Let’s say it once:

It is not a matter of avoiding the pain for the pain is inevitable; it is a matter of choosing the consequences of pain. – Maurice Maeterlink, Belgian writer

I. Flat Tax Law (IETU)

On January 1, 2008, the Flat Tax Law 2008 (Ley del Impuesto Empresarial a Tasa Unica or IETU for its acronym in Spanish) became effective.

A. Persons, activities and income to be taxed

The persons subject to this tax are individuals and corporations residing in Mexico and foreign tax residents performing entrepreneurial or service activities in Mexico through a place of business considered by the Income Tax Law as a permanent establishment. This new law taxes the income obtained from the following activities performed in Mexico by individuals or corporations:

i. Transfer of goods

ii. Provision of independent services

iii. Use or temporary enjoyment (rentals) of goods

The income is deemed as obtained at the moment of effectively receiving the payment (or compensation) for the activities mentioned above.

B. Income Exempted from the Flat Tax Law (IETU)

This new tax provides that the income received by the following persons, among others, is considered as an exempted income:

  • Income received by civil entities with scientific, political, religious or cultural purposes, except for those with sport installations exceeding 25 percent of the total value of the installation.
  • Income received by chambers of commerce, industry and professionals.
  • Income received by parental associations.
  • Income received by authorized entities to receive donations.
  • Income received by agricultural, livestock or fishing activities.
  • Income received by foreigners from retirement funds.
  • Income received by transferring credit titles.
  • Income received by exchanging currency, except if this is an activity of the contributor.
  • Income received by individuals who performed an activity taxed by this law in an accidental manner (that they are not performing entrepreneurial, professional or rental activities).

C. Deductions

Some deductions allowed by this new law are:

  • Expenses for the acquisition of goods, services, and leases in order to be able to perform the activities previously mentioned.
  • Taxes paid in Mexico. (Not including the flat tax payments, income tax and cash deposits taxes, social security contributions and the ones to be withheld and paid to the tax authorities.)
  • Value Added Tax (IVAIVA) and Special Tax over Services and Products (IESPYS) are deductible when it is not possible to off-set them, with certain conditions.
  • Payments for concessions.
  • Devolution, discounts or down payments reimbursed, while they were subject to taxes at the time they were originated.
  • Payment of damages and penalties imposed by law for liabilities against third parties coming from Acts of Gods or Unforeseen Events, except that the damages or penalties were produced by a breach of the contributor.
  • Payment of policies or bonds for an insured risk.
  • Donations or gifts with the limitations provided by the income tax law.
  • Losses for noncollectable debt and from results of Acts of God, or unforeseen events are deductible within the terms of the Income Tax Law.

D. Requirements of the deductions

The requirements of the deductions are that the expenses are made by the tax contributor for acquisition of goods, hiring independent services or for using or leasing goods that are strictly indispensable and effectively paid, and shall fulfill the same requirements for deductions in the Income Tax Law.

E. Tax Rate

The tax rate is the following:

2008 16.5 percent
2009 17 percent
2010 17.5 percent

F. Calculation of the Tax.

In a very general manner, this tax may be calculated:

Income
Less (-) Deductions
Equals (=)Tax Basis
X 16.5 percent during 2008, 17 percent during 2009, and 17.5 percent during 2010
= Tax to be paid

The flat tax will be declared in the same manner as the Income Tax, as a provisional manner (the 17th of each month) and in a definitive manner (annually, March 31st or April 30th for individuals and corporations, respectively).

G. Tax Credit (Tax Losses)

When the deductions are higher than the income received, the contributors will have a right to a loss as defined by this new law as a “Tax Credit.” This tax credit can reduce the tax to be paid.

E. Comments about the Flat Tax Law (IETU)

The comments about this law that I would like to highlight related to real estate are the following ones:

i) Transfer of real estate made by individuals in an accidental manner, i.e., that they are not performing entrepreneurial, professional or rental activities, is not subject to the Flat Tax (IETU).

ii) Investment in real estate made during September 1, 2007, through December 31, 2007, can be deducted by 33 percent in the fiscal years that follow. For real estate acquired before that time, the investment can be deducted by six percent for the following 10 fiscal years. This is a problem that developers will have to deal with by either challenging this law before the Tax Courts, doing tax planning, or by waiting for an amendment to this law.

iii) Among the exempted income, the Flat Tax Law does not consider condo associations. Therefore, maintenance fees can be considered as income for a condo association. In this relation a condo association needs to have all expenses invoiced so they can be deducted. In addition it is essential that all labor and social security expenses are paid. Again this is a problem that condos will have to deal with by either challenging this law before the Tax Courts, doing tax planning or waiting for an amendment to this law.

iv) Salaries and social security payments require special treatment to be deducted because they can only be deducted on a .175 factor (.175 for 2010, .170 for 2009 and .165 for 2008). Therefore, for Flat Tax deduction matters, it will be more beneficial for companies to hire external services than paying employees and social security.

II. Law on Cash Deposit Tax (LIDE)

On July 1, 2008, the Deposit Cash Tax Law (Ley del Impuesto a los Depositos en Efectivo or LIDE, for its acronym in Spanish) will take effect.

The tax rate for this new tax will be two percent and will be calculated over the excess of a cash deposit of 25,000 pesos (or its equivalent in foreign currency) made in any type of bank account. The bank is bound to withhold this two percent and pay it to the tax authorities.

All individuals and corporations are bound to pay this tax with exemptions, among others, of the following ones:

Authorized entities to received donations Individuals and corporations whose cash deposits do not exceed 25,000.00 pesos Individuals and corporations that receive deposits as part of a loan by financial institutions It is very important to clarify that this tax only taxes amounts deposited in CASH for the part that exceeds 25,000.00 pesos, with the understanding that this amount will be taxed considering all the cash deposits made in all the accounts of a person in the same bank.

The law provides that wire transfers, transfers, credit titles (checks among them) are not considered CASH. But is very important to clarify that a cashier´s check (cheque de caja) exclusively is considered CASH.

Please be aware that this tax can be offset for the payment of the Income Tax and the idea for this tax is to avoid informal economy (tax evasion).

III. How to legally minimize your income tax on capital gains for real estate

To be short, and in accordance with the Income Tax Law and its regulation, please consider the following:

  • If you are buying, make sure the real purchase price of the property you acquire is reflected in your title, because this is going to be the basis to calculate your gain, so the higher your purchase price, the lower your gain.
  • If you are buying, obtain official invoices for closing costs, such as: notary public fees, appraisal and transfer tax payment, because these are deductible.
  • If you are selling, obtain an invoice from the realtor, because this is deductible.
  • If you have already bought and you are building, obtain all invoices for construction, improvements and extension of the property, because these are deductible and need to be made official.
  • If for some reason as a seller you cannot demonstrate the cost of construction improvements or extensions of the property, the value stated in the completed notice of construction (and if the value is not provided then 80 percent of the value reflected in an appraisal referring to the date that such investments were completed) can be used as a deduction.
  • If you are a tax resident and you are selling your dwelling, you can obtain the benefit of tax exemption, under certain circumstances.

I am sorry if this article is extensive, my intention is to write more about this specific matter later on, but I believe that for real estate purposes you need to be ready to understand the consequences of the new Flat Tax Law (IETU) and Cash Deposit Tax Law (LIDE). This way you will be prepared to legally minimize as much of the inevitable pain as possible.