EDITORIAL

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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). Purchases prior to January 1, 2007 are still subject to the old ceiling.

Net operating loss (“NOL”)

Prior legislation limited the utilization of NOLs generated by the surviving company after a merger to income generated in the same trade or business (“Giro”). This rule continues to exist but the new rules also provide that NOLs can only be utilized to offset income in the same Giro when both of the following conditions exist: 1) there is a direct or indirect change in ownership in voting stock of more than 50% after incurring the loss, and 2) the sum of the corporation’s earnings in the previous 3 years is less than the amount of the NOL updated for inflation.

The above rule also applies in the tax consolidations regime.

The new limitations do not apply in the case of changes in ownership attributable to inheritance, gifts, corporate restructurings, and mergers or spin-offs that are not considered an alienation of shares under the Federal Fiscal Code. In the case of mergers and spin-offs that are not considered an alienation, the owners maintaining control before that transaction must maintain control after the merger or spin-off in order to avoid having the new limitation apply to the utilization of NOLs.

These new rules do not affect ownership changes prior to January 1, 2007.

Back-to-back loans

Interest on liabilities which are back-to-back loans is classified as non-deductible dividend. The new legislation expands the definition of back-to-back loans to include those loans guaranteed with shares or debt instruments of any type of the debtor or a related party, or when granting the loan is conditioned on the execution of any and all contracts which grant the right to the creditor or the creditor’s related party to exercise the option upon failure by the debtor to comply with the loan instrument. Also, a back-to-back loan includes the providing of money, assets or services indirectly through any other party.

Exemption of gain upon sale of personal residence

There is a personal residence gain exemption but only to the extent the sales price does not exceed $1,500,000 (UDIs), currently approximates US$515,000. The portion of the gain attributed to the amount which exceeds this amount is fully taxable.

The above monetary limitation does not apply if the taxpayer can prove that he or she used the property as his or her residence for the 5-year period immediately preceding the sale.

Moreover, the exemption only applies to one sale per year and the transaction has to be formalized using a Mexican Notary Public in order to benefit from these provisions. The Notary Public will be required to register each transaction with the Tax Authority and must consult with such Authority to determine if the taxpayer entered into another sales transaction during the year.

Salaried employees filing annual tax returns

Employees are now required to prepare annual tax returns when their salary exceeds $400,000 pesos (the ceiling was $300,000 in 2006). Tax liabilities of employees with salaries below the ceiling amount, are usually calculated by the employer and covered by payroll withholding, with no further annual tax return filing obligation.

However, even if the salary is less than $400, 000, the employee is required to file an annual income tax return unless the only income the employee receives is salary and inflation adjusted interest, and the sum total does not exceed $400,000, providing that the real interest portion does not exceed $100,000.

Income received from Mexican trusts by non-residents

The fiduciary (trustee) is required to withhold the income tax on income received from Mexican trusts by non-residents. This treatment was not clear prior to the new legislation.

Notwithstanding this rule, if the status of an effective beneficiary (beneficial owner) cannot be determined by the fiduciary due to the offering of the investment through the Mexican Stock exchange, the financial intermediary holding the securities on deposit in required to comply with the withholding obligation.

Interest paid to foreign registered banks

The annual legislation allowing a 4.9% withholding rate is again renewed for payments to foreign banks resident in countries that have a treaty with Mexico. In this case, certain compliance requirements are also added.

Mexican Real Estate Investment Trusts (“MREITS”)

The tax treatment of MREITS dedicated to the acquisition or construction or real estate is significantly modified, especially as follows:

1. The fiduciary must be a Mexican credit institution
    authorized to perform such activity in Mexico
2. The trust is now authorized to be constituted to
     finance the acquisition or construction of real estate
     for rental purposes, or to obtain the right to receive
     rental income, with the real estate serving as a
     guaranty (Mortgage) for the rented property
3. The real estate can not be alienated until at least 4 years after the acquisition or construction. Moreover,
    the trust is no longer required to have as one of its purposes the alienation of the
    real estate
4. The trust must distribute at least 95% of the trust taxable profit to the
    investors/beneficiaries annually, no later than March 15 of the following year
5. The trust profit attributed to each investor/beneficiary must be reported by such
    resident or a non-resident with a taxable permanent establishment in Mexico. In the
    case of the non-residents, the withholding tax will be considered as final as satisfying
    the related tax filing obligations of the non-resident
6. A prior rule required at least 20% of the investment certificates to be traded on the
    national stock exchange in order to exempt the MREIT from Asset Tax obligations.
    This rule eliminates that requirement for MREITS, thereby allowing exemption from the
    Asset Tax obligations altogether
7. The legislation provides rules for determining tax basis of trust investment certificates
    sold. Basis is determined based on the average cost method. The average cost
    method assigns total cost of all investment certificates held immediately prior to the
    sale and divides this cost by the total number of investment units held prior to the sale.
   The tax basis of the units sold is obtained by multiplying the average cost to the
    number of shares sold
8. Grantors contributing real estate to the MREIT may defer the payment of tax on the
   gain from alienating such property rather than deferring the gain from inclusion in
   taxable income
9. The exemption from taxation of the gain from the sale of investment certificates is
   maintained for Mexican resident individuals and residents abroad, when the
   participation certificates were purchased and sold on a recognized stock exchange

Stimulus for investments in motion pictures produced in Mexico

During 2006 there were a number of interpretations concerning this stimulus, including the manner of making the calculation and the date of application. The new legislation makes the following modifications:

1. The stimulus/credit is initially equal to the amount of contributions made during the
     year for investment projects in connection with the production of films in Mexico.

2. The stimulus is applied as a credit against the income or asset tax

3. The tax credit can not exceed 10% of the income tax or asset tax of the year which
     immediately precedes the year of application. In 2006, the 10% limitation was
    determined based on the tax owed for the year in which the investment was made

4. A 10-year carry forward period is provided to the extent the credit exceeds the income
    or asset tax

5. The maximum credit assigned to each production can not exceed $20 million pesos

6. The Inter-institutional Committee will publish the credit amounts, applicable taxpayer
     and projects receiving the benefits, on an annual basis no later than the last day of
     February for the preceding taxable year.

A transitional rule allows taxpayers making investments authorized by the technical Committees of the Investment Fund and Promotion of Cinema and the Fund to Produce High Quality Movies, to apply the above rules retroactively to 2006.