Overview of US & Mexico Double Tax Treaty

US & Mexico Income Tax Treaty

Mexico Income Tax Treaty with the United States: The United States has entered into several tax treaties with different countries across the globe — including Mexico. There are many US taxpayers who are originally from Mexico and/or still maintain offshore accounts, assets & investments and/or generate income from Mexico. The United States and Mexico have several tax agreements in place, including a FATCA Agreement and a Totalization Agreement. The purpose of the tax treaty is so Taxpayers can determine what their tax liability is for certain sources of taxable income. While the treaty is not the final word in how items of income will be taxed, it does help residents better understand how either the IRS and/or Mexico will tax certain sources of income – and whether or not the saving clause will further impact the outcome. Let’s review the basics of the US & Mexico Income Tax Treaty – and how the income tax treaty between US and Mexico works.

Mexico and US Taxation Basics

In general, the default position is that a Taxpayer who is a US person such as a US Citizen, Legal Permanent Resident, or Foreign National who meets Substantial Presence Test is taxed on their worldwide income. This would also include income that is being generated in Mexico, and may be tax-free or exempt under the tax rules of Mexico — unless an exception, exclusion or limitation applies (such as with pension).

Saving Clause in the Mexico Income Tax Treaty

As we work through the United States-Mexico Tax Treaty, one important thing to keep in mind is the saving clause. The saving clause is inserted in tax treaties in order to limit the application of the treaty to certain residents/citizens. With the saving clause, each country retains the right to tax certain citizens and residents as they would otherwise tax under general tax principles in their respective countries — absent the tax treaty taking effect.

What does the Saving Clause Say?

• • • 3. Notwithstanding any provision of the Convention except paragraph 4, a Contracting State may tax its residents (as determined under Article 4 (Residence)), and by reason of citizenship may tax its citizens, as if the Convention had not come into effect. For this purpose, the term “citizen” shall include a former citizen whose loss of citizenship had as one of its principal purposes the avoidance of tax, but only for a period of 10 years following such loss.

Limitations on the Saving Clause

• • • 4. The provisions of paragraph 3 shall not affect

    • a) the benefits conferred by a Contracting State

      • under paragraph 2 of Article 9 (Associated Enterprises),

      • under paragraphs 1(b) and 3 of Article 19 (Pensions, Annuities, Alimony, and Child Support), and

      • under Articles 22 (Exempt Organizations), 24 (Relief from Double Taxation), 25 (Non-Discrimination), and 26 (Mutual Agreement Procedure); and

    • b) the benefits conferred by a Contracting State under

    • Articles 20 (Government Service),

    • 21 (Students), and 28 (Diplomatic Agents and Consular Officers), upon individuals who are neither citizens of, nor lawful permanent residents in, that State.

What Does This Mean?

The Saving Clause is inserted into a tax treaty in order to allow each country to reserve the right to tax citizens and residents the way that they would otherwise tax them had the treaty not been in effect. Despite the insertion of the saving clause into a tax treaty, there are exceptions to the saving clause as well —

Permanent Establishment in the Mexico Income Tax Treaty with the US

• • • 1. For the purposes of this Convention, the term “permanent establishment” means a fixed place of business through which the business of an enterprise is wholly or partly carried on.

    • 2. The term “permanent establishment” includes, especially: a) a place of management; b) a branch; c) an office; d) a factory; e) a workshop; and f) a mine, an oil or gas well, a quarry, or any other place of extraction of natural resources.

    • 3. The term “permanent establishment” shall also include a building site or construction or installation project, or an installation or drilling rig or ship used for the exploration or exploitation of natural resources, or supervisory activity in connection therewith, but only if such building site, construction or activity lasts more than six months.

What Does This Mean?

If a resident of one country has a Permanent Establishment (PE) in the other country, then that other country has the right to tax income generated from the Permanent Establishment within its borders. But, if there is no permanent establishment in place, then the mere fact that a non-permanent establishment generates income in the other country does not allow that other country to tax the income.

