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New requirements for the application of income tax treaties
Historically, for the purposes of applying the benefits of an income tax treaty (ie reduced withholding rates), foreign investors have only been required to demonstrate that they are residents of a country that has concluded an income tax treaty with Mexico through a certificate of tax residence.
The Tax Bill for 2014, approved by the Mexican Congress and has been effective from 1 January 2014, contains additional requirements that must be fulfilled by foreign investors to apply the corresponding income tax treaty.
First, foreign investors are required to prepare and submit a disclosure return as established in the Federal Fiscal Code, or to file audited financial statements for tax purposes when they elect to do so.
Unfortunately, the wording of this provision implies that it is the foreign investor who will have to fulfill one of the aforementioned requirements, despite the fact that according to the Federal Fiscal Code only Mexican residents are obligated to do so. We expect additional guidance from the Mexican tax authorities on this measure considering that this would likely discourage foreign residents from investing in Mexico due to the additional administrative burden this creates.
Secondly, regarding transactions between related parties, the tax authorities will be entitled to request a statement from the foreign investor under oath executed by its legal representative, stating that there is juridical double taxation, and also that the income which will be subject to the benefits of the respective treaty will also be subject to taxation in the country of residence of the recipient.
This provision was included in domestic law to address some of the concerns included in the OECD‘s report on BEPS. However, we consider that this measure could affect the application of income tax treaties currently in force as a treaty override. According to legal precedents issued by the Supreme Court of Justice, international treaties rank above domestic federal laws.
It is unclear how the Mexican tax authorities will apply this provision in practice, but rather than sending someone to knock on the foreign investor’s door, we assume that they will rely on the exchange of information and assistance in the collection of taxes provisions included in the treaties.
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Foreign investors relying on income tax treaties concluded with Mexico for the decrease of their effective tax rate will have to fulfill additional requirements if they want to keep these benefits. Although it remains to be seen how the tax authorities will enforce these provisions, it is reasonable to assume that their application will not be straight-forward and will probably give rise to conflicts with the taxpayers.
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