taxation

Taxes in Mexico: What are you up Against?
I am always a little surprised at the number of people that we meet that believe Mexico is a bona fide tax haven. Mexico is a tax haven only to the extent that the country has not had the resources or will to enforce its own laws. In fact, the country has one of the lowest tax collections as a percentage of its GDP in Latin America and among the member nations of the Organization of Economic Co-operation and Development. The needs of the country and the demands of a new found sense of democracy are forcing the government to make its tax collections more efficient and fair, pursuant both to the existing laws and to the international tax treaties that Mexico has signed with several countries. The purpose of this article is to summarize the major taxes that the foreign community is exposed to in Mexico.

Tax Residence and Tax Treaties
Mexican tax residents are taxed differently than non-residents. As a general rule, non-residents are subject to higher taxes than residents.

The tax treaties Mexico has signed and local law establish who is a tax resident. Tax treaties also set forth the tax rates for different types of income. The main purposes of these treaties, however, are to provide the manner in which double taxation will be minimized, as well as to establish how countries will exchange information on their respective taxpayers. The Canadian and US tax treaties both establish that nationals of their country who are resident in Mexico may be subject to Mexican income taxes pursuant to local law.

As of 2004 the Mexican fiscal code has a new definition of "tax resident". Before 2004, a person needed to be in the country 183 days to be considered a tax resident. As of this year, tax residents are all those who have established an abode in Mexico irrespective of the time they have spent in the country. The law also provides that if they have one home in Mexico and another abroad, they are considered a tax resident in the place where they have their center of vital interests. Mexico will consider that that center of vital interests is in Mexico if over 50% of their income is derived from Mexican sources.

The main repercussion for the foreign residents is the effect it will have on the ability of foreign residents to obtain a homestead exemption on the sale of their principal residence in Mexico. If the homeowner has only one home, and that home is in Mexico, then they should be able to get a homestead exemption. However, if they have one home in Mexico and another in the US, it will be more difficult for the homeowner to get an exemption, especially if their income is not derived from Mexican sources.

In practice, it will be very difficult for the Notario, the attorney required by law to draft the deed and withhold taxes, to know if the homeowner has another home outside the country. However, I can see that some Notario's may request to see a Mexican tax return to prove that homeowner does in fact have his or her center of vital interest in the country.

The flip side is that those foreign residents that have a home in Mexico and abroad, and who derive most of their income from sources outside of Mexico, need not worry about reporting and paying Mexican income taxes. A clear example of these people are "snow birds" that spend six months in Mexico and six months abroad.

Income Taxes
Mexico taxes it residents on worldwide income pursuant to Article 1 of the income tax law. It is important to note that Mexico allows for a foreign tax credit for any taxes paid outside of Mexico. The US and Canada also allow for foreign tax credits. In effect, the taxpayer will pay taxes in both countries, but will also have offsetting tax credits. The net result is that the taxpayer usually pays an amount of taxes equivalent to the highest tax bracket among both countries.

As of last year, Mexican financial institutions have begun to request that US citizens provide a US social security number in order to open an account in Mexico. While I have not heard if the SAT (the Mexican equivalent to the IRS) is sharing any information with the US at this point, this is clearly the intent. Once the Mexican authorities have access to the taxpayer's social security number they can also receive tax information from the IRS on that particular individual. Eventually, the US and Mexico will regularly exchange information on their taxpayers, just as Canada and the US do now.

If you have a bank account in Mexico that pays interest, the financial institution will withhold a small percentage of your principal for income taxes. If you are not a resident, this is the most you will pay on this particular income and you will not need to file a Mexican tax return. If you are resident, you can generally credit this amount on your annual Mexican tax return.

Mexico does not have the problem of double taxation of dividends that the US has. Dividends paid by Mexican corporations are usually paid after tax and are received by Mexican residents tax free. Non-residents will pay a tax in Mexico pursuant to treaty rates.

Capital Gains Taxes
The concept of capital gains taxes is not as well developed in Mexico as it is in the US or Canada. Generally, the tax rate applied to gains is the same as the taxpayer's marginal tax bracket. Most expatriates will face a capital gains issue when they sell Mexican real estate. Non-residents must pay either 25% of the gross amount of the transaction or the amount resulting from applying the highest marginal income tax rate in Mexico to the gain, whichever is lower.

