Global Tax Alert (News from Americas Tax Center) | 20 September 2013
Mexico's tax reform proposal affects financial institutions
Mexico's new tax reform package (the Proposed Reform)1 includes significant changes to the tax law that, if enacted, could have a significant effect on companies operating in the financial services industry.
The Proposed Reform includes changes that would eliminate certain taxes, while increasing others and expanding the tax base overall. Financial institutions should be aware of the proposed changes to deductions for losses. Some of the proposed changes that would affect companies operating in the financial services industry are summarized below.
This Proposed Reform must still be discussed and approved by the two houses of Congress before being enacted. This process should be completed by 31 October 2013, and the provisions of the law, if enacted, would go into effect on 1 January 2014.
Income tax law
Allowance for loan losses
The rules for banks to create and deduct the allowance for loan losses would be repealed. Commencing 1 January 2014, banks would only be allowed to deduct bad debts once they become legally uncollectable, as defined under the Income Tax Law and provided that such bad debts have not been deducted in prior years under the allowance for loan loss rules.
Under the Proposed Reform, the deductibility of specific bad debts for financial institutions is still only allowed if, there is a mandate or authorization from the National Banking and Securities Commission. There are various issues related to this requirement, which could make the ability to take a deduction difficult.
Furthermore, under the transitory rules of the Proposed Reform, when the accumulated balance of the allowance for loan losses (created under the current rules) as of 31 December of each year is lower than the accumulated balance as of 31 December of the prior year, the difference would be recognized as taxable income in the corresponding fiscal year. This taxable income could be reduced by the remaining balance (adjusted by inflation) of the allowance for loan losses that can be carried forward (provided that this has not been deducted under the provision currently in force).
Insurance companies and surety companies
The rules for insurance companies and surety companies to create and deduct their technical reserves (risk, actuarial, etc.) would also be repealed. Deductions would be allowed only for actual losses.
Under the transitory rules of the Proposed Reform, if at the end of a fiscal year the balance of the technical reserves (created and deducted under the current tax provisions) is reduced taking into account the previous year balance, the difference would be recognized as taxable income in the corresponding fiscal year.
Tax on dividend distributions
The Proposed Reform provides for an additional income tax of 10% to be paid on dividends distributed by Mexican companies to shareholders who are Mexican individuals or foreign residents. The taxpayer, for this purpose, is the distributing company; therefore, there is no treaty protection for a foreign shareholder.
Non-deductibility of payments to related parties
Payments to a related party, resident in Mexico or abroad, would be non-deductible, when the recipient is not subject to tax on the income or is subject to tax on the income at an effective rate of less than 75% of the Mexican income tax rate, calculated based on the Mexican tax rules. This is a very broad rule that would appear to require that the taxable base of a nonresident recipient of income from Mexico be calculated based on Mexican rules.
The exemption from withholding tax established in the 2013 Revenue Law, with respect to debt derivatives referenced, directly or indirectly through other assets to TIIE (Mexican interbank lending rate), has been incorporated into the Income Tax Law under the Proposed Reform.
Withholding tax on interest income for foreign banks
Under the Proposed Reform, the reduced 4.9% withholding tax rate on interest paid to foreign banks would also be moved from the Revenue Law to the Income Tax Law as a transitory provision. This rule allows the reduced 4.9% interest withholding tax provided that the foreign bank: (i) is registered as a foreign financial institution before the Mexican Tax Administration, (ii) is resident in a treaty country and (iii) is the beneficial owner of the interest income.
Withholding tax on interest income for Mexican individuals
The Proposed Reform provides that the withholding tax for interest income paid to Mexican individuals would remain at 0.60% on the invested capital. Therefore, there are no changes proposed to the current regime; however, the deferred regime of calculating this tax based on a complicated formula has been eliminated in the proposal.
Capital gains tax
The Proposed Reform would repeal 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. The tax on these gains would be 10%, which would be lower than the capital gains rate for non-publicly traded shares (25% of gross value or 32% of the gain).
This 10% rate would appear to apply on all sales of publicly traded shares through an exchange as there is no limitation based on ownership levels. The 10% rate would also apply to the transfer of shares through financial derivative transactions in which the value of the share is derived from the value of Mexican listed stock or stock indices that represent Mexican listed shares. The exemption in the current law is allowed to the extent that the shareholder or related group of shareholders does not hold and sell more than 10% of the capital.
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 income tax rate 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%. If a Mexican broker dealer does not participate in the transaction, the foreign resident would be required to directly file the corresponding tax return.
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.
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.
Under current tax legislation, the capital gains exemption is limited to planned transfers of publicly traded shares through an on-exchange transaction, which include registry transactions, protected cross orders or any other transaction that prevents the seller from accepting more competitive offers before and during a bid even if these transactions are considered as on-exchange transactions under the regulations of the Mexican Stock Exchange. These gains are subject to tax at 5% of gross value or 20% of the net gain.
Under the Proposed Reform, the 10% capital gains tax would also apply to planned transactions.
In addition, the Proposed Reform would add rules to determine the gain on the transfer of shares borrowed by a nonresident under a nonqualified securities lending transaction.
The current tax rules do not specifically address the tax treatment of each part of the transaction when the transaction is not a qualified securities lending transaction. In this regard, general rules above for transfers of shares by nonresidents must be followed in terms of classifying the transaction and each of the payments. Current tax legislation does not provide any rules as to what the basis should be for the borrower in case he decides to use the securities to cover short sales transactions or when the securities are returned to the lender.
The Proposed Reform would clarify that the tax basis for the borrower, when the securities are used to cover short sales transactions or when the securities are returned to the lender, would be the fair market value at the moment the stock is borrowed. The gain would be the difference between the fair market value at the moment the shares are sold or returned.
Value Added Tax law (VAT)
VAT credit ratio for Multiple Purpose Financial Companies (SOFOM)
SOFOMs would be subject to the same treatment for calculation of the VAT credit mechanisms as other financial institutions. In this regard, the SOFOMs were excluded from a provision that would have required that the determination of the creditable VAT take into consideration interest and other financial activities.
VAT exemption in interest payments
The VAT exemption for interest would be expanded to include additional financial institutions (sociedades cooperativas de ahorro, sociedades financieras populares, among others).
The Flat Tax Law and the Cash Deposits Law would be repealed. However, financial institutions would still be obligated to report on an annual basis the cash deposits received from taxpayers when these deposits (taking into account all bank accounts in the same financial institution) exceed MXN$15,000 per month (approximately USD$1,150).
The Proposed Reform includes a provision that would allow the tax authorities to asses a tax liability on taxpayers when such authorities identify “practices or transactions” that lack a business reason. There is a lack of business reason on “practices or transactions” when there is no profit or economic benefit that can be quantified for the taxpayers involved (other than a tax deferral, refunds of taxes or avoidance).
The obligation to file a tax audit report (dictamen fiscal) would be repealed.
For additional information with respect to this Alert, please contact the following:
Mancera, S.C., International Tax Services, Mexico City
- • Manuel Solano
+52 55 1101 6437
- • Koen van´t Hek
+52 55 1101 6439
- • Eduardo Michán
+52 55 5283 1308
Mancera, S.C., Latin American Business Center, Mexico City
- • Terri Grosselin
+52 55 1101 6469
Ernst & Young LLP, Latin American Business Center, New York
- • Alfredo Alvarez
+1 212 773 5936
- • Ricardo Vargas
+1 212 773 2771
EYG no. CM3816