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Title II of the ISR Law, which regulates how legal entities should calculate their taxes, is complex and in many cases there are specific rules for particular situations. Despite this, in this section we briefly describe the procedure. Income tax is calculated by fiscal years which, as a general rule, coincide with the calendar year. The income tax rate is 28 percent. There is also a requirement to make provisional monthly tax payments for the annual tax incurred during the fiscal year.
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The first step in determining the taxable base on which the income tax rate is to be calculated is calculating the taxable profit for the previous fiscal year, which is the result of subtracting the deductions authorized by the ISR Law of that period from the total income of that fiscal year. As a second step in calculating the taxable profit, the losses from previous fiscal years may be subtracted.
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Income Tax
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The income that legal entities must accrue is the income they receive from any part of the world of any type, which includes cash, credit, and services. There are general rules for determining the time of receipt of the income, which rules depend on whether they concern income from the alienation of goods, the provision of services, the granting of use or temporary enjoyment of goods, financial leases, or debts not paid by the taxpayer.
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The ISR Law specifies that the following are not considered income obtained by a legal entity: income that is the result of a capital increase; income from the payment of a loss by shareholders; income from stock premiums obtained through the listing of stock issued by the company, or income from using the participation method to appraise the value of its stock; and income obtained from the reappraisal of its assets and capital. In addition, this code establishes that income obtained from dividends or profits that are obtained from other legal entities residing in Mexico are not accruable.
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Deductions
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In contrast to the general way in which income is defined, deductions are defined specifically in the ISR Law, and include the following: (a) refunds, rebates, or discounts, (b) cost of sales, (c) investments, (d) uncollectible debts and losses resulting from an Act of God, force majeure, or in certain cases from the alienation of goods, and (e) interest accrued for the fiscal year, without any adjustments.
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In addition to the fact that deductions are defined specifically, the ISR Law establishes a series of requirements that must be complied with in order to take the deductions, such as: (a) those that are strictly necessary for the purposes of the taxpayer’s activity, unless they are authorized donations within the limits indicated by the ISR Law, (b) those covered by documentation meeting certain requirements, (c) those duly registered in the accounting records, (d) those complying with the obligations of withholding and payment of taxes owed by third parties, (e) those that have had the Value Added Tax transferred, (f) those having interest on capital loans, and for whom such loans have been invested in the business, (g) those for which the merchandise is legally imported into the country, (h) those relating to social welfare payments granted generally to all employees in addition to other requirements, (i) those for whom the payments made for technical assistance and royalties are services actually provided, and the payment is made to whoever directly provided said service, and (j) when the requirements for deductions are complied with before the end of the fiscal year, except with regard to evidentiary records, which can be obtained up until the annual tax return is submitted for the corresponding fiscal year. Furthermore, the Income Tax Law establishes certain items that are not deductible, which includes a limitation on the deductibility of interest for excess debts known as thin capital or undercapitalization.
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We consider it important to give special mention to deductions based on investments of the sale cost and to the limit on the deduction of interest for excess debt (thin capitalization).
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The deduction of investments in fixed assets, charges, and deferred expenses is carried out by depreciation, for which the ISR Law establishes the percentages that must be used for such deductions, depending on the good involved.
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With regard to the sale cost, raw materials and semifinished and finished products are deducted when they are alienated (transferred). In order to determine the amount of the corresponding deduction, it is necessary to use the absorbent cost system on a historical or predetermined basis or the system of direct cost, but only on a historical basis.
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Thin capitalization or undercapitalization was introduced in the ISR Law as of 2005 on the theory that companies must keep their debt below a reasonable level, which for purposes of the ISR Law is three times the capital of the company. In the event that debts surpass this amount, the company cannot deduct the payment of interest derived from the debts that exceed this amount and that arise from debts contracted with related parties residing abroad.
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Losses
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Tax loss is the difference between the income accrued in the fiscal year and the allowable deductions, when the amount of the latter is greater than income. The tax loss in a fiscal year can be subtracted from the tax profit of the following ten fiscal years until it is eliminated.
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Tax losses cannot be transferred, not even through a merger. Furthermore, when in a merger the surviving company (the purchaser) has losses, these can only be subtracted from future tax profit resulting from the exploitation of the same activities that produced the loss.
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In the case of a change of partners or shareholders that have control of a company, it may also be the case that the application of the tax loss of said company will be limited and that the mentioned loss can only be subtracted from future tax profit resulting from the exploitation of the same activities that produced the loss.
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Consolidation
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The ISR Law allows for the possibility of consolidating the losses and earnings of Mexican companies belonging to the same group. In order to consolidate it is necessary to comply with certain requisites established by the ISR Law, among which is the prior authorization of the tax authorities. The minimum consolidation period is five years and in the event that this option is chosen, all Mexican companies belonging to said group must be included.
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Dividends
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The aim of the ISR Law is for income tax to be paid only once, so if a dividend is distributed from the profits account of a company that has already paid tax thereon, no new tax need be paid, since the profit has already been taxed at the corporate level.
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On the other hand, when dividends are distributed from company profits on which tax has not been paid, the company distributing them must apply the general income tax rate on the amount of the pyramided dividend (by multiplying it by the factor of 1.3889).
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Market value
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The ISR Law establishes that in the event that transactions are carried out at less than market value, at cost or below cost, the tax authorities can change the tax profit or loss, estimating the price at which they believe the transaction should have been carried out.
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Transfer pricing
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Legal entities with a tax residence in Mexico and a permanent domicile in the country who carry out transactions with related parties who are nonresidents must determine their income by taking into account the consideration that would have been paid among independent parties (“arm’s length transactions”). Two or more parties are considered to be related when one of them participates directly or indirectly in the administration, control or capital of the other or when a person or a group of persons participates directly or indirectly in the administration, control, or capital of both companies.
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In order to determine if the price of the transaction used is that which would have been agreed between independent parties, any of the following methods may be used:
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(a) comparable price, (b) resale price, (c) added cost, (d) profit sharing, (e) surplus after profit sharing, and (f) transactional margins of operating profit.
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The Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, approved by the Regulation Board of the Organization for Cooperation and Economic Development (OECD) in 1995, or any substitute thereof, should be used for the interpretation of transfer pricing regulation, provided such guidelines are consistent with Mexican law.
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Preferential tax regimes
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The Mexican government has decided to ensure that the nature and content of investments made in Preferential Tax Regimes (also known as tax havens) are revealed, such that income coming from these regimes will be considered taxable from the moment it is generated, even if such income, dividends, and profits have not yet been distributed.
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Income falling under any of the three following categories is considered to be income coming from a Preferential Tax Regime: (a) income not taxed abroad, (b) income taxed abroad but at a tax rate less than 75 percent of what would have been paid in Mexico, and (c) income generated through transparent legal entities or figures. The tax authorities have the authority to determine the existence of simulation in legal acts exclusively for tax purposes in cases of (a) income related to a Preferential Tax Regime, (b) transfer pricing, and (c) income determined to have come from a source of wealth within the country.
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Information by Von Wobeser & Sierra, S.C. |
