Category: Tax

The Income Tax in Mexico: Study on the criteria of permanent establishment and source of wealth in Mexico

In a previous article (http://tmclegal.com/el-impuesto-sobre-la-renta-en-mexico-investigacion-sobre-el-criterio-de-la-residencia-fiscal/?lang=en ), the Income Tax in Mexico (Impuesto Sobre la Renta) (ISR) was presented through a study focus on the tax residency criterion.

As a reminder, the income tax is generally defined as a direct tax based on income, profits and capital gains. It is established on the alleged or real income of a natural or legal person.

The Income Tax in Mexico is regulated by the same law for both natural and legal persons, the Law on Income Tax in Mexico (Ley del Impuesto Sobre la Renta) (LISR)[1].

Article 1 of LISR sets forth the principle that natural or legal persons are obliged to pay IRS in Mexico when they are in one of the following situations:

  • They are considered as tax residents in Mexico,
  • They are not tax residents, but they have a permanent establishment in Mexico,
  • They are not tax residents and do not have a permanent establishment, but have incomes which sources of wealth are located in Mexico.

Tax residency on ISR  implies  that persons considered as tax residents an unlimited tax liability obligation. On the other hand, both permanent establishment and sources of wealth located in Mexico drive to a limited tax liability obligation, concerning just some incomes.

The purpose of this second article on ISR focuses on these two criteria of permanent establishment and the sources of wealth which are located in Mexico, by studying their definitions (I) and then, their tax effects on ISR (II).

I. Definition of the concepts of permanent establishment and sources of wealth which are located in Mexico

A) The permanent establishment

The definition of permanent establishment is established in Article 2 of the LISR:

” It Should be considered as permanent establishment to any place of business in which, partly or wholly, business activities or independent personal services are provided in an independent way

The same article states that it should be considered as a permanent establishment, among others the subsidiaries, agencies, offices, factories, workshops, installations, mines, quarries or any place of exploration, extraction or exploitation of natural resources.

On the other hand, Article 3 of the LISR states that should not be considered as permanent establishment some activities which are mainly auxiliary or preparatory such as storage or delivery of goods.

The philosophy of permanent establishment criterion is based upon the principle of the exercise, by a foreign resident, of an economic activity with some autonomy in Mexico. The definition of permanent establishment of the LISR expressively states the word independent.

Under both Articles 2 and 3 of the LISR, even the concept of permanent establishment is quite accurate, despite its accuracy, it is still a broad concept as for the distinction between the auxiliary or economically independent activities that can be difficult to qualify sometimes.

B) Incomes which sources of wealth are located in Mexico.

Unlike the permanent establishment, the LISR does not give any definition of the incomes which sources of wealth are located in Mexico. Incomes which sources of wealth are located in Mexico are only mentioned by Article 1 of the LISR as generating a tax liability without any details.

The Tax Administration Service of Mexico (Servicio de Administración Tributaria) states that “In simple terms, source of wealth refers to the place where the incomes  are originated or generated”[2].

In the light of this definition, it should be considered as incomes which sources of wealth are located in Mexico, real incomes from real state located in Mexico, incomes from Mexican securities and the incomes from the performance of services and sales of services in Mexico.

The determination of the tax liability of a foreign resident with incomes which sources of wealth are located in Mexico should be determined case by case by the study of each of its incomes which could potentially be considered as a source of wealth located in Mexico according to the Mexican tax legislation.

Therefore, both concepts of incomes which sources of wealth are located in Mexico and permanent establishment are not defined as precise as the notion of tax residence in Mexico is,  established in  Article 9 of the Tax Code of the Federation (Código Fiscal de la Federación[3]). For the foregoing, it is necessary to study each individual situation in order to determine in advance its tax liability related to the payment or ISR in Mexico.

II. Tax consequences of the permanent establishment and income source of wealth in Mexico

 A) Impact of the national legislation

Article 1 of the LISR sets the principle that foreign residents with permanent establishment in Mexico are subject to the payment of ISR on the income attributable to that establishment.

The same article establishes that foreign residents who do not have a permanent establishment in Mexico but who perceive incomes which sources of wealth are located in Mexico are subject to the payment of  ISR on these incomes.

