Global Tax Alert (News from Americas Tax Center and Financial Services) | 24 October 2013
Mexico's lower House of Congress approves tax reform proposal affecting financial institutions
The tax committee of Mexico’s lower House of Congress released a revised proposed tax reform (Revised Proposal) on 17 October 2013, that modifies many of the provisions of the original proposed tax reform presented by President Pena Nieto on 8 September 2013.1 The lower House voted on and approved the Revised Proposal on 18 October 2013; it has now moved on to the Senate for debate and vote.2
Overall, the lower House adopted many of the President’s original proposals including the elimination of the deduction for banks of the allowance for loan losses, as well as the repeal of the nonresident’s capital gains exemption on publicly traded shares. The Revised Proposal, however, would allow deductions for certain reserves for insurance and surety companies and amend the anti-base erosion provisions and the dividend distribution tax to establish it as a withholding tax instead of a corporate tax.
This Tax Alert discusses the more significant items included in the Revised Proposal affecting the financial services industry that were modified from the original proposed tax reform.
Allowance for loan losses
The Revised Proposal reiterates the repeal of the rules for banks to create and deduct the allowance for loan losses. Therefore, beginning 1 January 2014, banks would only be allowed to deduct bad debts once they become legally uncollectable in terms of the Mexican Income Tax Law, provided that such bad debts have not been deducted in prior years under the allowance for loan loss rules. Under the Revised Proposal, the deductibility of specific bad debts for financial institutions would not be subject to a mandate or authorization from the National Banking and Securities Commission, but rather would be considered as legally uncollectable when the debt is downgraded to bad debt in terms of the provisions of the Mexican Banking and Securities Commission.
Transitory provisions would still require banks to recognize taxable income for the decrease of the balance of the allowance for loan losses as of 31 December of the previous year. However, the Revised Proposal would allow a deduction for the remaining balance of the allowance for loan losses as of 31 December 2013, as long as the deduction for bad debt in the corresponding year is less than 2.5% of the loan loss reserve average balance of that year and up to the amount of such difference.
Further, the Revised Proposal provides that when the remaining balance of the allowance for loan losses as of 31 December 2013, has been fully deducted, banks may be able to deduct write-offs, waivers, rebates and discounts on loan portfolios and the losses from the sale of loan portfolios and losses due to foreclosure. The wording of this provision may raise some issues for the deductibility of write-offs, waivers, rebates and discounts for loans that were not included in the allowance for loan losses as of 31 December 2013.
Insurance companies and surety companies
The Revised Proposal would continue allowing deductions for certain reserves for insurance and surety companies under the same terms provided in current law. Also, the Revised Proposal would continue allowing a deduction for yields for premium adjustments paid to the insured by the insurance company.
Withholding tax on dividend distributions
The Revised Proposal amended the original proposal by eliminating the additional 10% corporate tax on corporate profits at the time of distributions and adding a 10% dividend withholding tax on dividends paid to Mexican individual or nonresident shareholders. Based on this, treaty relief against the dividend withholding tax would be available to the extent the provisions of the applicable treaty and the Mexican Income Tax Law are complied with.
The definition of dividends for this purpose would include, among others, in addition to declared dividends: (i) interest paid on preferred shares; (ii) loans to shareholders and partners unless the loan is established for less than one year, is incurred in the operations of the business and meets certain requirements; (iii) nondeductible payments that benefit the shareholders; (iv) unrecognized amounts as a result of omissions of income or unrealized purchases; and (v) transfer pricing adjustments as a result of assessments by the tax authorities for related party transactions. The 10% dividend withholding tax would also apply on distributions from a branch to the home office as well as on deemed dividends determined in the case of capital redemptions.
The Revised Proposal would include a grandfather provision that would limit the withholding tax on dividends to after tax earnings generated in 2014 and subsequent years. For this purpose, the grandfather provision would allow distribution from pre-2014 accumulated previously taxed earnings (CUFIN) tax free. For such purposes, Mexican companies would be required to maintain separate CUFIN accounts on a stand-alone basis for pre-2014 and for 2014 and following years’ earnings. The grandfather provision would not include ordering rules to require 2014 and beyond earnings to be considered as distributed first. Note that CUFIN balance may be substantially different from book retained earnings and that holding companies may not have CUFIN balance if dividends have not been distributed from subsidiaries.
Capital gains tax
The Revised Proposal would retain the repeal of the capital gains exemption for holdings of less than 10% applicable to Mexican resident individuals and foreign residents with respect to the sale of publicly traded shares through the Mexican or a qualified foreign exchange, including the sale of Mexican American Depository Receipts (ADRs) in a qualified foreign exchange.
For nonresident investors the tax on these gains would be 10%, which would be lower than the nonresident capital gains rate for non-publicly traded shares (25% of gross value or 35% of the gain an increase from the current 30% of the gain).
Consistent with current law, publicly traded shares transferred outside the stock exchange or over-the-counter by a nonresident would be subject to tax at 25% of the value of the shares (i.e., the gross proceeds). If certain requirements are met, the nonresident taxpayer may elect to be taxed on the net gain at a rate of 35%.
Mexican broker dealers acting as intermediaries on sales performed by Mexican resident individuals would be required to determine the gain or loss arising from the sale. The information about the gain or loss would have to be reported by the intermediary to the Mexican individual who would be required to pay the corresponding tax on a tax return filed together with his/her annual tax return. The applicable capital gains tax rate for Mexican individuals would be 10%.
