By Enrique Benet Gregg
Mexican law is built on the heritage of civil law. The federal constitution is the supreme law of Mexico. It establishes fundamental individual rights, organizes the federal government, and defines the federal, state, and municipal governments' respective authorities. Certain areas of law are exclusively the province of the federal government, while others fall under the purview of state governments created by their state constitutions. The federal government has the authority to control commerce and trade, including the formation of corporate corporations, whereas states often have the authority to regulate property inside their borders.
The Mexican tax legal system is comprised of the following:
The Federal Income Law, which is passed annually and establishes the federal government's annual taxes, levies, penalties, assessments, fees, and other charges;
The United States Internal Revenue Code and its rules;
The Internal Revenue Code and its rules;
The law and regulations governing the value-added tax;
International treaties, such as conventions against double taxation and extensive tax information exchange agreements;
A variety of tax resolutions/the Omnibus Tax Bill;
Principles that are not legally obligatory;
Normative standards;
Often requested information;
Edicts; and
Tax rules and regulations on a local level.
Within five years, tax authorities must assess and collect taxes, examine returns, and impose extra tax liabilities (from the date the tax return is submitted). This period may be extended to ten years in some instances. Tax authorities retain the authority to conduct investigations into fiscal criminal violations even after these time limits have expired. Taxpayers must submit refund requests within five years.
Tax administrations
The Tax Administration Service (SAT in Spanish), a federal regulatory organization under the Ministry of Finance and Public Credit, is responsible for the federal administration of Mexico's tax and customs systems. However, coordination agreements between federal and state agencies exist that allow states to collect certain federal taxes under certain circumstances. Additionally, there are municipal tax administration agencies and state tax administration offices. PRODECON is a decentralized Mexican government institution that serves as an ombudsman for taxpayers. It advises, assists in resolving conflicts between rule interpretations, and makes suggestions to local tax authorities.
Recently, tax authorities have concentrated their efforts on tax inspections involving transactions with nonresidents (typically payments abroad), expense deductibility, the transfer of fiscal losses, the issuance of electronic invoices for non-existent transactions, transfer pricing issues, and customs duties.
Taxation of earnings
Income tax is levied on income received in cash, kind, credit, or services by a taxpayer. Individuals' ISR is based on a progressive rate that changes according to the nature of taxable income and may reach up to 35% in 2020. For businesses, the ISR rate is 30%.
To calculate a taxpayer's taxable income, all earnings and income received by the taxpayer must be evaluated, less expenses and allowable deductions (which should be documented). For businesses, taxable income is calculated as total taxable revenue less allowable deductions and mandatory employee profit sharing, as detailed below.
Foreign residents may be required to pay ISR on income earned via the sale of shares or membership interests in Mexican corporations, services rendered in Mexico, and products sold in Mexico, as well as royalties and similar payments received from Mexican residents. ISR is often collected through withholdings applied by the Mexican taxpayer while remitting funds to the foreign taxpayer. The usual rate of taxation fluctuates between 0% and 30% and is subject to any special regulations or exclusions provided under a double taxation treaty.
For LISR (Ley del Impuesto sobre la Renta) purposes, income attributable to a non-permanent resident's establishment must be taxed in the same manner as income attributable to residents, both persons and businesses. The LISR governs the taxation of a permanent establishment regardless of the existence of a tax treaty.
When a double tax treaty is in effect, a resident's commercial gains are taxed only in the contractual state, unless the person does or has conducted business in the other contracting state through a permanent establishment located there. If the resident conducts or has conducted business, the resident's business profits may be taxed in the other state, but only the portion of business attributable to the resident's permanent establishment. If a resident of a contracting state establishes a permanent establishment in another contracting state and alienates property to persons in that other state that is identical or similar to property alienated through that permanent establishment, the profits from that alienation are attributed to that permanent establishment.
Individual taxation
When an individual's primary residence is in Mexico, he or she is considered a tax resident. If an individual has two dwellings (one in Mexico and one in another country), the individual is regarded to be a resident of the country in which his or her primary place of residence is located. When more than 50% of an individual's income comes from Mexican sources of wealth or when the primary location of his or her professional activities is in Mexico, the individual's vital interests are considered to be in Mexico.
Employees who are tax residents
Individuals residing in Mexico are taxed and required to contribute to social security based on their worldwide income.
Income tax is due at the rate appropriate to the employee's income category. At the moment, the lowest rate is 1.92 percent and the highest is 35%.
Contributions to social security are based on an employee's consolidated income and are withheld by the employer (Social Security Law).
Businesses that are tax residents
For tax reasons, a business is regarded to be Mexican resident if its principal administration or effective management is located in Mexico.
When the person or persons who make or carry out decisions about the legal entity's control, direction, operation, or management are located in Mexico, the primary administration or seat of effective management is in Mexico. This is typically established through board meeting minutes, which specify the location of the meeting.