Therefore, the permanent establishment leads to a limited but generally determined tax liability by assessing all incomes of the permanent establishment and, on the other hand, foreign residents with incomes which sources of wealth are located in Mexico, also have a limited tax liability, cause they have a fiscal obligation which should be determined case by case.

In both situations, these dispositions concern the tax liability of a foreign resident and it is necessary to study the provisions of international tax treaties concluded between Mexico and the country of residence of the foreign resident.

B) The impact of international tax treaties on the permanent establishment and incomes which sources of wealth are located in Mexico

The purpose of international tax treaties was presented in the previous article about tax residence in Mexico (http://tmclegal.com/el-impuesto-sobre-la-renta-en-mexico-investigacion-sobre-el-criterio-de-la-residencia-fiscal/?lang=en ).

As a reminder, the scope of these treaties for both residents in Mexico and foreign residents with a permanent establishment or a source of wealth located in Mexico is the same: avoiding double taxation on the same income.[4]

For example, through an international tax treaty, the foreign resident who has a permanent establishment in Mexico will not pay income taxes on the permanent establishment’s income in Mexico and in its residence country. The tax treaty will spread the tax liability between the two signatory countries. The logic is the same for the incomes which source of wealth is located in Mexico.

For these purposes, tax treaties generally provides a definition of the permanent establishment and of source of national wealth in order to spread the tax liability on a common definition for each country. This definition given by international tax treaties is applicable to the determination of the tax liability of the person conducting economic activities in the countries which signed a tax treaty in order to avoid double taxation. The definitions provided under national law will be subsidiaries.

In fact, the definition of these concepts by the LISR is close to the definition given by most of the international tax treaties which are all mostly based on the same model. However, the definitions established by the international tax treaties should be studied carefully in order to recognize the  tax situation in the case that  an economic activity is conducted in Mexico.

 

TMC legal has supported for more than 15 years entrepreneurs, investors and individuals who wish to settle in Mexico in order to advise them on legal and strategic planning.

 

[1] Law on Income Tax in Mexico: http://www.diputados.gob.mx/LeyesBiblio/ref/lisr.htm (spa).

[2] http://www.sat.gob.mx/english/Paginas/fuente_de_riqueza.aspx (spa)

[3] Tax Code of the Federation of Mexico: http://www.diputados.gob.mx/LeyesBiblio/ref/cff.htm (spa).

[4] The list of international tax treaties ratified by Mexico on: http://www.sat.gob.mx/informacion_fiscal/normatividad/Paginas/tratados_fiscales.aspx (spa).

The Income Tax in Mexico: Study on tax residency criterion

Attribute of real power of the state, the tax is a fundamental source of income for exchequers.

Nowadays, very few countries are the that do not contemplate the income tax in their regulations. The income tax is generally defined as a direct tax based on income, profits and capital gains. It is established on the alleged or real income of natural or legal person.

The Income Tax in Mexico (Impuesto sobre la Renta) (ISR) is regulated by the same law for both natural and legal persons, the Law on Income Tax in Mexico (Ley del Impuesto Sobre la Renta) (LISR)[1].

Article 1 of LISR sets forth the principle that natural or legal persons are obliged to pay IRS in Mexico when they are in one of the following situations:

  • They are considered as tax residents in Mexico,
  • They are not tax residents, but they have a permanent establishment in Mexico,
  • They are not tax residents and do not have a permanent establishment, but have incomes whose sources of wealth are located in Mexico.

The purpose of this paper is to study the first paragraph of article 1 of the LISR: the criterion of tax residence in Mexico and its tax consequences on ISR.

The two other situations mentioned will be discussed on a later article (http://tmclegal.com/el-impuesto-sobre-la-renta-en-mexico-investigacion-sobre-el-criterio-de-la-residencia-fiscal/?lang=en).

After studying the criteria for determining tax residence in Mexico (I) its tax effects on the ISR will be studied (II).

 

I. The criterion of tax residence in Mexico

The definition of tax residence is established in Article 9 of the Tax Code of the Federation of Mexico (Código Fiscal de la Federación) (CFF)[2]  which establishes the different criteria for natural (A) and legal persons (B).

A) Natural person

In accordance with Article 9 of the CFF, natural persons are considered as tax residents in Mexico when they meet one of the following assumptions:

  • More than 50% of their annual incomes have their source of wealth in Mexico,

The law does not give definition of “source of wealth in Mexico”[3], therefore it is understood as the income originated or generated in Mexico.

