In a previous article (http://tmclegal.com/el-impuesto-sobre-la-renta-en-mexico-investigacion-sobre-el-criterio-de-la-residencia-fiscal/?lang=en ), the Income Tax in Mexico (Impuesto Sobre la Renta) (ISR) was presented through a study focus on the tax residency criterion.
As a reminder, 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 a natural or legal person.
The Income Tax in Mexico 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 which sources of wealth are located in Mexico.
Tax residency on ISR implies that persons considered as tax residents an unlimited tax liability obligation. On the other hand, both permanent establishment and sources of wealth located in Mexico drive to a limited tax liability obligation, concerning just some incomes.
The purpose of this second article on ISR focuses on these two criteria of permanent establishment and the sources of wealth which are located in Mexico, by studying their definitions (I) and then, their tax effects on ISR (II).
I. Definition of the concepts of permanent establishment and sources of wealth which are located in Mexico
A) The permanent establishment
The definition of permanent establishment is established in Article 2 of the LISR:
” It Should be considered as permanent establishment to any place of business in which, partly or wholly, business activities or independent personal services are provided in an independent way”
The same article states that it should be considered as a permanent establishment, among others the subsidiaries, agencies, offices, factories, workshops, installations, mines, quarries or any place of exploration, extraction or exploitation of natural resources.
On the other hand, Article 3 of the LISR states that should not be considered as permanent establishment some activities which are mainly auxiliary or preparatory such as storage or delivery of goods.
The philosophy of permanent establishment criterion is based upon the principle of the exercise, by a foreign resident, of an economic activity with some autonomy in Mexico. The definition of permanent establishment of the LISR expressively states the word independent.
Under both Articles 2 and 3 of the LISR, even the concept of permanent establishment is quite accurate, despite its accuracy, it is still a broad concept as for the distinction between the auxiliary or economically independent activities that can be difficult to qualify sometimes.
B) Incomes which sources of wealth are located in Mexico.
Unlike the permanent establishment, the LISR does not give any definition of the incomes which sources of wealth are located in Mexico. Incomes which sources of wealth are located in Mexico are only mentioned by Article 1 of the LISR as generating a tax liability without any details.
The Tax Administration Service of Mexico (Servicio de Administración Tributaria) states that “In simple terms, source of wealth refers to the place where the incomes are originated or generated”.
In the light of this definition, it should be considered as incomes which sources of wealth are located in Mexico, real incomes from real state located in Mexico, incomes from Mexican securities and the incomes from the performance of services and sales of services in Mexico.
The determination of the tax liability of a foreign resident with incomes which sources of wealth are located in Mexico should be determined case by case by the study of each of its incomes which could potentially be considered as a source of wealth located in Mexico according to the Mexican tax legislation.
Therefore, both concepts of incomes which sources of wealth are located in Mexico and permanent establishment are not defined as precise as the notion of tax residence in Mexico is, established in Article 9 of the Tax Code of the Federation (Código Fiscal de la Federación). For the foregoing, it is necessary to study each individual situation in order to determine in advance its tax liability related to the payment or ISR in Mexico.
II. Tax consequences of the permanent establishment and income source of wealth in Mexico
A) Impact of the national legislation
Article 1 of the LISR sets the principle that foreign residents with permanent establishment in Mexico are subject to the payment of ISR on the income attributable to that establishment.
The same article establishes that foreign residents who do not have a permanent establishment in Mexico but who perceive incomes which sources of wealth are located in Mexico are subject to the payment of ISR on these incomes.
Therefore, the permanent establishment leads to a limited but generally determined tax liability by assessing all incomes of the permanent establishment and, on the other hand, foreign residents with incomes which sources of wealth are located in Mexico, also have a limited tax liability, cause they have a fiscal obligation which should be determined case by case.
In both situations, these dispositions concern the tax liability of a foreign resident and it is necessary to study the provisions of international tax treaties concluded between Mexico and the country of residence of the foreign resident.
B) The impact of international tax treaties on the permanent establishment and incomes which sources of wealth are located in Mexico
The purpose of international tax treaties was presented in the previous article about tax residence in Mexico (http://tmclegal.com/el-impuesto-sobre-la-renta-en-mexico-investigacion-sobre-el-criterio-de-la-residencia-fiscal/?lang=en ).
As a reminder, the scope of these treaties for both residents in Mexico and foreign residents with a permanent establishment or a source of wealth located in Mexico is the same: avoiding double taxation on the same income.
For example, through an international tax treaty, the foreign resident who has a permanent establishment in Mexico will not pay income taxes on the permanent establishment’s income in Mexico and in its residence country. The tax treaty will spread the tax liability between the two signatory countries. The logic is the same for the incomes which source of wealth is located in Mexico.
For these purposes, tax treaties generally provides a definition of the permanent establishment and of source of national wealth in order to spread the tax liability on a common definition for each country. This definition given by international tax treaties is applicable to the determination of the tax liability of the person conducting economic activities in the countries which signed a tax treaty in order to avoid double taxation. The definitions provided under national law will be subsidiaries.
In fact, the definition of these concepts by the LISR is close to the definition given by most of the international tax treaties which are all mostly based on the same model. However, the definitions established by the international tax treaties should be studied carefully in order to recognize the tax situation in the case that an economic activity is conducted in Mexico.
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.
 Law on Income Tax in Mexico: http://www.diputados.gob.mx/LeyesBiblio/ref/lisr.htm (spa).
 Tax Code of the Federation of Mexico: http://www.diputados.gob.mx/LeyesBiblio/ref/cff.htm (spa).
 The list of international tax treaties ratified by Mexico on: http://www.sat.gob.mx/informacion_fiscal/normatividad/Paginas/tratados_fiscales.aspx (spa).