The applicable deduction requirements must be complied with no later than the last day of the tax year to which the deduction applies, although the invoice supporting the expense may be provided up to the date on which the tax return for the period in question is filed (or comes due). An expense invoice must contain a date within the year for which the deduction is claimed.
Deductions for certain business expenses are limited (e.g. business meals, use of company-owned cars).
Depreciation and amortisation
Straight-line depreciation is permitted at the rates specified in the law (i.e. estimated lives for assets are 20 years for buildings, 3.3 years for computers, 4 years for cars [the deductibility threshold for cars has been raised from MXN 130,000 to MXN 175,000, for electric cars the limit is MXN 250,000 starting from 2017], 10 years for certain M&E, etc.), and the deduction may be increased by applying the percentage increases in the NCPI from the month in which the asset was originally acquired. When an asset is disposed of or becomes useless, the remaining undepreciated historical cost may also be deducted, after application of the appropriate inflation adjustment factor to the undepreciated historical cost.
Starting from 2016, companies, including those dedicated to transportation infrastructure and those that invest in hydrocarbon-related activities and the generation of electricity, who have obtained revenues in the prior tax year up to MXN 100 million, can apply an accelerated depreciation (i.e. lump-sum deduction) for investments in new fixed assets that were acquired in the last quarter of the 2015 tax year, or in 2016 or 2017. The accelerated depreciation rate varies from around 60% to 90% depending on the type of assets and the year of acquisition (i.e. 2016 or 2017).
Intangible assets for the exploitation of goods that are in the public domain, or for rendering public services under concession, are considered deferred assets (i.e. not deducted as incurred). Therefore, these assets are subject to amortisation for income tax purposes.
Specific annual depreciation rates are established for goods used in certain industries.
Goodwill is a non-deductible item for Mexican tax purposes, and the corresponding input VAT (if any) will not be creditable.
Start-up expenses incurred prior to the commencement of operations may be amortised at the rate of 10% per year, after applying the adjustment factors.
In general terms, interest expenses are deductible items if, among others, the principal is invested in the main activity of the Mexican taxpayer, withholding obligations are complied with, informative returns disclosing information related to the loan and transactions carried out with related parties are filed, thin capitalisation rules (3:1 debt-to-equity ratio) are satisfied, the transaction is at arm's length, and the interest does not fall into the deemed dividend criteria.
Furthermore, a new interest deductibility limitation was introduced along with the 2020 Tax Reform. In this regard, the new limitation would apply to net interest (taxable accrued interest less deductible interest) exceeding 30% of an adjusted taxable profit amount. Note that such limitation would only apply to those taxpayers having deductible accrued interests exceeding MXN $20 million (i.e., approximately USD $1M), allowance that should be accounted on a Mexican group basis or related party basis. For purposes of this limitation, the adjusted taxable profit (“ATI”) is defined as the amount resulting from adding the standard taxable profit with accrued interest, depreciation, amortization and pre-operative expenses.
Furthermore, this limitation would not be applicable to entities belonging to the Mexican Financial Sector. In addition, interests deriving from debts destined to finance public infrastructure, constructions (including the land acquisition where those constructions will be made) located in Mexico, the exploration, extraction, transport, distribution and storage of oil and hydrocarbons or other extractive industry, electric energy projects or water related projects would be excluded from the limitation. Note however that revenues deriving from such projects would be subtracted from the aforementioned ATI.
The Mexican Income Tax Law provides that this limitation would only apply when more burdensome than the existing thin capitalization limitation.
For purposes on the annual inflationary adjustment, the amended text of the Mexican Income Tax Law provides that debts deriving non-deducible interests in connection with this limitations should not be considered in the computation. However, they must be considered if at any point the interests become deductible because of the 10 year carryforward.
Note that this applies to the entirety of interest expenses made by a Mexican entity and will be applicable from 2020, notwithstanding the interests derive from debts engaged in previous years and must be reflected in the annual tax returns of the taxpayer.
Bad debts may be deducted on the earlier of the date on which the debt prescribes or the date on which the taxpayer substantiates the practical impossibility of collection, as defined by the law, among other detailed rules.
The maximum amount for deductible donations is limited to 7% of the taxable income of the previous year.
Fines and penalties
In general terms, fines and penalties are non-deductible items for income tax purposes, except interest for underpayment of taxes.
In general, all federal, state, and local taxes levied on a company (not including those required to be withheld from other parties) represent deductible expenses for CIT purposes, with the following exceptions:
- Federal VAT and excise tax when the company is entitled to credit the tax.
- Taxes on acquisitions of fixed assets and real estate, which must be capitalised and deducted as part of the total cost of such assets to be depreciated.
Payments derived from labour subcontracting will be deductible when, among other requirements, the contractor obtains from the subcontractor (i) copies of the tax receipts for salary payments made to the employees performing the outsourced services, (ii) a copy of the acknowledgement of receipt, (iii) a copy of the tax return showing that the income tax withholding and contributions to the Mexican Social Security Institute were paid;
As from FY 2020, from a VAT perspective, the contractor would have to withhold the 6% of the value of the consideration effectively paid.
Net operating losses
Subject to certain limitations, losses incurred in prior years by a business may be carried forward and deducted from income earned over a subsequent ten-year period. Net operating loss carrybacks are not allowed.
