©2006 procopio international tax institute investing in mexican real estate 2006 outlook:...

©2006 Procopio International Tax Institute

Investing in Mexican Real EstateInvesting in Mexican Real Estate2006 Outlook: 2006 Outlook: Residential Properties and Residential Properties and

DevelopmentsDevelopmentsPresented by:Presented by:

Procopio International Tax InstituteProcopio International Tax Institute

February 25, 2006 February 25, 2006


U.S.-Mexican Non Tax Issues Real Estate (Comparative Overview)

Key Non-Tax Considerations Mexico U.S.

Notário Público vs. Notary Public Attorney No

Escrows and Closing No Yes

Title Insurance Generally No Yes

Foreign Ownership Restrictions Yes No

Ejidos Yes No


U.S.-Mexican Taxes on Real Estate (Comparative Overview)

Type of Tax Mexico U.S.

Income Taxes Yes Yes

State Income Taxes No Yes

Withholding Taxes Yes Yes

Branch Profits Tax No -Indirectly

Yes

Yes

Value Added Taxes (IVA) Sometimes No


U.S.-Mexican Taxes on Real Estate (Comparative Overview)

Type of Tax Mexico U.S.

Local Transfer Taxes Yes Yes

Local Property Taxes Yes Yes

Estate or “Death” Taxes No Yes

“Asset” Tax Yes No

“Gift” Taxes Sometimes Yes


Mexican Taxes on Real Estate

Resident Individuals Worldwide Income Progressive Tax Rates

- (Range: up to 29% max

Nonresident individuals Source of wealth in Mexico Permanent establishment in Mexico



Residents of Mexico - Individuals

— Principal residence in Mexico (habitual abode)

— Income Tax Law “Tie Breaker”

Center of vital interests (50% income criteria, if a

core of professional activities is maintained in

Mexico).

— Sale of Primarily residence is exempted (only for

Mexican Residents)

— Article 4 - “Tie Breaker” Rules



Nonresidents of Mexico without Permanent Establishment

– Capital Gains:

Sale of Real Estate

Sale of Stock in Real Estate Holding Companies




– Withholding on sale of Mexican Real Estate

25% Gross Amount (or)

33% Net Gain Amount Election / Art. 6 and 25 of US/Mex Treaty

Withholding is done by the Notary Public.




– Withholding on sale of Mexican Real Estate Holding Company– Source of wealth in Mexico if

– The issuer is a Mexican Resident – The value of the Holding is made up of 50% or more from underlying Mexican Real Property

25% Gross Amount (or)

33% Net Gain Amount Election / Art. 6 and 25 of of US/Mex Treaty




Special Issues

- Acquisition of Mexican Real Estate, (Mexican corps or foreign corps with 50% + value represented by Mex RE) by gift is subject

to 25% gross withholding tax

- Only exemption applicable is for gifts among spouses, No exemption for gifts among linear descendants!

- Question as to acquisition by inheritance.

- No “home” exemption (similar to U.S. “principal residence”)

- If Seller understates selling price (10% + difference as to FMV) Foreign Buyer is liable for the unreported tax at a 25% rate on

the gross understated difference.




Lease: Real Estate in Mexico

Withholding at 25% (Gross Amount)

— Done by the lessee if it’s a Mexican resident or a foreigner with permanent

establishment in Mexico, otherwise the lessor must pay the tax within 15 days of

receipt of the funds

— Done by the trustee if its an asset in trust (fideicomiso).



ASSET TAX (IMPAC)

Rate of 1.8%. Foreigners granting use of the assets to a Mexican individual or a

company and affected to the entrepreneurial activity will be taxed IMPAC: to be credited against the Income Tax liability (akin to

the Alternative Minimum Tax) Tax Holiday for New Entities

— Not applicable to entities granting use of the assets.— Exemption of USD$1.4 Million



Mexican “Gift” Taxes (Limited Application)

— Exceptions for

Lineal Family Members

Spouses

General donations - $5,000



Estate, Inheritance or other “Death” Taxes?

— None

— Income Tax applies subject to exemption among spouses

and linear descendents or ascendants.



