Recognition of income
Income is generally recognised on an accrual basis. However, the service revenues of civil entities that render professional services (e.g. law and accounting firms) and low-income entities (as defined in the Mexican Income Tax Law) are reported on a cash basis.
The costing system to be used will be the incurred cost system, based on historic costs or pre-determined costs. If the requirements provided in the regulations of the Mexican Income Tax Law are met, the direct cost system (based on historical costs) may be used.
Inventory may be determined by any of the following methods:
- First in first out (FIFO).
- Identifiable costs.
- Average cost.
The FIFO method must be applied to each type of merchandise and each movement. The monetary FIFO method may not be used. Taxpayers selling goods that are identifiable by serial numbers, at a cost exceeding MXN 50,000, must determine their inventory by the identifiable cost method.
Once elected, a method is compulsory for five years and can be changed only if the requirements established in the regulations of the Mexican Income Tax Law are fulfilled. The monetary results of the change in method are amortised over the following five years.
For accounting purposes, different methods and certain variations can be adopted. However, a record of the differences must be maintained, and such difference will not be taxable or deductible.
The cost of imported goods may be deducted (and included in the cost of goods sold) only if it can be supported that the goods were legally imported into the country.
Capital gains are taxed as follows.
Gains on securities are included in regular taxable income.
The tax basis of shares of Mexican corporations sold may be increased by the inflation adjustment applicable for the holding period.
When computing the tax basis of the shares, there are certain items to be considered, such as: (i) the movement in the after-tax earnings account (CUFIN) of the issuing company (including the possible negative CUFIN effects), as adjusted for inflation, (ii) the unamortised prior years' tax losses at the date of the sale, (iii) tax losses arising prior to the date on which the shares were acquired and amortised during the holding period, and (iv) any capital reductions of the issuing company.
When the sum of: (i) the CUFIN balance at the date of acquisition of the shares, (ii) the capital reductions paid, (iii) the unamortised prior years’ tax losses at the date of the sale, and (iv) the negative CUFIN balance of the issuing corporation is higher than the sum of: (i) the CUFIN balance at the date of the sale and (ii) the tax losses arising prior to the date on which the shares were acquired, and amortised during the shares’ holding period, the difference must be subtracted from the tax basis of the shares to be disposed of (potentially resulting in the shares’ tax basis being equal to zero).
When the aforementioned difference exceeds the tax basis of the shares disposed of, this excess (restated by inflation) must be subtracted from the tax basis of the shares in any subsequent share sale by the same taxpayer, even if the shares are issued by a different company.
The aforementioned procedure allows the average cost (tax basis) of the shares to be determined, which is then updated and considered as the acquisition cost for future sales.
A different but simpler procedure is available (optionally) for computing the tax basis of shares held during a period of 12 months or less.
Deduction of losses arising from the sale of shares is limited to the value of gains from similar transactions in the same or the following ten fiscal years. Losses may not be deducted by non-residents selling shares.
A gain from the sale of shares is considered Mexican-source income when the transferred shares are issued by a Mexican resident or when more than 50% of their book value arises directly or indirectly from immovable property located in Mexico, including cases where the shareholding is structured in different levels.
In general terms, the sale by non-residents of shares issued by a Mexican company is subject to a 25% WHT applicable to the gross amount of the transaction (i.e. without deductions). However, there may be the option for gains realised by non-residents on the sale of shares issued by a Mexican company to be taxed by applying the 35% rate to the net gain. The tax rate for these purposes is generally the same as the top bracket rate for individuals (currently 35%), unless a lower tax treaty rate is applicable.
This net income election is available only if the foreign shareholder income is not deemed to be subject to a regime considered as a ‘preferred tax regime jurisdiction’ (i.e. tax haven, which is deemed to exist when the non-Mexican resident income is not subject to taxation or taxed at a rate lower than 75% of the tax that would be paid in Mexico) or resides in a country with a territorial tax system. The non-resident seller must have previously appointed a representative in Mexico and have a public accountant assigned to issue a statutory tax audit report on the transfer of shares. The public accountant issuing the respective report must specify the accounting value of the shares sold and explain the factors used in determining the sales price and the market value of the shares if shares are sold between related parties.
