Mexico Tax Reforms for 2005

Tax system reform in Mexico is an ongoing process. Changes to tax regulations are often motivated more by a need to increase income rather than by a strategic decision to improve the nation’s tax system. President Fox’s administration has attempted to make tax collection more efficient, transparent and progressive. However, in some instances failure to comply with existing treaties or to reach a positive result through reforms has occurred. The tax reforms approved by Congress, which became effective January 1, 2005, will affect international corporations doing business in Mexico. The following are some important reforms for this year:

I. Income Tax

a) Tax Rate
This tax reform institutes a gradual reduction of corporate tax from 33%, the corporate tax rate for 2004, to 30% for 2005, 29% for 2006, and 28% thereafter.

The maximum individual tax has also been reduced. However, Mexico City (Federal District), and State Governments are explicitly authorized to assess taxes of up to 5% at the local level. Any state or municipal tax would be deductible for federal tax purposes.

b) Profit Sharing
As established by the Mexican Constitution, employers are required to share 10% of their taxable profits with their employees. The tax reform allows the employee profit sharing amount to be deducted from the corporation’s taxable income.

c) Consolidated Tax Return
As part of this tax reform, Mexican parent companies may consolidate 100% of their subsidiaries’ profits and losses rather than 60% as established by the Income Tax Law in 2004.

d) Nonresidents with Mexican-Source Income
An important modification was made to the definition of “business income.” According to article 7 of the US-Mexico Convention for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income (“Treaty”), the definition of business income includes activities such as technical assistance payments, construction services, management fees and so forth. These activities have been subject to tax under the Treaty only if the nonresident has a permanent establishment in Mexico. Under this reform such activities will be excluded from the definition of business income in the Treaty, thus being subject to withholding taxes at the ordinary tax rates.

II. Asset Tax

Debt Owed to Nonresident Companies and Financial Institutions
As a result of a Supreme Court decision, article 5 of the Asset Tax Law has been amended allowing the deduction of debt contracted with nonresident companies or financial institutions when determining the asset tax base.

For more information on Mexican tax issues, please contact Gabriel Sanchez at csanchez@kmclaw.com.