VALUE ADDED TAX (IVA)

General Rate of 15%

— 10% in Border Region (except that sale of RE in border

region is subject to 15% when applicable and leases are

subject to 15% if the lessor is not a resident of the Border

Region).

Basis Computation

— Transfer of land and residential buildings: Exempt of IVA (different than 0% rate which eliminates the tax)



REAL PROPERTY TRANSFER TAX (ISABI)

Local tax

General Rate, In Baja: 2% (May vary from State to State)

PROPERTY TAXES (Predial)


U.S. Tax Considerations - Choice of Entity - Corp. continued

One consequence of the corporation's status as a separate taxpayer is that there will often be so called "double taxation". The corporation pays a corporate income tax on its profits. If the after-corporate-tax profits are then distributed to the shareholders as dividends, the individual shareholders pay a separate, second tax on these dividends.

Advantages of the Corporation Limited Liability Continuity of life

Centralized management Stock ownership freely transferable

Possibly lower tax rate on entities income

Disadvantages Double taxation in dividend distributions and liquidation

Business losses cannot be used personally


U.S. Tax Considerations - Entity Classification Rules (the “Check-the-Box” or “CTB” Regime)

U.S. corporation always treated as a corporation U.S. partnership, U.S. limited liability company, and most foreign entities may be

treated under CTB regime as a corporation, partnership (if 2 or more members) or simply disregarded (if single member)

Certain foreign entities are per se treated as corporations

— Mexican S.A. and S.A. de C.V., Dutch NV, German AG are per se corporations To obtain desired classification, must either file IRS Form 8832 or rely on default

classification of entity


S.A. vs. S.R.L.Schedule of Estimated Worldwide Income Taxes (U.S. Individual Shareholders)

Income of U.S. Shareholders From Foreign CorporationJurisdiction: Mexico (Dollars Calculation)

Selection of Form of Foreign Legal Entity - Foreign Corporation

FOREIGN CORPORATE STRUCTURE*Sociedad Anonima. De facto foreign corporation pursuant to Treas. Reg. Section 301.7701-2(b)(8) Foreign Corporation

*Mexican Taxable Income 1,000,000$ U.S. Indirect Foreign -$

Tax Credit (not eligible)*Mexican Corporate Tax Rate 29%

U.S. FTC without regard to FTC -$

Mexican "Corporate" Taxes 290,000$ limitations (not eligible)

Mexican After Tax Income 710,000$ U.S. Taxable Dividend 710,000$

U.S. Tax Rate 35%Dividend Distribution 710,000$

U.S. Income Tax (Before FTC) 248,500$

*Max. Mexican Withholding Tax Rate 0% U.S. After Tax Income 461,500$

Tax Treaty Rate (Article10) -10% (Before FTC)

Mexican Withholding Taxes -$ U.S. FTC (not eligible) -$

Mexican Taxes 290,000$ Total U.S. Income Taxes 248,500$

with FTCMexican Effective Tax Rate 29.00%

Effective U.S. Tax Rate 35.00%

DATA FOR INPUT (CHANGING VARIABLES) Worldwide Taxes 538,500$ Corporate U.S. Shareholder (Yes/No)? No*Mexican Taxable Income 1,000,000$

*Mexican Corporate Tax Rate 29% *Worldwide After Tax Income 461,500$ *Mexican Withholding Tax Rate 0%U.S. Indirect Foreign Tax Credit 0 Worldwide Effective Tax Rate 53.85%

U.S. Income Tax Rate 35%

Worldwide Tax Cost (Structured as a Foreign Corporation)

$290,000

$248,500

$461,500

Mexican Taxes

Total U.S. Income Taxes

*Worldw ide After Tax Income


S.A. vs. S.R.L.Schedule of Estimated Worldwide Income Taxes (U.S. Individual Partners)

Income of U.S. Partners From Foreign Partnership/DREJurisdiction: Mexico (Dollars Calculation)

Selection of Form of Foreign Legal Entity - Foreign Partnership/DRE

PROPOSED STRUCTURE*Sociedad de Responsabilidad Limitada. Foreign Partnership/DRE if Election Filed under Treas. Reg. Section 301.7701-3

