With the purpose of adopting the OECD and G-20’s recommendations issued within the BEPS (Base Erosion and Profit Shifting) project, the 2020 Tax Reform includes important modifications to regulate the tax regime of foreign transparent entities and foreign vehicles, which affect the tax transparency of limited partnerships that are traditionally used within the private equity industry to structure their Mexican investments.
After several discussions held with industry experts –in particular with members of the AMEXCAP (Mexican Private Equity Association) – the Lower Chamber of Congress decided to grant a tax incentive that recognizes the status quo of Mexican private equity and venture capital funds. The Tax Reform regulates the tax transparency regime granted to foreign entities or vehicles typically used within private equity investment structures, directly in the Mexican Income Tax Law (MITL), whilst such treatment had historically been granted through temporary tax rules (reglas misceláneas), rulings or from the interpretation of current legislation.
Although the new legislation maintains, in general terms, the same regime that existed for the industry prior to the reform, these amendments do carry the enactment of different compliance obligations that were not formerly applicable, and may require adjustments to some of the current structures. Regardless, these modifications have raised important questions which we intend to clarify throughout this document.
What specific amendments are being considered?
The proposal intends to incorporate articles 4-A, 4-B and 205 in the MITL, which generally establish the following:
article 4-A regulates the general tax regime applicable to foreign transparent entities and foreign legal vehicles;
article 4-B modifies the tax regime applicable to Mexican residents and foreign residents with a Mexican permanent establishment, that obtain income through foreign transparent entities or foreign vehicles, and
article 205 grants a tax incentive by recognizing tax transparency to foreign vehicles that manage private equity investments and obtain interest, dividend, rental (immovable property) and capital gains from Mexican source.
When will the new legislation be enforced?
Articles 4-A and 205 of the MITL, which are the main articles that will regulate the tax transparency regime within the private equity industry going forward, will enter into force on January 1st, 2021. This means that the tax transparency rules that are currently in place (specifically rule 3.18.25 of the 2019 Temporary Tax Rules (Resolución Miscelánea Fiscal)) will remain in force until then.
What is a foreign entity or vehicle for purposes of the MITL?
Foreign entities are understood to be companies and other legal bodies created under foreign legislation that have legal personality (i.e., limited liability companies incorporated under Delaware law). In addition, foreign entities are considered to be legal entities that are incorporated under Mexican law, but are foreign residents for tax purposes; this is, Mexican entities that have their effective place of management abroad.
Conversely, foreign vehicles are understood to be trusts, partnerships, investment funds or any other similar vehicles created under the laws of a foreign jurisdiction, which lack legal personality, (i.e., Canadian limited partnerships).