Mexican tax residents can obtain a capital gains exemption of the sale of a principal residence. If the property is not a principal residence, they must pay taxes on the gain based on their marginal tax bracket. The Notario will withhold a percentage of the gain and the taxpayer must pay the difference, or apply for a credit, with his or her annual tax return.

How the gain on the sale of real estate is calculated is based on the "declared value" stated in the deed, known in Mexico as the "escritura". Historically, the declared value has been significantly lower than the fair market value. Often, the purpose of having a lower value is to pay less in the way of transfer taxes. While common practice, the habit of declaring a value that is less than the fair market value is not legal in most states. The Mexican tax authorities have realized that they are losing significant amounts of tax revenue by not paying closer attention to these declared values and have begun to scrutinize these transactions more closely. The result is that the declared values in many parts of Mexico are much closer to the fair market values than they were ten years ago.

One result of this increased scrutiny is that Notarios are much more careful about the declared value they are willing to accept in the deeds that they prepare. Therefore, people that have artificially low declared values in their deeds may need to pay more in capital gains than they would have otherwise if they had used the transaction value. We have even seen people sell real estate at a loss and still have to pay capital gains taxes.

Our recommendation is to make sure that the value declared on the deed is as close to the full transaction cost as possible.

Gains from the sale of securities traded in the Mexico are tax free. Interestingly, the stocks of the Dow Jones Industrial average began trading on the Mexican exchange in 2003, but currently these are only available to institutional investors.

Other Taxes
Property taxes on real estate in Mexico, called predial, are low compared to other parts of the world. Depending on which part of the country you live in, you may not necessarily receive a bill in the mail. You may need to go to the local property tax office to request a bill.

The tax on Mexican plated automobiles, tenencia, is often more than the real estate property tax bill! Again, depending on where you live in the country, you may need to go to the corresponding local office to ask for the bill. A new law was passed in 2003 that will require that residents with an FM-3 pay tenencia on their US plated vehicles. However, I have not heard if the authorities have begun to enforce this law as of yet.

Mexico has a value added tax that is applied to most products and services. It is 15% in most of the country and 10% in border areas.

Conclusion
Mexico is modernizing. In the past, the Mexican governments simply printed money to meet its needs, or relied on oil revenues, and tax collection was a secondary source of income. The country today is run more responsibly and it is not possible to simply to order the Bank of Mexico to print an extra billion here and there. Necessarily, the government must now look to taxes as one of its primary sources of income in order to meet its residents' needs (including the needs of its expatriate community). As it does, the government will become stricter in its enforcement, as well as more efficient.

This is not welcome news to those that move to Mexico in order to avoid all income taxes. However, those that are willing to pay their fair share will find that by planning effectively they may even pay less taxes than they did back home. This is certainly the case for most Canadian citizens that move to Mexico and is also the case for many US citizens.

Confused - and Concerned - About Tax Obligations Related to the Sale of Your Mexican Real Estate? Here's How to Build Your Case for a Mexican Homestead Tax Exemption!

"How can I obtain a capital gains, or homestead, tax exemption on the sale of my Mexican real estate?" is one of the most frequently asked questions by expatriate residents in Mexico when they contemplate selling their homes.

Residents may not be aware that the requirement that you live in your Mexican home for two years before it can be sold as a qualifying property under the homestead exemption was eliminated by tax reform in 2002. And, different interpretations by Notarios (the attorneys responsible for preparing and recording deeds of title and for calculating taxes on real estate transactions) may have sparked the current concern in the expatriate community about the so-called "capital gains" tax. A new awareness and sensitivity to how it's applied, especially to foreign sellers, seems to have created the confusion.

Answers differ depending on where in Mexico you are selling property. For instance, in Los Cabos, foreigners are almost never granted the homestead tax exemption by Notarios. In Mexico City, homestead exemptions are almost always granted to foreigners. And, in San Miguel, the homestead exemptions are granted on a case-by-case basis to the extent that the sellers comply with certain legal requirements.
What it boils down to is the tax status of the seller, not his or her residency status.