Income From Real Property (US & Mexico Tax Treaty)

• • • 1. Income derived by a resident of a Contracting State from immovable property (real property), including income from agriculture or forestry, situated in the other Contracting State may be taxed in that other State.

    • 2. The term “immovable property” shall have the meaning which it has under the law of the Contracting State in which the property in question is situated. The term shall in any case include property accessory to immovable property, livestock and equipment used in agriculture and forestry, rights to which the provisions of general law respecting landed property apply, usufruct of immovable property and rights to variable or fixed payments as consideration for the working of, or the right to work, mineral deposits, sources and other natural resources. Ships, boats, aircraft, and containers shall not be regarded as immovable property.

    • 3. The provisions of paragraph 1 shall apply to income derived from the direct use, letting, or use in any other form of immovable property.

What Does This Mean?

This article provides that if income is earned by residents of one country, as a result of real property that is located in the other country — then it may be taxed in that other country. And, since it does not use the word shall, it presumes that either country may be able to tax the income. Still, foreign tax credits from a US perspective should avoid a US person from having to pay tax to both the United States and Mexico on the same income (although the foreign tax credit is not always a dollar-for-dollar credit).

Dividends (US & Mexico Tax Treaty)

• • • Dividends paid by a company which is a resident of a Contracting State to a resident of the other Contracting State may be taxed in that other State.

    • Such dividends may also be taxed in the Contracting State of which the company paying the dividends is a resident, and according to the laws of that State. However, if the beneficial owner of the dividends is a resident of the other Contracting State, except as provided in paragraph 3, the tax so charged shall not exceed:

      • a) 5 percent of the gross amount of the dividend if the beneficial owner is a company which owns at least 10 percent of the voting stock of the company paying the dividends;

      • b) 10 percent of the gross amount of the dividends in other cases. This paragraph shall not affect the taxation of the company in respect of the profits out of which the dividends are paid.

      • For a period of five years from the date on which the provisions of this Article take effect, the rate of 15 percent will apply in place of the rate provided in subparagraph (b) of paragraph 2.

What Does This Mean?

When dividends are paid by a company of one country to a resident of that other country, then that other country has the opportunity to tax the income. Noting, that the first country (aka country of source) still gets the opportunity to tax the income — but may only tax the dividend income up to a certain tax rate not to exceed 15%.

Interest (US & Mexico Tax Treaty)

• • • 1. Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State.

    • 2. Such interest may also be taxed in the Contracting State in which it arises and according to the laws of that State. However, if the beneficial owner of the interest is a resident of the other Contracting State, except as provided in paragraph 3 the tax so charged shall not exceed: a) 4.9 percent of the gross amount of interest derived from: (i) loans granted by banks, including investment banks and savings banks, and insurance companies; (ii) bonds or securities that are regularly and substantially traded on a recognized securities market; b) 10 percent of the gross amount of interest if the beneficial owner is not a person described in subparagraph (a) and the interest is: (i) paid by banks, including in vestment banks and savings banks; (ii) paid by the purchaser of machinery and equipment to a beneficial owner that is the seller of the machinery and equipment in connection with a sale on credit; and c) 15 percent of the gross amount of the interest in all other cases.

What Does This Mean?

It means that while either state may tax the interest income generated from either state for residents of either state — there are limitations to the amount of tax and the type of interest that may be taxed.

Capital Gains

• • • Gains derived by a resident of a Contracting State from the alienation of immovable property, as defined in Article 6, and situated in the other Contracting State may be taxed in that other State. 

    • For the purposes of this Article, the term “immovable property situated in the other Contracting State” includes: a) immovable property referred to in Article 6 (Income from Immovable Property (Real Property)) which is situated in that other Contracting State, b) an interest in a partnership, trust, or estate to the extent that its assets consist of immovable property situated in that other State, c) shares or comparable interests in a company or other legal person that is, or is treated as, a resident of that other Contracting State, the assets of which company consist or consisted at least 50 percent, by value, of immovable property situated in that other Contracting State, and d) any other right that allows the use or enjoyment of immovable property situated in that other Contracting State.