The representative is jointly liable for the tax on the sale of shares, even when the statutory report is issued by a public accountant.
The tax authorities may authorise the deferral of taxes that would otherwise be triggered by the transfer of shares in a group reorganisation to the extent it is a share-for-share type of deal (the authorisation must be obtained prior to the share transfer). The price used on the transaction must be at arm’s length. The tax deferred, adjusted for inflation, is due upon the sale of the originally transferred shares outside the same interest group. An interest group consists of shareholders that have over 50% common voting stock of the companies.
In principle, authorisations for tax deferral are not granted if the party acquiring or selling the shares is resident in a tax haven or is a resident of a country that has not signed a comprehensive exchange of information agreement with Mexico. However, in the latter case, an authorisation may still be granted if the taxpayer provides documentation to the Mexican tax authorities stating that the taxpayer has authorised the foreign tax authorities to provide information to the Mexican authorities regarding the operation in question.
If the share sale qualifies as an exempt reorganisation under tax treaty rules, the non-resident must appoint a legal representative in Mexico prior to the sale and file a notice with the Mexican Tax Administration informing them of such appointment and the details of the reorganisation process intended to be carried out. Additionally, certain formal requirements are established in the regulations of the Mexican Income Tax Law that must be satisfied when carrying out this type of transaction.
Tax treaty rules (optionally) override domestic law rules when the seller resides in a tax treaty country.
Shares sold through the stock market
Capital gains realised on (i) the sale of shares issued by Mexican companies, (ii) securities exclusively representing such shares, (iii) shares issued by foreign companies quoted in the Mexican stock market, and (iv) derivative financial operations referenced to stock indexes and/or to the aforementioned shares, when the sale is conducted in stock markets or in derivative markets recognised under the Securities Market Law, are subject to a 10% income tax rate.
The applicable income tax on the gain obtained must be withheld by the broker/intermediary; however, there is no obligation to make this withholding if the investor is a resident in a country with which Mexico has signed a tax treaty to avoid double taxation and provides the broker with a sworn statement explaining said situation and providing their registration number or tax ID issued by the proper authorities in their country. If this is not provided, the income tax must be withheld.
When a non-Mexican resident sells shares that do not satisfy the above requirements to be taxed at a 10% income tax rate, they must pay their tax by applying either 25% of the sale price or 35% of the net gain, complying with the requirements established for these purposes in the domestic law.
In determining the taxable gain of real estate, the cost basis of land and buildings may be adjusted (i.e. increased) for tax purposes on the basis of the period of time for which the assets have been held. This adjustment is performed by applying inflation adjustment factors to the net undepreciated balance. Similar rules apply to non-residents electing to pay tax on net income by appointing a legal representative in Mexico. The rate of tax on the net gain is 35% (or lower treaty rate). Otherwise, the 25% final WHT on gross income applies to non-residents.
Machinery and equipment (M&E)
Gains or losses from the disposal of machinery, equipment, and other fixed assets are also calculated after adjusting the basis in these assets, by applying inflation factors to the net undepreciated balance.
Inflationary gain or loss
Taxpayers are required to calculate an adjustment for inflation (resulting in additional taxable income or deductible expense) on an annual basis by applying the percentage increases in the National Consumer Price Index (NCPI) to the value of essentially all liabilities, reduced by monetary assets, including bank balances, investments (except in shares), and some debt and receivables.
For purposes of the inflationary adjustment, the amount of non-deductible interests derived from the new interest deductibility limitations are excluded from the determination of the annual average of debts. However, if the amount of non-deductible interest is deducted in a subsequent period (up to 10 years), the corresponding debts must be considered in the determination of the annual average.
Dividends received by Mexican corporations from other Mexican corporations need not be included in gross income. Dividend income must be included within the recipient corporation’s CUFIN.
