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US Tax Credit on Mexican IETU Available
42 of the 43 countries, with which Mexico has signed a treaty for the avoidance of double taxation (double tax treaty), have accepted that the Mexican flat rate business tax ("IETU" as per its initials in Spanish) is covered by the corresponding double tax treaties. The IETU is considered to be comparable to income tax. Taxand Mexico reviews the IETU and in particular discusses the impact this is having on US taxpayers investing in the country.
The only country that has not accepted or recognised the IETU as a tax covered by the double tax treaty, is the US. The Internal Revenue Service ("IRS") stated they would not allow US taxpayers to take a foreign tax credit on the IETU under the terms of Article 24 of the Mexico-US double tax treaty, until they have studied whether the IETU should be creditable as a type of income tax.
Over 30,000 Mexican taxpayers challenged the constitutionality of the IETU back in 2008. As a result, in September 2010, the Mexican Supreme Court upheld the constitutionality of the IETU, based, among other arguments, on the fact that the IETU was a tax different from a tax on income.
Furthermore, in July 2011, the Mexican Ministry of Finance laid a study before the Mexican Congress in which the relevance of the IETU was explained and a suggestion made to Congress that the IETU should continue to exist.
Considering the latest interpretations of the IETU, as well as recent news indicating that it will not be abolished, it will be interesting to analyse the position that the IRS will take with US taxpayers who credit the IETU as a foreign tax credit going forward and evaluate any potential impact on US taxpayers investing in Mexico.
If the IRS takes the position that IETU is not a tax that is creditable in the US as a tax comparable to income tax in Mexico, US investors with stakes in Mexican companies, and who apply pass-through treatment to the income obtained in Mexico, may end up having a higher tax burden in the US for having operations in Mexico. It's possible this could significantly affect operations in Mexico. Consequently, businesses could review alternative investment structures in Mexico to minimise the impact of the IETU in the US.
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