David Cuellar		Mario Alberto Gutierrez

The Baltic States are those countries east of the Baltic Sea that gained independence from the Russian Empire in the wake of World War I. Today, this means the countries of Estonia, Latvia and Lithuania. The three countries' market economies in recent years have undergone rapid expansion in early 2000 and their previous fast growth has switched to recession in Estonia and Latvia as from end of 2008 followed by Lithuania in 2009.

Nonetheless, Mexico's approach to expand its treaty network includes entering into tax treaties with this region of Eastern Europe. The tax treaty status with the region is shown in Table 1.

Since Estonia's tax treaty is the one lagging in the process to become applicable, our comments are focused on the tax treaties with Lithuania (already applicable) and Latvia (applicable as from beginning of next year).

Taxes covered

Like in all recent tax treaties concluded by Mexico, the taxes covered include both income and flat tax (IETU for its acronym in Spanish).

Permanent establishment (PE)

The treaty with Lithuania has a broad PE definition that considers services (including consulting services) rendered by an enterprise through employees or other personnel contracted by the foreign enterprise, if the activities in the other country last for more than 183 days within a 12-month period.

A PE would be created under the Latvian treaty for the performance of activities related to the exploration of seabed or natural resources if they are carried on for more than 90 days within a 12-month period.

Dividends

In Lithuania, the withholding tax rate on dividends is 15%, while in Latvia it is 10%. These withholding tax rates are reduced under the treaties on one hand with Latvia to 5% when the shareholding exceeds 10% and on the other hand to 0% under the treaty with Lithuania provided that the shareholding exceeds 10%.

Interest

Both treaties provide for a 10% reduced withholding tax rate for intercompany interest payments.

The treaty with Latvia includes a 5% withholding on interest paid to banks. The tax treaty with Latvia exempts from withholding tax the interest paid to certain pension funds.

Royalties

The treaty with Lithuania provides a broad definition of royalties including the right to use visual images or sounds transmitted through satellite, fiber optic cable or similar technology.

Capital gains

The tax rate in both tax treaties is capped to 20% of the net gain. Furthermore, the tax treaty with Lithuania allows the taxation of capital gains from the sale of shares only when within a 12-month period, the seller has held a participation of at least 25% of the company. The protocol to the Lithuanian treaty includes a most favoured nation provision allowing the possibility to automatically apply additional benefits.

The Latvia tax treaty provides for a reorganisation benefit to the extent the transfer of shares takes place between members of the same group and the remuneration is on share-for-share basis upon other requirements being satisfied.

Limitation on benefits

If companies or other persons are totally or partially exempt from tax, based on a special regime in accordance with the legislation or administrative practices of either state, the tax treaty benefits with Latvia would be denied. A special regime will be considered to exist only after both contracting states have decided such under a mutual agreement procedure.

The treaty with Lithuania includes an anti-abuse rule that denies treaty benefits if one of the main purposes is just to obtain treaty benefits.

David Cuellar (david.cuellar@mx.pwc.com) and Mario Alberto Gutierrez (mario.alberto.gutierrez@mx.pwc.com), Mexico City

PwC

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