Energy AlertSeptember 2015

After Mexico’s energy sector was opened to private investors in late 2013, devising efficient ways to finance infrastructure projects became a pressing issue. One possibility was to replicate the master limited partnerships (MLPs) traded in the United States since the early 1980s. By grouping together qualifying assets that generate stable cash flows, US MLPs allow companies to raise capital at a lower cost when compared to more traditional sources of financing. Investors, in turn, generally receive higher-than-average yields.

On 11 September 2015, the country’s Finance Ministry announced the tax rules that will govern Mexico’s recently launched MLP-like vehicle, the FIBRA E. In general terms, according to the amendments of the Miscellaneous Tax Resolution, the FIBRA E tax regime is based on the current regulations applicable to the existing real-estate FIBRA.

In the real-estate FIBRA, the issuer trust or subsidiary trust must directly own the assets (immovable property exclusively intended for leasing). However, in the case of a FIBRA E, a legal entity must own the assets. This is due to the nature of the FIBRA E’s “exclusive activities,” which are detailed in the next section. As such, under FIBRA E, the issuer trust must invest in shares issued by one or several Mexican legal entities (the so-called “Promoted Companies”), which in turn own the assets and perform such exclusive activities. All investors of the FIBRA E are subject to taxation in Mexico on income obtained through the FIBRA E, according to the regime applicable to each investor.

Mexico’s FIBRA E tax regulations

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General FIBRA E requirementsThe following requirements apply, in addition to those established by the Mexican tax legislation with regards to real-estate FIBRAs, if applicable:

• A FIBRA E must be a trust created according to Mexican legal guidelines. A Mexican tax resident banking institution or an authorized brokerage house must act as trustee.

• All shareholders of a Promoted Company must be legal entities that reside in Mexico for tax purposes. This requirement should be met before a FIBRA E acquires shares of a promoted company.

• At least 90% of a Promoted Company’s annual taxable income should derive from the following “exclusive activities”:

• The treatment, refining, transportation and storage of oil; the processing, compression, liquefaction, decompression, regasification, transportation, storage and distribution of natural gas; the transportation, storage and distribution of oil products; and the transportation by pipeline and subsequent storage of petrochemicals, among others

• The generation, transmission and distribution of electricity, in compliance with the Electric Industry Law and its regulations

• Infrastructure investment projects that include concessions, services or any other contractual arrangement executed between private parties and the Government for performing services for the public sector or the final user, provided that such projects are currently in operation and have a remaining term of at least seven years, in the following areas:

• Roads, highways, railways and bridges

• Ports, maritime terminals and port facilities

• Civilian airfields, excluding private airfields

• The expansion of the country’s telecommunications network

• Public safety and social reintegration

• Drinking water, sewerage and wastewater treatment

• The administration and management of the FIBRA E trusts.

3Energy Alert Mexico’s FIBRA E tax regulations |

Gains from the sale of land, fixed assets and deferred expenses might be considered as taxable income for purposes of calculating the 90% income threshold, provided that such assets are used in the development of the exclusive activities. In addition, the taxable annual inflation adjustment and foreign-exchange profits might be excluded from total taxable income to calculate the 90% income threshold.

Other rules:

• State Productive Companies and their subsidiaries that are entitled to hydrocarbons exploration and production rights, as well as other legal entities that entered into a contract for hydrocarbons exploration and production with the National Hydrocarbons Commission, are not allowed to qualify as Promoted Companies.

• No more than 25% of the accounting value of a Promoted Company’s non-monetary assets in any given year can be invested in “new” assets (less than 12 months since their acquisition and start of operations).

• At least 70% of the annual average net worth of a FIBRA E trust must be invested in shares of Promoted Companies, which in turn must comply with the “exclusive activities” test. The remainder must be invested in securities issued by Mexico’s Federal Government and registered at the National Securities Registry, or in shares of debt-related mutual funds.

• A FIBRA E trustee must issue trust certificates (certificados bursátiles fiduciarios, or CBFIs) amounting to the entire trust’s patrimony. Such CBFIs must be registered at the National Securities Registry.

• A FIBRA E trustee must distribute to CBFI holders, at least once a year and no later than 15 March of the following year, at least 95% of a FIBRA E tax result.

• A notice should be filed before the Mexican tax authorities stating under oath that all the requirements of the FIBRA E tax regime are met.

• A FIBRA E must be registered in the FIBRA registry, which is managed by the Mexican tax authorities.

• Promoted Companies’ shareholders must fulfill a number of formal obligations to ensure that income tax is paid on tax profits pertaining to such Promoted Companies (see “Tax regime applicable to a Promoted Company” below).

