Last month, the Mexican federal government sent the proposed 2022 Economic Plan (the Proposal) to the Congress of the Union, which includes the 2022 Federal Budget, as well as the 2022 Revenue Law (Ley de Ingresos) and proposed amendments to the Income Tax Law (Ley del Impuesto Sobre la Renta), the Value Added Tax Law (Ley del Impuesto al Valor Agregado) and the Federal Fiscal Code (Codigo Fiscal de la Federacion), among others.
While the proposed changes are not substantive in nature (in the sense that they do not create new taxes or increase applicable rates), they are intended to close certain loopholes available in some areas, increase the taxing authorities’ (Servicio de Administracion Tributaria or SAT) oversight and review rights and impose harsher penalties on taxpayers in violation of tax laws.
The Proposal is currently pending debate in the House of Deputies (Camara de Diputados) and the Senate of the Republic (Senado de la Republica). Many interest groups have also begun to lobby the SAT and Congress, seeking modifications to certain items of the Proposal, therefore, the final bill may differ from the specifics outlined in this article. The Proposal must be voted on no later than November 15, 2021, and the final bill will go into effect on January 1, 2022.
Below is a detailed summary of the more relevant items in the Proposal.
If approved, the Proposal would expand the definition of back-to-back loans to include any related party debt that lacks business purpose. As such, interest payments on any related party loan or transaction would be recharacterized as dividends if the financing transaction were deemed to lack a business purpose. Mexican legislation does not define the term “business purpose,” however, the Federal Fiscal Code does provide some guidance in that sense. Specifically, it provides that the tax benefit derived from a specific transaction cannot exceed the value of the transaction itself.
Thin Capitalization Rules
Mexico currently has a three-to-one debt-to-equity ratio limitation for determining related party interest deductibles paid to nonresidents. Taxpayers have the option to use either the book value or tax equity to calculate the limitation on the interest deduction. The Proposal would modify the thin capitalization rules to make these two calculations more consistent. Specifically, the Proposal would require taxpayers to include net operating losses (NOLs) in addition to paid-in capital and previously taxed earnings when the tax equity option is elected to calculate their limitation on interest deductions. Losses are not currently included in the tax equity calculation. If the book value and tax equity differ by more than 20% for purposes of the thin capitalization rules, the Proposal would only allow taxpayers to use the tax equity option if there is a business purpose for the difference and other requirements are met.
Domestic Restructuring, Spin-Offs and Mergers
Currently, domestic restructurings, spin-offs and mergers are treated as tax free to the extent that certain formal requirements are met. In addition to the current requirements, the Proposal would require taxpayers to have a valid business purpose for these transactions to be treated as tax free.
Mergers and spin-offs would also be subject to additional reporting and scrutiny by the SAT if a relevant transaction (as defined in the Proposal) occurs within five years, before or after, the reorganization. Relevant transactions include the following:
- The transaction involves a transfer of stock ownership or the use or enjoyment of the voting rights or veto rights of shares for the merged entity (or entities) involved in a spin-off, as applicable.
- Rights are granted for the assets or profits of one of the reorganization parties for reductions of capital or liquidations.
- The value of the shareholders’ equity in any of the reorganization parties (survivors) increases or decreases by more than 30% compared to the value determined at the date of the reorganization.
- The capital stock (capital social) of the shares increases or decreases compared to the value at the date of reorganization.
- A shareholder’s participation in the company increases or decreases, resulting in an increase or decrease of another shareholder’s interest as compared to the date of the reorganization.
- One of the shareholders of the reorganization parties changes its residence.
- One of the reorganization parties sells a line of business.
Additionally, the Proposal would change the definition of a spin-off to refer to the transfer of capital stock instead of capital equity (capital contable). This provision aligns with other changes that disallow the creation of capital accounts because of a split-up.
The Proposal would also expand the current limitations for the allocation of NOLs resulting from a spin-off to require that the losses may only be transferred between entities that carry on the same business activity.