What Does This Mean?

The capital gains rules provide that when gains are earned by a resident of one country as a result of alienating real property located in the other country — then the other country has the opportunity to tax the income. It is important to evaluate the definition of the term immovable property situated in the other Contracting State to determine whether that particular type of asset qualifies.

Artistes and Athletes (US & Mexico Tax Treaty)

• • • Notwithstanding the provisions of Articles 14 (Independent Personal Services) and 15 (Dependent Personal Services), income derived by a resident of a Contracting State as an entertainer, such as a theatre, motion picture, radio, or television artiste, or a musician, or as an athlete, from his personal activities as such exercised in the other Contracting State, may be taxed in that other State, except where the amount of the remuneration derived by such entertainer or athlete, including expenses reimbursed to him or borne on his behalf, from such activities does not exceed $3,000 United States dollars or its equivalent in Mexican pesos for the taxable year concerned. The other Contracting State may impose tax by withholding on the entire amount of all gross receipts derived by such entertainer or athlete during the taxable year concerned, provided that such entertainer or athlete is entitled to receive a refund of such taxes when there is no tax liability for such taxable year in accordance with the provisions of this Convention.

    • Where income in respect of activities exercised by an entertainer or an athlete in his capacity as such accrues not to the entertainer or athlete but to another person, that income of that other person may, notwithstanding the provisions of Articles 7 (Business Profits), 14 (Independent Personal Services), and 15 (Dependent Personal Services) be taxed in the Contracting State in which the activities of the entertainer or athlete are exercised, unless it is established that neither the entertainer or athlete nor persons related thereto participate directly or indirectly in the profits of that other person in any manner, including the receipt of deferred remuneration, bonuses, fees, dividends, partnership distributions, or other distributions.

    • Notwithstanding the provisions of paragraphs 1 and 2, income derived by a resident of a Contracting State as an entertainer or athlete shall be exempt from tax by the other Contracting State if the visit to that other State is substantially supported by public funds of the first-mentioned State or a political subdivision or local authority thereof.

What Does This Mean?

This section provides that, subject to other sections, an artist or entertainer who is a resident of one country and provides entertainment services in the other country may be tax in the other country — although any income that is less than $3,000 in total is exempt; there are exceptions, exclusions and limitations.

Pensions in the Mexico Income Tax Treaty with the US

• Subject to the provisions of Article 20 (Government Service):

  • a) pensions and other similar remuneration derived and beneficially owned by a resident of a Contracting State in consideration of past employment by that individual or another individual resident of the same Contracting State shall be taxable only in that State; and

  • b) social security benefits and other public pensions paid by a Contracting State to a resident of the other Contracting State or a citizen of the United States shall be taxable only in the first-mentioned State.

• 2. Annuities derived and beneficially owned by an individual resident of a Contracting State shall be taxable only in that State. The term “annuities” as used in this paragraph means a stated sum paid periodically at stated times during a specified number of years, under an obligation to make the payments in return for adequate and full consideration (other than services rendered).

What Does This Mean?

Pensions are always an integral part of any tax treaty. Paragraph 18 provides that pension earned by resident of one country is only taxable in that country if that is where the pension was earned in that country. But, when referring to Social Security payments and other public pensions, it is taxed by source, which means the country that is making the payment gets the opportunity to tax the income. A portion of the pension application is exempted from the Saving Clause.

Government Service (US & Mexico Tax Treaty)

• • • Remuneration, other than a pension, paid by a Contracting State or a political subdivision or local authority thereof to an individual in respect of services rendered to that State or subdivision or authority shall be taxable only in that State.

    • However, such remuneration shall be taxable only in the other Contracting State if the services are rendered in that State and the individual is a resident of that State who:

      • (i) is a national of that State; or

      • (ii) did not become a resident of that State solely for the purpose of rendering the services.

    • Any pension paid directly by, or out of funds created by, a Contracting State or a political subdivision or a local authority thereof to an individual in respect of services previously rendered to that State or subdivision or authority shall be taxable only in that State.