Losses carried forward may be increased by the percentage increase in the NCPI between the seventh and 12th months of the fiscal year in which they are incurred and thereafter up to the sixth month of the fiscal year in which they are applied.
In the case of entities engaged in activities related to the exploration and production of hydrocarbons in maritime waters at depths of 500 meters or more, net operating losses (following the same adjustment rules mentioned above) may be used to reduce their taxable income within the following 15 years.
Tax loss carryforwards are non-transferable, not even by virtue of a merger. However, the tax losses the surviving entity had prior to the merger may continue to be used to offset the income derived from the same business activities that originated them and, with certain restrictions, may also be used to offset income that derives from new business activities. In the case of a spin-off, tax loss carryforwards should be divided between the surviving entity and the spun-off entities in accordance with their main business activity, prior to the spin-off, as follows:
- Commercial main business activity: In proportion to inventory and accounts receivable.
- Other non-commercial entrepreneurial activities: In proportion to fixed assets.
Current tax legislation may limit the offsetting of tax loss carryforwards upon direct or indirect changes in ownership that imply a change in control of the Mexican entity in certain situations (i.e. whenever the revenue of the last three years is less than the tax loss carryforwards updated for inflation balance of the year prior to the change in control, among other situations). The limitation, if applicable, would limit the netting of tax loss carryforwards available prior to the change in control against the income derived from the same business activities that originated them.
Payments to foreign affiliates
Taxable income and authorised deductions must be determined on the basis of prices that would be agreed with independent parties in comparable transactions (arm’s-length values).
For this purpose, taxpayers must secure and maintain contemporaneous documentation supporting transactions with related parties residing abroad, supporting that income and deductions are based on fair market values in accordance with Mexican transfer pricing principles. The documentation must be prepared per type of transaction and must include all operations carried out with related parties.
Domestic transactions with affiliates must also be supported by the application of a recognised transfer pricing method selected in accordance with the Mexican tax legislation in connection with the particularities of the transactions.
The sale price of shares (other than publicly traded shares) sold to a related party must be set at market value in accordance with Mexican transfer pricing provisions, and the transaction must be supported by the corresponding contemporaneous transfer pricing documentation.Payments to non-residents of a prorated portion of expenses (i.e. allocations of expenses) are, in principle, not deductible for Mexican corporations. However, per current administrative tax rules, they may be deductible if a comprehensive set of requirements is complied with.
Payments made by Mexican residents to domestic or foreign related parties, which are in the hands of such related parties also deductible, are not deductible for the Mexican resident unless the corresponding income is included in the related party taxable income in the same or in a subsequent tax year.
Technical assistance, royalties, and interest payments
In order to be deductible, payments related to technical assistance, the transfer of technology, or royalties must be made directly to companies with the required technical capabilities to provide the corresponding service and should correspond to services actually received. In some situations, the payments may be made to a third party to the extent the relevant agreement expressly includes it. Note that per the 2020 tax reform, the royalty definition is broadened to included the temporary use of movable assets destined to commercial, scientific or industrial activities will be treated as royalties (instead being treated as a regular lease).
A deduction for technical assistance, interest, or royalty payments (including those treated as royalties related to industrial M&E leases) is disallowed when paid to a foreign related party entity that controls or is controlled by the Mexican taxpayer and at least one of the following scenarios is applicable:
- The recipient of the income item is a fiscally transparent entity in its residency jurisdiction, unless its shareholders or members are subject to tax for income received by such transparent entity and the payment made by the Mexican resident to the foreign entity is at arm’s length.
- The recipient entity considers the payment to be disregarded for tax purposes in its residency jurisdiction.
- The recipient does not include the payment as part of its taxable income in its residency jurisdiction.
Amendments were made to an existing rule limiting the deductibility of payments to related party residents whose income is subject to a preferential tax regime.
The fair market value exemption was eliminated and updates were included to cover those situations where the payment is directly or indirectly configured among related parties that lead ultimately to a PTR scenario and also situations that imply a structured agreement that in broad terms seeks to cover those situations where the payments are made to a third party not subject to a preferential tax regime when such third party in turns makes payments to related parties of the Mexican resident in function of the consideration received from Mexico.
Note that the aforementioned deductibility limitation application is general to all types of deductible payments (e.g., acquisition of goods, interest, royalties, services).
As defined earlier in the document, a foreign entity’s revenue is considered as subject to a PTR on the tax effectively paid on the income generated abroad. An investment is considered subject to a PTR if the revenue is not subject to tax or tax paid abroad is less than 75% of the income tax that would have been incurred and paid in Mexico if the income had been taxed under Mexican rules.
There are several exceptions to the aforementioned deductibility limitation, the main one being when the payment that is considered as revenue subject to a PTR, derives from the business activity of the recipient thereof, provided that it is demonstrated that it has the personnel and assets necessary for the realization of such activity. This paragraph will only be applicable when the recipient of the payment has its effective place of management and is incorporated in a country or jurisdiction with which Mexico has a comprehensive information exchange agreement.
The aforementioned exception would not be applicable in a scenario where the PTR is configured due to a hybrid mechanism (unless in some cases when it arises due to a shareholder – subsidiary relationship), a branch income exemption scheme or in cases of structured agreements.
From an international tax perspective, special focus and analysis on this new deductibility limitation rule potential application is recommended on a case by case basis, as there are particularly sensitive international structures exposed to it such as: shared services center structures, related party financing structures, captive insurance structures and intellectual property management structures, among others.