It is not uncommon for US businesses, large and small, to unintentionally make decisions which impact the business for years to come. Before expanding to Mexico, companies should be aware of the following tax and financial statement considerations:
1. Permanent Establishment
Even if a company does not have a physical presence in the form of an office or a plant in Mexico, the activities performed there on behalf of the company could create a “permanent establishment” (PE), which may cause the company to be obligated to pay taxes in Mexico. Generally, a PE is created by a person when that individual is in Mexico for 183 days in a rolling 12-month period. While an individual only needs to be concerned with the number of days they spend in Mexico, a company could create a PE by sending multiple employees to Mexico during a rolling 12-month period. For example, if a company sends four employees to Mexico for a 46 day project, they have likely created a PE (4 employees × 46 days = 184 days the company was “in Mexico”).
It is important for companies to be aware of these rules because it is much easier to plan beforehand than it is after the fact.
2. Tax Planning
If a company chooses to create a separate legal entity in Mexico, deciding which type of legal entity and making the proper timely elections in the US could have a substantial tax effect, as illustrated here:
Entity – Type A
|Taxable income of Mexican entity||$100,000|
|Mexican tax (assuming 30% rate)||(30,000)|
|Dividend to US parent company||$70,000|
|US tax on dividend (assuming 39.6%)||(27,720)|
|Net cash after all taxes paid||$42,280|
Entity – Type B
|Taxable income of Mexican entity||$100,000||$100,000|
|Taxes on income (30% Mexico, 39.6% US)||(30,000)||(39,600)|
|US foreign tax credit||0||$30,000|
|Net cash after all taxes paid||$60,400|
|Tax Savings of Entity B or Entity A||$18,240|
This is a simplified example used to illustrate the different entity type and tax elections that may be made. Each company’s circumstances are different and Clayton & McKervey recommends a review of the situation prior to beginning to do business in Mexico.
3. Reporting Requirements
Doing business in Mexico could subject a company, and possibly its officers, to penalties if certain requirements are not met. Reporting is required for anyone with signature authority over certain foreign bank accounts, even if the individual does not have a financial interest (i.e., an officer of a US company with signature authority over a Mexican bank account). There are also reporting requirements when US companies transfer cash to foreign entities. Although there is no tax associated with these forms, many of these reporting requirements carry stiff penalties of $25,000 (as of 2018), minimum, for non-compliance.
The US is not the only country with reporting requirements. Mexico requires transfer pricing studies to be filed with a company’s Mexican tax return if there are related party transactions. Transfer pricing rules have been enacted by both US and Mexican governments to prevent related parties from shifting income to low tax jurisdictions by requiring that arm’s length pricing (the price negotiated between two unrelated parties) be used when engaging in transactions between commonly controlled businesses. While a formal transfer pricing study is not required by the Internal Revenue Service, it is required by the Hacienda (Mexican IRS).
4. Additional Taxes
In addition to income taxes, companies doing business in Mexico may be subject to withholding taxes on interest, royalties or dividends, and Value Added Tax (VAT) on certain services. VAT can be particularly tricky if a US company is doing business in Mexico because it could receive payments net of VAT withholding (currently at 16%) with no inexpensive means to request a VAT refund. They may find themselves in a situation where it would cost more to file the appropriate paperwork than the VAT withholding.
5. Hiring Employees
Employment laws are different in Mexico compared to the US While payroll taxes are similar to the US, the Mexican government requires holiday pay, Christmas bonus pay, severance pay, and even profit sharing of 10% of the company’s income. If a company properly plans, they can establish various tax planning ideas to help control the amount of profit sharing required.
6. Financial Statements & Loan Covenants
According to generally accepted accounting principals (GAAP) in the US, wholly-owned subsidiaries (even those located in Mexico) must be consolidated for financial reporting purposes. Consolidating a US parent’s financial statements with a Mexican subsidiary’s financial statements can present some challenges.
The above information and examples are simplified to provide a broad overview of the issues. For more information on doing business in Mexico, contact Clayton & McKervey.