RESIDENCE FOR MEXICAN TAX PURPOSES – RESIDENCE FOR MEXICAN TAX PURPOSES
RESIDENCE FOR MEXICAN TAX PURPOSES
Mexico offers various investment and business opportunities for U.S. entrepreneurs. In order to take advantage of these opportunities it may be necessary for U.S. nationals to stay in Mexico, and thus it is important to know what tax consequences can arise. We have prepared this material in order to explain the residency rules for U.S. individuals and companies that are present in Mexico.
FOREIGN INDIVUALS SUBJECT TO MEXICAN TAXATION
Under Article 1 of the LISR, individuals that are residents of Mexico are subject to Mexican income tax on their worldwide income. Non-resident individuals, on the other hand, are subject to Mexican income tax only on income derived from Mexican sources.
Mexican tax law under Article 9 of the CFF states that individuals who have established an abode in Mexico are considered residents of Mexico, regardless of the time spent in Mexico. However, if the individual also maintains an abode in another country, the individual’s “center of vital interest” will be used as the criteria for determining residence for tax purposes.
Center of vital interest is deemed to be situated in Mexico when more than 50% of the total income earned by the individual is Mexican source income or when the individual’s professional activities are centered in Mexico.
US-MEXICO INCOME TAX TREATY
In the case that an individual is considered to be a resident for tax purposes of both the U.S. and Mexico, special tie-breaker rules from the Income Tax Treaty apply. However, it should be mentioned that unlike Mexico, the U.S. does not treat the Treaty as a primary source of tax law. Article 4 of the treaty states that where an individual is a resident of both contracting States, then his residence shall be determined as follows:
The individual shall be deemed to be a resident of the State in which that person has a permanent home available; if a permanent home is available in both contracting States, then the individual shall be deemed to be a resident of the State with which the person’s personal and economic relations are closer (center of vital interests);
If the State in which the center of vital interests cannot be determined, or if the person does not have a permanent home available in either State, then the deemed residence will be in the State in which the person has a habitual abode;
If a habitual abode exists in both States or in neither of them, then the deemed residence will be in the State of which the individual is a national;
In any other case, the competent authorities of the contracting States shall settle the question by mutual agreement.
These tie-breaker rules only apply to individuals, not to companies; if a company holds residence in both countries than it is deemed to not be a resident of either and therefore it cannot avail itself of the benefits of the tax treaty.
FOREIGN COMPANIES SUBJECT TO MEXICAN TAXATION
A company that is organized under the laws of a foreign country is presumed to be a nonresident for Mexican tax purposes and not subject to Mexican tax unless it establishes a nexus with Mexico that causes it to be subject to Mexican taxation.
Article 9 of the CFF states that a foreign company will be deemed to be a resident if it establishes its administration or place of management in Mexico, such as in the following circumstances:
1. If the shareholders’ or board meetings are held in Mexico;
2. If the individuals that make day-to-day management, control or administrative decisions for the legal entity are tax resident in Mexico or have their offices in Mexico;
3. If the entity has an office in Mexico at which the administration or control of the entity is carried out; or
4. If the accounting records are maintained in Mexico.
A company will cease to be a resident of Mexico for tax purposes when it establishes its administration or place of management in another country, giving rise to the following consequences:
In accordance with Article 12 of the LISR, the company will be deemed to have been liquidated, and must include in its tax base the assets of the establishment located in the foreign country, such assets will be valued at their fair market value on the date in which the residency was changed or the appraised value if the fair market value cannot be determined. This is to avoid the transfer of income to foreign countries which where generated in Mexico and are legally obligated to Mexican tax.
A foreign company or individual will be subject to Mexican tax if it is considered to be operating in Mexico through a “permanent establishment.” The permanent establishment concept enables Mexico to tax income earned by foreigners that is attributable to a permanent establishment as if the foreign company or individual were a Mexican resident.
Article 2 of the LISR provides that a nonresident company will be treated as having a permanent establishment if it maintains a fixed place of business in Mexico through which it conducts business operations. A fixed place of business is defined as a branch, an agency, an office, a factory, a workshop, an installation, a mine, a quarry, or any other place of exploration or extraction of natural resources. The determination of whether a permanent establishment exists is based on the overall facts and circumstances.
Additionally the LISR under Article 2 provides that a nonresident company may be deemed to have a permanent establishment if it operates in Mexico through a dependant agent. A dependant agent is deemed to create a permanent establishment if the agent has the power to enter into contracts, in the name or on behalf of the nonresident company, with respect to business activities that are not preliminary or auxiliary to the nonresident company’s business activities. Further, an independent agent will create a permanent establishment if it is not acting in its ordinary course of business.
A fixed base of business is treated as a permanent establishment and is taxed in the same manner. A fixed base is any place where independent personal services of a scientific, literary, artistic, educational or pedagogical nature are rendered. A fixed place of business also includes any place where independent professional services are rendered.
A foreign corporation engaged in a construction, supervision or inspection project is considered to have a permanent establishment in Mexico if the project lasts for more than 183 days during a consecutive 12-month period. When a foreign resident performs construction related services in Mexico and a portion of these services are subcontracted, the time spent by subcontractors must be included in the calculation of the 183 days for purposes of determining whether a permanent establishment exists.
The determination of whether a U.S. national is subject to Mexican taxation on his or her worldwide income is based on whether “residency” exists. The determination of “residency” differs for individuals and companies. An individual must make a careful determination as to whether they have established an abode in Mexico and whether their center of vital interests lies in Mexico. A company’s residency is determined by the location of its administration or place of management. However, a non-resident individual or company may still be subject to Mexican income tax if it establishes a permanent establishment in Mexico as to its sources of income derived from the permanent establishment.