No further corporate-level taxes apply on dividends distributed out of the CUFIN. However, non-CUFIN distributions (i.e. distributions that for any reason have not been subject to CIT) are subject to tax at the level of the distributing company at the general income tax rate on the grossed-up distribution at the effective rate of 42.86%. This tax is creditable in the year of payment or two subsequent years.
Interest received by Mexican corporations is generally subject to tax on an accrual basis and included in gross income (see also Inflationary gain or loss above).
Royalties received by Mexican taxpayers are taxable income at the general corporate rate (i.e. 30%). Such revenue shall be accrued for tax purposes at the earliest of the due date for the royalty payment collection or the issuance of the corresponding invoice.
When the government grants economic or financial assistance to taxpayers through governmental budgetary programs, the cash received will not be treated as taxable revenue to the extent that (i) there is a public list of beneficiaries, (ii) the funds are wire-transferred to the beneficiaries’ accounts, (iii) if applicable, the tax authorities issue a certificate of good tax standing to the beneficiary, and (iv) the assets or services the taxpayer acquires with the grant are not deducted.
A Mexican corporation is taxed on foreign-source income when earned. Double taxation is reduced, or possibly eliminated, by means of foreign tax credits. However, the undistributed profits of a foreign subsidiary are not subject to Mexican tax until dividends are paid, with the exception of companies with investments in entities with revenue subject to a preferred tax regime (tax haven or PTR) (discussed below), in which case income is generally taxable even if no distributions are received from those entities.
In addition, note that per the 2020 Tax Reform, foreign sourced revenue generated by Mexican residents and PEs through transparent legal entities or juridical figures will be taxable in Mexico as part part of the regime that is in line with the treatment of the individual or entity generating the foreign sourced revenue and not separately as it was previously taxed under the PTR rules. Note that this is relevant as differently from the PTR regime, no exceptions on revenue anticipation that may be applicable to the PTR regime would be available in such cases.
Investments in tax havens (income subject to PTRs)
Investments in tax havens include those made directly or indirectly in entities, branches, real property, shares, bank accounts, or investment accounts, and any kind of participation in entities, trusts, joint ventures, or investment funds, as well as in any other similar legal entities created or incorporated in accordance with foreign law and located in a tax haven, and including those that are carried out through an intermediary.
A business, entity, trust, or joint venture is considered to be located in a tax haven when it has a physical presence, an address, a post office box, or effective management in a tax haven, or when its bank account is held in or through financing entities located in a tax haven.
Unless it can be demonstrated that the taxpayer does not have management control of the foreign investments, the taxpayer must include the income generated through such entities or foreign vehicles in the proportion that corresponds to their direct or indirect participation in the capital of the entity or vehicle.
Revenue and profits subject to PTRs are taxed separately. This revenue cannot be combined with other taxable income or losses and it is not considered for purposes of making advance income tax payments. Tax applicable to this type of income is payable together with the annual CIT return. In addition, the 2020 tax reform establishes additional provisions in order to determine if the profits obtained by the taxpayers are subject to a PTR, including the following:
- The profit or loss generated by all the transactions carried out in the calendar year by each foreign entity; or
- The consolidated profit, in the event of having a participation in two or more foreign entities resident in the same country or jurisdiction, and these entities consolidate for tax purposes in their residency country.
The classification of a PTR is not based on the location of the investment but 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. However, the taxpayers may opt to compare on a simplified basis the statutory CIT rate of the tax residency country of the foreign entity versus the corresponding Mexican CIT rate, if certain requirements and characteristics are met (e.g., broadly that all revenue is taxable for the foreign entity and deductions are effectively incurred) in the same moments than under the Mexican Income Tax Law. Note that the updated text of the 2020 Tax Reform, provides that the PTR regime testing for purposes of interpreting other provisions of the MITL that refer to the definition of PTR must be seen on a transactional basis.
In general, interest income and the annual inflationary adjustment made to liabilities of the investment in the tax haven are included in taxable income without subtracting the annual inflationary adjustment on receivables. However, the annual inflationary adjustment on receivables may be subtracted from interest income earned, provided an information return is filed.