Under Mexican Income Tax Law, Notarios are jointly liable with the seller for all taxes due on the sale of real property in Mexico. If Hacienda (the equivalent to the Treasury Department in the US) decides the Notario did not calculate these taxes correctly, the Notario may be required by the tax authorities to make up the difference. Obviously, when they are doing dozens of transactions each year, very possibly involving millions of U.S. dollars, Notarios have to be very careful and will generally take a conservative approach.

The homestead tax exemption is still available to resident taxpayers in Mexico, and it is the Notario who decides who meets the requirements of tax residence. To make this determination, Notarios can base their decision on two different sets of laws: Mexican tax laws and Mexican immigration laws.

How foreign nationals who reside in Mexico are taxed in this country depends, first of all, on the tax treaties Mexico has signed with other countries. Often, tax treaties override any national legislation. In the case of U.S. citizens, therefore, one must review the Mexico-U.S. Tax Treaty, as amended in November 2002.

Article 4 of this treaty states that a "tax resident means any person who, under the laws of that state, is liable for tax therein by reason of his domicile, place of incorporation, or any other criterion of similar nature." This article goes on to state that if the taxpayer is a resident of both states he or she will be considered a resident of the country where he or she has a permanent home.

A tax resident in Mexico is distinctly different from someone who is a legal resident, although often a legal resident generally is also a tax resident. Article 9 of the Fiscal Code of Mexico, amended for 2004, establishes that tax residents are those "who have established an abode in Mexico". If they have two homes available to them, one in Mexico and another one abroad, they will considered a tax resident of the country where the taxpayer has his or her center of vital interests. Mexico will consider that that the center of vital interests is Mexico if over 50% of the taxpayer's income is derived from sources inside of Mexico.

Expatriate tax residents have all the obligations and benefits of all other tax residents in the country, including the homestead exemption contained in Article 109 of Mexican Income Tax Law, which identifies that the transfer of certain properties are exempt from taxes, including: "Those resulting from the transfer of…the taxpayer's home…."

Where the current confusion arises is that some Notarios are of the opinion that the homestead exclusion is available only to legal permanent residents, and they make their tax liability determination on the basis of immigration law, not tax law.

Legal permanent residence is granted pursuant to Article 48 of the General Population Law and is evidenced by possession of an FM-2 visa. Temporary visitors on an FM-3 visa pursuant to Article 42, or on a tourist visa, are not considered permanent legal residents. In fact, the FM-3 document specifically states that the holder does not automatically acquire residency by merely holding the visa.

Your Notario will carefully examine a "fact pattern" before deciding if you qualify for a homestead tax exemption when you sell your Mexican residence. By complying with as many of the points below, you can greatly increase your chance of obtaining a homestead exemption on your Mexican property:

1. Obtain an FM-2 visa to establish legal and permanent residence. There are some Notarios in Mexico who will indeed grant holders of an FM-3 visa a homestead exemption to the extent that the seller qualifies under the tax laws. However, you will gain more credibility as a legal resident with the FM-2. Most Notarios will allow the tax exemption if you hold an FM2.

2. Obtain a Mexican tax identification number, known as "RFC", to show that you take your tax responsibilities seriously. Remember: the homestead exemption is available to "taxpayers" per Article 109 of the Mexican Income Tax Law. What better way to prove that you are a taxpayer than by showing that you have a Mexican tax ID?

3. Open a Mexican bank account that pays interest. The bank will withhold income taxes on your behalf, making you a taxpayer.

4. Live in your home for at least six months. While there is now no time requirement to establish tax residence, often Notarios will want to see at least six months of continued residence at the house.

5. Make sure that your utility bills are in the name of the person who holds title to the property. If the property is owned jointly, try to obtain at least one utility bill in the names of both persons. Gather at least six months of these utility bills as documentation for your Notario.

6. Make sure that the address of the property is exactly the same as the address listed on your FM-3 or FM-2.

If you meet most of the requirements above, and you have been told that you do not qualify for a homestead exemption, you owe it to yourself to get a second opinion and possibly save yourself thousands of dollars in taxes. There are Notarios who follow the tax laws -- and who will grant you the homestead exemption, even if you only have an FM-3. You just need to make the effort to find one!

