By CP y MI Mario Cesar Nuñez Jimenez. CEO Englobally México
In Mexico, a country of great opportunities for doing business with foreign residents, nearshoring emerges as a global strategy for companies that outsource their operations or services to a nearby country instead of a distant land. In the context of Mexico, nearshoring refers to the practice of foreign companies establishing operations in Mexico to take advantage of its strategic geographic proximity, access to international markets, skilled labor, and competitive operating costs. This allows companies to maintain better communication, more remarkable similarity in time zones, and less cultural impact compared to traditional offshoring.
Mexico has established itself as an attractive destination for foreign companies looking to expand in the region, but companies need help to overcome challenges. They must meet several complex tasks, from adapting facilities to hiring and training personnel and their culture and establishing solid business relationships with suppliers and strategic partners.
In coordination with the U.S. government, the Mexican government is designing a tax incentive plan to accelerate foreign investment in North America, which is only a technical design for now. This means that the governments are identifying how they can operate in Mexico, and no doubt their conclusions will be published through a decree of the Federal Executive.
The main objective of the tax incentive decree is to increase the profitability of the companies’ investments in the different productive sectors in our country, besides forcing the companies to demonstrate that they contribute to the generation of jobs and investment. The first incentives will be in the geographical area of the Transisthmian corridor and the subsequent ones throughout the country, depending on the location of the different industrial sectors such as electronics, pharmaceuticals, electronic vehicles, microprocessors, aerospace, and film content. Undoubtedly, it represents an excellent circumstance for the country to take advantage of this cascade of investment opportunities.
In terms of taxation in Mexico, foreign companies that come to the country, as well as Mexican companies that hire their services, must consider, to establish a business in the country, all the procedures, licenses, authorizations, registrations, etc., as well as the promptness and efficiency of their execution.
Regarding Income Tax, we must analyze and apply concepts modified in the last years to understand the fiscal effects in this matter that can be derived from any foreign investment, such as the fiscal residence. For these purposes, a company is considered to be a resident in Mexico when its central administration and the persons who make the management, direction, operation, and control decisions are in Mexican territory, regardless of whether it is incorporated under Mexican Law or the Law of its country of origin, and as such, the company must pay Income Tax on income from a worldwide source of wealth, that is, any income that comes from another country.
In addition, foreign companies must also consider that if they constitute an establishment in Mexico without a legal entity other than the foreign resident itself, which is known as a “permanent establishment,” they will also be subject to Income Tax. It may occur when a company performs business activities in Mexico through a dependent person, such as an employee or a legal representative.
Globalization has caused more and more people and companies to establish themselves and do business in our country, hence the importance of knowing the content and application of the tax laws, since in legal terms, foreign residents with a permanent establishment in Mexico are considered as subjects obligated to pay Income Tax, only for the income attributable to such permanent establishment.
Article 1. Income Tax Law. Individuals and corporations are obligated to pay income tax in the following cases:
I. Residents in Mexico, concerning all of their income, regardless of the location of the source of wealth from which it originates.
II. Residents abroad with a permanent establishment in the country for the income attributable to such permanent establishment.
III. Residents abroad, concerning income from sources of wealth located in Mexican territory, when they do not have a permanent establishment in the country or when having one, such payment is not attributable to such permanent establishment.
As we can observe in Article 1 of the Income Tax Law, Section II, it refers to foreign residents who have a permanent establishment in the country to the income attributable to such permanent establishment, as the taxpayers are obligated to pay the tax. The Income Tax Law considers the residence of the taxpayer as a connecting factor, with the fact of having a residence in Mexican territory, obliged to contribute to the public expenses emanating from our Political Constitution, regardless of the source of their income; that is to say, residents in Mexico will be obliged to pay Income Tax on their worldwide base.
Residents abroad will be obliged to pay ISR only on the income attributable to the permanent establishment or, in case of the absence of such establishment, only on the income of the Mexican source.
The legal assumption is that a foreign individual with a permanent establishment within the country must make the corresponding ISR payment like a Mexican taxpayer would. Following this provision, the form of taxation corresponds to the business activity and/or professional services regime, in terms of Title IV of the Income Tax Law, for individuals.
On the other hand, it is essential to emphasize that by Article 2 of the Law, offices, factories, workshops, exploitation facilities, mines, quarries, and/or any other place of exploitation of natural resources, among others, are considered for these purposes as permanent establishments. Thus, when a foreigner carries out his activities through any of these modalities, he must be regarded as a subject of payment of ISR.
Article 2. LISR On Foreign Residents with Permanent Establishment. For this Law, a permanent establishment is considered any place of business where business activities are carried out, partially or totally, or independent personal services are rendered. A permanent establishment shall be understood as, among others, branches, agencies, offices, factories, workshops, facilities, mines, quarries, or any place of exploration, extraction, or exploitation of natural resources.
Under Article 2 of the Law, a permanent establishment is considered to be any place of business in which business activities are carried out, partially or totally, or in which independent personal services are rendered, considering the current world philosophy established in the OECD Model Agreement on Income and Wealth, merging at present the concepts of permanent establishment and Fixed Base into a single one.
Continued Article 2 LISR
Notwithstanding the provisions of the preceding paragraph, when a resident abroad acts in the country through an individual or legal entity other than an independent agent, the resident abroad will be considered to have a permanent establishment in the country in connection with all the activities that such individual or legal entity performs for the resident abroad, even if it does not have a place of business in the country if such person habitually concludes contracts or habitually acts the prominent role that leads to the conclusion of contracts entered into by the resident abroad and these:
I. Are entered into in the name or on behalf of the resident;
II. Provide for the alienation of property rights, or the granting of the use or temporary enjoyment of an asset owned by the resident abroad or over which they have the right of use or temporary enjoyment, or
III. Oblige the resident abroad to render a service.
The preceding establishes that, in addition to a permanent establishment generated directly by a resident abroad, it is also possible for the foreigner to constitute a permanent establishment when acting in the country through a dependent agent in connection with all the activities that such agent performs for the foreigner, if such agent exercises powers to enter into contracts in the name or on behalf of the foreigner, even when there is no place of business or for the rendering of services.
