Tax considerations for M&A in Mexico

During 2020, the mergers and acquisitions (M&A) market underwent some challenges due to the COVID-19 contingency and plenty of transactions were put off.  Nonetheless, during 2021 and 2022, the M&A market recovered, as evidenced by the number of Mexican entities across various industries and sectors being acquired.

Mexico’s main market comprises small and medium-sized enterprises (SMEs), some of which have enjoyed constant rates of growth.  This could signal good opportunities for possible acquisitions or strategic alliances that allow expansion or incorporation into new markets.

Equally, Mexico is in a geographical location that makes it attractive, not only because of its resources but also because of the free trade agreements with many regions, work force quality, and competitive labor cost.   

On the other hand, it is important to consider that the incorporation of newly created companies, also known as “start-ups”, has become relevant in recent years especially in the digital economy focusing on food delivery services, ecommerce, Fintech and Digital Government.

The analysis of Mexican tax implications when acquiring a business is an important consideration. In this respect, tax due diligence is helpful for M&A transactions in Mexico to gain an overview of the tax implications that could impact the seller and the acquirer.

Through a tax due diligence process, the investor can remain aware of liabilities, contingencies and key findings that will be essential in deciding to acquire a business in Mexico.

So, from a Mexican tax perspective, what are the common ways to acquire a business and the joint and several liabilities that may apply to each of them? Moreover, what are the most important changes derived from the recent tax reforms that could impact M&A transactions?

Acquisition of shares versus acquisition of assets

Buying a business in Mexico can be done through either an acquisition of shares or an acquisition of assets, also known as an asset deal.

In the case of acquisition of shares, the historical tax liabilities remain with the target entity to be acquired. Therefore, the buyer normally requires high warranties to safeguard the purchase and reduce risks.

On the other hand, the seller normally needs to be sure that tax exposures or tax liabilities associated with the acquisition are identified or, at least, mitigated easily to safeguard the price determined on the possible transaction.

In the case where the seller of the shares resides abroad, income tax is imposed under domestic law at the rate of 25% of the purchase price, which the buyer must withhold if a Mexican resident or a non-resident with a permanent home in Mexico. Otherwise, the seller residing abroad must directly pay the tax within 15 days following the sale.

Notwithstanding the above, if certain requirements are complied with, residents abroad may be taxed at the rate of 30% on a net basis, which is calculated as purchase price minus the cost of shares. However, this option is only available so long as certain requirements are fully satisfied.

It is also important to consider that Mexico has a large number of tax treaties around the world, which can be used to reduce or even eliminate the incidence of tax on disposal in some circumstances.

The tax implications of an asset deal

In a transaction involving the disposal of assets instead of the share representing the company wrapper, it is relevant to bear in mind that the transaction cost could be higher due to the fact that the disposal of assets in Mexico is normally subject to Valued Added Tax (VAT).  There is the possibly of other local taxes related to real estate acquisitions. If goodwill arises from the transaction for the purchaser, it will not be deductible for tax purposes.

However, a review of the asset deal purchase structure by financial, tax, legal and labour advisers can help to mitigate tax exposure.

Whether considering an acquisition of shares or acquisition of assets, it is highly recommended that a valuation is carried out by a recognised expert appraiser from the Mexican tax authorities to prevent any unexpected tax exposures.  It will also be important to consider that if such transactions are carried out between related parties, a transfer pricing study or a benchmark study shall be needed.

Changes to joint liability

In the tax reform of 2022, the Federal Tax Code was amended in terms of the joint liability for taxes on the acquisition of shares or the acquisition of assets.

The main change stipulates that there will be joint liability for Mexican taxes due on a full or partial transmission of assets or liabilities on legal transactions between seller and acquirer, where the tax authority determines that a company transfers or acquires a set of goods, rights, or obligations. Such obligations include, among other items, suppliers, workforce, tax address, board members, social security register, brands, copyright and installations. Such joint liability will not exceed the value of such items.

Likewise, joint liability was also amended to include legal representatives appointed by residents abroad.

Under Mexican tax provisions, on acquisition, the seller and buyer share joint liabilities incurred by the business. This commonly covers the period for the last five years, which is the statutory limitation period in Mexico, or up to ten years where there have been irregularities in accounting or tax administration.

Recent changes in Mexican tax legislation that may impact M&A transactions

Mexican general anti-avoidance rule (GAAR): As part of the 2020 Tax Reform, the Federal Tax Code was modified to introduce a new article for a general anti-avoidance rule. The clause introduced in the Federal Tax Code is not aimed at identifying abuses in the application or interpretation of the law but is rather limited to comparing the results between the economic benefit and the tax benefit of a given operation identified in the context of an audit.

If the tax benefit is greater than the economic benefit, the tax authority could conclude that the operation lacks a business reason, and thus charge tax to eliminate the effect of tax avoidance.

It is important to consider that these new powers may be exercised retroactively, that is, concerning transactions performed prior to 2020.

Mandatory disclosure (BEPS ACTION 12): Additionally, as part of the Mexican Tax Reform of 2020, a new Title VI has been added to the Federal Tax Code related to reportable schemes for tax purposes. This reform aligns the Federal Tax Code with BEPS Action 12 mandatory disclosure rules.

In summary, reportable schemes’ rules require either a taxpayer or a tax adviser to report to the Mexican tax authorities any transactions that are designed, marketed, organised, implemented, or administered as tax avoidance schemes or that meet certain other criteria.

Outsourcing reform: Derived from the outsourcing reform, as of 1 September 2021, subcontracted services are forbidden unless they are specialised services pursuant to labour provisions.  In this sense, it is relevant to have mandatory registration (certification) of specialised service providers (REPSE) to avoid any problems in deducting income tax or applying for VAT credits.

Interest expense limitation based on profit levels provisions (BEPS ACTION 4): In addition, net interest deductibility limitation (BEPS ACTION 4) applies as a result of the 2020 tax reforms. In this sense, taxpayers subject to MITL with interest expense over MxP$20m are subject to a net interest expense deduction limitation equal to 30% of adjusted taxable income. Any non-deductible interest expense for each year can be carried forward for up to ten years. Certain debts incurred for construction, operation, or maintenance of productive infrastructure associated with Mexico’s strategic or electricity generation areas may be excluded from the computation of these restrictions.

Next steps

In recent M&A transactions, we have observed that some acquirers are not considering the joint and several liabilities that may exist on an asset deal transaction in Mexico.

As well as ensuring joint and several liability considerations are taken into account, it is also advisable to perform a deeper review of transactions involving family member participation in family businesses.  This may be particularly important given the fact that such entities may have significant tax exposures due to a lack of internal controls, which could be a material factor when considering M&A in Mexico.

All in all, tax due diligence is highly recommended to help determine the full extent of potential tax exposures in a transaction, whether via a purchase of shares or acquisition of assets.