Foreign Partnership/DRE

*Mexican Taxable Income (47% share) 1,000,000$ U.S. Indirect Foreign -$

Tax Credit (FTC)*Mexican Corporate Tax Rate 29%

U.S. FTC without regard to FTC 290,000$

Mexican "Corporate" Taxes 290,000$ limitations (now eligible)

Mexican After Tax Income 710,000$ U.S. Taxable Income 1,000,000$

U.S. Tax Rate 35%Dividend Distribution 710,000$

U.S. Income Tax (Before FTC) 350,000$

*Max. Mexican Withholding Tax Rate 0% U.S. After Tax Income 650,000$

Tax Treaty Rate (Article10) -10% (Before FTC)

Mexican Withholding Taxes -$ U.S. FTC 290,000$

Total Mexican Taxes 290,000$ Total U.S. Income Taxes 60,000$

with FTC (without regard to FTC limitations)Mexican Effective Tax Rate 29.00%

Effective U.S. Tax Rate 6.00%

Worldwide Taxes 350,000$ Corporate U.S. Shareholder (Yes/No)? No*Mexican Taxable Income 1,000,000$ *Worldwide After Tax Income 650,000$

*Mexican Corporate Tax Rate 29%*Mexican Withholding Tax Rate 0% Worldwide Effective Tax Rate 35.00%U.S. Indirect Foreign Tax Credit 0

U.S. Tax Rate 35% Wordwide Tax Rate Savings 18.85%

Wordwide Tax Dollars Savings 188,500$

Worldwide Tax Cost (Structured as a Foreign Partnership/DRE)

$290,000

$60,000

$650,000

Total Mexican Taxes

Total U.S. Income Taxes

*Worldwide After Tax Income


Outbound Transactions§6038 – Information With Respect To Certain Foreign Corporations

U.S. person who “controls” a foreign corporation (>50% vote or value), or who is a 10% shareholder of a “controlled foreign corporation,” must file Form 5471 to report certain information concerning the foreign corp

Complex ownership attribution rules apply

Penalty for failure to timely file Form 5471 is $10,000 per form / per year, with additional $10,000 penalties each 30-day period during which failure continues after expiration of the 90-day IRS notice period, up to a maximum of $50,000 per form; total penalty can be $60,000 per form for the year of failure; reasonable cause exception


Outbound Transactions Form 8858 Applicable to foreign disregarded entities (FDEs) for all tax returns

required to be filed after December 31, 2004 Does not apply to real branches Applies to U.S. persons who are tax owners of FDEs or that own

certain interests in foreign tax owners of FDEs. Due by the due date of the U.S. person’s income tax return, including

extensions Filed as an attachment to:• Form 1120 if first tier• Form 5471 if owned by a CFC• Form 8865 if owned by a CFP• Form 1040 if owned by an individual Failure to file may make corresponding Form 5471 or Form 8865

“substantially incomplete”


Outbound Transactions

§6038 – Information With Respect To Certain Foreign Partnerships

U.S. person who “controls” a foreign partnership, or who is a 10% partner of a “controlled foreign partnership,” must file Form 8865 to report certain information concerning the foreign partnership


Penalty for failure to timely file Form 8865 is $10,000 per form / per year, with additional $10,000 penalties for continued failure after notice by the IRS, up to a maximum of $50,000 per year; reasonable cause exception



§6038 – Information With Respect To Certain Foreign Corporations And Partnerships

Penalty may also include reduction of foreign tax credit

Statute of limitations with respect to reportable items does not commence until a complete and accurate Form 5471 or 8865 is filed. §6501(c)(8), CCA 200024051

Penalty exposure may be eliminated if foreign corporation has single owner, is an “eligible entity,” and can make check-the-box election to be disregarded entity


Outbound Transactions§6038 – Information With Respect To Certain Foreign

Corporations (Example)

U.S. Person

FC-1 FC-2

100% 100%

• U.S. Person forms FC-1 and FC-2 in 2001 (through the internet) but inadvertently fails to file Forms 5471 for tax years 2001, 2002 and 2003