Regarding the existing restrictions on the use of NOLs when there is a change in control, the Proposal would expand on the current assumptions for determining when there is a direct or indirect change in the control of a company. Under the Proposal, a direct or indirect change in control would occur when (1) there is a change in the holders of the direct or indirect rights to make decisions in shareholders’ assemblies or to change members of the Board of Directors, or (2) a company and its shareholders stop consolidating their financial statements after a merger.
Nonresident Capital Gains
The Proposal would modify certain provisions related to the authorization to defer income tax for capital gains in corporate reorganizations carried out by nonresidents. Under current provisions, nonresident shareholders may request a ruling to approve the transfer of shares in a Mexican entity with the payment of the deferred income tax due when the shares leave the group. This ruling is an indefinite gain recognition agreement. The Proposal would allow the SAT to cancel the deferral authorization if, based on the information provided, it is concluded that the reorganization lacks a business purpose or that the exchange of the shares related to the reorganization resulted in income subject to a preferential tax regime. Once the deferral authorization is cancelled, the capital gains tax would be triggered.
When it comes to shares, the Proposal would deem them subject to the deferral ruling to be transferred out of the corporate group. Payment of the corresponding capital gains tax would be triggered if the issuer entity and the acquiring entity stop consolidating their financial statements.
In addition, the Proposal would include information regarding reporting provisions for relevant transactions carried out by the taxpayers within five years, before or after, the authorized date of the corporate reorganization.
The Proposal would also modify the requirements nonresidents must satisfy for electing to be taxed on capital gains on a net gain basis at a 35% rate. Specifically, it would require nonresidents to show that they have complied with the transfer pricing rules. For these purposes, the registered public accountant would have to include the transfer pricing supporting documentation in the tax audit report.
One requirement of the Proposal: The Mexican entity (issuer of the shares being transferred) must notify the SAT about transfers of its shares between foreign residents. Failure to do so could result in the Mexican entity becoming jointly liable for any tax due by the foreign residents.
The Proposal would include additional obligations for Mexican legal representatives of nonresidents appointed for specific compliance related to Mexican-sourced income. For example, the Proposal would require a legal representative to voluntarily assume joint and several liability up to the amount of any tax liability due by the nonresidents and must demonstrate that it has sufficient assets to cover possible assessments. This provision is not exclusive to capital gains income.
Maquiladora Transfer Pricing Rules
The Proposal would eliminate the option for maquiladoras (aka, a factory in Mexico run by a foreign company) to request an advanced pricing agreement (APA) in order to comply with maquiladora transfer pricing rules. The Proposal would also repeal the APA option for nonresidents operating through “shelter” companies.
Without this alternative, as of 2022, maquiladoras would only be able to apply the “safe harbor” methodology, which requires taxable income in Mexico to be the greater of 6.5% of total costs incurred by the maquiladora or 6.9% of the total value of the assets used in the maquiladora operation (including the average value of inventory, machinery and equipment owned by the maquiladora’s principal).
Additionally, the Proposal would eliminate the need to file an annual notice informing the SAT of the application of the safe harbor methodology (which was considered an administrative burden) as this information should already be disclosed in the annual maquiladora information tax return.
Given the size, relevance and strength of the maquiladora industry alliance and the consequential nature of this proposed reform, it is expected that the final bill will restore the ability for maquiladoras to seek APAs, however, in a more limited fashion.
VAT Credit on the Importation of Goods
The Proposal would clarify that value-added tax (VAT) credits for the importation of goods would only apply if the import documentation (pedimentos) is issued in the name of the taxpayer claiming the credit, thereby making it more costly for the taxpayer to use a third party for importing goods into Mexico.
Disallowance of VAT Credits for Activities Carried Out Outside of Mexico
The Proposal includes provisions regarding the allocation of activities between taxable and non-taxable activities, including those performed outside of Mexico, for purposes of calculating the amount of credits that may be taken for input VAT. These rules would eliminate a taxpayer’s ability to credit any VAT paid on the acquisition of goods, services, imports, etc. related to activities carried out abroad.
