Tax Residency in Mexican Tax Law

From the many taxes in Mexico, two stand out: Value Added Tax (Impuesto al Valor Agregado – IVA) and Income Tax (Impuesto Sobre la Renta – ISR). The criteria for the IVA is very simple (and not residential): it taxes added value from transactions done inside the Mexican Territory. The criteria for ISR is more complex as the law foresees different scenarios: a) Tax Residents, b) Foreign Residents with a Permanent Establishment in Mexico (only in relation to such establishment) and c) Foreign Residents in relation to any other income which source is located in Mexican Territory.

For foreigners living in Mexico, the array of possibilities for tax strategies depends on properly establishing first which of the scenarios applies, because Tax Residency is not equal to Migration Residency or even to owning a home. After establishing this, one can look at which international treaties can be taken advantage of and how Mexican Commercial Law can be used in favor of an optimal tax strategy.

Subjects to ISR according to Law

Mexico follows the world income tax system. In article 1 of the ISR Law, the subjects of Income Tax are defined as follows: 

  1. The residents of Mexico, in respect to all of their income; regardless of the location of the source of such income. 
  2. The foreign residents who have a permanent establishment in the country, in respect to the income that can be attributed to such establishment. 
  3. The foreign residents, in respect to the income from wealth sources located in national territory, when they don’t have a permanent establishment in the country or when such income can’t be attributed to such establishment.

Tax Residency concept

The concept “resident of Mexico” mentioned in the first fraction must be understood using the Federal Tax Code of Mexico and not the Migration Laws or any of the Civil Laws (lex specialis criteria). Article 9 of the Federal Tax Code defines “resident of Mexico” with a distinction between physical individuals (real people) and moral individuals (associations, companies, unions, etc.). The article says (in italics, several paragraphs):

Article 9o.- The following will be considered residents of the national territory: 

  1. The physical individuals: 
    • Who have established their home in Mexico. When such individuals have also a home in another country, they will be considered residents of Mexico if in the national territory they have their center of vital interest. For this effect, it will be considered that they have their center of vital interest in national territory when, among other cases, they are located in any of the following suppositions: 
      • When more than 50% of the total income that the individual acquires in a calendar year has its source in Mexico.
      • When inside the country the individual has his main center of professional activities. 
    • Those who are Mexican and are working as State Officials of workers of the Mexican State, even when their center of vital interest is located outside of Mexico. 

Those who are Mexican and report they have a new tax residency in a country considered a tax haven, in the terms of the Income Tax Law, will still be considered Mexican Tax Residents. This disposition will be applied in the tax year in which the report is presented and during the following three tax years. 

  1. The moral individuals (associations, companies, etc.) that have established in Mexico the main administration center of its business or their effective decision headquarters. 

Unless proved otherwise, it is presumed that the physical individuals with mexican nationality are residents in national territory. The physical and moral individuals who are no longer residents of Mexico in accordance to this Code, must file a report to the tax authorities in less than 15 days after the change of tax residency happens. (ARTICLE ENDS HERE)

The case of physical individuals that are Tax Residents

First thing to note, criteria from fraction I. is only for physical individuals and can’t be applied to moral individuals (associations, companies, etc.), who have their own criteria in fraction II. Now, in regards to fraction I.A (individuals who have established a home), three complexities arise: i) what does establishing a home means, ii) which are the specified definitions of a center of vital interest and iii) which are the possibilities of unspecified definitions of a center of vital interest. 

On what does establishing a home means, the most clear case is owning a home in Mexico with a public deed. The next most clear case would be renting a home in Mexico with a private contract with a landlord. It would be unclear and subject to court interpretation if a person living in Mexico one hotel after the other has or not established a home in the country. The same analysis applies to having a home in another country. 

About the specified definitions of a center of vital interest, this article gives two: 1) When more than 50% of the income has its source in Mexico and 2) when the principal center for professional activities is in Mexico. The first definition is simple, it’s only about adding up the income from Mexico in relation to foreign income. The second definition seems more complex, but actually is simple when properly understanding its objective: taxing the main professional activities. The following examples can illustrate this:

  • A mexican journalist who travels every week to USA to see newsworthy events and then comes back to write and report to his Media Outlet in Mexico City, he clearly has Mexico as his center for professional activities, regardless of being paid in Mexico or in the USA. In this case, the law’s objective is to tax the income of the journalist in relation to his professional activities in Mexico (reporting to a Mexican News Company), so then he is considered a tax resident. 
  • A US lawyer who works for many clients in the USA and who spends half of his time drinking margaritas in his beach house in Mexico, while coordinating and communicating with his clients. He can’t have his center for professional activities in Mexico as he can’t practice law in Mexico but only in the US. As the objective of the law is to tax the main professional activities in Mexico, this is not a case of tax residency. 