• US. Person exposed to $60,000 in penalties per year

• If FC-1 and FC-2 are not “per se” corporations, possible to eliminate penalty exposure with favorable private letter ruling granting extension to file Form 8832 check-the-box election for disregarded entity treatment



§6038B – Notice Of Certain Transfers To Foreign Persons

U.S. person who transfers property to a foreign corporation in a nonrecognition transaction (§§332, 351, 354, 355, 356, 361) must file form 926 to report the transfer

U.S. corporation’s liquidation distribution (§336) to foreign person must also be reported by filing Form 926

U.S. person who transfers property to a foreign partnership in a nonrecognition transaction (§721), must file Form 8865 - Schedule O to report information concerning the transfer



§6038B – Notice Of Certain Transfers To Foreign Persons

Penalty for failure to timely file applicable form is 10% of the fair market value of the property, not to exceed $100,000, unless the failure was due to intentional disregard of the rules and regulations

In the case of a contribution to a foreign partnership, in addition to the monetary penalty, gain is recognized on the transfer at Fair Market Value

Statute of limitations with respect to reportable items does not commence until applicable form is filed. §6501(c)(8), CCA 200024051



§6039G – Information On Individuals Losing U.S. Citizenship Reporting requirement imposed in connection with rules on expatriation to avoid

tax under §§877 and 2107 Old law: Individual who loses U.S. citizenship or long-term resident status (green card)

must report for the year of expatriation: taxpayer identification number; mailing address of principal foreign residence; foreign country of citizenship; and, if net worth exceeds $500,000 (adjusted for inflation; i.e., $622,000 for 2004), information detailing assets and liabilities (Form 8854)

Penalty for each year of the ten-year period beginning with the loss citizenship or resident status equal to greater of $1,000, or 5% of tax to which individual subject under §877; reasonable cause exception

American Jobs Creation Act of 2004 amended §6039G to require annual reporting for each year taxpayer is subject to §877 (§877 also amended; applies if 5-year average annual net income tax is greater than $124,000, or net worth in excess of $2,000,000)

Penalty increased to $10,000 for each failure to file; reasonable cause exception



§6046 – Organization or Reorganization of Foreign Corporations and Acquisitions and Dispositions of its Stock

The following U.S. persons are required to file Form 5471 - Sched. O

U.S. persons who become officers or directors of a foreign corporation if a U.S. person owns 10% of its stock,

U.S. persons who acquire stock that causes them to own 10% or more of a foreign corporation,

U.S. persons who dispose of enough stock in a foreign corporation to reduce his interest to less than 10%, and

Other U.S. persons who are treated as U.S. stockholders of foreign corporations under the captive insurance rules of §953(c)



§6046 – Organization or Reorganization of Foreign Corporations and Acquisitions and Dispositions of its Stock


Penalty of $10,000 for failure to file Form 5471 for any tax year, with additional $10,000 penalties each 30-day period during which failure continues after expiration of 90-day IRS notice period, up to a maximum of $50,000; reasonable cause exception

Statute of limitations with respect to reportable items does not commence until Form 5471 is filed. §6501(c)(8), CCA 200024051


§6046A – Acquisitions, Dispositions and Changes of Interests in a Foreign Partnership

U.S. person who acquires or disposes of an interest in a foreign partnership must file Form 8865 - Schedule P if the 10% ownership rule is met

Reporting is also required if their proportional interest in a foreign partnership changes substantially (10%)

Penalty for failure to timely file Form 8865 - Schedule P is $10,000, with additional $10,000 penalties each 30-day period during which failure continues after expiration of 90-day IRS notice period, up to a maximum of $50,0000; reasonable cause exception

Statute of limitations with respect to reportable items does not commence until Form 8865 is filed. §6501(c)(8), CCA 200024051


Trusts Under Mexican Law – General Overview

– Civil Law Legal System

– Securities and Loan Transactions General Act or Ley General de

Títulos y Operaciones de Crédito (“LGTOC”)

– Written instrument between the Settlor and the Trustee

– Must be a financial institution authorized to act as Trustee

– Contractual and fiduciary relationship

– Independent patrimony (§§385,381,387 LGTOC)



