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 Mexican Taxes By Raoul Rodriguez-Walters, CFP®
Mananging Partner, Mexico Advisor
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I am always a little surprised at the number of people I meet who believe Mexico is a bona fide tax haven. Mexico is a tax haven only to the extent that the country has not had the resources or will to enforce its own laws. In fact, according to the Organization of Economic Cooperation and Development (OECD) the country has the lowest level of tax revenues in relation to GDP among member nations. 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 that Mexico has signed. My purpose here is to provide a brief synopsis of the major taxes that individuals of the foreign community might be exposed to in Mexico.
| Tax Residence
| Legal residence and tax residence are two different concepts. The first is related to the authorization, generally from the immigration authorities, to be in Mexico for a given period of time. This authorization comes is various forms, typical examples of which are evidenced in a tourist card or an FM-3. Tax residence, on the other hand, is defined in the tax law and tax treaties. The distinction between who is a Mexican tax resident and who is not is important because generally non-residents are subject to higher taxes than tax residents.
In 2004, the Mexican Fiscal Code (the “Code”) established a new definition of “tax resident,” as anyone who has established an abode in Mexico, irrespective of the time he or she has spent in the country. The Code also stipulates that if you have one home in Mexico and another abroad, you are considered a tax resident of the country where you have your “center of vital interests.” Mexico considers that your center of vital interests is in Mexico if over 50% of your income is derived from Mexican sources or if you are employed (or self-employed) in Mexico.
There are two main repercussions for a foreigner in Mexico as regards tax residency. The first is that tax residents are supposed to register to obtain a tax ID, known as an “RFC” and file an annual tax return reporting worldwide income. The second, and perhaps more of an immediate concern to many foreigners who own real estate in Mexico, is the ability of the foreign national to obtain a tax exemption on the sale of their Mexican residence. This income tax exemption is outlined in the section of the Mexican Income Tax Law applicable to tax residents and is clearly meant to benefit taxpayers who have been complying with their Mexican income tax obligations.
The good news is that with proper financial planning you can permanently and legally live in Mexico without acquiring a Mexican tax ID, filing a tax return or paying income taxes on foreign income (Mexican source income is still subject to tax). By doing so you may give up the benefit of lower Mexican taxes available to tax residents but you will gain a greater level of peace of mind.
What follows is a necessarily brief overview of the most important taxes individuals, both residents and non-residents, may need to pay in Mexico.
| Income Taxes
| Mexico taxes it tax residents on worldwide income pursuant to Article 1 of the income tax law. It is important to note that Mexico allows for a foreign tax credit for any income taxes paid outside of Mexico. Many countries, including the U.S. and Canada, also allow for foreign tax credits. In effect, a taxpayer may need to file an annual return in both countries but if prepared correctly the taxpayer may also have offsetting tax credits, significantly lowering or even eliminating the need to pay income tax in one of those jurisdictions. In other words, just because you file twice does not translate into a doubling of your tax burden.
The highest marginal tax bracket for individuals in Mexico for 2008 is 28%. Some Mexican states have a state income tax that is capped at 2%.
| Interest Income
| The real rate of interest received (the difference between the annual inflation rate and the interest rate) is taxable at regular rates. Interest payments made by financial institutions are subjected to withholding.
Banamex, one of Mexico’s largest banks (owned by Citi Group), will issue a US 1099, advising the Internal Revenue Service and its US clients of interest payments. Other financial institutions are also collecting the US social security numbers of their account holders.
As far as Mexico is concerned, any taxes withheld on interest payments to non-residents are final. That is, you cannot request a refund from the government.
The tax rates established in the different treaties signed by Mexico may be advantageous to those looking for a tax break in their home country. For example, while interest payments received in the US are generally taxed at regular rates, interest received by a US citizen from a Mexican financial institution is taxed at a maximum rate of 10%, as per the US-Mexico tax Convention. You need to ask for the special tax rate on your US return to get it. Make sure that you discuss this issue with your tax preparer.
| | Dividends | Mexico does not have the problem of double taxation of dividends as in the United States. Dividends paid by Mexican corporations are usually paid from corporate coffers after tax. Mexican tax residents report dividend income on their annual return but at the same time receive a tax credit for the amount of taxes paid by the corporation on the distribution. This eliminates any tax consequences to the individual.
Dividends paid to non-residents may be subjected to income tax withholding. Many non-residents may be able to get a tax credit on any income tax so withheld and should also check the applicable treaty to see if the treaty rates are favorable.
| Rental Income
| Rental income generated in Mexico is taxed at regular income tax rates, after deducting an amount equal to qualified expenses or a blind deduction of 35%, whichever is greater (depreciation is not an allowable deduction). Usually the blind deduction is more generous and is certainly easier to calculate!
