Mexico: Controversy over applicability of 4.9% withholding tax rate on interest

The SAT ruling now has expanded the situations where the 4.9% withholding tax rate is not applicable to include interest derived from certificates, loans and other financial transactions.

Mexico's Tax Administration Service (SAT) issued a nonbinding ruling on May 16 2017 that contains a new and controversial interpretation of the rules in the Income Tax Law (ITL) that allow for a preferential withholding tax rate of 4.9% to be imposed on certain interest paid to a non-resident.

Article 166 of the ITL sets out the situations in which interest payments made by a Mexican resident to a non-resident will be subject to income tax withholding at a rate that ranges from 4.9% to 35%. Paragraph 11 of Article 166 provides that the 35% rate rather than the 4.9% rate will apply where the non-resident beneficiaries of the interest hold bonds issued by a Mexican entity and receive more than 5% of the interest arising from the bonds; and (i) own directly or indirectly more than 10% of the stock of the bond-issuing entity, or (ii) is an entity whose shares are more than 20% owned directly or indirectly, individually or with related parties, by the bond-issuing entity.

Until the SAT ruling, the accepted interpretation of paragraph 11 (by taxpayers and the SAT) was that the scope of the limitation was restricted to interest derived from bonds and similar credit or financial instruments, but not to interest derived from other transactions, such as loans (i.e. bank loans). This interpretation was aligned with the explanation given by the Mexican Congress at the time Article 166 was enacted.

The SAT ruling now has expanded the situations where the 4.9% withholding tax rate is not applicable to include interest derived from certificates, loans and other financial transactions. Instead, the 35% withholding tax rate will apply in these cases.

Due to this unexpected new interpretation of Article 166, several consultations (writs) were filed with the Taxpayers General Attorney Office (PRODECON, sometimes known as the tax ombudsman, a public agency that specialises in tax matters, but with functional autonomy), requesting its view on the SAT ruling. On November 7 2017, the PRODECON concluded that the correct reading of Article 166 should not exclude other financial or credit transactions, such as loans, from the preferential 4.9% withholding tax rate, and that the restriction on the lower rate should apply only to interest derived from bonds placed in financial markets when the holders are economically related to the Mexican issuer. According to the PRODECON, the purpose of the provision is to aid the financing of Mexican corporations through the placement of bonds in foreign markets.

It is important to note that, while the PRODECON's decision is not binding on the SAT, it may be considered by a court as favourable evidence in support of the taxpayer.