• All shareholders of a Promoted Company must state in writing,

before the Mexican tax authorities, that they (i) accept to offset their tax losses from previous years to the first sale of shares to a FIBRA E, only against profits not obtained from the Promoted Company; (ii) assume a joint liability with respect to the income tax resulting from the FIBRA E tax regime (vis-à-vis their shareholding participation); (iii) assume a joint liability with regards to all the tax obligations of the Promoted Company, before its shares are transferred to a FIBRA E (vis-à-vis their shareholding participation); and (iv) accept the primacy of the Promoted Company’s rules of distributions.

• A Promoted Company should not be subject, either before or after a FIBRA E acquires its shares, to the regimes of “Sociedad Anónima Promotora de Inversión Bursátil” or “Sociedad Anónima Bursátil,” as defined by the Mexican Securities Market Law.

• The trust agreement must include distribution rights for managers, the trust settlor or related parties of a FIBRA E. The payment of any compensation, commission, fee, incentive or distribution will be subordinated to the payment of a preferred return to CBFI holders, excepting those commissions, fees or distributions that are required to keep the fund functioning properly.

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Transfer of a Promoted Company to a FIBRA EA Promoted Company’s shareholders, whose shares are transferred (totally or partially) to a FIBRA E, must determine the taxable gain or loss from the sale of the company’s land, fixed assets and deferred expenses on a proportional basis, as if they were selling assets instead of shares. The sale price of such assets will be the amount agreed to for the share transfer, plus the debt that the Promoted Company may have at such a date, also on a proportional basis. To determine the gain or loss, the Promoted Company’s shareholders must compare the sale price with the tax cost basis of such assets.

If a taxable gain is due, shareholders are obliged to pay the applicable income tax without any deferral option. This taxable gain implies a deferred expense for the respective FIBRA E. However, if the result is a tax loss, this will imply that the FIBRA E should have to recognize a deferred gain (see “Tax regime applicable to the FIBRA E” below). The sale of shares issued by a Promoted Company must be audited by a Certified Public Accountant registered before the Mexican tax authorities.

Drop-down rules

a) Contribution of assets. The transfer of land, fixed assets or deferred expenses from a legal entity residing in Mexico to another (a Promoted Company) is not considered as a sale of goods for Mexican federal tax purposes if these requirements are met: (i) assets are related only to the exclusive activities described above; (ii) the transfer is made as an equity contribution to a Promoted Company, as long as the full consideration for the assets’ contribution is paid with shares issued by the Promoted Company; (iii) a trust that complies with FIBRA E requirements acquires at least 2% of the shares issued by the Promoted Company within up to six months from the date on which the assets’ contribution is effective; and (iv) the Promoted Company complies with all the requirements to qualify as an investment target of a FIBRA E.

If any of the applicable requirements are not met, the transfer of the assets will be considered as a taxable sale of goods for Mexican federal tax purposes, and the applicable taxes will have to be paid retroactively.

b) Spin-off. The spin-off of a Mexican resident entity, whereby land, fixed assets and/or deferred expenses are transferred to a Promoted Company, will not be considered as a sale of goods for Mexican federal tax purposes if these requirements are met: (i) assets are related only to the exclusive activities referred to above; (ii) a trust that complies with the FIBRA E requirements acquires at least 5% of the shares issued by the Promoted Company within up to six months from the date on which the spin-off is effective; and (iii) the Promoted Company complies with all the requirements to qualify as an investment target of a FIBRA E.

If any of the applicable requirements are not met, the transfer of the assets will be considered as a taxable sale of goods for Mexican federal tax purposes, and the applicable taxes will have to be paid retroactively.

To calculate income tax base (see “Tax regime applicable to a Promoted Company” below), the original investment value of the assets transferred to a Promoted Company, by either an equity contribution or a spin-off, will be the undepreciated value before such a transfer (there is no step-up for tax purposes).

5Energy Alert Mexico’s FIBRA E tax regulations |

Tax regime applicable to a Promoted CompanyA Promoted Company is considered as a business trust for tax purposes. This implies that a Promoted Company is not considered a taxpayer per se with regards to income tax. According to the tax regime applicable to business trusts, a Promoted Company must determine its yearly tax result as per Title II (“Legal Entities”) of the Mexican Income Tax Law and then apportion it proportionally among its shareholders. The latter, in turn, are responsible for settling their respective tax payment. Meanwhile, the FIBRA E must take into account such distribution when determining its own yearly tax result.