In the case of non-residents the income tax on rental income is significantly higher. They pay a flat 25% on the gross income and no deductions are allowed. If you are a non-resident and want to comply with the payment of this tax, you will need to apply for a Mexican tax ID. However, the tax authorities generally only issue Mexican tax IDs to individuals present in Mexico (i.e. requiring an FM-3) often putting well intentioned foreigners in a “Catch-22” situation. They may want to pay the tax but the tax authorities will not issue a Mexican tax ID.
Both residents and non-residents may be required to charge value-added taxes, state income taxes and may also need to charge a 2% hotel tax, depending on the particular circumstances of the rental.
| Captial Gains
| The concept of “capital gains” taxes is not as well developed in Mexico as it is in the United States. Generally, the tax rate applied to capital gains is the same as the taxpayer’s marginal tax bracket. Two notable exceptions to this are: the sale of securities on Mexican markets and the sale of one’s principal residence.
Income received by tax residents from the sale of securities on a Mexican exchange is free from tax in Mexico as long as the sale does not represent 10% of the total shares issued by the company. It is interesting to note that many shares of well known international companies, and funds investing in these securities, now trade in Mexico.
Non-residents investing in the market pay income tax equivalent to either 25% of the transaction value or 28% on the gain depending on their particular circumstance.
Undoubtedly, the most significant capital gains tax issue faced by expatriates in Mexico, whether they are considered tax residents or not, is the sale of their Mexican home.
Mexican tax residents have been granted some sort of exemption for many years. Every once in a while the rules regarding the exemption are tweaked. But in 2007 we saw major changes regarding when the exemption is allowed and what amounts are exempted from Mexican tax.
The rules as of 2007 are the following: If the seller can show that he or she lived in the house for more than 5 years, there will be no tax on the sale, regardless of the transaction amount. If the house was owned for less than 5 years and the transaction amount is less than approximately $523,000 USD (the exemption amount varies per a specific financial index called an “UDI” and the US-peso exchange rate) there will be no tax on the proceeds from the sale. However, if the home was occupied by the owner for less than five years, and the transaction value is higher than approximately $523,000 USD, then a prorated tax will be paid taking in consideration the amount over the exemption and the adjusted cost basis of the property.
Non-residents do not have a right to an exemption on the sale of their Mexican home and thus pay either 25% of the gross amount of the transaction or 28% of the adjusted gain, whichever is lower.
In either case the Notario, the attorney responsible for determining if the foreigner is a tax resident, is responsible for withholding any taxes due. Any income tax paid is available for a credit in the US or Canada. Since it is the Notario who makes a determination of who qualifies as a tax resident, it is important to find one that will make a favorable determination based on the law and your circumstances.
| Other Taxes
| Property Taxes
| Property taxes on real estate in Mexico, called predial, are low compared to other parts of the world. Depending on which part of the country you live in, you may not necessarily receive a bill in the mail. Go to the local property tax office to request a bill in January. In many municipalities if you pay the entire amount in the first quarter of the year you are given a discount. Also ask if the local government provides discounts to senior citizens. Some do.
| Value Added Taxes
| Mexico has a value added tax (VAT) that is applied to most products and services. It is 15% in most of the country and 10% in border areas. Mexico does not refund VAT to non-residents.
| State Income Taxes
| Mexican states can now charge income tax to its residents. The rate cannot exceed 2%.
| Alternative Minimum Tax
| Individuals engaged in a business and companies may need to pay the new alternative minimum tax, really a flat tax, applicable as of 2008. The rate for 2008 is 16.5% with few deductions allowed. If you are running a business, make sure you hire the services of a certified public accountant, called a contador público certificado, to assist in proper tax planning.
| Hotel Tax
| If you are running a B&B, or similar business, you may be required to pay a 2% hotel tax that is payable to the state government. States use this tax to promote tourism.
| Mexico Is Modernizing
| Past Mexican governments simply printed money to meet their needs, or relied on oil revenues, and tax collection was a secondary source of income. The country today is run more responsibly and it is not possible to simply order the Bank of Mexico to print an extra billion here and there. Necessarily, the government must now look to taxes as one of its primary sources of income in order to meet its residents’ needs (including the needs of its expatriate community). As it does, the government will become stricter and more efficient in enforcement.
This is not welcome news to those who move to Mexico in order to avoid all income taxes. However, those who are willing to pay their fair share will find that by planning effectively they may even pay less tax than they did back home. This is certainly the case for most Canadian citizens who move to Mexico and is also the case for many U.S. citizens, especially those who are coming from states, such as New York and California, with their own high tax structures.
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