Businesses that are not tax residents
Non-resident corporations with a permanent establishment in Mexico are subject to income tax at a rate of 30% on net income. In general, a permanent establishment is a location where an enterprise's operations are conducted entirely or in part. This comprises corporate headquarters, regional offices, and mining operations. If a non-resident corporation does not have a permanent establishment in Mexico, revenue from Mexican sources is taxed, however at a variable rate. If the payer is a Mexican tax resident or a foreign resident with a permanent establishment in Mexico, the 25% rate is normally applied on a gross basis and withheld by the payer.
Payments to related parties who are inhabitants of a tax haven or a jurisdiction with a preferential tax system are subject to a 40% withholding tax, unless an information exchange arrangement is in effect.
When one party participates in the capital, administration, or control of another, the former is often deemed to be related to the latter. Similarly, two parties are considered connected if they are entirely or largely controlled, owned, or administered by the same person or group of persons.
Dividend taxation
Dividends received by a resident firm in Mexico from another resident company in Mexico are tax deductible. Dividends received from a foreign corporation are subject to corporate tax in the period in which they are received, but normally, a credit for underlying corporate and withholding taxes paid overseas is allowed.
Mexican corporations may freely distribute dividends on profits taxable in Mexico; otherwise, corporate taxes on the dividend distribution must be paid. Businesses must maintain a separate CUFIN account for the purpose of tracking previously taxed profits.
Municipal governments impose a tax on the ownership of real property. Rates are deducted when determining an individual's taxable income from leasing real estate.
Tariffs for transfers
Additionally, the Income Tax Law contains rules governing transactions between related parties and techniques for complying with transfer pricing principles, including the arm's length principle.
Mexican taxpayers conducting transactions with domestic and overseas connected parties are obligated to use the same pricing and consideration as would be used in analogous transactions by unrelated parties. All transactions involving related parties are subject to transfer price documentation and reporting requirements. The reporting must be accompanied by transfer price analyses conducted in accordance with the applicable laws' procedures.
Mexico recognizes transfer pricing mechanisms (e.g., comparable unregulated price, resale price, cost-plus, and profit split) that are consistent with and aligned with the OECD's transfer pricing standards.
Tax on the value added (VAT)
VAT is collected on the supply of products and independent services in Mexico, on the importation of goods and services, and on the provision of temporary use or pleasure of commodities in Mexico. The typical VAT rate is 16%, but certain activities are exempt from VAT. Additionally, the VAT statute exempts some activities/transactions from the tax.
The LIVA (Ley del Impuesto al Valor Agregado) imposes taxes on the following activities conducted in Mexico:
The movement of things;
Provision of self-contained services;
The temporary use or enjoyment of property; and
The acquisition of commodities or services through imports.
Although the LIVA does not define a permanent establishment, non-residents who have one are subject to the IVA if they engage in any of the listed activities in Mexico.
VAT is often levied at a rate of 16 percent. However, sales of zero-rated goods are taxed at 0%.
The Executive Branch issued a presidential proclamation establishing tax advantages in some communities near Mexico's northern border. The order took effect on January1, 2019 and is effective for the fiscal years 2019 and 2020. Under certain conditions, sales, leasing, and providing of services occurring on the northern border may be taxed at a lower VAT rate of 8%. This tax credit does not apply to the sale of intangible property or real estate.
VAT is a pass-through tax, which means that it is incurred by the final customer in any given supply chain. VAT paid by businesses on purchases and expenditures (including zero-rated purchases and expenses) may be offset against VAT collected from customers on sales or services given. VAT paid on purchases and expenses that exceeds VAT received from customers on sales may be reclaimed as positive VAT balances through a refund process (if requested, and if certain conditions are met).
Contributions to social security
Contributions to social security include those made to the Mexican Social Security Institute (Instituto Mexicano del Seguro Social, IMSS), the National Workers Housing Fund (Instituto del Fondo Nacional de la Vivienda para los Trabajadores, INFONAVIT), and the Workers Retirement Fund (Sistema de Ahorro para el Retiro, SAR).
Contributions to social security vary according to numerous criteria, including the number of employees, the employer's risk premium, and the services supplied by employees, and may account for between 25% and 35% of payroll costs.
Import duties
Individuals or businesses importing products into Mexico must pay import taxes in addition to the applicable VAT and any applicable customs fees. The rate of taxation on imported goods is determined by the tariff classification number specified in the General Import and Export Taxes Law. Taxes on imports are not always applicable. Taxes and custom charges are set by the Customs Law based on the objective of the transaction. Import taxes, in principle, are applicable only to products imported under the definitive import regime. Numerous products are duty-free.
Excise duties
Mexico imposes a variety of excise taxes, the majority of which are governed by the Special Production and Services Tax Law. Excise taxes in Mexico are similar to VAT in that they are paid by the end user and apply solely to specific products. Excise taxes are levied on gasoline, diesel, alcoholic beverages, cigarettes, tobacco goods, energy drinks, and foods and beverages with a high calorie content. Gambling and raffles are both subject to excise taxes. Rates vary according to circumstance.