Under the Mexican Income Tax Law (MITL), a transfer of shares by a foreign resident will trigger Mexican source income when more than 50% of the foreign resident’s accounting value is directly or indirectly derived from real property located in Mexico. These types of shares are often referred to as “real estate shares.”
This means that from an internal tax perspective, whenever a non-Mexican entity transfers shares issued by another non-Mexican resident, which in turn holds assets or participates in a Mexican resident company, two concepts must be considered to determine whether a Mexican There are the following taxes: (i) the value of the shares transferred; (ii) the value of the real property located in Mexico.
Although in principle these calculations seem easy to compute, from a practical point of view there are many doubts that lead to different interpretations.
As the accounting value of shares is involved, neither MITL nor any other legal provision provides a definition of such a concept; however, under Mexican Financial Reporting Standards, accounting value can be interpreted as the value of a right or obligation recorded in an accounting record (i.e. “book value”). ”). Therefore, the book value of an entity is shareholders’ equity, which is calculated by subtracting total liabilities from total assets.
Article 13 of the Organization for Economic Cooperation and Development’s Model Convention on the Taxation of Income and Capital (OECD Model Convention) does not refer to the accounting value of shares, but only to the “value” of such goods. The same applies to double taxation treaties in Mexico. This can lead to different interpretations of the value that should be used (i.e. accounting value or market value, which can vary widely).
Furthermore, because the transferred shares are not issued by residents of Mexico, the accounting principles applicable in the issuer’s jurisdiction may differ from the Mexican Financial Reporting Standards.
If the transferred entity directly holds Mexican assets, there should be no distortion, as the accounting value of shares and real property will be registered according to the same accounting principles.
Conversely, if the entity being sold holds shares or participates in Mexican companies, there may be distortions, as the latter may register real property under different accounting principles. The value of the shares of the transferred company (registered by the transferor) may not always reflect the value of the Mexican real estate.
In addition, the real property value may exceed the accounting value of the shares if the directly transferred entity or the Mexican entity has indirect debt. To clarify this situation, the commentary to Article 13 of the OECD Model Convention states that it is usually calculated by dividing the value of immovable property (numerator) by the value of all assets owned by the entity (denominator), without regard to debt or other liabilities.
Mexico’s tax code does not mention it as it relates to the “value of immovable property”; however, according to the OECD Model Convention and its Commentary, it can be interpreted that “book value” should apply rather than fair market value or the actual value of the transaction.
If a transferred entity holds the participation of different entities residing in different foreign countries, the determination of real property value may be more complicated due to differences in domestic regulations (such as differences in depreciation rates).
In addition to questions about the correct method of determining these values, classifying assets as real property is a common problem faced by many taxpayers in such transactions.
Under the OECD Model Convention, “immovable property” has the meaning given to it by the law of the Contracting State in which the relevant property is located. From the point of view of Mexican law, real property includes land and outbuildings; docks and buildings, even when floating, intended to remain in fixed points on rivers, lakes, or shores; and everything attached to real property, if not deteriorated cannot be separated (i.e. natural gas pipelines).
Assets considered “attached” to land under MITL include houses, buildings, industrial and power plants, warehouses, highways, bridges, railroads or dams.
To avoid some of the risks of possible conflict between domestic law and tax treaties, the OECD Model Convention also clarifies that the term “immovable property” shall in all cases include property attached to immovable property, livestock and property used in agriculture and forestry, related land The general legal provisions of the law apply to the rights and use of immovable property and the right to variable or fixed payments in consideration for the right to exploit or use mineral deposits, resources and other natural resources.
At the time of writing, there is no court precedent or guidance from Mexican or international tax authorities to clarify these issues. Therefore, when transferring the participation of a non-Mexican resident entity that owns real property directly or indirectly in Mexico, the non-Mexican tax resident must be careful when analyzing the existence of Mexican source income and have evidence to support the calculations and positions taken.