In this sense, it is sufficient that the dependent agent exercises de facto powers that bind the foreigner. It is not required that such might be in writing. Likewise, the ability to enter into contracts in the name or on behalf of the foreign resident must be understood about the activities that constitute the foreign resident’s business. In this sense, it is irrelevant that the dependent agent has the power to perform actions that are not an essential part of the foreigner’s business.
According to the explanatory memorandum, this paragraph was amended in 2020 to incorporate those cases suggested by Action 7 of the BEPS project to avoid the use of tax avoidance strategies that seek to prevent a permanent establishment. Such issues include instances where a person other than an independent agent routinely concludes contracts or habitually plays the principal role in concluding such agreements, and they meet any of the conditions outlined in that paragraph.
For the preceding paragraph, it will not be considered that there is a permanent establishment in Mexican territory when the activities carried out by such individuals or legal entities are those mentioned in Article 3 of this Law.
This paragraph clarifies that in the case of persons performing activities on behalf of a foreign resident who performs preparatory or auxiliary activities, which are those mentioned in Article 3 of the Law.
Suppose a resident abroad performs business activities in the country through a trust. In that case, where the trustee performs such activities and complies on behalf of the resident abroad with the tax obligations derived from them, it will be considered the place of business of such resident.
This fourth paragraph establishes that, in the case of business activities carried out through a trust, the place where the trustee carries out such activities will be considered as the place of business of the foreign resident, i.e., when a foreign resident carries out business activities in the country through a trust, it will be understood that such foreigner has a permanent establishment in Mexico for such activities.
Mexico has followed punctually, and on several occasions with greater intensity, the recommendations of the BEPS Actions and, in fact, for the case of situations that may give rise to a permanent establishment, it has moved forward in the case of the division of activities in companies to establish that, notwithstanding the separation of activities, for purposes of Mexican Law, there will be a permanent establishment if the operation as a whole generates a permanent establishment.
With the entry into force of the Multilateral Instrument (from now on MLI), it will be necessary to review the definitions of the treaties, the MLI itself, and the domestic Law to determine the possible permanent establishment.
It is established that a company resident abroad permanently exists when it receives income in the country or provides services in Mexico through an advisor. In this sense, in addition to the possibility of establishing a permanent establishment directly or through a dependent advisor that exercises powers to perform activities on behalf of or in the name of the foreigner, by this simple fact, it will also be considered a permanent establishment for the foreign company.
Likewise, a foreign resident will be considered to have a permanent establishment in the country when it acts in the national territory through an individual or legal entity that is an independent agent if the latter does not work in the ordinary course of its business. For these purposes, it is considered that an independent agent is not acting in the ordinary course of business, among others, when it is located in any of the following cases:
l. Has stocks of goods or merchandise they make deliveries on behalf of the resident abroad.
11. Assume the risks of the resident abroad.
111. Act subject to detailed instructions or general control of the resident abroad.
IV. Exercise activities that economically correspond to the resident abroad and not its activities.
V. Receives his remunerations independently of the result of his activities.
VI. Performs transactions with the resident abroad using prices or amounts of consideration different from those that would have been used by unrelated parties in comparable transactions.
It is presumed that an individual or legal entity is not an independent agent when it acts exclusively or almost exclusively on behalf of foreign residents who are its related parties.
In this regard, Article 90 of the Income Tax Law determines that foreign residents with a permanent establishment within the country must make the corresponding tax payments mentioned above. These will be made on income in cash, accrued goods, credit, professional services, and any other type established by Law attributable to that place (permanent establishment). Under the second paragraph of Article 100, residents abroad who have a permanent establishment are obligated to pay the tax established in this Section and will pay for the income attributable to it, derived from business activities or the rendering of professional services. The above, regardless of any other tax such as Value Added Tax; for example, when their operations are considered acts or activities subject to this tax.
Article 90 Income Tax Law. Individuals are obligated to pay ISR. Individuals residing in Mexico who obtain income in cash, in goods, accrued when under the terms of this Title, in credit, in services in the cases indicated in this Law, or of any other type, are obligated to pay the tax established in this Title. Individuals residing abroad who carry out business activities or provide independent personal services in the country through a permanent establishment must also pay the tax on the income attributable to such establishment.
As a reminder, it is considered income for the rendering of professional services, the remunerations derived from an independent professional service, and which are not considered income from salaries or subordinate benefits. In addition, within Title V of the Income Tax Law, Article 156 establishes that the source of wealth is in Mexican territory when the service is rendered in the country. It is presumed that the totality of the service is provided in the country when it is demonstrated that part of it was supplied in national territory unless the taxpayer shows that part of that service was performed abroad. In this case, the tax will be calculated proportionally.
In conclusion, it is crucial to analyze how foreigners operate or conduct their business within the country because if they fall under any of the assumptions for the permanent establishment fiction to apply, then they will have to register in the Federal Taxpayers Registry, keep accounting records for the income of such establishment and pay the corresponding income tax. Also, knowing that not having a Permanent Establishment subjects you to the treatment of Title V, of income of foreigners with a source of wealth in the country, since there is an assumption. It is essential to consider that companies in Mexico must prepare themselves to adapt to all these changes and challenges, be updated on corporate legal issues, and comply with the new legal provisions, seeking strategies that allow them to take advantage of the opportunities offered by Nearshoring in an efficient and competitive way.