Mexico–US tensions creating tax withholding uncertainty on cross-border credit operations

The relationship between Mexico and the US has long been shaped by complex economic, political, and social dynamics. With the re-election of President Donald Trump and the election of President Claudia Sheinbaum in Mexico, tensions between the nations have resurfaced and are impacting key sectors, including finance.

One of the most pressing challenges is the uncertainty surrounding the 4.9% income tax withholding rate applicable to interest income paid to foreign banks, a long-standing cornerstone of cross-border credit operations. This rate, which is crucial to facilitating international transactions, now faces increased scrutiny as both governments navigate their evolving diplomatic landscape.

For many years, the US and Mexico have upheld an agreement on the taxation of cross-border financial operations, with a key provision being the 4.9% income tax withholding rate under Mexican law. This rate, which applies to interest payments from Mexican entities to US banks, has served as a major incentive for financial institutions to engage in cross-border lending and investment.

Supported by both governments as part of broader efforts to enhance economic ties, promote trade, and encourage investment, the 4.9% rate has played a crucial role in fostering bilateral financial activity. However, recent political shifts have raised concerns about the sustainability of this favourable tax rate for US banks.

While the 4.9% rate currently applies to foreign banks that are resident in any treaty jurisdiction, not only the US, the majority of the Mexican financing still comes from US sources.

The re-election of Trump as US president marked a significant shift in US–Mexico relations. During his first term, the administration adopted a hardline stance on issues such as trade, immigration, and border security, which strained diplomatic and economic ties. This approach is expected to continue into his second term, contributing to uncertainty in the financial markets, particularly regarding the stability of tax treaties and agreements governing cross-border operations.

President Sheinbaum’s administration, in turn, has taken a more assertive position on matters such as trade sovereignty, the environment, and labour rights, sometimes in opposition to US priorities. This growing discord has intensified concerns over the future of the 4.9% income tax withholding rate, with both governments potentially reconsidering or revising tax agreements and treaties in response to evolving political and economic dynamics.

The uncertainty surrounding the continuation of the 4.9% withholding income tax rate is creating significant challenges for banks and financial institutions involved in cross-border credit operations. These institutions have long relied on the favourable rate to facilitate lending between the US and Mexico. However, with the increasingly unpredictable political climate, many are concerned that the rate may be revised or eliminated altogether.

For banks, particularly those engaged in multinational transactions, the prospect of a higher withholding rate raises concerns about profitability. An increase would directly impact US lenders, which would face higher tax burdens on interest payments to Mexican borrowers, potentially raising costs for Mexican borrowers. This could lead to a shift towards alternative financing sources, possibly at higher interest rates.

The potential for a higher tax burden also makes US financial institutions more hesitant to engage in cross-border lending, as the increased withholding tax could reduce the appeal of these transactions. For Mexican banks and businesses, this scenario could result in a more restrictive credit environment, marked by higher borrowing costs and less favourable lending conditions.

One of the most pressing challenges is the hesitance of banks to finalise terms for cross-border credit operations amid the current uncertainty. The lack of clarity regarding the future of income tax withholding rates has made financial institutions wary of entering into new agreements. Without assurance that the 4.9% rate will remain in place, many banks are reluctant to commit to long-term cross-border transactions or are including very aggressive ‘change in law’ clauses in all bilateral cross-border credit operations.

Indeed, some banks have begun exploring alternative structures for cross-border credit deals, seeking to bypass the traditional withholding tax framework. They are trying to negotiate clauses that differ from the ones established by the Loan Syndications and Trading Association (LSTA) model credit agreement, which have been commonly applied in Mexico (for its Mexican tax considerations, please refer to the book LSTA Model Credit Agreement for Latin American Cross-Border Transactions: Mexican Tax Considerations, by Oscar López Velarde).