Mexican Tax Law: Third Party Taxes, Part III

Withholding Third Party Taxes

In accordance with the provisions of the US-Mexico Tax Treaty, the following applies (although in this case the ITL provides better benefits):

1. By general rule, the tax on interests is allowed in the state from which they originate;
2. It is important to consider the debtor’s residence status;
3. If the effective beneficiary of the interest payments resides in the U.S. or in Canada, the withholding rate that shall prevail is: (a) 4.9% on gross interests derived from loans granted by banks, insurance companies, negotiable securities in a well known stock market. (b) 10% on gross interests derived from loans different from those mentioned in sub-section (a) above, or when the debtor is a bank or the buyer of machinery and/or equipment.
   (c) 15% on gross in all other cases.
4. iv. Of the effective beneficiary of the interest payments performs or has performed entrepreneurial or professional activities by means of a permanent establishment in Mexico from which such interest payments derive, the interest payments mentioned in sub-section (a) and (b) will not apply.

Dividends

Dividends are subject to a special tax treatment. The main objective of the ITL regarding this matter is to avoid tax burdens on dividends that have already been levied with income tax. For this purpose, a "net profit account" has to be determined every time a company pays dividends or when the year's fiscal profits have been determined. In general terms, profits net from income tax, profit sharing and non-deductible expenses, increase the "net profit account," and the payment of dividends reduces the account.

If the amounts of dividends to be paid exceed the "net profits account," the excess is levied up to 35% rate, dividends paid which do not exceed the "net profits account" are levied at 0%. However, due to a gross up of the income tax in the operation, the beneficiary receives the total amount of dividends and the company absorbs the tax burden.

However, under the US-Mexico Tax Treaty, this rate is 10%. Even though this is arguable, the Ministry of Finance applies the treaty rate. For profits or money remittances to the parent company abroad, as subject up to 35% rate provided that such profits or remittances do not come from the "net profit account," "reinvested net profit account" or "capital remittances account."

If the foreign individual or entity receiving dividends is a resident in a low-tax jurisdiction (tax havens) the withholding rate will be 40%.

The definition of dividends into the ITL also comprises any amount received from the partners of an "Association in Participation" from the managing partner thereof.

In general terms, according to the US-Mexico Tax Treaty, if the effective beneficiary of the dividends is a resident in the US, the withholding tax rate shall not exceed the following:

(a) 5% levied on the gross amount of dividends if the effective beneficiary owns at least 10% of the shares of the capital stock with voting rights.

(b) 10% levied on the gross amount of dividends in all other cases.

The above mentioned will not apply if the beneficiary of the dividends performs or has performed entrepreneurial activities by means of a permanent establishment in Mexico and such dividends derive from the permanent. If this is the case, the tax treatment that would prevail would be based on the company’s profits from such permanent establishment.

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