FW speaks with Alejandro Barrera, a partner at Basham Ringe & Correa, about tax reform in Mexico.
FW: Could you provide a brief background on Mexico’s recent tax reforms? What were the main reasons behind this legislative overhaul?
Barrera: Mexico’s economy relies strongly on oil revenues. As a result, the economic growth of the country depends on different uncontrollable aspects, such as production and international prices. This has brought uncertainty to the Mexican economy, as oil revenues have decreased over the past few years. The tax reform purports to reverse this trend by increasing tax revenues. In addition, it aims to simplify the tax system as a whole, while being as compliant as possible with the BEPS principles issued recently by the OECD.
FW: What changes have been made to anti-elusion provisions in the new law?
Barrera: The tax reform contains several anti-elusion provisions. For example, tax treaty benefits will only be available to related party transactions when it is demonstrated that the relevant item of income is subject to double taxation. Likewise, tax will not be deductible from interest or royalty payments made to a foreign related party which controls or is controlled by the taxpayer, and either the foreign related party is a flow-through entity, or the consideration is either not taxed or not considered as accruable income.
FW: For multinationals in particular, how does the new law address issues such as avoidance of non-double taxation treaties, payments with related parties, rules surrounding controlled foreign companies (CFC), and cost sharing agreement provisions?
Barrera: Tax treaty benefits will only be available to related party transactions when it is demonstrated that the relevant item of income is subject to double taxation. As for payments to related parties, the tax policy is to strengthen the requirements for their deduction in relation to royalties or interest to related parties. Further, the definition of passive income for the purposes of the Controlled Foreign Corporation rules has been expanded to include additional items, such as donations. Finally we must note that under the reform, payments associated with cost sharing agreements are still non-deductible, although they are accepted internationally.
FW: Could you explain the consolidation regime under the new law?
Barrera: From a practical perspective, the consolidation tax regime in Mexico was eliminated several years ago, becoming a complicated deferral system. The reform proposes a new deferral regime which is simpler than the current deferred system. In particular, an authorisation is still required to apply the deferral, and the relevant group may continue thereafter to do so, until it elects otherwise. The deferral arising from consolidation lasts only three years. Finally, the calculation is rather simple as the tax profits of some members of the group may be offset by the losses sustained by others.
FW: The new law introduces joint and several liability for management and raises the corporate veil. How will this affect the way business leaders conduct themselves in Mexico?
Barrera: From an administrative perspective, shareholders who have effective control over a taxable entity will be jointly and severally liable for any unpaid taxed up to an amount equal to their capital contribution at the time of the assessment in certain specific cases. Such circumstances include the entity’s failure to keep accounting records or its disappearance from its tax domicile. From a criminal perspective, legal ‘guarantors’, such as managers, will be held responsible for any inactivity that may result in criminal activity. Management and shareholders should certainly be more aware of the tax situation of their companies.
FW: In your opinion, how will the additional tax on dividends affect the market? What about the repeal of the Single Rate Business Tax and the Cash Deposit Tax?
Barrera: The theory behind the tax on dividends is that developed countries have higher tax rates than Mexico and therefore foreign taxpayers will be able to take a tax credit on the taxes paid in Mexico against their own taxes. The truth is not that simple, as they are not considering international competitiveness as well as economic efficiency. In other words, there are other countries which may offer a better tax result than Mexico. Regarding the repeal of the single rate business tax and the cash deposit tax, both have been more than welcomed by the business community.
FW: How will the new rules impact specific industries, such as mining companies and maquiladoras?
Barrera: The tax reform will certainly impact all industries, as they will all have to pay more taxes. Nonetheless, some of them have a greater impact than others. In particular, the mining industry will be heavily impacted. Likewise, the maquiladora will certainly be impacted by the harsher rules on qualification for safe harbour on transfer pricing and permanent establishment. Certainly, these industries are not as mobile as others, but these reforms will certainly become a factor to consider for future investments and, in some cases, even a consideration for staying in Mexico.
FW: Why have lawmakers repealed the accelerated depreciation of investments and introduced new deduction limitations?
Barrera: This is clearly a measure to offset the revenue loss derived from repealing the Single Rate Business Tax. Lawmakers, however, seem to disregard the fact that these items encouraged new investments and that they were first enacted to encourage taxpayers to include state-of-the-art technologies in their processes, while preserving the environment.
FW: Could you explain the new interpretation principles of substance vs. form?
Barrera: The original proposal provided tax authorities with the ability to re-characterise transactions if the business reason was not proven, but fortunately this proposal was eliminated. There is no substance-over-form principle in Mexico, as conceived in common law countries. Nevertheless, there is a set of rules in Mexico to prevent ‘the abuse of law’, just as there is a set of rules in other counties conceived for that same purpose. The reform does require a higher degree of consistency between the legal documents evidencing the relevant transaction and the actual conduct of the parties with respect to such documents. Further, business reasons other than tax-related reasons should support the relevant transactions.
FW: What advantages can companies gain from engaging external tax experts to assess the impact of these recent tax reforms on their business?
Barrera: External counsel can more rapidly absorb the contents of reform and therefore are more likely to spot issues that may arise therefrom and provide appropriate solutions. This is made possible by external counsels’ understanding of their client’s matters and the contact they have with most of the parties involved in taxation, such as tax authorities, judges, colleagues and even lawmakers. Companies may take advantage of their external counsels’ experience to obtain quick, sound, cost-efficient and tailored solutions to their problems.
Alejandro Barrera is a partner at Basham Ringe & Correa. He has over 20 years experience in national and international tax. Mr Barrera graduated from the Law School of the UNAM and he pursued five post graduated studies at Universidad Panamericana. He holds an LL.M in International Taxation from the New York University and was also awarded the Fulbright Scholarship. Mr Barrera is Professor of Graduate and Post Graduate studies at UNAM, Universidad Anahuac and Universidad Panamericana, and is fluent in Spanish, English and Portuguese. He can be contacted on +52 (55) 5261 0458 or by email: firstname.lastname@example.org.
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