US and Canadian citizens living in Mexico frequently ask, "Do I need a Mexican Will? While there is no legal requirement to have a Will executed in Mexico, our recommendation, even for people whose only asset in Mexico is their real property held in trust, is to be proactive and draft a Mexican Will. The principal reason is that Mexican property is often caught outside of the trust arrangements: automobiles, jewelry, objects of art, shares in golf clubs, business interests, etc. The second reason is that intestate laws in Mexico are not always favorable to surviving spouses and seldom distribute property in the manner in which the decedent would have liked. If you have property in Mexico and die without any Will, the state courts will look to the interstate provisions of their respective civil code to determine the disposition of assets and establish guardianships.

If absolutely all of your property in Mexico will pass by operation of law or contract, then a Mexican Will may not be required. For example, if you hold property in a fideicomiso (Mexican Trust), the trust document will determine who inherits the beneficial right to the property. Another good example are bank accounts that have beneficiary designations. In either case, property will avoid probate.

Here are some of the most common questions foreign nationals ask about Mexican Wills and estate planning in general:

US and Canadian Wills are valid in Mexico. However, getting the US and Canadian instruments recognized here can entail a relatively lengthy and expensive process. In the case of US documents, these need to be apostiled and notarized in the US and these documents need to be converted into Spanish by a court approved translator before the file is brought to the Notario, who will initiate probate. In the case of Canadian Wills the process is incredibly more complicated because apostils are not issued in Canada pursuant to the appropriate Hague Convention. Therefore, a Mexican Will generally provides for a quicker transfer of assets to the heirs, in a more cost efficient manner.

Mexican Wills are also valid in the US and Canada. However, for ease of administration we usually suggest that if property is owned in those jurisdictions, that an appropriately executed document be prepared in the US or Canada. As an example, Mexican Wills do not contain the signature of the testator, and this fact can cause delay in having the document accepted in common law jurisdictions.

Wrong! There is no such thing as rights of survivorship in Mexico. At the first death, assuming that the partners own the property 50/50, an undivided half will be transferred pursuant to either the decedents Will or pursuant to state intestate provisions.

In the event that the couple does not have a Mexican Will and that they have surviving children, it is probable that the surviving spouse will be disinherited. For obvious reasons, most couples will want to have a Will for this reason alone.

Yes, the executor or executrix is the person in charge of locating the property, preparing an inventory, paying all debts, and is generally in charge of administering the estate and supervising the transfer of title. Some Mexican states require that the executor post a bond.

We suggest that, when possible, the executor live in Mexico or that the executor be given the power to hire a Mexican representative.

Probate is the legal process of transferring title to those properties that do not transfer some other way, after a person dies. If there is a Will, probate in Mexico is generally carried out in private and at a Notario's office. If there is no Will, if the Will is contested, or if there are guardianship issues, the Mexican courts get involved.

Court proceedings in Mexico are private matters and only parties in interest would be able to consult the court's proceedings.

Mexico does not have either an estate tax nor deemed disposition rules. However, the settlement of an estate still has expenses to deal with. Attorney and appraisal fees, transfer taxes, bonds, etc. may all be costs to an estate.

As with anything else, you get what you pay for. A simple Mexican Will can cost anywhere from $150 to $600 US dollars.

We suggest a Mexican springing durable power of attorney be executed. This document would come into effect upon disability of the person who holds title to the property and allows decisions to be made with the Mexican property during incapacity.

We also suggest that medical directives also be prepared to give caregivers an idea of the level of health care that is desired, also during incapacity. While the medical directive is not legally binding in Mexico, it does provide the caregiver with guidance at a critical time. This document is especially important when the person is not married and is dependant on family, doctors, friends and neighbors for care.

Estate planning, as we know the concept the US and Canada is not available in Mexico. In most states, when a foreigner who does not speak Spanish goes to a Notario to prepare a Will he or she is told to handwrite their testament, which is then translated word for word. If you do happen to speak Spanish you tell the Notario what you want and your wishes are given legal form. The problem with this approach is that little thought is often given to the complexities of any estate plan, especially international estates: family relationships, ancillary probate processes, US estate taxes, survivorship issues, special planning situations, etc. Here are a few tips:

1. Make sure that you know what your Mexican Will says. If you did not write it and do not understand Spanish, have it translated. Review your Will today.

2. Mexican Wills we have reviewed often revoke any prior Wills either explicitly or implicitly. Prior Wills are explicitly revoked with a revocation clause. If there are prior Wills and the Mexican Will is silent on the matter, the Mexican Will revokes all prior Wills by operation of law. Often, this is not the testator's intention.