Moreover, the 2020 Tax Reform provides that revenue earned through foreign transparent entities or foreign juridical figures held by Mexican residents would be dealt with as part of the regime that is in line with the treatment of the individual or entity generating the foreign sourced revenue and not separately. Note that this is relevant as differently from the PTR regime, no exceptions on revenue anticipation that may be applicable to the PTR regime would be available in such cases.
Tax on investments in a PTR is determined by applying the general CIT rate to taxable income (currently 30%). However, the rate for PTR was updated based on the tax reform to match those of Mexican individuals (the highest rate currently being 35%) in cases where the PTR is triggered by them directly. Additionally, net operating loss carryforwards associated with an investment in a PTR may be amortised against the tax profit of the following tax years arising from investments in a PTR, and tax deductions related to the investment may also be applied, as long as accounting records pertaining to those investments are available and the annual information return on the investments is filed on time.
Undistributed income from investments in entities located in a PTR need not be immediately included in taxable income (under the provisions discussed above) in certain particular cases (e.g. income arising from qualified active business activities in accordance with the applicable legislation and in the case of passive income from indirect investments in a tax haven when certain strict conditions are met).
Income earned in a PTR will be taxed until its distribution where the PTR income arises from a business activity. This treatment will not be applicable, however, if income such as interest, dividends, royalties, certain capital gains, and rents (i.e. passive income) represent more than 20% of the total income generated. In this regard, note that per the 2020 Tax Reform this exception is no longer allowed in those situations where the revenue of the foreign entity are Mexican sourced or have directly or indirectly derived in a deduction in Mexico.
Other specific cases of income on which the tax may apply until distribution include the case of share transfers within the same group and for income derived from royalties and interest that do not represent a tax deduction for Mexican tax residents, to the extent that certain specific requirements are satisfied.
As discussed in the Corporate residence section, companies operating under an IMMEX program (Maquiladoras/in-bond processing companies) are considered to not have a PE in Mexico. This is the case for the non-resident principal that owns the M&E and inventory, to the extent it is a resident of a country that has a tax treaty in force with Mexico, complies with all the terms and requirements of the treaty, satisfies any mutual agreements between Mexico and its treaty partner, and complies with the transfer pricing provisions provided in the law.
Revenues associated with productive activities must be derived solely from Maquila activities. Additionally, the rules on M&E ownership are consistent with the IMMEX Decree definition (i.e. 30% or more of the M&E used in the Maquila operation must be owned by the foreign principal).
The effective income tax rate on Maquila profits is 30%.
In terms of transfer pricing, only the safe harbour and advance pricing agreement (APA) alternatives are applicable to Maquilas.
Under a Presidential Decree published in Mexico’s Official Gazette, the following benefits are also granted to the Maquiladora industry:
- An additional deduction for 47% of tax-exempt benefits paid to employees involved in the relevant Maquila operation (since 2014, the Mexican tax law limits this deduction to 53% of tax-exempt benefits). Maquiladoras applying this benefit should inform the Mexican tax authorities of the amount of the benefit granted, and how it was determined, in a report due March of each taxable year.
- For sales of goods that are located in Mexico between a foreign resident and a Maquiladora that are taxed at the 16% VAT rate, the Maquiladora may credit the VAT in the same month of the sale if certain certification requirements are met. This benefit applies if a certification is secured.
Additionally, among other rules, the Miscellaneous Tax Regulations (MTRs) include further guidance in connection with the Maquiladora industry, as follows:
- Revenues associated with productive activities must derive solely from Maquila activities. In this regard, this rule provides that such revenues may also include those obtained for other Maquila services rendered to related parties resident abroad and other miscellaneous income, provided that the Maquila’s books clearly identify every type of income and related expenses.
- Income relating to the manufacture and distribution of finished goods for resale cannot be considered as 'solely derived from Maquila manufacturing activities'.
- The MTRs also provided that a foreign principal may still apply safe harbour protection relating to PE immunity contemplated in the 2013 Income Tax Law, provided that the foreign principal is resident in a country with which Mexico has a DTT and the principal is fully compliant with any treaty requirements applicable to its Mexican activities.