Tax Reform in Mexico

01/21/2002

Introduction
 
One of the important legislative initiatives for the Fox Administration was a tax reform package that could improve tax collection, while reducing the government’s historic reliance on Pemex for its tax revenues (typically approximately one-third).  In theory, such reform would improve the country’s financial position, permit greater social spending (even in times of declining oil prices), and elevate the country’s debt rating to investment grade status (for the largest rating service).
 
Effective January 1, 2002, and after heated and extensive congressional debate (lamentably leaving little time for consistency and technical analysis), the Mexican Congress enacted the long-awaited tax reform.  However, the tax reform package contains only a few of the tax reforms proposed by President Fox and leaves open many questions as to both interpretation and the appropriateness of assessing certain taxes for a country with an emerging economy.  Specifically, the new tax package does not include the fundamental tax reforms proposed by the Fox Administration, which proposed eliminating VAT exemptions for basic food stuffs and medicines.
 
The new tax reform includes a new Income Tax Law and Special Tax on Products and Services Law.  The new Special Tax on Products and Services Law simplifies the application of the tax, but its scope has been expanded to apply to more products and services.  In addition, as a by-product of last-minute negotiating, the legislation contains many technical deficiencies such as inconsistencies and ambiguities, leaving much anticipated work for the Mexican courts.   Set forth below are some of the highlights:
 
Income Tax Law
 
The general corporate income tax rate will be reduced from 35% to 32%.  Effective in 2002, this rate reduction will be implemented in gradual 1% reductions per year.  In addition, effective in 2002, the top income tax bracket for individuals will be reduced from 40% to 35% and will be reduced an additional 1% per year, effective in 2003, until it also reaches 32%.  Also, companies will no longer have to make a 5% withholding on dividends paid to individuals residing in Mexico.  Mexico has also adopted a higher withholding rate of 25% for remittances abroad, in the absence of a bilateral tax treating setting a different rate. 
 
The new tax law also permits 50% deductions for certain work-related restaurant expenses.  Deductions for work-related travel expenses have been restricted with the use of tighter Peso amounts.
 
The new tax package contains only one material tax incentive, permitting the immediate depreciation (in the same fiscal year) of investments in new fixed assets located outside the metropolitan areas of Mexico City, Guadalajara, and Monterrey or for those metropolitan areas as well, when involving labor intensive and environmentally friendly projects.
 
In addition to the gradual reduction in the income tax rate, the income tax law has been simplified in certain respects, Mexican businesses and individuals have lost some deductions, a few more concepts have been included as “taxable income,” and the new tax package contains simpler rules for inflation accounting.
 
Special Products and Services Tax- Alcohol and Tobacco  Mexico continues to impose a special tax on alcohol and tobacco products. The rates have been dramatically increased, and now range from 25% to 60% on alcoholic beverages, depending on alcoholic content, and up to 110% tax on certain tobacco products.
 
Tax on Certain Telecommunications Services  Mexico adopted a 10% tax on certain telecommunications services, covering paging services, cellular services, mobile radiotelephony services, specialized communication services between automobile fleets, and cable and satellite TV services.  There are certain exemptions for prepaid cellular phone cards, residential monthly local service where bills do not exceed $250 Pesos (US$28.00), residential monthly long distance service where bills do not exceed $40 Pesos (approximately US$4.50), public phones, internet use, and other services.
 
5% Tax on Luxury Goods  Mexico adopted a 5% luxury tax (in addition to the applicable value added tax) for certain products and services bought for final consumption by the general public.  These products and services include: (i) smoked salmon, caviar, and eels, (ii) certain types of motorcycles (based on certain specifications), (iii) perfumes, guns, silk and leather garments, and TV sets of more than 25 inches, (iv) “computer equipment” with a price higher than 25,000 pesos (equivalent to approximately US$2,777), handheld computers, and camcorders, (v) gold and jewelry (vi) golf club memberships, and (vii) consumption in bars and restaurants where alcohol (other that wine and beer) is available.  Initial popular reaction to the tax on computers and restaurant service has been negative, due to the belief that personal computers are not luxury items, but rather indispensable items in this technology era and that eating out should not be considered a luxury.
 
Authority Granted to States to Tax Income and Consumption.  The Mexican Congress authorized the states to impose a state income tax on its residents.  This authorization is subject to a maximum income cap of $4,000,000 Pesos (equivalent to approximately US$420,000) and a maximum rate of 5%.  In addition, Congress also authorized the states to impose a tax on general consumption (akin to a local sales tax) of up to 3%.  Given that these are state taxes, it remains to be seen which states adopt these taxes and their impact on local economies.
 
3% Tax on Payroll Tax Credit.  Historically, as a means of promoting employment, Mexico has offered employers a 3% payroll tax credit for certain employees with a low salary.  The tax reform now places a 3% tax on employers who elect this option.  The new rules are confusing in this area and call into doubt the continued viability of this tax credit.  Regulations on this issue were recently issued on January 14, 2002.
 
Conclusion
 
The overall outcome is a tax reform that may satisfy few.  It is unlikely to generate the additional revenue desired by the Fox Administration.  Moreover, due to technical flaws, either Congress will be required to amend its work or the Ministry of Finance will have to issue clarifying regulations (miscelanea fiscal) – a constitutionally dubious but convenient way to correct technical mistakes.  Finally, certain analysts argue that Congress adopted new taxes that are inconsistent with the economic development of the country, such as taxes on computers and telecommunications services (teledensity is relatively low in Mexico by Latin American standards).  The Fox Administration, facing the political reality of divided government between three parties for the first time in modern times, may find that its efforts to improve public finances produced unintended effects.
 
For more information, please contact one of the authors at the top of this page.

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