Mexican Taxes

Taxes in Mexico: What are you up Against?

I am always a little surprised at the number of people that we meet that believe Mexico is a bona fide tax haven. Mexico is a tax haven only to the extent that the country has not had the resources or will to enforce its own laws. In fact, the country has one of the lowest tax collections as a percentage of its GDP in Latin America and among the member nations of the Organization of Economic Co-operation and Development. The needs of the country and the demands of a new found sense of democracy are forcing the government to make its tax collections more efficient and fair, pursuant both to the existing tax laws and to the international tax treaties that Mexico has signed with several countries. The purpose of this article is to summarize the major taxes that the foreign community is exposed to in Mexico.

Tax Residence and Tax Treaties

Mexican tax residents are taxed differently than non-residents. As a general rule, non-residents are subject to higher taxes than residents.

The tax treaties Mexico has signed and local law establish who is a tax resident. Tax treaties also set forth the tax rates for different types of income. The main purposes of these treaties, however, are to provide the manner in which double taxation will be minimized, as well as to establish how countries will exchange information on their respective taxpayers. The Canadian and US tax treaties both establish that nationals of their country who are resident in Mexico may be subject to Mexican income taxes pursuant to local law.

As of 2004 the Mexican fiscal code has a new definition of "tax resident." Before 2004, a person needed to be in the country 183 days to be considered a tax resident. As of this year, tax residents are all those who have established an abode in Mexico irrespective of the time they have spent in the country. The law also provides that if they have one home in Mexico and another abroad, they are considered a tax resident in the place where they have their center of vital interests. Mexico will consider that that center of vital interests is in Mexico if over 50% of their income is derived from Mexican sources.

The main repercussion for the foreign residents is the effect it will have on their ability to obtain a homestead exemption on the sale of their principal residence in Mexico. If the homeowner has only one home, and that home is in Mexico, then they should be able to get a homestead exemption. However, if they have one home in Mexico and another in the US, it will be more difficult for the homeowner to get an exemption, especially if their income is not derived from Mexican sources.

In practice, it will be very difficult for the notario, the attorney required by law to draft the deed and withhold taxes, to know if the homeowner has another home outside the country. However, I can see that some notarios may request to see a Mexican tax return to prove that homeowner does in fact have his or her center of vital interest in the country.

The flip side is that those foreign residents that have a home in Mexico and abroad, and who derive most of their income from sources outside of Mexico, need not worry about reporting and paying Mexican income taxes. A clear example of these people are "snow birds" that spend six months in Mexico and six months abroad.

Income Taxes

Mexico taxes it residents on worldwide income pursuant to Article 1 of the income tax law. It is important to note that Mexico allows for a foreign tax credit for any taxes paid outside of Mexico. The US and Canada also allow for foreign tax credits. In effect, the taxpayer will pay taxes in both countries, but will also have offsetting tax credits. The net result is that the taxpayer usually pays an amount of taxes equivalent to the highest tax bracket among both countries.

As of last year, Mexican financial institutions have begun to request that US citizens provide a US social security number in order to open an account in Mexico. While I have not heard if the SAT (the Mexican equivalent to the IRS) is sharing any information with the US at this point, this is clearly the intent. Once the Mexican authorities have access to the taxpayer's social security number they can also receive tax information from the IRS on that particular individual. Eventually, the US and Mexico will regularly exchange information on their taxpayers, just as Canada and the US do now.

If you have a bank account in Mexico that pays interest, the financial institution will withhold a small percentage of your principal for income taxes. If you are not a resident, this is the most you will pay on this particular income and you will not need to file a Mexican tax return. If you are a resident, you can generally credit this amount on your annual Mexican tax return.

Mexico does not have the problem of double taxation of dividends that the US has. Dividends paid by Mexican corporations are usually paid after tax and are received by Mexican residents tax free. Non-residents will pay a tax in Mexico pursuant to treaty rates.

Rental income generated in Mexico is taxed at regular income tax rates, after deducting actual expenses or a blind deduction of 35%, whichever is greater. This provision applies to residents. Non-residents pay a flat 25% on the gross income. Both residents and non-residents may be required to charge valued added taxes and may also need to charge a 2% hotel tax, depending on the circumstances. While it has been relatively easy to avoid taxes on Mexican rental income, some jurisdictions, for example in San Miguel de Allende, are cracking down on those persons who are not paying income taxes on rental income.