Compliance for Nonresidents Rendering Digital Services in Mexico
The Proposal would require foreign digital service providers to submit VAT information returns monthly, instead of quarterly. This provision is consistent with the monthly return form. The Proposal would also sanction foreign digital service providers that fail to file information returns and pay taxes for three or more consecutive months.
VAT on the Leasing of Goods
The Proposal would subject the leasing of goods to Mexican VAT, regardless of the place where the goods are delivered (i.e., Mexico or abroad). Currently, leasing transactions are subject to VAT in Mexico only when the leased goods are delivered within the Mexican territory.
OTHER AMENDMENTS ON COMPLIANCE AND AUDIT PROCEDURES
The Proposal would establish that taxpayers may not lose their Mexican tax resident status for five years, unless tax residency can be demonstrated in another country not considered a preferential tax regime. If Mexico has entered into an information exchange agreement with the relevant country and that agreement allows for assistance in the collection and remittance of taxes, this provision would not apply.
Cancellation and Restriction of Digital Stamp Certificates
The Proposal would modify the current procedure to cancel digital stamp certificates (CSDs) required to issue invoices. The Proposal would also clarify the procedure for rebooting a cancelled CSD or obtaining a new one. The cancellation of a CSD is an enforcement tool typically applied by the SAT in cases of deemed incompliance by Mexican taxpayers (i.e., missed tax returns, transactions with blacklisted companies, a mismatch in records or non-locatable tax domicile).
Joint and Several Liability
Currently, joint and several liability applies to the acquirers of going concerns. The Proposal would create several assumptions for deeming a going concern as acquired, even if the title is not formally transferred. Specifically, the Proposal would deem a going concern as acquired when there is an identical continuation of certain elements (i.e., assets, liabilities, members of the Board, shareholders, suppliers, tax domicile, employees and copyright).
The Proposal would also impose joint and several liability for up to the amount of the tax liability on any Mexican legal representatives appointed by foreign residents.
The Obligation for Certain Taxpayers to File an Annual Tax Report
The Proposal would reinstate the requirement that taxpayers have their financial statements audited by a registered public accountant and file an annual tax report (Dictamen Fiscal) if they recorded gross income of at least $876,171,996.50 Mex$ (approximately $45 million USD) on their tax returns or if the company is publicly traded in Mexico. Taxpayers have been relieved of this obligation in recent years.
The Obligation of CPAs to Report on Potential Tax Criminal Offenses
The Proposal would require certified public accountants (CPAs) to report any conduct by the audited taxpayer, identified because of the preparation of the annual tax report that may constitute the commission of a tax criminal offense, to the SAT. It would also hold CPAs who fail to report these situations criminally liable for concealing the potential tax offense.
Common Reporting Standard/Foreign Account Tax Compliance Act
The Proposal would (1) incorporate into Mexico’s domestic legislation the international covenants assumed by Mexico regarding the exchange of information, (2) strengthen compliance and (3) provide enforcement tools for financial institution reporting obligations.
In addition, the Proposal would require companies, trustees, other entities and legal vehicles (e.g., partnerships) to obtain and keep information on their ultimate beneficial owner in an accurate and updated manner. It would also grant new verification powers to the SAT for auditing these persons.
Simulation of Legal Acts for Tax Purposes
The Proposal would authorize the SAT to determine the simulation of legal acts in related party transactions exclusively for tax purposes and determine upon audit the outstanding tax liability amount according to the true nature of the transaction. While the process for determining the simulation of related party transactions is already contained in the Mexican Income Tax Law, the Proposal would allow the SAT to determine simulation from a procedural perspective at the Federal Fiscal Code level. This provision would close the loophole for certain challenges to this process that have been raised in the past.
Tax Offense for Simulating Employment Relationships
In line with the recent Mexican outsourcing reform under which the subcontracting of employees is restricted or forbidden, the Proposal would add, as an aggravating circumstance to the committing of tax fraud, the false treatment of employees as independent contractors for tax purposes. The Proposal would also add obtaining any tax benefit from payments that violate anti-corruption laws as an aggravating circumstance to tax fraud.
The McDermott Will & Emery Tax Practice Group look forward to any questions or comments regarding the content in this article.