Attribute of real power of the state, the tax is a fundamental source of income for exchequers.
Nowadays, very few countries are the that do not contemplate the income tax in their regulations. The income tax is generally defined as a direct tax based on income, profits and capital gains. It is established on the alleged or real income of natural or legal person.
The Income Tax in Mexico (Impuesto sobre la Renta) (ISR) is regulated by the same law for both natural and legal persons, the Law on Income Tax in Mexico (Ley del Impuesto Sobre la Renta) (LISR).
Article 1 of LISR sets forth the principle that natural or legal persons are obliged to pay IRS in Mexico when they are in one of the following situations:
- They are considered as tax residents in Mexico,
- They are not tax residents, but they have a permanent establishment in Mexico,
- They are not tax residents and do not have a permanent establishment, but have incomes whose sources of wealth are located in Mexico.
The purpose of this paper is to study the first paragraph of article 1 of the LISR: the criterion of tax residence in Mexico and its tax consequences on ISR.
The two other situations mentioned will be discussed on a later article (http://tmclegal.com/el-impuesto-sobre-la-renta-en-mexico-investigacion-sobre-el-criterio-de-la-residencia-fiscal/?lang=en).
After studying the criteria for determining tax residence in Mexico (I) its tax effects on the ISR will be studied (II).
I. The criterion of tax residence in Mexico
The definition of tax residence is established in Article 9 of the Tax Code of the Federation of Mexico (Código Fiscal de la Federación) (CFF) which establishes the different criteria for natural (A) and legal persons (B).
A) Natural person
In accordance with Article 9 of the CFF, natural persons are considered as tax residents in Mexico when they meet one of the following assumptions:
- More than 50% of their annual incomes have their source of wealth in Mexico,
The law does not give definition of “source of wealth in Mexico”, therefore it is understood as the income originated or generated in Mexico.
- They have the center of their professional activities in Mexico,
This general approach will be determined by several factors such as the investment destination of the person, the headquarters of the companies that own the place in which its economic activities are developed.
- They have Mexican nationality and they are functionaries or workers of the government and they have the center of their vital interests in Mexico.
This criteria is economic and social, and is characterized to be defined by an objective criteria in order to determine whether the individual is stronger in Mexico than in other countries about its professional and personal relationships.
B) Legal persons
The CFF states that legal persons are considered as tax resident in Mexico when they meet one of the following assumptions:
- They have their principal business management in Mexico,
This criterion refers to the registered office of the company. A company with establishments in different countries, but whose holding is located in Mexico, will be considered tax resident in Mexico.
- They have their effective management in Mexico.
Effective management is a criterion used by tax authorities once the location of the administrative headquarters (registered office) is different from the place of effective management of the company.
Article 9 of the CFF establishes a presumption of tax residence for any person with Mexican nationality.
II. Effects of having tax residence in Mexico
Tax residents in Mexico will be subject to ISR about all their incomes (A) which can arise to double taxation (B).
A) The principle of unlimited liability of the ISR
Article 1 of LSR requires that persons considered as tax residents an unlimited tax liability obligation. Such persons are subject to the IR on “all income, regardless of the location and the source of wealth in which they arise”.
As tax residency requirements, the LISR distinguishes between the taxation of natural persons (which will be the subject of ISR calculated on a progressive rate based on income) or legal persons (who will charge a fixed rate of 30% on all income above 1 million pesos).
Therefore, a French national regarded as tax resident in Mexico will be subject to pay ISR despite its income in Mexico but also in France under the provisions of international tax treaties.
B) The challenge of international tax treaties
It follows the general obligation of the payment of ISR under an unlimited tax liability of tax residents in Mexico which represents a controversy as residents have economic interests in other countries.
In fact, incomes earned abroad may also be taxed abroad, the principle of unlimited tax liability provided by LISR does not generate an obligation to forgo tax revenue for the others countries.
For example, a French national which is a tax resident in Mexico, who rents real estate in France will be taxed in France about its income of rented property (French tax law imposes the land income of properties located in France) and also in Mexico for the ISR due to the unlimited tax liability principle.
The person would be taxed in both France and Mexico on its land income, it is called double taxation.
To promote foreign investment, Mexico has ratified many international tax treaties with several countries in order to avoid double taxation.
These international treaties allow to pay a single tax for the same income that could potentially be taxed in both countries.
Although most tax treaties are based on the same model, they all have differences and one must be careful for their terms in order to anticipate imposing the model which result more convenient.
In the previous example, the French national tax resident with land incomes in France, will, through the international tax treaty between Mexico and France, be exempt from the tax burden on land income in Mexico and pay these taxes in France.
The list of international tax treaties ratified by Mexico on: http://www.sat.gob.mx/informacion_fiscal/normatividad/Paginas/tratados_fiscales.aspx (spa).
International tax treaties generally define the criteria of tax residence and their provisions compliment the national tax laws of each country.
Therefore, tax residence in Mexico leads to significant tax liability on ISR and it is convenient to study this situation before installing in Mexico in order to comply with the tax obligations.
As mentioned in the previous paragraph, it is also necessary to study the international tax treaties provisions of the countries in which economic interest may be set forth, since those provisions will apply instead of the national tax law.
TMC legal has supported for more than 15 years entrepreneurs, investors and individuals who wish to settle in Mexico in order to advise them on legal and strategic planning.
 Ley del Impuesto sobre la Renta http://www.diputados.gob.mx/LeyesBiblio/ref/lisr.htm (spa).
 Código Fiscal de la Federación http://www.diputados.gob.mx/LeyesBiblio/ref/cff.htm (spa).
 Article 154 of the Ley Sobre la Renta of Mexico.
 Artículo 6 del Convenio Fiscal entre México y Francia (spa).