Offshore Tax Summaries-Mexico

Offshore Tax Summaries-Mexico Mexico has one of the lowest tax collections as a percentage of its gross domestic product in Latin America and among the member nations of the Organization of Economic Co-operation and Development. However, the needs of the country and the demands of a newfound sense of democracy are forcing the government to make its tax collections more efficient and fair, pursuant both to the existing laws and to the international tax treaties Mexico has signed with several countries.

Tax residence and tax treaties

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

Both the tax treaties Mexico has signed and the local law establishes who is a tax resident. Tax treaties also set forth the tax rates for different types of income. However, the purposes of these treaties 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 U.S. tax treaties both established that nationals of their country who reside in Mexico may be subject to Mexican income taxes pursuant to local law. Since 2004 the Mexican fiscal code has a new definition of "tax resident." Before that time, a person needed to be in the country 183 days to be considered a tax resident. Now, a tax resident is anyone who has established an abode in Mexico, irrespective of the time spent in the country. The law stipulates that if anyone has one home in Mexico and another abroad, they are considered a tax resident in the place where the have their "center of vital interests." Mexico will consider that that center of vital interests is in Mexico if over 50% of income is derived from Mexican sources.

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

The reverse is that foreign residents who 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.

Income tax

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

In 2005, , Mexican financial institutions started to request that U.S. citizens provide a U.S. social security number in order to open an account in Mexico. While it's unknown whether the SAT (the Mexican equivalent to the IRS) is sharing any information with the U.S., 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 U.S. and Mexico will regularly exchange information on their taxpayers, just as Canada and the U.S. do now.

If anyone has a Mexican bank account earning interest, the financial institution will withhold a small percentage of the principal for income taxes. If he is not a resident, this is the most he will pay on this particular income and he won't need to file a Mexican tax return. If he is resident, he can generally credit this amount on his annual Mexican tax return. Mexico does not have the problem of double taxing dividends that the U.S. has. Dividends paid by Mexican corporations are paid after tax and are received by Mexican resident's tax free. Nonresidents 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. Nonresidents pay a flat 25% on the gross income. Both residents and nonresidents may be required to charge value-added taxes and may also need to charge a 2% hotel tax, depending on the circumstances.

Capital gains tax

The concept of capital gains taxes is not well developed in Mexico as it is in the U.S. or Canada. Generally, the tax rate that is applied to gains is the same as the taxpayer's marginal tax bracket. Most expatriates face a capital gains issue when they sell their Mexican real estate. Nonresidents must pay either 25% of the gross amount of the transaction or the amount resulting from applying the highest marginal income tax rate in Mexico to the gain-whichever is lower.

Mexican tax residents can obtain a capital gains tax exemption on the sale of a principal residence. If the property is not a principal residence, they must pay taxes on the gain based on their marginal tax bracket. The notario will withhold a percentage of the gain and the taxpayer must pay the difference, or apply for a credit, with his or her annual tax return.

How the gain on the sale of real estate is calculated is based on the "declared value" that is stated in the deed, known in Mexico as the escritura. While a common practice, the habit of declaring a value that is less than the fair market value is not legal in most states. The Mexican tax authorities realize that they are losing significant amounts of tax revenue by not paying closer attention to these declared values and have begun to scrutinize these transactions more closely. The result is that declared values in many parts of Mexico are much closer to the fair market values than they were ten years ago.