Late last year (2001) the Mexican Congress decided to get off their behinds and bring about a badly needed tax reform. Not liking what President Fox proposed, they waited until the very last days of of the year to seriously discuss and pass new laws. Unfortunately, there is general agreement among tax and constitutional attorneys, as well as accountants, that this new legislation contains many mistakes. Some of these are simple errors in how the document was drafted.
However, quite a few of the new provisions are deemed to be unconstitutional and there have already been an innumerable number of constitutional appeals (“amparos”) filed on behalf of aggrieved taxpayers. In the end, Mexico is learning to become a democracy and the legislators are realizing that they are no longer the proverbial rubberstamp.
While they learn to ride without training wheels, their mistakes will become our reality. We need to learn to oppose those provisions that are unconstitutional, or live with the new laws. The purpose of this article will be to review those areas of the new Income Tax Law most likely to affect residents in Mexico.
In our opinion, the most significant change in the law is the increased ability of Hacienda to monitor individuals. In the past, Hacienda (The Tax Secretariat of Mexico) needed to make a formal request to a financial institution asking for details on a particular individual’s account. Now all financial institutions in the country, as well as Notary Publics, must automatically provide financial information on clients to the tax authorities. Hacienda will have the ability to match tax returns with banking information, for example. We can only suppose that if there is a large discrepancy between the banking activity and what is reported on the tax return, Hacienda may want to take a closer look at that person’s finances.
Furthermore, several of the important income tax exemptions provided for in the previous law are preserved, but in certain cases the taxpayer must now declare such income on a tax return for the exemptions to prevail. If the taxpayer fails to declare this income, taxes may be due at regular income tax rates.
The net result of these changes, principally increased vigilance from the tax authorities and a desire to keep tax exemptions, will make it advisable for more foreign residents in Mexico to obtain a tax identification number ( ” Registro Federal de Causantes” or “RFC”) and file Mexican tax returns.
In summary fashion, here are the most important changes that Mexican residents should be aware of:
- Income Tax Rates and Brackets.
The top marginal income tax rate for 2002 is 35%, down from 40% in 2001. The maximum marginal rate will decrease one percentage point each year until 2005, when the maximum rate will be 32%. However, this apparent reduction in taxes is not entirely beneficial, as the tax brackets themselves will be compressed. What this means is that at those with lower incomes will be pushed up into higher tax rates.
- Interest Income.
Before 2002, Mexican financial institutions paid interest to their account holders’ net of income taxes, and income thus received did not need to be reported on the individual’s tax return. As of 2003, the difference between the official inflation rate, as reported by the Bank of Mexico, and the sums of interest received, will need to be reported on the individual’s tax return.Mexican financial institutions will continue to withhold income taxes on interest payments. As of 2003, any amounts withheld will be considered provisional payments, not payment in full. Depending on the individual’s tax bracket, the financial institution may withhold at a higher income tax rate than the individual’s marginal tax rate, in which case the person will need to file a return to receive a credit or request a refund.
Those individuals who have income consisting exclusively of interest payments, and if this income does not exceed $100,000 pesos per year, will not need to file a Mexican income tax return. In this case, any withholding made by Mexican financial institutions will be considered final.
Interest earned aboard must be reported on the Mexican income tax return as well.
- Dividend Income.
As of 2002 dividend income paid by Mexican companies needs to be reported on the individual’s tax return. Prior to 2002, most of this dividend income was received by individuals, net of Mexican income taxes, and did not need to be declared on a return. Per the current law, this income now needs to be reported on the tax return, even if the corporation has already paid taxes on the distribution of dividends.Dividend income paid by non-Mexican entities needs to be reported on the resident’s tax return in all cases.
- Capital Gains.
Proceeds from the sale of stock on the Mexican stock exchange continue to be exempt from Mexican taxes for residents.Significantly, the requirement that a person live in a house for two years to enjoy a capital gains exemption on the sale of the property is eliminated. There is now no tax due on the gain derived from the sale of single-family homes for Mexican residents. However, to enjoy the exemption, a tax return needs to be filed and the income reported. If the income derived from the sale is not reported on a return, the entire proceeds become taxable income. Note further that Public Notaries are now obligated to inform Hacienda of the real estate transactions that they record, and the Notary may require that you have an RFC to record the transaction properly.
- Estate and Inheritance Taxes.
There is still no estate tax. Also, the income tax exemption on property received via an inheritance continues in place. However, it is now a requirement to file an income tax return reporting the value of the property received in order to preserve the exemption. Recall that the probate process in Mexico is generally carried out by Public Notaries, and as per the new law, these individuals now need to report to Hacienda all transactions involving the transfer of property.
Gifts are generally exempt from taxes, both to the donor and the recipient, when made between spouses and between ascendants and descendents. For example, a gift between brothers would be subject to income taxes. Gifts equivalent to three annual minimum wages, as determined by the Mexican government, are also exempt, regardless of the identity of the recipient. This is about $1,700 USD.Note also that if the total amount of gifts received in a year exceeds $1,000,000 pesos, these must be reported on the annual tax return in order to remain tax-exempt for the recipient.
- Rental Income.
Prior to 2002, Mexican residents who rented homes could take either a blind deduction of 50% against rental income, or the actual deductions, which ever was greater. Now the blind deduction is reduced to 35%, plus the amount paid in property taxes. You are still allowed to select between the higher of the blind deduction, plus property taxes or actual expenses.
- State and Municipal Taxes. A mechanism is now established so that individual states and municipalities can charge income and sales taxes. The maximum state income tax allowed will be 5% and the maximum sales tax permitted will be 3%. While some states have flirted with this possibility, we do not see any jurisdictions putting these levies into effect in the near future due to political considerations.
- Luxury Tax.
There is now a luxury tax on certain items. Of all changes made, it is here that one can better appreciate the lack of serious consideration given to the new laws. The law published a list of articles to which a 5% excise tax will apply. The list, frankly, makes no sense. My favorite “blooper” is that the tax specifically applies to the sale of magnesium wheels for cars. Well, they have not made magnesium wheels in a long, long time!This tax applies to jet skis, but not yachts, to salmon, but not lobster, to expensive cars, but not airplanes. It applies to some sporting activities, such as golf and horseback riding, but not to others, like scuba diving or skydiving.
- Personal Deductions.
Not all the changes in the new tax law were to the detriment of the taxpayers. Interest payments on mortgages granted by Mexican financial institutions as of 2003, contributions to retirement plans, and medical insurance premiums are now deductible within certain limits.
This review has dealt with several aspects of the new tax reform, especially provisions in the Income Tax Law, as applicable to Mexican residents. In no way has this been an in-depth study of the new law, and as always, we suggest that you consult with your trusted advisors in order to get advice specific to your situation. You may also want to approach your bank and Notario to ask how they will deal with the new requirements.