13 Jan 2014
On 31 October 2013, the Mexican Congress approved the Tax Bill for tax year 2014, which includes several amendments to Mexican Income Tax Law and the Federal Fiscal Code. Taxand Mexico and US explain this provision and its impact on US multinationals.
The new legislation has been effective since 1 January 2014. Among other important changes, the Tax Bill imposes a new tax on dividend distributions made by Mexican companies to Mexican individuals and foreign shareholders.
The new tax law imposes a 10% withholding tax on dividend distributions made by Mexican companies to Mexican individuals and foreign shareholders. The new withholding tax also applies to remittance made by Mexican permanent establishments to their foreign home offices. Previously, such dividend distributions were not subject to tax. The withholding tax will be computed on the gross amount of the dividend or profit distribution.
The new dividend withholding tax is in addition to the corporate income tax paid by Mexican companies and permanent establishments. It is only applicable to dividends paid out of CUFIN (“Cuenta de Utilidad Fiscal Neta” or Net Tax Profits Account) generated starting fiscal year 2014. Thus, dividends that are paid from CUFIN generated as of 31 December 2013 and prior years were not subjected to dividend withholding.
The transitional provisions of the new law include a procedure to determine the CUFIN’s balance as of 1 January 2014. The procedure ignores the CUFIN created prior to 2001 and takes into account only the tax profits accumulated and dividends paid in fiscal years 2001-2013. As expected, a significant number of Mexican companies distributed dividends in 2013 before the new law took effect. Financial analysts called this massive distribution a “dividend fiesta” which could be the last we see in a while.
Foreign resident shareholders may apply conventions for the avoidance of double taxation entered into by Mexico, which may reduce the applicable withholding tax on dividends. The Mexico-US tax treaty eliminates the withholding tax on dividend distributions if the US shareholder (the beneficial owner) is a company which owns 80%
or more of the shares of the Mexican company and the limitation on benefits requirements of the treaty are met. In this situation, documenting the ownership and the residency requirements under the tax treaty may be all that’s needed to preserve the current status. The withholding rate under the Treaty increases to 5% if the beneficial owner is a company that directly owns at least 10% of the voting stock of the company paying the dividends. For all others, the Treaty provides a 10% tax (these shareholders mostly likely will not claim treaty benefits given the lower domestic rate). As a result, those shareholders not otherwise qualifying for the full treaty exemption on dividend withholding will face a significant tax increase for which tax planning is very much needed.
Foreign tax credit planning may play a key role for US multinationals. Generally, withholding tax on dividends is creditable for US tax purposes subject to certain limitations. Thus, planning around Mexican dividend distributions may entail coordinating distributions from other jurisdictions in order to maximize US foreign tax credit opportunities. Such planning may also involve indirect foreign tax credits that US corporate shareholders may be entitled to, which generally require tracking foreign earnings and profits pools and tax pools related thereto. Indirect tax credits are not allowed for individuals and flow-through entities.
US multinationals may also need to analyse the implications that Mexican dividend distributions on its treasury function. Depending on the size of the Mexican operations, US multinationals will need to analyze the impact of the new tax on the group’s cash flow management. Additionally, foreign currency issues will need to be considered both from the Mexican and US side.
From a financial statement perspective, many US multinationals do not account for US taxes on foreign earnings on the assumption that such earnings are permanently reinvested abroad. Generally, that position may be undermined by dividend made in anticipation of the new withholding tax, resulting in a higher global effective tax rate being reflected on the group’s financial statements.
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