On June 20 2017, Mexican tax authorities published the final version of the protocol modifying the DTA entered into by Mexico and Spain. In addition, on the same date, the executive decree approving the new DTA between Mexico and Argentina was published.
Having signed more than 60 DTAs throughout the past 15-plus years, Mexico is the jurisdiction with the largest DTA network amongst Latin American economies. As a learned member of the OECD, Mexico’s constant effort to expand its network progresses alongside the introduction of measures developed around the BEPS initiative, and the instruments discussed below serve as an example thereof.
One of the oldest Mexican DTAs adapted from the OECD Model Convention is the Mexico-Spain DTA enforced back in 1995. Alongside DTAs such as the Netherlands or Luxemburg, it has been widely used by multinationals investing into Mexico due to Spain´s socioeconomic and political reliability. Most importantly, however, it has been used for its investor-friendly provisions when it comes to the taxation at source of dividends and capital gains, further enhanced by the publication of this new protocol that, although uncertain, is expected to enter into force early next year.
On the other hand, Mexico currently holds an enforceable DTA with Argentina, an important commercial partner (4th most important in Latin America), but which merely covers the taxation of income derived from the commercial exploitation of internationally operated ships and aircrafts. After 20 years since its publication and enforcement, the DTA has been integrally renegotiated to cope with measures included in most of Mexico´s modern OECD based DTAs, and although uncertain, it is also expected to enter into force early next year.
The BEPS based provisions are notable starting from the DTA’s preamble, where the contracting states establish that the intention of the DTA is to avoid double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance, and goes further with the inclusion of a “principal purpose test” to limit the applicability of the DTA. These provisions are expected to be included in most DTAs covered by the OECD’s Multilateral Instrument (ML”) to which Mexico is part of.
A new and attractive dividend withholding tax exemption was introduced for payments made to companies that directly hold at least 10% of equity participation on the paying entity. Formerly, the maximum withholding tax reduction for dividends was 5% and the equity participation threshold was set at 25%.
A couple of positive amendments on the taxation of interest are:
- The default rule applicable to interest payments that was different from those paid to banks or financial institutions was formerly set at 15% and is now limited to 10%; and
- There will be no withholding tax levied for pension funds receiving, as beneficial owners, interest payments.
On the capital gains side, a few amendments were aimed at redrafting the sale of shares provision in order to avoid room for abusive interpretations. In addition, a maximum capital gains tax rate was limited to 10% at source, but most importantly, a significant benefit comes from the newly introduced exemption from taxation at source applicable to financial institutions, insurance companies, pension funds and companies selling shares through a recognised stock exchange. A restructuring provision was also included that provides companies with a tax deferral benefit when certain requirements are met.
Lastly, it is reasonable to assume that as a consequence of the energy reform that has allowed and attracted an important array of investors to carry out hydrocarbon exploration and extraction activities in Mexico, a sector specific article was introduced to delimit narrower permanent establishment (PE) thresholds. Similar to domestic provisions introduced for the sector, the provision contemplates the possibility of companies triggering a PE within 30 days of carrying these type of activities in the other country in any 12-month period.
From the introduction of the anti-treaty shopping preamble discussed above to specific PE provisions aimed at preventing its artificial avoidance, the DTA is clearly intended to circumvent BEPS amongst both countries’ economies. However, from an investor’s perspective, this will be far from being a go-to DTA.
From a Mexican tax perspective, the DTA will not represent a great deal of benefits with regards to the repatriation of capital through dividend payments; it includes a withholding tax limitation of 10% at source (already provided for through Mexican domestic provisions) and does not incorporate any other limitations.
This is the same with regards to interest payments under which a default 12% withholding tax limitation is applicable at source. Although there are exemptions at source, those are only granted for interest paid to or by political subdivisions and other state-owned dependencies.
With regards to the taxation of capital gains, there is a possibility to reduce source taxation to 10% on the gain when holding a direct equity participation of at least 25% in the entity being transferred, with the default rule of 15% in all other cases. However, this is only to the extent that the transferred shares do not stem their value from immovable property located in Mexico.
Unlike most Mexican DTAs, a limitation of benefits clause was included. This provision intends to narrow the eligibility for applying the DTA by imposing the application of certain “substance” tests that must be met before applying any treaty benefits. Similar to the Spanish protocol, the DTA includes a hydrocarbons PE provision and does not provide taxpayers with any significant benefits with regards to the payment of royalties.
Therefore, multinationals conducting business activities in Mexico should determine, based on the facts and circumstances applicable to each particular case, whether these newly introduced instruments could represent direct economic benefits if proper action is taken or if their investment structures should be reviewed in order to assess and avoid any adverse tax impacts.
Juan José Paullada Eguirao (firstname.lastname@example.org)
Jessica Trejo Solther (email@example.com)
Ritch, Mueller, Heather y Nicolau, S.C.www.ritch.com.mx
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