The signficant modifications to Mexican tax law effective as of January 1, 2008, including the new IETU (flat tax on business operation) and IDE (tax on cash deposits) are well-summarized in a brief article by Everardo Teran of Connell & Associates, available here.

Carlos Vargas and Patricia Rubirosa of KPMG wrote a nice article summarizing the tax implications of merger and acquisition transactions in Mexico in the July 15, 2008 issue of Venture Equity in Latin America.  Excerpts of the article follow; businesses and investors contemplating merger or acquisition transactions in Mexico should engage Mexican tax counsel in the early stages of the proposed transaction to determine its full tax implications. 

The most commonly-used Mexican entities for the purpose of running a business are the corporation, known as the S.A., and the limited liability partnership, known as the S.R.L.  Both entites are taxable at the same rate of 28% in Mexico.

Generally, in the case of stock acquisitions, the statute of limitations in Mexico is five years.  In some cases, the statute of limitations may be increased by another five years, for a total of 10 years.

Asset Acquisitions

One potential advantage of consummating an asset acquisition in Mexico is that it is possible to step up the basis of the acquired assets to market value.

Labor issues, however, may arise in asset acquisitions.  In Mexico, it is also common for an acquirer or surviving entity to be held jointly liable for any unpaid taxes related to social security contributions.

Goodwill resulting from an asset acquisition is not deductible for Mexican income tax purposes.

Furthermore, net operating losses (”NOLs”) and other tax attributes are not transferred to the acquiring company.  It is important to note that Mexican NOLs can be carried forward for 10 years and are subject to inflation adjustments.

All assets sold, with the exception of land (which is subject to a real estate tax between two and five percent), are subject to value-added tax (”VAT”).  The general Mexican VAT rate equals 15 percent.  Usually, VAT can be refunded.  It may take approximately 30 to 45 days to receive a VAT refund from the Mexican tax authorities.

Stock Acquisitions

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In as stock acquisition, tax attributes, such as NOLs, remain with the acquired entity.  However, such NOLs may be subject to an annual usage limitation as a result of the acquisition (i.e., change of control).

Goodwill resulting from a Mexican stock acquisition is added to the tax basis of the shares acquired.  Such basis is also subject to an inflation adjustment.

No transfer tax or VAT is generally due in connection with a stock acquisition in Mexico.

One potential disadvantage of consummating a stock acquisition in Mexico is that it is not possible to step up the basis of the acquired assets to market value.

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The tax on capital gains arising from the disposition of shares equals 25 percent of the gross proceeds.  That being said, the Mexican income tax law provides taxpayers the option to pay capital gains tax at a rate of 28 percent of the net gain, if certain requirements are satisifed.

Mexico has a large network of treaties that can allow for the reduction of domestic tax, under specific circumstances.  Payments made by Mexican residents to tax haven countries are subject to a withholding tax rate of 40 percent.

The U.S.-Mexico Tax Treaty, available here on the U.S. Internal Revenue Service website, provides certain tax benefits to U.S. individuals and businesses that are shareholders and/or affiliates of Mexican companies.  The treaty contains provisions preventing double taxation, limiting taxes on dividends and royalties, and other matters. 

The Mexican Tax Administration (Servicio de Administracion Tributaria - SAT) has determined that the employment outsourcing activities performed by certain Mexican outsourcing companies violate tax laws, according to a SAT press release dated June 16, 2007.  The violations involved the transfer of workers to various partnerships with the purpose of avoiding the required employee profit sharing, federal taxes, and social security contributions under Mexican law.

U.S. companies with Mexican subsidiaries that retain outsourcing companies should always make certain they are contracting with outsourcers that fully comply with Mexican tax laws.  If an outsourcing deal seems to good to be true, it probably is, and the outsourcer probably isn’t complying with such laws. 

In due diligence investigations pending acquisitions of Mexican companies, we have seen business structures where one or more services companies designed to lease workers to the target (and thereby enable the target to avoid employee profit sharing obligations) is organized as a partnership.  Among the problems with these structures for the acquirer is that the SAT and/or the Mexican Social Security Institute could, after the close of the acquisition, retroactively impose liability and penalties on the target and/or such affiliates for unpaid employee profit sharing, social security payments, and other obligations arising from the improper use of the partnership.