Mexican broker dealers acting as intermediaries on sales performed by foreign residents would be required to withhold the tax on the gain at a rate of 10% per each transaction without the ability to deduct losses.
The gain would, in all cases, be the difference between the purchase price (based on the closing quote of the day of the transfer) and the average acquisition price during the holding period. The Revised Proposal would allow the deduction of commissions incurred by the nonresident for trading.
However, the Revised Proposal would include an exemption for foreign investors that are resident in a treaty jurisdiction regardless of the applicable treaty provisions, holding period or holding percentage. Treaty resident investors would be required to provide a statement under penalty of perjury that it is a treaty resident and provide a taxpayer identification number issued by the corresponding tax authorities. The Mexican broker-dealer or intermediary would be required to withhold if the nonresident investor failed to provide this information. The Revised Proposal also clearly would define when the treaty-resident exemption would not be applicable, providing for example that if the shares were acquired outside the stock exchange, the treaty-resident exemption would not be applicable.
The Revised Proposal would not specifically provide a mechanism for non-treaty resident investors to pay the capital gains tax in those cases where a Mexican broker dealer does not participate in the trade, for example in the case of the sale of Mexican ADRs. The general rule for private shares or publicly listed shares traded outside the stock exchange requires the Mexican buyer to withhold, otherwise the nonresident seller is required to pay the tax and file a tax return within 15 days of closing.
Mexican broker-dealers or intermediaries are required to report each year to the Mexican tax administration the information related to all sales of publicly traded shares carried out in the Mexican stock exchange.
A transitory provision in the Revised Proposal would provide rules for the determination of the tax basis for publicly traded shares acquired prior to 1 January 2014, and sold in the exchange after 1 January 2014. In this case, the tax basis would be the average value of the last 22 closing quotes prior to 1 January 2014, and the use of the average value of the last six months would be allowed if the last 22 closing quotes are not representative of the stock trends in value and trading volume.
In addition, the Revised Proposal would retain the rules to determine the gain on the transfer of shares borrowed by a nonresident under an unqualified securities lending transaction. The tax on these deemed transfers would be 25% of gross value or 35% of the gain.
Base erosion limitations
The Revised Proposal would retain the framework of the original proposal by limiting the deduction of fringe benefits that are exempt compensation for employees, but adjusts such limitation from 41% to 43%. The Revised Proposal would continue allowing the deduction for contributions to pension funds, but now limited to 43%.
The original proposal would have denied a deduction for expenses that are also deducted by a related party in another jurisdiction. The Revised Proposal would allow a corresponding deduction if the nonresident is also recognizing as taxable income, in the same or the subsequent year, the income obtained by the Mexican taxpayer.
The Revised Proposal would eliminate the broad rule that was included in the original proposal denying a deduction for payments to related parties that were not subject to tax or subject to tax at an effective tax rate of less than 75% of Mexico’s corporate tax rate. Instead, the Revised Proposal introduced a rule to deny deductions of payments made to residents in a preferred tax jurisdiction, as defined, if the payment is not at arm’s length. This rule would apply to related and unrelated parties and is consistent with current law.
The Revised Proposal also introduced a rule that would disallow deductions of interest, royalties or technical assistance payments made to a nonresident related party that controls or is controlled by the Mexican taxpayer to the extent one of these conditions is met: (i) payments are made to a fiscally transparent entity (as defined), unless the shareholders or partners are subject to tax on the fiscally transparent entity’s income and payments are made at arm’s length (ii) payments are not deemed to exist for tax purposes in the jurisdiction in which the entity is resident or (iii) the nonresident does not accrue the taxable income under the applicable tax rules.
For this purpose, control would be deemed to exist when one of the parties has, either directly or through an intermediary, effective control or control of the administration of the other to the level of deciding the moment to distribute or share revenue, income or dividends.
The Revised Proposal would retain the requirement for a nonresident taxpayer seeking treaty benefits to appoint a tax representative in Mexico and to file certain information with the tax authorities.
The Revised Proposal also would provide tax authorities with the ability to request nonresident affiliates seeking treaty benefits to provide a statement of their tax
positions and that the income is subject to double taxation. It is not clear the tax authorities could rely under this rule to deny treaty benefits.
The Revised Proposal retains the repeal of the Single Rate Business Tax and the Tax on Cash Deposits.
The Revised Proposal does not include the general anti-avoidance provision proposed by President Pena Nieto or the elimination of the VAT exemption on the sale of primary residence by individuals or the provisions that intended to tax interest and commissions on a mortgage for a residential home with VAT at the 16% general rate. In VAT matters, the Revised Proposal would retain the changes for Multipurpose Financial Companies (SOFOMs) regarding VAT credit mechanisms, so they would be subject to the same treatment as other regulated financial institutions starting on 1 January 2014.
2 This process should be completed by 31 October 2013, and most of the provisions of the law, if enacted, would go into effect on 1 January 2014.
For additional information with respect to this Alert, please contact the following:
Mancera, S.C., Latin American Business Center, Mexico City
- • Terri Grosselin
+52 55 1101 6469
Mancera, S.C., Mexico City
- • Koen van´t Hek
+52 55 1101 6439
Ernst & Young LLP, Latin American Business Center, New York
- • Alfredo Alvarez
+1 212 773 5936
- • Enrique Perez Grovas
+1 212 773 1594
- • Ricardo Vargas
+1 212 773 2771
EYG no. CM3906