As previously informed, President Andres Manuel Lopez Obrador announced a plan of special incentives to foster the economy of the northern border region of Mexico.

In this respect, on 26 December 2018, the National Commission of Minimum Wages published an increase to the daily minimum wage for the Northern Border Zone, in order to be of 176.72 pesos, which is effective as of 1 January 2019, whereas on 31 December 2018, the Ministry of Finance and Public Credit published in the Federal Official Gazette the Decree of Tax Benefits for the Northern Border Region (the "Decree"), effective as of 1 January 2019.

Below, please find a summary of the Decree:

What is the geographical area covered by the "Northern Border Region"?:

Although President Lopez Obrador previously declared that the Northern Border Region would cover a strip of 20 to 30 kilometers parallel to the international border line with the United States of America, the Decree establishes a different geographical area.

Specifically, the Decree provides that the tax incentives will be applicable to taxpayers that undertake business activities in the border municipalities listed below (jointly referred to as Northern Border Region):

Baja California Sonora Chihuahua
  • Ensenada
  • Playas de Rosarito
  • Tijuana
  • Tecate
  • Mexicali
  • San Luis Rio Colorado
  • Puerto Peñasco
  • General Plutarco Elías Calles
  • Caborca
  • Altar
  • Sáric
  • Nogales
  • Santa Cruz
  • Cananea
  • Naco
  • Agua Prieta
  • Janos
  • Ascensión
  • Juárez
  • Praxedis G. Guerrero
  • Guadalupe
  • Coyame del Sotol
  • Ojinaga
  • Manuel Benavides
   
Coahuila Nuevo Leon Tamaulipas
  • Ocampo
  • Acuña
  • Zaragoza
  • Jimenez
  • Piedras Negras
  • Nava
  • Guerrero
  • Hidalgo
  • Anáhuac
  • Nuevo Laredo
  • Guerrero Mier
  • Miguel Aleman
  • Camargo
  • Gustavo Díaz Ordaz
  • Reynosa
  • Río Bravo
  • Valle Hermoso
  • Matamoros

  
What are the specific tax incentives established in the Decree?

  • For income tax purposes, a tax credit will be granted to taxpayers, consistent of one third of the income tax triggered, and which may be utilized against each monthly estimated payment and the annual income tax return, in the proportion of the revenue from the Northern Border Region with respect to the total revenue of the taxpayer.
  • For Value Added Tax (VAT) purposes, a tax credit equivalent to 50% of the VAT triggered by taxpayers that carry out business activities within the Northern Border Region. For administrative simplification, the tax credit will be applied directly on the VAT rate to be shifted to reduce it from 16% to 8% upon the sale or lease of goods, or the rendering of services in the Northern Border Region.
  • The above mentioned tax incentives will be applicable throughout years 2019 and 2020.
       

Who is entitled to the tax benefits established in the Decree?

  • With respect to the income tax benefits:
    • Only legal entities and individuals with entrepreneurial activities that apply for their incorporation into the "Registry of beneficiaries of the tax regime of the Northern Border Region" (the Registry);
    • In order to be incorporated into the Registry, taxpayers must demonstrate:
      • That their tax domicile, branch, agency or establishment is located within the Northern Border Region for at least 18 months prior to the date in which they request their incorporation into the Registry;
      • Those who have a tax address, branch, agency or establishment for less than 18 months in the Northern Border Region, must demonstrate that they have sufficient economic capacity, assets and premises in the Northern Border Region, that they will use "new fixed assets" in the performance of its business activities and that 90% of their revenue is obtained from activities carried out in said Northern Border Region ("new fixed assets" are deemed any assets used for the first time in Mexico or that are acquired from unrelated parties);
      • Have a valid tax electronic signature;
      • Secure a positive opinion of compliance with tax obligations
      • Have full access to the electronic tax mailbox
      • Collaborate each six months with the tax authority in the real-time verification program;
    • The above mentioned timeframe of operation within the Northern Border Region is intended to avoid the artificial migration of business activities to the Northern Border Region, and to foster new business activities with new assets in said region.
        
  • With respect to the VAT incentive
    • The VAT incentive will only apply to the sale and lease of goods, as well as to the rendering of services, that takes place within the Northern Border Region.
    • In order to be subject to the VAT benefit established in the Decree, taxpayers shall comply with the following, in addition to other requirements to be included in administrative rules to be subsequently issued by the tax authority:
      • The material delivery of goods, and/or the rendering of services must take place within the Northern Border Region;
      • File a notice within 30 natural days following to the entry into force of the Decree;
      • Taxpayers that begin operations after the entry into force of the Decree must file the notice jointly with their registry application in the Federal Taxpayers Registry.
          

What are the relevant dates for the application of the Decree?

  • For income tax purposes:
    • Taxpayers shall submit their request for incorporation into the Registry not later that 31 March 2019;
    • The tax authority must issue the resolution within a month following to the filing of the application;
      • In the event that the tax authority does not issue a resolution within such timeframe, the resolution shall be deemed to be rejected (known as deemed denial).
  • For VAT purposes:
    • Taxpayers must file the corresponding notice before the tax authority not later than 31 January 2019;
      • Taxpayers that begin operations in the Northern Border Region after the entry into force of the Decree, must file the notice jointly with the application to the Federal Taxpayers Registry.
          

Are there limitations on the application of the tax benefits?

