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New Flat Rate Business Tax update

11 Mar 2010

The 17.5% single rate business tax (the so-called "IETU") was incorporated into the Mexican Tax System in 2008. The main intention of the IETU is that taxpayers will not be able to deduct 100% of their: (i) inventory and (ii) investments (fixed assets), and will not be able to amortise 100% of their net operating losses. Taxand Mexico provides an update on the new flat rate business tax and how this may impact US taxpayers looking to invest in Mexico.

Payment of interest and royalties paid to related parties are not deductible for IETU purposes. Payroll expenses are not directly deductible, but a credit against IETU is granted to taxpayers, however, such credit can be easily lost if the taxpayer is in an IETU or income tax loss position in a given year.

Mexican tax practitioners and taxpayers believe that such restrictions are clearly in breach of the constitutional rights of the Mexican taxpayers, and consequently, more than 34,000 taxpayers filed a constitutionality lawsuit against the IETU during 2008.

At that time, it was not possible to predict whether the lawsuit would be won by taxpayers, because, even though there were several aspects of the tax that affected constitutional rights, the Supreme Court recently solved tax cases giving priority to the collection of taxes by the Mexican government to sustain social programs over the protection of the rights of a specific economic groups.

However, just recently, the Mexican Supreme Court has solved the lawsuit claims against IETU by upholding the constitutionality of such tax, arguing that tax is different to a tax on "income" since it is a new tax on the value added to the price of goods and services. Therefore the law establishing it shall not grant IETU taxpayers the same deductions as established in the Mexican Income Tax Law,

Another important aspect was the IETU may generate a double taxation problem for non-Mexican residents subject to IETU in Mexico and for Mexican subsidiaries of non-Mexican investors who consolidate Mexican tax results in their countries. If such non-residents are not able to credit this tax against the income tax due in their country of residence, the related country may conclude that the IETU tax is not a tax on "income".

Therefore, the Mexican Government has negotiated with most countries that the IETU should be included in the taxes covered by Tax Treaties signed with them to avoid double taxation. So far 34 Countries have accepted IETU as a tax covered by Tax Treaties signed with Mexico.

The US and the Internal Revenue Service ("IRS") are analysing the nature and characteristics of the IETU. The Mexican tax authorities are also preparing a review which will be filed before the Mexican Chamber of Deputies no later than 30 June 2011. The IRS will not make future objections to crediting IETU in the US, as long as the IETU qualifies as a tax on income.

Taxand's Take

If the US does not accept that the IETU is a tax on "income", the US may deny its taxpayers from investing in Mexico and the IETU credit against US income tax. This therefore creates the potential for double taxation with one of the most important commercial partners of Mexico, and therefore, US investors will have to be aware and look for mechanisms to mitigate such a tax burden. We will give our Taxand's Take readers regular updates on this matter in order to evaluate alternatives thus minimising any adverse impact derived from this issue.

Your Taxand contact for further queries is:
Manuel Tamez Zendejas
T. +52 (55) 5201 7403

Taxand's Take Author