A Promoted Company’s tax loss in a given year cannot be apportioned among shareholders. Such a loss can be offset only against its future taxable profits. The FIBRA E tax regime does not allow for a step-up with regards to the assets that belong to a Promoted Company, as opposed to the step-up granted under the real-estate FIBRA regime. Therefore, a Promoted Company must determine its tax result based on the assets’ remaining tax cost. A Promoted Company is not obliged to make income tax advance payments; this is consistent with the regime contained in the Mexican Income Tax Law for real-estate FIBRAs. Finally, a Promoted Company may freely distribute cash flow to its shareholders as dividends or capital reimbursements without triggering a corporate income tax payment. The 10% dividend tax withholding is not applicable in respect of dividends distributed to the FIBRA E.

Tax regime applicable to the FIBRA E• Tax result computation. A FIBRA E trustee must determine the

yearly tax result of its vehicle in accordance with the provisions of Title II of the Mexican Income Tax Law. To do so, the trustee must take into account (i) all the tax results distributed by a Promoted Company to the FIBRA E; (ii) a tax deduction through the amortization of the deferred expense arising from the acquisition of a Promoted Company shares, or the recognition of the deferred gain at an annual rate of 15% if a tax loss is triggered upon the transfer of the shares to the FIBRA E, if applicable (see “Transfer of a Promoted Company to FIBRA E” above); and (iii) any other deduction that may be required for the proper operation of the FIBRA E trust.

• Tax result distribution. The distribution of tax results by a FIBRA E follows the same rules applicable to a real-estate FIBRA. In general terms, tax result distributions should be subject to a 30% income tax withholding, except on the portion attributable to exempt CBFI holders (i.e., Mexican SIEFORES) and legal entities residing in Mexico for tax purposes (see “Tax regime applicable to FIBRA E investors” below). Any undistributed tax result is subject to a 30% tax rate and is considered as a final payment. If the amount of the distributions exceeds the tax result, it is considered as a capital reimbursement, in turn lowering the acquisition value of the respective CBFIs.

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Tax regime applicable to FIBRA E investors• Tax result distributions. The distribution of tax results by a FIBRA E to CBFI holders follows

the same rules applicable to a real-estate FIBRA. The applicable tax regime depends on the nature of each CBFI holder, as summarized below:

Type of holder Exempt Withholding

Definitive payment

withholdingLegal entities residing in Mexico NA NA

Individuals residing in Mexico X

Mexican pension funds NA NA

Foreign residents X

Foreign pension funds X

Individuals residing in Mexico should consider the withholding on the distribution of tax results as income from business activities.

Foreign residents, including pension funds, should consider the withholding on the tax result distribution as a final payment. Unlike real-estate FIBRAs, in the case of FIBRAs E foreign pension funds are not exempt from taxation with regards to income obtained through a FIBRA E. The rationale is that FIBRA E income has an “active” nature. By contrast, foreign pension funds are exempted on real estate investments made in Mexico (i.e., income obtained through real-estate FIBRAs).

• Sale of CBFIs. Capital gains obtained by CBFI holders follow the same rules applicable to real-estate FIBRAs. The applicable tax regime depends on the nature of each CBFI holder, as summarized below:

Type of holder ExemptLegal entities residing in Mexico X

Individuals residing in Mexico

Mexican pension funds

Foreign residents

Foreign pension funds

• Nonresidents. As a general rule, foreign holders of CBFIs are deemed to have a permanent establishment in Mexico. However, foreign investors are not obliged to comply with all the formal obligation related to creating and maintaining a permanent establishment in Mexico (e.g., obtaining a tax ID number, filing returns), provided that all the requirements that apply to the FIBRA E regime are met and that tax result distributions made by such a trust are subject to income tax withholding, when applicable. In this case, income tax withheld on FIBRA E tax result distributions is a final payment.

SummaryThe development of the FIBRA E regime is positive news for companies looking to finance infrastructure projects in Mexico. With the continued disparities in private market valuation, companies continue to evaluate public markets to access growth capital and/or alternative growth platforms.

Contacts:Alfredo Álvarez alfredo.alvarez@ey.com +52 55 1101 8422

Deborah Byers deborah.byers@ey.comm +1 713 750 8138

Mario Karim mario.karim@mx.ey.com +52 55 1101 7226

Greg Matlock greg.matlock@ey.com +1 713 750 8133

Francisco Olivares francisco.olivares@mx.ey.com +52 55 5283 1489

Óscar López Velarde oscar.lopezvelardeperez@ey.com +52 55 5283 8677

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This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors for specific advice.

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