After the harsh impact that COVID-19 has left on global economies, Mexico is beginning to show a slow and gradual economic recovery, especially in some sectors of the manufacturing industry.
However, capital outflow continues not only due to the downturn of the country’s economic activity that has occurred, but also due to the controversial reforms promoted by the government that have generated uncertainty for large corporations, as well as the lack of proposals that encourage investment in the country.
One of the main mechanisms by which companies resident for tax purposes in Mexico repatriate capital abroad is through the distribution and payment of dividends.
Tax treatment of the distribution of dividends
According to the Mexican income tax law, residents abroad who obtain income in cash, goods, services or credit, from sources of wealth located in national (Mexican) territory, are obliged to pay income tax (IT).
In the case of income from dividends or profits, and in general from earnings distributed by legal entities to shareholders residing abroad, whether legal entities or individuals, it is considered that the source of wealth is located in national territory when the entity that carries out the distribution resides in the country.
The legal entities that distribute dividends or profits must withhold the IT resulting from applying a 10% rate on dividends or profits. The paid tax is considered as final and must be paid no later than the 17th day of the month following the one in which the dividend is distributed.
It is important to mention that according to tax provisions, items such as loans to partners or shareholders (unless certain requirements are met), non-deductible expenditures that benefit shareholders, omissions of income or purchases not made, among others, are considered as dividends in addition to the profits distributed by legal entities.
This becomes relevant when considering that in most conventions to avoid double taxation, the definition of ‘dividends’ does not include concepts such as the aforementioned.
When a legal entity residing in Mexico for tax purposes distributes dividends to residents abroad, the residents abroad are obliged to pay an IT of 10%, which will be withheld and paid by the legal entity that pays the dividend.
It is important to note that the withholding of 10% only applies to the distribution of profits generated as of 2014; therefore, if legal entities distribute profits generated prior to January 1 2014, these profits would not be taxed in accordance with domestic law.
The legal entities that make payments of dividends or profits must provide to whomever receives said dividends, a tax certificate that states the amount of the dividend, the withheld tax as well as whether said dividend comes from the net taxable income account, the net taxable income account (known by its Spanish acronym CUFIN) is a book account where the profits that already paid taxes at the corporation level are registered and controlled.
Conventions to avoid double taxation
Mexico has signed approximately 60 agreements to avoid double taxation. Among them, several stipulate lower rates for dividends (0% and 5%), which could be applicable if certain requirements are met.
According to domestic law, the benefits of the conventions to avoid double taxation are only applicable to taxpayers who comply with the following.
Proof of residency
Taxpayers who may want to prove their tax residence in another country with which Mexico has entered into a convention to avoid double taxation, may do so through a certificate of tax residence, or with the tax return for the last fiscal year. Both documents will be valid during the calendar year in which they are issued; therefore, taxpayers must obtain them for each year in which they intend to apply the benefits of the convention.
The certificates issued by foreign authorities to prove tax residence are valid without the need for authentication, and it will be necessary to produce an authorised translation only when required by the tax authority.
Compliance with the convention provisions
This will depend on the convention that is being applied, but in general terms these requirements are related to demonstrating that the recipient of the dividends is the effective beneficiary of the dividend, complying with the presence time and the percentage of shareholding stipulated in the convention in question, observing the limitation on benefits clauses, etc.
Compliance with other procedural provisions in the IT law
Regarding the procedural provisions contained in domestic law, these are related to the filing of information returns, issuance of tax receipts, filing of a tax report or informative tax situation return, etc.
Operations between related parties
In the case of operations between related parties, the tax authority may request the resident abroad to declare under oath that the income subject to tax in Mexico is also taxed in the country of residence.
Regarding this requirement, the tax authorities issued a rule that stipulates that taxpayers residing abroad will not be requested to prove the existence of double taxation.
Among other cases, with regard to dividends, when the resident abroad is the effective beneficiary of said dividends and is not subject to taxation by virtue of having applied the exemption as a method of avoiding double taxation in accordance with the legislation of the country in which it is resident for tax purposes. Generally speaking, the exemption method consists of taxing income only in the source country.
As mentioned previously, residents abroad who receive dividends from legal entities residing in Mexico for tax purposes are obliged to pay an IT of 10% on the amount of the dividends, which will be withheld and paid by the legal entity that pays the dividends.
Residents abroad may invoke the benefits of a convention to avoid double taxation and, where appropriate, apply a tax rate of less than 10%, provided they comply with the requirements indicated throughout this document.
There are cases in which the tax withheld in Mexico, whether in accordance with domestic law or pursuant to a convention to avoid double taxation, cannot be creditable in the country of residence or its accreditation is limited, in which case it is important for business groups to analyse alternatives through which capital can be repatriated abroad, other than the distribution and payment of dividends.
Likewise, there are cases in which the recipient of the dividend does not have the possibility of crediting the corporate tax paid at the level of the Mexican corporation. In these cases it is also convenient to analyse the different alternatives that may exist, prior to the distribution and payment of dividends.
As of fiscal year 2021, there is an obligation for tax advisers and/or taxpayers to inform the tax authorities of the schemes that are deemed reportable, in terms of tax provisions.
In general terms, any scheme (a scheme means any plan, project, proposal, advice, instruction or recommendation expressed in an express or tacit way with the purpose of materializing a series of legal acts) is deemed a reportable scheme when it generates or may generate, directly or indirectly, a tax benefit in Mexico and has, among others, any of the following characteristics:
- It involves a resident abroad who applies a convention to avoid double taxation signed by Mexico, with respect to income that is not taxed in the country or jurisdiction of tax residence of the taxpayer. The provisions of this section shall also be applicable when said income is taxed at a reduced rate compared to the corporate rate in the country or jurisdiction of tax residence of the taxpayer; and
- It avoids the application of the 10% withholding rate, in the case of payments of dividends and/or profits to residents abroad.
It is important that when agreeing on the distribution of dividends, an analysis is made on whether it is necessary to report this operation to the tax authorities, in particular if the recipient of the dividend resides in a country where there exists one of the tax regimes known as ‘participation exemption on dividend income’.
This is particularly important since according to the rules issued in regard to reportable schemes, it must be indicated under oath if the resident abroad is the effective beneficiary of the income with respect to which a convention to avoid double taxation is applied.
Ricardo Delgado is a partner at Copper Wolf in Mexico City. He has more than 20 years’ experience in national and international corporate taxes focusing on in tax advice and compliance.
Prior to Copper Wolf, Ricardo was a partner in the tax practice of an international firm.
Ricardo has a bachelor’s degree in public accounting from the National Autonomous University of Mexico (Universidad Nacional Autónoma de México), and a diploma in international taxes from the Autonomous Technological Institute of Mexico (ITAM). He is currently studying for a master’s degree in taxes at the Panamerican University (Universidad Panamericana).
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