  • They have the center of their professional activities in Mexico,

This general approach will be determined by several factors such as the investment destination of the person, the headquarters of the companies that own the place in which its economic activities are developed.

  • They have Mexican nationality and they are functionaries or workers of the government and they have the center of their vital interests in Mexico.

This criteria is economic and social, and is characterized to be defined by  an objective criteria in order to determine whether the individual is stronger in Mexico than in other countries about its professional and personal relationships.

B) Legal persons

The CFF states that legal persons are considered as tax resident in Mexico when they meet one of the following assumptions:

  • They have their principal business management in Mexico,

This criterion refers to the registered office of the company. A company with establishments in different countries, but whose holding is located in Mexico, will be considered tax resident in Mexico.

  • They have their effective management in Mexico.

Effective management is a criterion used by tax authorities once the location of the administrative headquarters (registered office) is different from the place of effective management of the company.

Article 9 of the CFF establishes a presumption of tax residence for any person with Mexican nationality.

 

II. Effects of having tax residence in Mexico

Tax residents in Mexico will be subject to ISR about all their incomes (A) which can arise to double taxation (B).

A) The principle of unlimited liability of the ISR

Article 1 of LSR requires that persons considered as tax residents an unlimited tax liability obligation. Such persons are subject to the IR on “all income, regardless of the location and the source of wealth in which they arise”.

As  tax residency requirements, the LISR distinguishes between the taxation of natural persons (which will be the subject of ISR calculated on a progressive rate based on income)[4] or legal persons (who will charge a fixed rate of 30% on all income above 1 million pesos)[5].

Therefore, a French national regarded as tax resident in Mexico will be subject to pay ISR despite its income in Mexico but also in France under the provisions of international tax treaties.

B) The challenge of international tax treaties

It follows the general obligation of the payment of ISR under an unlimited tax liability of tax residents in Mexico which represents a controversy as residents have economic interests in other countries.

In fact, incomes earned abroad may also be taxed abroad, the principle of unlimited tax liability provided by LISR does not generate an obligation to forgo tax revenue for the others countries.

For example, a French national which is a tax resident in Mexico, who rents real estate in France will be taxed in France about its income of rented property (French tax law imposes the land income of properties located in France) and also in Mexico for the ISR due to the unlimited tax liability principle.

The person would be taxed in both France and Mexico on its land income, it is called double taxation.

To promote foreign investment, Mexico has ratified many international tax treaties with several countries in order to avoid double taxation.

These international treaties allow to pay a single tax for the same income that could potentially be taxed in both countries.

Although most tax treaties are based on the same model, they all have differences and one must be careful for their terms in order to anticipate imposing the model which result more convenient.

In the previous example, the French national tax resident with land incomes in France, will, through the international tax treaty between Mexico and France, be exempt from the tax burden on land income in Mexico and pay these taxes in France.[6]

The list of international tax treaties ratified by Mexico on: http://www.sat.gob.mx/informacion_fiscal/normatividad/Paginas/tratados_fiscales.aspx (spa).

International tax treaties generally define the criteria of tax residence and their provisions compliment the national tax laws of each country.

 

Therefore, tax residence in Mexico leads to significant tax liability on ISR and it is convenient to study this situation before installing in Mexico in order to comply with the tax obligations.

As mentioned in the previous paragraph, it is also necessary to study the international tax treaties provisions of the countries in which economic interest may be set forth, since those provisions will apply instead of the national tax law.

TMC legal has supported for more than 15 years entrepreneurs, investors and individuals who wish to settle in Mexico in order to advise them on legal and strategic planning.

[1] Ley del Impuesto sobre la Renta http://www.diputados.gob.mx/LeyesBiblio/ref/lisr.htm (spa).

[2] Código Fiscal de la Federación http://www.diputados.gob.mx/LeyesBiblio/ref/cff.htm (spa).

[3] http://www.sat.gob.mx/english/Paginas/fuente_de_riqueza.aspx (spa)­­.

[4] http://www.sat.gob.mx/informacion_fiscal/tablas_indicadores/Paginas/tarifa_anual.aspx (spa).

[5] Article 154 of the Ley Sobre la Renta of Mexico.

[6] Artículo 6 del Convenio Fiscal entre México y Francia (spa).