EDITORIAL
   
2008 Mexican Tax Reforms - Part V

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By PriceWaterhouseCoopers
Financial system entities

Interest income is not subject to Flat Tax for non-financial system entities to the extent it arises from regular financing activities. However, financial sector entities which include credit institutions (banks), the general deposit warehouses, financial leasing companies, stock brokers, credit unions, financial corporations, the financial factoring companies, the “limited object” financial companies and the “multiple object” financial companies (which are members of the financial system in accordance with the MITL), as well as taxpayers exclusively engaged in financial intermediation and those engaged in collection of receivables pertaining to credit portfolios, are required to consider the following base for purposes of determining the Flat Tax margin for financial intermediation activities:

Accrued interest income
(minus)
Accrued interest expense
(plus/minus)
Result of the net monetary position
(equals)
Margin of financial intermediation or Flat Tax base

For these effects, “interest” has the same definition as thedefinition for Income Tax purposes, and is an accrual vs. cash method of accounting concept, generally used for other Flat Tax purposes.

The activity of a financial service entity will be considered exclusively as a financial intermediation activity, when the income from this concept represents at least 90% of the total Flat Tax income of the taxpayer.

The result of the net monetary position corresponds to debt obligations whose interest income and expenses are measured on a margin basis and are calculated in accordance with the requirements which must be observed by the members of the financial system.

The Flat Tax applies to the other services for which financial entities receive consideration in the form of commissions.

Insurance companies (margin of financial intermediation)

In the case of insurance companies, the margin of financial intermediation will be determined by adding the accrued interest income corresponding to the resources that are subject to mathematical reserves of life and pension insurance, referred to in the General Law of Insurance and Mutualistic Insurance Companies (LGISMS) and the accrued interest on the resources represented by the funds used to administer life insurance contracts, minus the interest that refers to mathematical reserves and the additional accrued interest owed to the insured.

Insurance companies will have the following additional deductions:

1. The creation or increase of the mathematical reserve which is linked to life or pension insurance, as well as the creation or increase to the funds used to administer life insurance programs.

2. The creation or increase of the special mathematical reserve, as well as the other reserves included in the LGISMS.

3. The creation or increase of catastrophic event reserves, for the part that exceeds the real interest. If the real interest is greater than the amount of the creation or increase to these reserves, the difference will be considered as taxable income for Flat Tax purposes.

4. Amounts paid by insurance companies to the insured or their beneficiaries, as well as the amounts paid by bonding companies to cover claims.

5. The losses arising from bad debts, with respect to the services yielding interest income, whenever certain deductibility requirements are met.

6. A deduction also applies to amounts arising from debt forgiveness, allowances, and discounts on credit portfolios which generated interest income, as well as losses originating from the sale of the credit portfolios.

An option is provided in lieu of the options previously mentioned, whereby the credit institution will be able to deduct the preventive global reserves that are created or increased, observing the rules established in the Credit Institutions law, as well as by the National Banking and Securities Commission, with respect to those debt obligations classified as risk type C, D and E, but the deduction cannot exceed 2.5% of the annual average balance of the portfolio of total credits of the corresponding tax year. In the cases that the accumulated balance of the global preventive reserve as of December 31st of the taxable year is smaller than the balance at the closing of the immediately preceding taxable year, the difference is considered additional Flat Tax income. Once this option is selected, it must also be applied in future years.

Gains and losses from purchase and sales of currencies

The purchases and sales of currencies is not subject to the Flat Tax, except when it is the primary business activity of the entity engaging in such transactions. It is considered that a taxpayer is primarily engaged in this trade or business when this income represents at least 90% of its total income.

Flat Tax for taxpayers in bankruptcy proceedings

According to the FTC, when the declaration of bankruptcy is filed with the competent court, the collection of Flat Tax will be suspended until the agreement is signed by the taxpayer with the creditors and the tax authority, or until the bankruptcy decree is issued by the court and then the Flat Tax can be forgiven.

The suspension of the payment of the Flat Tax, as well as its forgiveness, will apply to those taxpayers who on the date the Flat Tax law was enacted, had filed the declaration of bankruptcy, or executed an agreement with their creditors in terms of the Bankruptcy law, according to the following:

1. The agreement must stipulate that the taxpayer will enjoy the suspension of the Flat Tax while the agreement is in effect, without exceeding three years beginning on January 1, 2008.

2. At the end of those three years, the authorities will forgive the payment of the Flat Tax according to the following:

a) The Flat Tax will be updated for each taxable year that the obligation was in suspension.

b) The amount forgiven each taxable year will be the amount determined by multiplying the Flat Tax for each taxable year by the factor resulting from dividing the Flat Tax income that would have been recognized if such law had existed in 2007, by the total Flat Tax income in each taxable year.

c) The difference between the Flat Tax caused in the taxable year and the forgiven amount must be paid by March 31 of the taxable year which immediately follows the last year in which the suspension of collections of the Flat Tax applied, which cannot exceed three years.

The benefit will not apply in the following circumstances:

1. When during the suspension period, the taxpayer agrees to a merger transaction.

2. When during the suspension period, a change of shareholders representing more than 10% of the voting shares occurs.

3. When during the suspension period, the taxpayer changes its predominant activity.

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