    • However, such pension shall be taxable only in the other Contracting State if the individual is a resident of, and a national of, that State.

What Does This Mean?

When it comes to government service, it is important to note that if a person earns remuneration — including pensions as a result of working for the government — then those public funds are generally only taxable in that country, although exceptions such as which country the Taxpayer resided in at the time of earning the remuneration may impact the application of treaty,

Relief from Double Taxation in the Mexico Income Tax Treaty with the US

• • • 1. In accordance with the provisions and subject to the limitations of the law of the Contracting States (as it may be amended from time to time without changing the general principle hereof), a Contracting State shall allow to a resident of that State and, in the case of the United States to a citizen of the United States, as a credit against the income tax of that State: a) the income tax paid to the other Contracting State by or on behalf of such resident or citizen; and b) in the case of a company owning at least 10 percent of the voting stock of a company which is a resident of the other Contracting State and from which the first-mentioned company receives dividends, the income tax paid to the other State by or on behalf of the distributing company with respect to the profits out of which the dividends are paid. For purposes of this paragraph, the taxes referred to in paragraphs 3 and 4 of Article 2 (Taxes Covered) shall be treated as income taxes, including any profits tax imposed on distributions but only to the extent such tax is imposed on earnings and profits as calculated under the tax accounting rules of the Contracting State of the beneficial owner of such distribution.

    • 2. Where in accordance with the provisions of the Convention income derived by a resident of Mexico is exempt from tax in that State, Mexico may nevertheless, in calculating the amount of tax on the remaining income of such resident, take into account the exempted income.

What Does This Mean?

This is more of a general provision that provides that the purpose of the tax treaty is to avoid certain double taxation — and that subject to certain restrictions in the different articles, double taxation will prevent a person from being taxed twice on the same income.

Exchange of Information and Administrative Assistance (US & Mexico Tax Treaty)

• • • The competent authorities shall exchange information as provided in the Agreement Between the United States of America and the United Mexican States for the Exchange of Information with Respect to Taxes signed on November 9, 1989. 

    • In the event such Agreement is terminated, the competent authorities of the Contracting States shall exchange such information as is necessary for carrying out the provisions of this Convention or to administer and enforce the domestic laws of the Contracting States concerning taxes covered by the Convention insofar as the taxation thereunder is not contrary to the Convention. The exchange of information is not restricted by Article 1 (General Scope). Any information received by a Contracting State shall be treated as secret in the same manner as information obtained under the domestic laws of that State and shall be disclosed only to individuals or authorities (including judicial and administrative bodies) involved in the determination, assessment, collection, and administration of, the recovery and collection of claims derived from, the enforcement or prosecution in respect of, or the determination of appeals in relation to, the taxes which are the subject of the Convention. Such individuals or authorities shall use the information only for such purposes. These individuals or authorities may disclose the information in public court proceedings or in judicial decisions.

    • For the purposes of this Article, the Convention shall apply, not withstanding the provisions of Article 2 (Taxes Covered), to all federal taxes.

What Does This Mean?

The exchange of information provision is designed to further enforce the fact that the purpose of the tax treaty is to promote cooperation and to facilitate any exchange of information necessary for each country to obtain the goals and objectives of being in a double taxation agreement with the other country.

Offshore Reporting (FBAR & FATCA) & United States/Mexico Tax Treaty

When a US person has various Accounts, Assets or Investments in Mexico, they have to reported to the United States each year on various different forms depending on the value of and category of the assets/accounts.

Here are some common forms which may need to be filed:

5 International Tax Forms You May Have Missed

The following is a summary of five (5) common international tax forms.

FBAR (FinCEN 114)

The FBAR is used to report “Foreign Financial Accounts.” This includes investments funds, and certain foreign life insurance policies.

The threshold requirements are relatively simple. On any day of the year, if you aggregated (totaled) the maximum balances of all of your foreign accounts, does the total amount exceed $10,000 (USD)?