3. Coordinate your estate plan so that all your Wills work to achieve your goals. A Mexican Will should cross-reference any US or Canadian Will, and visa-versa.

4. Have your estate plan reviewed by a competent party, with expertise in international estate issues.

5. If your only Will is a Mexican one, and you own property abroad, we suggest that you include a residuary clause. The residuary clause that makes provisions for residuary estate income, revisionary and contingent interests, and undisposed of remainders or revisionary interests in property with respect to which a life estate has been devised or bequeathed. While residuary clauses make no legal sense in Mexico, and Notarios often do not want to include them, they are important in the US. Failure to include a residuary clause may result in having some assets, at least in the US, distributed pursuant to intestate laws. In addition, taxes will be paid, in the US, from the residuary, unless specifically directed to do otherwise.

6. Other clauses and documents that you may consider depending on the circumstances:

A. Simultaneous Death Clause. This clause is used in the event that both spouses die simultaneously and provides the presumption that one spouse predeceased the other.

B. Testamentary Clause. These are used to direct the executor to create Mexican, US or Canadian trusts.

C. No Contest Clause. These are used to discourage heirs from contesting the Will.

D. Letter of Intent. Often times we do not want to clutter a Will with unnecessary details. These details are better placed in a letter of intent, which will be invaluable in guiding the executor as to your wishes. Furthermore, because there is no such thing as a codicil in Mexico, every time you want to change your Mexican Will, you need to draft a new document. Much in the way of instructions and bequests of personal property can effectively be placed in a letter of intent, making it easy to change your mind at a later date.

Summing it all up, unless all of your Mexican assets are held in a Mexican Trust, the relatively small cost of having a Mexican Will is money well spent for the peace of mind gained from knowing your wishes will be carried out with nothing left to chance - or to the unique provisions of Mexican laws

5/29/04 Mexican tax laws regarding capital gains on the sale of your residence from Don Gussin.

The web has what seems to be a knowledgeable and thorough analysis of capital gains on the sale of a Mexican home by foreigners. See http://www.selectrealestate.com.mx/docs/Mex%20Homestead%20Tax%20Exemption%20July%2020032%20AR%20edits%20-6.pdf.

It says that if you are legally a resident for at least 183 days, you are deemed to be a "tax resident" and are exempt from paying capital gains tax. To nail this down, it presents a checklist on how to save your money:

Your Notario will carefully examine a “fact pattern” before deciding if you qualify for a homestead tax exemption when you sell your Mexican residence. By complying with as many of the points below, you can greatly increase your chance of obtaining a homestead exemption on your Mexican property:

1. Obtain an FM-2 visa to establish legal and permanent residence. There are some Notarios in Mexico who will indeed grant holders of an FM-3 visa a homestead exemption to the extent that the seller qualifies under the tax laws. However, you will gain more credibility as a legal resident with the FM-2. Most Notarios will allow the tax exemption if you hold an FM-2.

2. Obtain a Mexican tax identification number, known as “RFC”, to show that you take your tax responsibilities seriously. Remember: the homestead exemption is available to “taxpayers” per Article 109 of the Mexican Income Tax Law. What better way to prove that you are a taxpayer than by showing that you have a Mexican tax ID?

3. Live in your home for at least six months, the time necessary for you to establish official “tax residency” in Mexico (a total of 183 days).

4. Make sure that your utility bills are in the name of the person who holds title to the property. If the property is owned jointly, try to obtain at least one utility bill in the names of both persons. Gather at least six months of these utility bills as documentation for your Notario.

5. Make sure that the address of the property is exactly the same as the address listed on your FM-3 or FM-2.

If you meet most of the requirements above, and you have been told that you do not qualify for a homestead exemption, you owe it to yourself to get a second opinion and possibly save yourself thousands of dollars in taxes. There are Notarios who follow the tax laws -- and who will grant you the homestead exemption, even if you only have an FM-3. You just need to make the effort to find one!

Objectives of this page this section will contain all "tips regarding taxation on expatriates living in Mexico" that meet the criteria described in Instructions . All tips will be published in the date order of receipt, with the latest letters on top (the oldest nearer the bottom).