Gazette, but it still has not been deposited before the OECD in order for it to enter into force. The MLI is expected to enter into force in 2023 and be applicable to withholding and other taxes from January 2024.
The MLI’s objective, from the moment it was envisioned, was to have an effective mechanism to implement measures/modifications related to tax treaties (double taxation agreements, or DTAs) to:
Address certain hybrid mismatch agreements;
Prevent treaty abuse;
Address artificial avoidance of permanent establishment; and
Improve dispute resolution.
It is important to consider that the MLI will only affect or modify a DTA if the other country expressly accepted that possibility; that is, if compatibility exists. Accordingly, modifications to provisions may differ from one country to another. For example, provisions related to anti-abuse rules in a treaty signed by Mexico with one country may differ from related provisions contained in another treaty also signed by Mexico with a third country.
As recognised in the content of the MLI, and its explanatory statement, the measures should be able to be applied in a synchronised and efficient manner across the network of existing DTAs on income without the need to renegotiate each one bilaterally.
Existing Mexican DTAs
Even though Mexico has a wide variety of DTAs signed with different countries (61), not all of them have signed, or will sign, the MLI. This implies that the treaty will not be modified in any way by such instrument, so this is to be considered when deciding the applicability of a treaty provision. This is especially relevant, for example, regarding the DTA signed by Mexico and the United States, which is broadly used because of the close and recurrent commercial and border relationship between the countries and which the latter has not signed, and most likely will not sign.
Mexico, as a signatory to the MLI, will have to direct financial, human, and material resources to the fulfilment of the modifications to the treaties the MLI affects, to comply with the provisions and measures taken in each one, and exercise its review powers in transactions where, due to the existence of the MLI, it decides whether the applicability of a provision is correct.
Impact on taxpayers
From a taxpayer perspective, on the one hand, the approval of the MLI and its entry into force may be seen as handing the Mexican tax authorities even more powers to review their transactions, even though they may be legitimate and not have the objective of abusing the application of a treaty provision. In this regard, it is important to note that the past couple of years have been extremely difficult for Mexican taxpayers as the tax authorities have already broadened their reviews and made them harsher based on specific local anti-abuse rules included recently in Mexican tax laws.
On the other hand, the improvements to mutual agreement procedures offer Mexican taxpayers more efficient access to this kind of procedure in international taxation controversies, particularly considering that Mexico’s tax authorities have been particularly aggressive in attacking domestic and international structures, notwithstanding that Mexico has not accepted arbitration clauses.
The objective of the MLI (swift, coordinated, and consistent application) may be difficult to achieve in practice, as a significant administrative burden is created for the corresponding tax authorities and taxpayers due to the flexibility the MLI possesses regarding the optional changes to provisions allowed.
Taxpayers will need to verify the applicability of the MLI, and the way it develops, in connection to any relevant DTA that Mexico has signed, and concretely with regard to the transactions carried out to determine the way a provision of the tax treaty should be applied, or even if it should be applied.