Saturday, 23 April 2016

Signed protocol amending the double tax treaty between Mexico and Spain

On 17 December 2015, Mexico and Spain signed a protocol to amend the existing tax treaty between the two countries dating back to 1992, after almost a year and a half of negotiations. The amending protocol is expected to enter into force three months after the exchange of diplomatic notes between the contracting states on the fulfillment of the necessary domestic ratification requirements. Among other measures, the protocol will implement recommendations under action 6 of the OECD’s base erosion and profit shifting (BEPS) action plan (treaty abuse) (including the first principal purpose test to be introduced into a Mexican treaty); modify the withholding tax provisions for dividends, interest and capital gains; change the anti-deferral rule for intragroup reorganizations; and make certain other modifications.
The most relevant changes to the treaty are detailed below:

Treaty abuse
In line with BEPS action 6, the preamble to the tax treaty will be modified to reflect that it is not the intention of the parties to create opportunities for nontaxation as a result of tax evasion or tax avoidance practices.
Additionally, following the proposals under BEPS action 6 almost to the letter, a new limitation on benefits (LOB) provision will be introduced in the form of a “principal purpose test.” The test provides that the benefits of the treaty will not be granted for an item of income if, taking into account all relevant facts and circumstances, it is reasonable to consider that the agreement or transaction that directly or indirectly resulted in the right to claim the treaty benefit had among its principal purposes the obtaining of that benefit, unless it is determined that, under the circumstances, the obtaining of the benefit is in accordance with the object and purposes of the tax treaty.
As a consequence of the new LOB, the targeted anti-avoidance rules included in the interest and royalties articles of the current treaty (article 11(9) and 12(8), respectively, will be eliminated).

Withholding taxes
The protocol will modify the source-country withholding tax provisions for dividends, interest and capital gains (the withholding tax on royalties will not be affected by the protocol).

Dividends: The source-country withholding tax rate on dividends currently is 5% where the beneficial owner is a corporation that owns directly at least 25% of the shares of the company paying the dividends; otherwise, the rate is 15%. The protocol will provide an exemption from source-country taxation where the dividend recipient is:

  • A corporation whose capital is divided into shares or participations and that owns at least 10% of the shares of the payer company; or
  • A pension fund resident in the other contracting state. 

The rate will be 10% in all other cases, regardless of whether the recipient is a corporation or an individual, and there will be no minimum holding requirement.

Interest: The interest article currently provides that interest income derived by a resident of one contracting state and arising in the other contracting state is subject to tax in the source country at a rate of 10% where the interest is paid to a bank that is the beneficial owner, and at a 15% rate in all other cases (although no source-country taxation is triggered on certain loans targeted to promote exports, or when interest is paid by or to the contracting states, their subdivisions or local authorities).
A most-favored nation clause in the current treaty that applies to the interest article (as well as the royalties article) provides that if Mexico subsequently concludes a treaty with another OECD member country that provides for tax rates lower than were agreed in the Mexico-Spain treaty, the lower tax rate will apply automatically. (For example, the tax rate is reduced to 5% where interest is paid to a bank of the other state or derived from securities publicly and substantially traded in recognized markets by virtue of Mexico’s tax treaties with Denmark, the Netherlands and the UK.)
The amending protocol will provide a new exemption from source-country taxation where the beneficiary of the interest is a pension fund and will reduce the withholding tax rate to 4.9% where interest is paid to a bank or other financial institution of the other contracting state, as well as where interest is paid on securities publicly and substantially traded in recognized markets; a 10% tax rate will apply in all other cases.

Capital gains: The de minimis rule under the current treaty that eliminates source-country taxation in the case of direct share disposals where the seller’s shareholding does not exceed 25% of the company’s capital in the 12 months before the sale will be eliminated; however, the source-country tax on direct disposals of shares will be reduced from 25% to 10% of the net gain. Additionally, a new source-country taxation exemption will apply where the seller of the shares is a financial or insurance institution or a pension fund, or where the shares are publicly traded in a recognized market (except for certain real estate shares).

Intragroup reorganizations
The tax deferral provision for certain reorganizations that currently is available for mergers, spinoffs or share-for-share exchanges will be limited to share-for-share exchanges that comply with the following conditions:

  • The consideration received by the transferor consists solely of a participation or other rights in the capital of the transferee or of another company that, before the transfer: (1) owns, directly or indirectly, 80% or more of the transferee; or (2) is owned, directly or indirectly, 80% or more by the transferee;
  • Immediately after the transfer: (1) the transferor owns, directly or indirectly, 80% or more of the voting rights and capital of the transferee; (2) another company owns, directly or indirectly, 80% or more of the voting rights and capital of both the transferor and transferee; or (3) the transferor owns 80% or more of the voting rights and capital of the company that previously was owned by the transferee; and 
  • All corporations involved are residents of one of the contracting states or of a country with which the source state has a treaty or an effective information exchange agreement at least as broad as article 27 of the Mexico-Spain treaty (as amended by the new protocol).

Other provisions

  • Residence tiebreaker rule for corporations: Where the application of the “place of effective management” test for tax residence results in dual residence, the competent authorities will, via the mutual agreement procedure, determine the country of residence of the corporation for purposes of the application of the treaty by considering where the delegated council and high executives habitually carry on their functions, where the day-to-day upper management decisions take place and other similar factors.
  • Transfer pricing: A new provision will be included in the associated enterprises article of the treaty (article 9) on secondary adjustments in the case of double taxation resulting from an assessment by the tax authorities in transactions between related parties.
  • Technical assistance payments as business profits: Similar to the protocol of the Mexico-Netherlands tax treaty, a clarification will be included regarding the treatment of technical assistance payments under the business profits article (article 7) or independent personal services article (article 14) of the Mexico-Spain treaty.
  • Permanent establishments for oil and gas exploration and production industry: In line with the provisions of the Mexican Hydrocarbons Law and Hydrocarbons Revenue Law, a new article 22 will be included in the treaty, which will provide that a resident of one contracting state carrying on exploration, production, refinement, processing, transportation, distribution, warehousing or trading of hydrocarbons in the other contracting state for a period exceeding 30 days in any 12-month period will create a permanent establishment in the other contracting state. For purposes of the 30-day term, the activities carried on by associated enterprises may be aggregated, if such activities are identical or substantially similar. A similar provision will be included for purposes of the taxation of wages and salaries of employees carrying on the relevant activities.
  • Elimination of double taxation: The protocol includes a provision that Mexican corporations may credit the underlying corporate income tax paid by Spanish subsidiaries where the Mexican corporation holds at least 10% of the Spanish subsidiary. The provision is in line with article 5 of the Mexican Income Tax Law. (In the case of Spain, Spanish residents are able to deduct the corporate income tax paid in Mexico by Mexican subsidiaries paying dividends, as well as the applicable taxes withheld by Mexico, in accordance with the domestic legislation.)
  • Tax arbitration: A new mutual agreement procedure (article 26) will be included in the treaty. Mexico agreed that if, in the future, a tax treaty with an arbitration provision similar to the one included in the OECD model treaty is concluded with a third state, the provision will apply automatically between Spain and Mexico as from the date of entry into force of the treaty between Mexico and the third state.
  • Exchange of information and assistance in collection of taxes: The exchange of information article (article 27) will be modified to align with article 26 of the OECD model treaty, since its scope will be  extended to other taxes not covered by the treaty. Additionally, a new article 28 will be introduced regarding assistance in the collection of taxes. 

Source: De3loitte