As part of the 2017 economic budget and proposed tax reform, the Mexican government intends to incentivize a couple of activities that may be intertwined: first, by allowing information technology (IT) services to qualify as an export subject to 0 percent value added tax (VAT), as opposed to the 16 percent general VAT rate; and second, by reintroducing a tax credit for research and development (R&D) activities carried out in the country.
0 percent VAT on IT services
Under Article 1 of the VAT Law, entities and individuals are subject to VAT when they carry out the following activities while in Mexican territory: 1) sale of goods; 2) rendering of independent personal services; 3) grant of temporary use and enjoyment of goods; or 4) import of goods or services.
The VAT is a turnover tax and is paid and credited by intermediaries until the goods or services reach the ultimate consumer. VAT paid by a company on the purchase of goods or services is generally allowed as a credit against the VAT collected from customers; as a result, the net tax paid to the government is the amount by which VAT collections on sales exceeds VAT paid on costs and expenses. If, in a given period, VAT paid to suppliers exceeds the VAT collected from customers, the excess may be carried forward to the following tax period; or, alternatively, the taxpayer may obtain a refund for such excess. The credit procedure is capped to the percentage of activities subject to VAT.
Under existing VAT rules, IT services provided in Mexico, whether the beneficiary or recipient of the services is located there or elsewhere, would be subject to the general 16 percent VAT rate. This is because they are provided in Mexico and do not fall within the definition of exportation of services.
In an effort to increase competitiveness in the market, however, the proposed 2017 tax reform provides that IT services rendered by Mexican taxpayers could qualify as an export subject to the 0 percent VAT rate, if the recipient of the services is a foreign resident.
The IT services that would qualify as an export are the following:
- Development, integration, and maintenance of applications or computer systems
- Processing, storage, and backup of information, as well as the management of databases
- Accommodation of data applications
- Modernization and optimization of information security systems and
- Ensuring operational continuity of the previously mentioned services.
The proposed reform sets out certain limitations that most likely will be addressed through regulations, among them:
- Technological infrastructure, human, and material resources should be located in Mexico
- IP addresses and Internet provider should be located in Mexico
- IP addresses and Internet provider of the service beneficiary should be located abroad
- The tax ID number of the service recipient that requested and paid for the services should be included
- Electronic payments from foreign financial institutions into Mexican banks should be demonstrated.
R&D tax credit is back
As part of the 2017 tax reform, the Mexican government is bringing back to life a tax incentive that was available up to 2008 and later changed to a cash type of grant for R&D activities. The proposed incentive consists of a credit of 30 percent of qualified R&D expenses, aimed at encouraging investment in this area.
The Mexican government has significantly increased the total amount of the budget destined for this incentive to MX$1.5 trillion, with a cap of MX$50 million per taxpayer.
An Interinstitutional Committee (i.e., National Council for Sciences and Technology, Ministry of Finance, Ministry of Economy, and Ministry of Education) oversees the assignment of the funds, based upon the individual characteristics of each project presented.
Specifically, proposed Article 202 of the Mexican Income Tax Law (MITL) provides a tax incentive in the form of a credit of 30 percent on the average amount of R&D expenses incurred during the previous three years. Moreover, the credit must be used within 10 years. It is important to mention that this credit would not be considered as taxable income.
In general terms, in order to qualify for this incentive, the expenses must be incurred in Mexico, with the purpose of carrying out projects focused on the development of products, materials, or production processes that represent a scientific improvement or technological advance, according to regulations to be issued by the Interinstitutional Committee.
Although pre-approval is required from the Interinstitutional Committee, the mechanism should be fairly simple - a taxpayer takes a direct credit of 30 percent based on its costs incurred for the approved R&D projects against its income tax due at the end of the year. In the past, the incentive was granted on a per-project basis; hence, a taxpayer could receive an incentive for multiple projects. This seems to be the case for the proposed rules.
Moreover, in the past, the incentive was granted based on a first-come, first-served basis; thus, preparing in advance for the filings is critical to ensure ability to respond in a timely way, as is being in compliance with the requirements to be published through regulations.
Companies could benefit by creating an IT services hub or shared services center (SCC) in Mexico, or by shifting or expanding some of their IT related activities into the country. Mexico offers relatively low labor costs and a skilled workforce for IT related activities. This should be among the factors for multinationals to ponder, along with other considerations that could also confer benefits. Among these factors: domestic costs to be incurred under local currency, which has been devaluing recently; and income that could be invoiced in foreign currency, as it would be an exportation of services.
Further, many companies operating in Mexico and carrying out IT activities could benefit from R&D incentives and are not fully aware of how the tax credit would work. Even though the incentive is not received in cash, it could represent a significant reduction in future income taxes.
Please feel free to reach out to us to discuss further.
*Abelardo Acosta is a Mexican lawyer working as a Law Clerk and based in DLA Piper’s San Diego office.