On the unspecified definitions of a center of vital interest, let’s remember what the article says: “it will be considered that they have their center of vital interest in national territory when, among other cases, they are located in any of the following suppositions”. This three words (among other cases) seem to open the possibilities to other cases different from the two specified. Does this creates legal uncertainty in regards to tax residency? No, it doesn’t. The jurisprudence on this matter is very clear: 

“The principle of tax legality contained in article 31 of the Constitution demands that the legislator and not the administrative authority is who establishes the elements of any contribution, to a considerable degree of clarity, so that the subjects have certainty about their obligations. So this Supreme Court of the Nation, in relation to definitions of tax concepts, has declared them in violation of such principle if they are confusing or unspecified. The legislator can’t foresee formulas that represent the absolute indefinite of a relevant concept, leaving open the possibility for the authority to create such definition and creating the duty of paying unforeseeable taxes…”

As we can see, the phrase “among other cases” was both poor legislative work and unconstitutional, so only the two specified cases for centers of vital interest should be taken into account. 

Being Mexican and being a Tax Resident

As it can be seen from the Law, being Mexican has nothing to do with being a Tax Resident. One could be of foreign nationality and a tax resident or Mexican and not a tax resident. But the difference is that Mexicans are presumed to be tax residents and they have to prove they are not. By exclusion, it is possible to argue that foreigners can’t be presumed to be tax residents.  

The case of moral individuals that are Tax Residents

Fraction two of the previously referred article 9 of the Federal Tax Code says: “The moral individuals (associations, companies, etc.) that have established in Mexico the main administration center of its business or their effective decision headquarters.”

Two criteria can be seen: i) the location of the main campus or offices for a company and ii) where do they have their effective decision headquarters. 

The first criteria is simple, as a main administration center would be the address of the corporate headquarters where the President or Director of a company works with his highest officials and such address would be specified in the Corporation Deed. The second criteria is there to prevent misuse of the first criteria, so that a board of directors can’t have its offices in Mexico and send everyone else to a bigger office in other country to prevent paying taxes. 

With a good imagination, it is possible to imagine many conflicting examples with this law. Regardless, the most simple approach is to make sure the main offices and the decision making takes place in the preferred country or countries. 

Foreign Residents and Permanent establishment

If one is not a Tax Resident, but a Foreign Resident, then fraction II and III of article 1 of the ISR Law applies. Let’s remember those fractions: 

II. The foreign residents who have a permanent establishment in the country, in respect to the income that can be attributed to such establishment. 

III. The foreign residents, in respect to the income from wealth sources located in national territory, when they don’t have a permanent establishment in the country of when having one, such income can’t be attributed to such establishment. 

A permanent establishment is defined by international conventions. Article 5 of the Model of the Organisation for Economic Co-operation and Development (OECD) notes that a permanent establishment is a “place of business through which the business of an enterprise is wholly or partly carried on”. Mexican Law mirrors all of this international conventions and creates an incredible complexity. There is too many criteria that applies to know if one has or not a permanent establishment in Mexico. We recommend that each case is studied separately with legal advice from the firm. 

Permanent Establishments have some legal rights, that is, they can have some tax deductions and tax credit. Income without Permanent Establishment has no tax deductions or tax credit, so there could be cases where it is better to open a Permanent Establishment in the country. 

Foreigners with no Permanent Establishment or in regards to income not related to such establishment, pay tax by retention from whomever is paying them. The tax percentages change depending on the type of income, so we recommend studying each case separately with advice from the firm. 

Tax strategies, treaties and commercial law

On a final note, Mexico has many tax treaties to prevent double taxation signed with other countries. A full tax strategy for individuals with income in many parts of the world has to take advantage of such treaties to establish if it’s better to pay or not taxes in Mexico. This also implicates that the advantages of Mexican commercial entities come into place, specially the entities which have tax incentives in Mexican Law.  This subject is too vast to cover in one legal note, but the firm is available to generate tax strategies for any individual with international operations so that an optimal tax strategy can be executed.  

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