If it does, then you most likely have to file the form. The most important thing to remember is you do not need to have more than $10,000 in each account; rather, it is an annual aggregate total of the maximum balances of all the accounts.

Form 8938

This form is used to report “Specified Foreign Financial Assets.”

There are four main thresholds for individuals is as follows:

• Single or Filing Separate (in the U.S.): $50,000/$75,000
• Married with a Joint Returns (In the U.S): $100,000/$150,000
• Single or Filing Separate (Outside the U.S.): $200,000/$300,000
• Married with a Joint Returns (Outside the U.S.): $400,000/$600,000

Form 3520

Form 3520 is filed when a person receives a Gift, Inheritance or Trust Distribution from a foreign person, business or trust. There are three (3) main different thresholds:

• Gift from a Foreign Person: More than $100,000.
• Gift from a Foreign Business: More than $16,076.
• Foreign Trust: Various threshold requirements involving foreign Trusts

Form 5471

Form 5471 is filed in any year that you have ownership interest in a foreign corporation, and meet one of the threshold requirements for filling (Categories 1-5). These are general thresholds:

• Category 1: U.S. shareholders of specified foreign corporations (SFCs) subject to the provisions of section 965.
• Category 2: Officer or Director of a foreign corporation, with a U.S. Shareholder of at least 10% ownership.
• Category 3: A person acquires stock (or additional stock) that bumps them up to 10% Shareholder.
• Category 4: Control of a foreign corporation for at least 30 days during the accounting period.
• Category 5: 10% ownership of a Controlled Foreign Corporation (CFC).

Form 8621

Form 8621 requires a complex analysis, beyond the scope of this article. It is required by any person with a PFIC (Passive Foreign Investment Company).

The analysis gets infinitely more complicated if a person has excess distributions. The failure to file the return may result in the statute of limitations remaining open indefinitely.

*There are some exceptions, exclusions, and limitations to filing.

Receiving a Gift or Inheritance from Mexico

If you are a U.S. Person and receive a gift from a Foreign Person, Foreign Business or Foreign Trust, you may have to file a Form 3520. The failure to file these forms may lead to IRS Fines and Penalties (see below).

Which Banks in Mexico Report U.S. Account Holders?

As of now, there are nearly 2000 Foreign Financial Institutions, within Mexico that report US account holder information to the IRS. The FFI list can be found here:

What is important to note, is that the list is not limited to just bank accounts. Rather, when it comes to FATCA or FBAR reporting, it may involve a much broader spectrum of assets and accounts, including:

• Bank Accounts
• Investment Accounts
• Retirement Accounts
• Direct Stock Ownership
• ETF and Mutual Fund Accounts
• Pension Accounts
• Life Insurance or Life Assurance Policies

Totalization Agreement for US & Mexico

The purpose of a Totalization Agreement is to help individuals avoid double taxation on Social Security (aka U.S. individuals living abroad and who might be subject to both US and foreign Social Security tax [especially self-employed individuals] from having to pay Social Security taxes to both countries).

As provided by the Agreement:

• • • An agreement effective September 1, 1993, between the United States and Mexico improves Social Security protection for people who work or have worked in both countries. It helps many people who, without the agreement, would not be eligible for monthly retirement, disability or survivors benefits under the Social Security system of one or both countries. It also helps people who would otherwise have to pay Social Security taxes to both countries on the same earnings.

    • The agreement covers Social Security taxes (including the U.S. Medicare portion) and Social Security retirement, disability and survivors insurance benefits. It does not cover benefits under the U.S. Medicare program or the Supplemental Security Income program.

    • This document covers highlights of the agreement and explains how it may help you while you work and when you apply for benefits.

The United States has entered into 26 Totalization Agreements, including Mexico.

The Mexico Income Tax Treaty with the US is Complex

In conclusion, The US and Mexico tax treaty is a great source of information to help better understand how certain income may be taxed by either country depending on the source of income, the type of income, and the residence of the taxpayer. The tax outcome may be changed depending on whether or not the savings clause impacts how tax rules will be applied for certain types of income.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure.

Contact our firm for assistance.