By PriceWaterHouseCoopers.
INTRODUCTION

Although the Executive branch stated that the legislation is aligned with the long term revenue policies of the country, it considered that these reforms are no substitute for the need to formulate a more comprehensive tax reform package, which is planned to occur in 2007 or 2008. In this connection, it is understood that both the Executive and the Legislative branches will undertake a detailed study of the tax laws in the context of the existing circumstances of the country.

The vast majority of the sectors agree that there is the need to increase tax collections in order to reduce poverty levels and to meet growth and employment objectives. There is also widespread consensus that the overall base of taxpayers contributing to the revenues needs to be singnicantly expanded. This requires not only a reform in the tax and spending laws but in the procedures to be used by the Tax Authorities. In order to achieve these goals, this will require more resources and the application of clear and equitable tax laws which provide greater efficiency of the tax enforcement bodies. It is also agreed that the reforms need to consider incentives for growth in employment and investment while rationalizing the spending of public resources.

The primary changes are summarized below:

1. Increase in the income tax rate applicable to the farming, fishing, forestry and cattle
    raising sector (also known as the Primary Sector)
2. Restriction of the use of business trust net operating losses
3. Limitation on the deduction of interest for thinly capitalized companies
4. Limitation on the use of net operating losses after a change in ownership
5. Changes in the incentives for Mexican real estate investment trusts (MREITS)
6. Increase in the tax base for calculating the asset tax by eliminating the reduction
    of liabilities offset to some extent by lowering the tax rate to 1.25%
7. Restriction on the taxpayers’ right to challenge administrative ruling decisions.

REVENUE LAW OF THE FEDERATION (RL)

The statement of motives and legislator’s intent for the RL forecasts that 2007 will result in an increase of real value Gross Domestic Product to a 3.6% annual rate.

The RL estimates that in the medium term, Mexico will enjoy stability of prices, with an expected annual inflation rate of between 2% and 4%.

Interest rates on tax payments

In the case of an extension to pay tax assessments, the monthly interest rate of 0.75% will apply, while self corrections before an audit will be subject to a 1.125% rate, applied on the tax.

When the Tax Authorities grant the taxpayer the right to pay tax in installments, the following rates apply:

The above rates already include the effect of inflation adjustments on the unpaid tax.

Withholding tax rates on interest

The income tax withholding rate on interest paid to Mexican residents by Mexican financial system entities (such as banks) of 0.5% applied to capital, is extended for 2007.

Tax Incentives (economic stimulus or subsidy provisions)

The following tax incentives are either added or modified:

1. There is a new tax incentive allowing taxpayers required or electing to be audited for tax purposes in year 2007, to reduce their taxable income by an amount equal to 0.5% of the taxable income for the year, providing the taxpayer filed and paid taxes on a timely basis, satisfying the entire obligation for each and every monthly estimated advance tax payments for the same year.

The reduction in tax shall be an amount equal to 0.25% of the taxable income, when the difference between the amount paid in the monthly estimated advance tax payments and the amount which should have been paid with those monthly payments did not exceed 5% for each of those payments.

This benefits shall be applied exclusively to reduce the 2007 unpaid income tax liability and shall be credited based upon the filling of an amended tax return in connection with the presentation of the annual statutory tax audit report, compensating income or other taxes due, although a refund can not be obtained.

2. It is established that the tax stimulus determined under article 219 of the Mexican income tax law, which is to be distributed to those taxpayers engaging in research and development shall be maintained at $4,500 million pesos for 2007.

3. The prior rule allowing an exemption from the application of the minimum asset tax for individuals and corporations with prior year revenues of up to $4 million pesos, no longer applies. The law now requires the Executive branch to develop criteria by January 31, 2007, describing the characteristics that would be required for taxpayers to apply a tax incentive which could be equivalent to being exempt from the asset tax.

Abatement of tax liabilities and reduction of penalties

The Tax Authorities are now authorized to abate certain tax liabilities, surcharges and penalties upon request the taxpayer.

In the case of liabilities for years prior to 2003, the Tax Authorities are authorized to forgive up to 80% of the tax liability, and allowed to abate up to 100% of the related surcharges and penalties, as long as the agreed-upon amount is paid in one installment.

Notwithstanding the above, in the case of liabilities incurred for years prior to 2003, the Tax Authorities are permitted to waive up to 100% of the total assessment if the taxpayer was examined “during” (not “for”) 2004, 2005 and 2006 and the liabilities resulting from those examinations, if any, were entirely satisfied. This is a form of concession for good behavior. An example might be that 2001 and 2002 was examined in 2004, 2005 and 2006 and no tax assessment was made. Moreover, further assume that a 1996 court case was decided in favor of the Tax Authority during 2007. In this case upon request by the taxpayer, the Tax Authorities could abate up to 100% of the 1996 liability including, taxes, surcharges and penalties.

In the case of liabilities for 2003 through 2006, the tax liability can not be abated. However, the Authorities are able to abate up to 100% of any surcharges and penalties for those years, as long as the agreed-upon amount is paid in one installment.

Authorities providing certain information to credit bureaus

Beginning in 2008, the Tax Authorities will provide taxpayer information on unpaid liabilities to credit rating agencies.

INCOME TAX LAW (MITL)

Corporations changing their residence from Mexico to another country

If a corporation is no longer considered a Mexican resident under current Federal Fiscal Code or an applicable tax treaty, this change in status is considered to be a deemed liquidation for income tax purposes. The new legislation also provides that such deemed liquidation treats the liquidating entity as selling all of its assets for tax purposes, regardless of where the assets are located, as part of the liquidation, at the time the liquidation is deemed to occur.

Business Trusts

The new legislation still requires the beneficiaries of the business trusts to include the income of the trust in their taxable income but limits the utilization of trust losses by beneficiaries, such that any losses of business trusts are now only available to be utilized against the trust’s own future profits.

The law reform also requires the fiduciary to determine and maintain a tax basis investment capital account for each of its beneficiaries.

Upon extinguishment of the trust, any unused losses can be utilized by the beneficiaries, but only to the extent of their investment in the trust.

Deduction for the cost of meals in restaurants

The deduction for meals in restaurants is now 12.5% of the cost, while the deduction in 2006 was 25% of the cost. There are no changes to existing law for meals incurred as part of travel expenses.

Thin capitalization

The thin capitalization rules were modified. All liabilities are now considered for purposes of calculating the disallowed interest expense amount in determining the annual average liabilities. Prior income tax law appeared to refer solely to liabilities arising from loans.

The proposed legislation also clarifies that the disallowance only applies to interest on debts with related parties resident abroad

In addition, the previous law provided that certain loans were excluded from the computation of the disallowed interest, if the loan terms had at least one of the following items limiting the debtor’s ability to:

1. make distributions of profit/dividends
2. make capital reductions
3. sell material fixed assets
4. initiate new debts/loans
5. transfer the majority of ownership/capital

In addition to one of the above requirements, the loan provisions were required to permit the creditor to intervene in how the loan proceeds are applied in order to exclude the debt from the calculation.

The new legislation no longer allows such debt to be excluded for purposes of determining the annual average liabilities. On the other hand, liabilities incurred for construction, operation or maintenance of the productive infrastructure associated with the strategic areas of the country will not be included in the annual average liabilities.

Ceiling on deduction for the cost of automobiles acquired during the year

The new legislation reduces the maximum allowable deductible costs for automobiles from $300,000 to $175,000 pesos (this excludes value-added tax, tags, certain registration fee although the new automobile tax is included in the ceiling). .... more information.