With M&A activity soaring in the U.S., we have been involved in dozens of deals involving U.S. entities with Mexican subsidiaries. These types of businesses have become more attractive to potential buyers for many reasons: China vs. U.S. commercial war, increased freight costs, shipment delays, disruption and operational limitations due to COVID-19; especially for Asian companies. All these factors have triggered M&A interest by companies with a presence in Mexico.
CPAs know that tax planning is key to preparing for any type of transaction. For companies thinking about selling their Mexican subsidiary, here are four considerations before initiating conversations with potential buyers.
- Ownership of shares – The process of transferring ownership shares in Mexico takes time. First, you should review the ownership structure to ensure the pre-deal structure makes sense for the transaction. Is the business owned by an individual or a Limited Liability Corporation (LLC)? Ownership by an LLC is generally preferred as it allows for more flexibility, and ownership can occur either in the U.S. or Mexico. Transferring from individual ownership to an LLC typically takes 60-90 days.
- Understanding the “CUFIN” balance – A Net Tax Profit Account (CUFIN) is an account every company with tax residence in Mexico is required to establish to comply with the Federal Income Tax Law (ITL). In general, CUFINs show the aggregate amount of profits for which the company has paid corporate income tax and the employees’ statutory profit sharing. The CUFIN balance is the amount that can be distributed without paying any additional taxes. This information is important to understand and may provide flexibility when considering structuring options. The main use of CUFINs is to allow companies to distribute dividends to their shareholders free from income tax otherwise applicable to such distributions. The balance of CUFIN also increases the cost of shares, which reduces the taxable profit in the case of a sale.
- Transfer pricing requirements – Since the corporate tax rate in the U.S. is 21% compared to 30% plus profit sharing in Mexico, many businesses structure related party transactions in a manner that increases profits in the U.S. This occurs when Mexican entities are either overallocated expenses or undercompensated for goods/services in Mexico to drive profits in the U.S. Both the U.S. and Mexico require that arms-length transfer pricing methods be used when pricing related party cross-border transactions. Failure to comply with transfer pricing rules could result in a huge tax liability. Sellers should be sure their Mexican business is compliant so there are no surprises during due diligence. The due diligence process allows potential buyers to assess the deal and ensure there are no potential tax liabilities or contingences.
- Tax “assets” – Value-added tax (VAT) in Mexico is payable at the general rate of 16% on sales of goods and services, as well as on lease payments and imports of goods and services. For many manufacturers with large amounts of exports, VAT asset balances can increase overtime. Obtaining VAT refunds is not an easy task. If there isn’t proper documentation, the potential buyer’s due diligence team could set aside a contingency which could impact the total cash to be received as a result of the transaction.
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These elements are difficult to maneuver during the transaction phase once there’s an actual buyer. Therefore, it’s important to anticipate such challenges and consult with an international M&A subject matter expert to obtain the best outcome. Contact us today for additional support.