  • For income tax purposes, among other, the following are not eligible for incorporation into the Registry:
    • Companies that undertake maquila operations for income tax purposes;
    • Taxpayers that provide personnel services through the labor outsourcing regime or that are considered as labor intermediaries under the Federal Labor Law;
    • Taxpayers engaged in the rendering of professional services;
    • Taxpayers that are listed by the tax authority for any of the following reasons:
      • Having an undisputed or an enforceable tax liability;
      • Having tax liabilities that have not been paid or in which the payment has not been guaranteed by the taxpayer;
      • Taxpayers that were not located in their tax domicile, branch, agency or establishment;
      • Having a negative judicial resolution for the commission of a tax crime;
      • Having a cancelation of tax liabilities due to insolvency on the taxpayer; or,
      • Having any tax liability cancelled or pardoned by the tax authority.
    • Taxpayers that undertake tax sham or inexistent transactions, or those that held transactions with such entities without demonstrating that they effectively acquired the goods or received the services on such transactions (known as EFOS and EDOS for their acronym in Spanish language);
    • Taxpayers that have an assessment of a tax liability in any of the previous 5 fiscal years without self-correction or payment;
    • Taxpayers that apply other tax incentives or benefits;
    • Legal entities with stockholders that individually lost their right to apply the Decree;
    • Taxpayers on revenue derived from intangible goods
    • Taxpayers on revenue from e-commerce activities;
    • Taxpayers that undertake business activities through a trust;
    • Banking institutions, insurance companies, and general deposit warehouse companies;
    • Coordinated entities;
    • Entities that are taxed in the optional Tax Regime for Group of Companies ("known as "integradoras" companies, which is similar to the former tax consolidation regime)
    • Taxpayers that form part of the Tax Incorporation Regime (which are small taxpayers)
    • Taxpayers that operate in the "cooperative entities" tax regime, known as Sociedades cooperativas de producción.
  • For VAT purposes, the 8% rate shall not apply in the following cases:
    • Importation of goods and services;
    • Sale of immovable property (construction or improvement portion, as land is VAT exempt);
    • Transactions with intangible goods;
    • Supply of digital content;
    • Taxpayers that are listed by the tax authority for any of the following reasons:
      • Having an undisputed or an enforceable tax liability;
      • Having tax liabilities that have not been paid or in which the payment has not been guaranteed by the taxpayer;
      • Taxpayers that were not located in their tax domicile, branch, agency or establishment;
      • Having a negative judicial resolution for the commission of a tax crime;
      • Having a cancelation of tax liabilities due to insolvency on the taxpayer; or,
      • Having any tax liability cancelled or pardoned by the tax authority.
    • Taxpayers that undertake tax sham or inexistent transactions, or those that held transactions with such entities without demonstrating that they effectively acquired the goods or received the services on such transactions (known as EFOS and EDOS for their acronym in Spanish language).
         

Is it possible to relinquish or withdraw the application of the tax benefits prior to the end of a tax period?

  • For income tax purposes:
    • By unilaterally filing the corresponding request before the tax authority, or;
    • The tax authority may revoke the incorporation in the Registry, whenever the taxpayer does not file a renewal request, or whenever the taxpayer fails to comply with the requirements to obtain and maintain the status in the Registry.
    • Whenever the termination is effective prior to the end of the fiscal year, the taxpayer shall pay the income tax corresponding to the tax credit already applied, along with inflation and surcharges (penalty interest) adjustments.
  • For VAT purposes:
    • In terms of the Federal Tax Code, taxpayers shall not vary the elected option for taxation in one same tax period. Therefore, relinquish from the VAT benefit can only take place after the end of the corresponding tax term.
         

Other general considerations:

  • The tax authority will issue additional administrative rules for the application of the Decree. It is expected that these rules will be issued within the first days of January (the tax authority informally announced that the ruled will be published by January 7);
  • Considering that the tax authority has not yet issued the administrative rules concerning the formal requirements to file the notice to apply the VAT incentive, it is unclear whether the VAT incentive can be applied for transactions of the month of January prior to the filing of the notice, and if so, whether or not it will be possible to cancel the invoices issued on a prior date to replace them with new invoices shifting the reduced 8% VAT rate;
  • It is important to determine the applicable transfer pricing methodologies on inter-company transactions, for the recognition of the operating margin corresponding to the Northern Border Region, taking into account the functions, assets and risks that give materiality and substance to such transactions;
  • There is a concern about the generation of favorable balances of VAT by taxpayers of the Northern Border Region who, according to the Federal Revenue Law of this year, will not be able to offset against other taxes (i.e. against income tax as per the universal offsetting) during fiscal year 2019, which in turn will generate the need to constantly submit VAT refund requests before the tax authority, and in turn could affect the cash flow position;
  • It is convenient to analyze the rules pertaining to the use of "new fixed assets" for any reorganization or restructuring of companies already operating in the Northern Border Region, and for companies with new operations in said region;
  • It is advisable to implement software systems or mechanisms to control operations with suppliers of goods and services to mitigate the risk of carrying out transactions with taxpayers that are or will be included by the tax authority in the lists of taxpayers issuing invoices on alleged sham or inexistent transactions;
  • It is advisable to establish internal mechanisms to avoid being listed as taxpayers that can not apply the tax incentives of the Decree (i.e. internal control to avoid being included in lists of taxpayers with unclaimed or guaranteed tax liabilities, not being located, having pardoned tax liabilities, among others);
  • Even though the tax incentives are established in the Decree as an optional regime, there may be particular circumstances allowing the submission of an appeal, because it may be argued that the limitations or exclusions established in the Decree violate constitutional rights of certain taxpayers. However, this must be analyzed on a case-by-case basis.

As you know, our team of economists and tax professionals, as well as our experts in tax audit and tax litigation, is ready to assist you in assessing the possible effect that the special regime for the Northern Border Region may have on your current operations, as well as alternative models of operations that could be implemented.

In Baker McKenzie we are committed to share valuable information with our clients and friends. If you would like any further advice regarding the above, as well as to resolve any other inquiry you may have, please do not hesitate to contact us.

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