For Mexican tax purposes:— If business activities are carried out through the Mexican Trust, tax

obligations arise for the Trust: Registration before the Ministry of Finance Keep accounting books Filling of tax prepayments Annual tax returns is responsibility of beneficiaries

– Beneficiary is treated as the owner of the Mexican Trust, and it’s income (whether distributed or not), and deductions are considered for calculation of the beneficiary’s individual annual tax return

— If no business activities are carried out (testamentary, guarantee or other purposes) the Mexican Trust is considered a pass-through entity



Business activities— Commercial activities – Mainly acquisitions and sale of

goods with speculative intent

— Industrial activities

— Agricultural activities

— Ranching activities

— Fishing activities

— Forestry activities



Sale of property— For Mexican tax purposes it is considered that the grantor alienates the

goods transferred to the Mexican Trust, if grantor does not reserve the right to “reacquire” the properties transferred, or loses such right

— For grantor: All tax consequences arise, including the possibility of deductions

— For beneficiaries: No acquisition cost basis with exceptions for individuals Tax on the acquisition of immovable property is triggered when the

acquisition takes place (dispositions may change from State to State in Mexico)


Mexican Fideicomisos – US Implications

• Various U.S. Tax Implications of Mexican Fideicomisos

– No statutory definition under Internal Revenue Code (IRC)

– Agreement where Trustee takes title to property for the benefit of another – Treas. Reg. 301.7701-4(a)

– Characterization under State Law not definitive for U.S. income tax purposes


Foreign Trusts – U.S. Tax and Reporting Requirements

When do we have a foreign Trust?

Domestic Trust if:

— Court Test - IRC 7701(a)(30) AND

— Control Test – Substantial decisions - Treas.

Reg. 301.7701-7(c)(1)

Substantial decisions include power to

litigate, arbitrate claims, designate

Beneficiaries


§6048 – Information With Respect To Certain Foreign Trusts

Gratuitous transfers by U.S. persons to foreign trusts (e.g., creation of foreign trust) must be reported by the transferor on Form 3520

Form 3520 is filed – In years where reportable transactions take place Annually by U.S. persons treated as owners In years when distributions are received

Failure to file Form 3520 results in penalty equal to 35% of the reportable amount, with additional $10,000 penalties for continued failure after notice up to a maximum of the reportable amount


§6048 – Information With Respect To Certain Foreign Trusts

A foreign trust with a U.S. person treated as an owner is required to file Form 3520-A annually to report information regarding the trust

U.S. owner should appoint a U.S. person to act as trust’s limited agent regarding requests by the IRS to examine records and/or produce testimony, otherwise IRS can unilaterally determine amount U.S. owner is required to take into income

Failure to file Form 3520-A results in penalty equal to 5% of the gross reportable amount, with additional $10,000 penalties for continued failure after notice up to a maximum of the gross reportable amount


U.S. Estate and Gift Taxes and Mexican Real Estate

• Lifetime Exemption Equivalent –

• Currently $ 2 million (for U.S. citizens and

those domiciled in U.S.)

• IRC Code Section 2010(c)

• USD$ 60,000 (not domiciled in U.S.)

• I.R.C. §§ 2102(c)

• No Lifetime Exemption Equivalent for

Gifts


U.S. Estate and Gift Taxes

55% + 5% (surtax in higher estates)

US$ 1,000,000US$ 60,0002011

N/A35%

Estate Tax - RepealedGift Tax Rate - Maximum Rate

Estate Tax - RepealedGift Tax Rate - Equal to Income Tax Rate

2010

45%US$ 3,500,000US$ 60,0002009

45%US$ 2,000,000US$ 60,0002008

45%US$ 2,000,00US$ 60,0002007

46%US$ 2,000,000US$ 60,0002006

47%US$ 1,500,000US$ 60,0002005

48%US$ 1,500,000US$ 60,0002004

49%US$ 1,000,000 US$ 60,0002003

50%US$ 1,000,000US$ 60,0002002

Highest estate andgift tax rate

Estate Tax Exemption Equivalent for U.S. Citizens or U.S. Domiciles

Estate and Gift Tax Life Time Exemption Equivalent for Non-U.S. Citizens with Foreign Domicile

