PPT: substantial requirements for applying double tax treaty benefits in Mexico
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PPT: substantial requirements for applying double tax treaty benefits in Mexico

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Juan José Paullada Eguirao and Fernando Caballero Gout of Ritch Mueller discuss the substance requirements for applying double tax treaty benefits in the context of the MLI’s Principal Purpose Test.

Mexico submitted the “Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting” (MLI) to the OECD on March 15, 2023. The MLI is set to enter into force in July 2023, with the provisions related to taxes withheld at source and other taxes levied in Mexico taking effect on January 1, 2024.

Article 7 of the MLI includes a minimum standard related to the prevention of treaty abuse, a situation that contracting states may address, among others, by having a “principal purpose test” (PPT) provision. The PPT allows tax authorities to deny benefits granted under a tax treaty when it is reasonable to conclude , taking into account all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction. The exception is when granting the benefit in question is in accordance with the object and purpose of the provisions of the relevant tax treaty.

The PPT has highly subjective elements, with terminology that is not defined within the MLI. In the absence of related domestic precedents, this circumstance could represent significant challenges for multinational groups that intend to access the benefits provided in double tax treaties to which Mexico is a party.

Notwithstanding, it is important to consider that some of these elements have been addressed through other valid interpretation sources. These include the 2017 OECD Model Tax Convention Commentary (Commentary), the different BEPS Action Plans, and international precedents.

Something to consider (due to the uncertainty it generates) is if the transaction in question has obtaining a treaty benefit “as one of its principal purposes”. The Commentary elaborates on this point, stating that a purpose will not be considered “principal” if it is possible to conclude that taking into account all applicable facts and circumstances, that obtaining that benefit was not one of the fundamental reasons, nor would it serve to justify the operation that gave rise to the benefit.

For multinational groups that, for example, establish their headquarters in a jurisdiction whose tax treaty allows for the reduction or elimination of taxes, particular attention should be paid to the economic substance of such headquarters. The group should be able to justify its corporate operation on a basis that goes beyond obtaining a benefit under the corresponding tax treaty.

In Mexico, there are no specific rules on substance requirements to be met by foreign residents, or precedents that provide guidelines for applying the PPT. However, several OECD publications, precedents, and regulations issued by other countries become useful for defining a minimum benchmark or substance ‘wish list’ for the purposes of surpassing these tests:


·  The company’s directors should mainly be residents of the country where the entity resides;

·  The board of directors´ decisions should be taken in the company’s country of residence;

·  Directors should be professionally or technically competent; and

·  Directors should have enough authority to conclude business transactions.




·  The company should have sufficient personnel to carry out its business;

·  The company´s personnel should be technically and professionally competent; and

·  Salaries or wages paid should be at market standards and economically proportional to the duties personnel actually perform.




·  Companies should have enough office space in the country of residence; and

·  Companies should have a registered phone number, address, and fixed assets to operate the business.




·  The company should hold at least one bank account in its country of residence;

·  Bookkeeping of the entity should be carried out in its country of residence; and

·  The company should have its tax registry/identification number in its country of residence.




·  The company should bear the economic risk regarding its business; and

·  The company should have equity to confront risks and operational necessities.

In addition, the OECD has provided suggestions that may prove to be useful for companies. Depending on the type of business activities and tax regimes under which companies operate, keeping records to support that the enlisted activities are carried out within the jurisdiction in question is key to addressing economic substance requirements.

For example, foreign fund managers are generally expected to:

  • Take decisions on the holding and selling of investments;

  • Calculate risks and reserves;

  • Take decisions on currency or interest fluctuations and hedging positions; and

  • Prepare relevant regulatory or other reports for government authorities and investors.

For companies carrying out banking activities, the core income-generating activities include:

  • Raising funds;

  • Managing risk (including credit, currency, and interest risk);

  • Taking hedging positions;

  • Providing loans, credit, or other financial services to customers;

  • Managing regulatory capital; and

  • Preparing regulatory reports and returns.

Shipping companies typically obtain income from:

  • Activities related to crew management (including hiring, paying, and supervising crew members);

  • Hauling and maintaining ships;

  • Monitoring and tracking deliveries;

  • Determining what goods to order and delivery deadlines; and

  • Organising and supervising trips.

Holding companies are expected to undertake all applicable corporate law filing requirements and have the substance necessary to engage in holding and managing equity participation. For example, this includes showing that they have both the people and the premises necessary for these activities. This should, in principle, preclude letterbox and brass plate companies from surpassing these substantial thresholds.

Although the above principles should be construed as guidelines, economic substance requirements will likely be under heavy scrutiny by the Mexican tax authorities, and therefore a case-by-case analysis is recommended.

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