Death inyear


Informational Reporting Requirements§6048(c) – Information With Respect To Certain Foreign Trusts

Beneficiary should obtain from the trust a Foreign Nongrantor Trust Beneficiary Statement (or a Foreign Grantor Trust Beneficiary Statement) and attach to Form 3520 to avoid default treatment as accumulation distribution. Notices 97-34

Penalty for failure to file Form 3520 is 35% of the distribution (even if distribution was non-taxable), with additional $10,000 penalties for each 30-day period failure continues after 90-day notice period, not to exceed amount of distribution; reasonable cause exception. §6677

Statute of limitations does not commence until Form 3520 filed. §6501(c)(8), CCA 200024051


Other Considerations

Mexico’s New Thin Capitalization Rules - Structuring Debt Financing from U.S. to Mexico on Real Estate Deal

U.S. Mexico Income Tax Treaty Benefits on Structured Finance of Mexican Real Estate Deal

Contingent Interest – Benefits of Utilizing


Mexican Taxes: Purchase and Lease of Mexican Real Estate

Purchase of Real Estate

U.S. IndividualBuyer/Landlord

U.S. IndividualBuyer/Landlord

•Transfer Taxes 2% Arising From Sale

Mexican Real Estate

•Federal Asset Tax 1.8% (Annual Tax)

•Local Property Taxes

-No Mexican “Death” Tax

-No Mexican State Income Tax

Mexican Tenant

Lease

•Mexican Withholding Tax - 25%

• Tax on Gross Payment Amounts - -Payable by Mexican Tenant

•Mexican IVA Tax

• Tax on Gross Amounts•15% on Rental Payments•10% in Border Region


Mexican Taxes: Sale of Mexican Real Estate

Mexican Real Estate

-No Mexican State Income Tax

Mexican Buyer

Sale Agreement

• Mexican Income Tax

-25% Withholding on Gross Receiptsor

-33% Tax on Gain (Net Profit)

U.S. IndividualU.S. Individual

•Transfer Taxes 2-4%• Arising From Sale

• Mexican Value Added Tax

-15% of Buildings/Structures


Mexican Company

•Income Tax on 33% (2004) 32% as of 2005 on Net Income

-Depreciation and other Deductions in Mexico

Mexican Tenant

Lease

Purchase


•Transfer Taxes 2%• Arising From Sale

Mexican Real Estate

-No Mexican “Death” Tax -No Mexican State Income Tax

•Federal Asset Tax 1.8% (Annual Tax)

•Local Property Taxes 2%

Mexican Taxes: Purchase and Lease of Mexican Real Estate

• Mexican Value Added Tax (IVA)

-15% of Gross Payments - 10% in Border Region


Taxes from Mexican Real Estate Lease

U.S. Tax Impact

•Foreign Tax Credit?

• Foreign Corporation -S.A. de C.V.

•No FTC if U.S. Individual SH•Indirect FTC if U.S. Corporate SH


•Income Tax on 33% (2004) 32% as of 2005 on Net Income• Mexican Value Added Tax -15% of Buildings/Structures

Mexican Tenant

LeaseMexican Company

Mexican Real Estate

• Foreign Partnership -S.R.L.

•FTC for Mexican Income Taxes and Withholding Taxes

•Must Make “Check the Box Election”

•NO Mexican Withholding Tax on “Dividend” Distributions


Taxes from Mexican Real Estate LeaseU.S. Tax Impact

•Foreign Tax Credit?

• Foreign Corporation -S.A. de C.V.

•Indirect FTC for U.S. Corporate Shareholder (Not Ultimate U.S. Individual)


•Mexican Income Tax of 33% (2004) 32% (as of 2005) on Net Income

Mexican Tenant

Lease

Mexican Company

Mexican Real Estate

• Foreign Partnership -S.R.L.

•Direct FTC for Mexican Income Taxes and Withholding Taxes

•Must Make “Check the Box Election”

•No Mexican Withholding Tax on “Dividend” Distributions

U.S. Company


THE END

©2006 procopio international tax institute investing in mexican real estate 2006 outlook:...

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