Eligibility for Treaty Benefits Under the Mexico-U.S ... · Eligibility for Treaty Benefits Under The Mexico-U.S. Income Tax Treaty by Jason Connery, Ron Dabrowski, and Jennifer Blasdel-Marinescu

Eligibility for Treaty Benefits UnderThe Mexico-U.S. Income Tax Treaty

by Jason Connery, Ron Dabrowski, and

Jennifer Blasdel-Marinescu

Reprinted from Tax Notes Int’l, June 27, 2016, p. 1285

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Eligibility for Treaty Benefits UnderThe Mexico-U.S. Income Tax Treatyby Jason Connery, Ron Dabrowski, and Jennifer Blasdel-Marinescu

To benefit from income tax treaties, companiesmust satisfy eligibility requirements. This article

includes decision-making flowcharts to assist taxpayersand tax practitioners in navigating the eligibility re-quirements of the Mexico-U.S. income tax treaty andits accompanying protocols (collectively referred to as

the treaty) as applied to Mexican companies. Particularattention is paid to the eligibility requirements for the 0percent withholding tax rate on dividends.1

Income tax treaties can exempt business incomefrom source-country income taxes and eliminate orreduce domestic withholding taxes on payments be-tween residents of countries that are income tax treatypartners. To benefit from a U.S. income tax treaty,companies generally must be resident in a treaty part-ner country and must satisfy at least one of the testsunder the applicable limitation on benefits provision.

The flowcharts in this article are focused on the eli-gibility of Mexican companies to claim treaty benefitsunder the treaty’s LOB article (article 17) on incomethat would otherwise be subject to U.S. federal incometaxation. The article does not address the treaty benefiteligibility of entities that are partnerships or are other-wise transparent for U.S. or Mexican tax purposes. Thearticle is based on the treaty, its accompanying proto-cols, and U.S. Treasury technical explanations.

The article also addresses the eligibility of Mexicancompanies for the 0 percent withholding tax rate ondividends under article 10.3 and the LOB provision ofthe treaty.

Although the flowcharts in this article provide acomprehensive review of applicable provisions underthe treaty, taxpayers and their tax advisers should care-fully evaluate each individual case and determine

1Convention Between the Government of the United States ofAmerica and the Government of the United Mexican States forthe Avoidance of Double Taxation and the Prevention of FiscalEvasion With Respect to Taxes on Income, signed on September18, 1992; and accompanying protocols signed on September 18,1992, September 8, 1994, and November 26, 2002.

Jason Connery Ron Dabrowski Jennifer Blasdel-Marinescu

Jason Connery and Ron Dabrowski are princi-pals in KPMG LLP’s international tax group ofits Washington National Tax practice. JenniferBlasdel-Marinescu is a senior manager withKPMG’s international tax practice and based inColumbus, Ohio.

The information in this article is of a generalnature and based on authorities that are sub-ject to change. Applicability of the informationto specific situations should be determinedthrough consultation with your tax adviser.

This article represents the views of the au-thors only and does not necessarily representthe views or professional advice of KPMG.

In this article, the authors provide flowchartsto assist practitioners in determining whethercompanies are eligible for benefits under thelimitation on benefits provision in the Mexico-U.S. income tax treaty.

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TAX NOTES INTERNATIONAL JUNE 27, 2016 • 1285


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whether the requirements of the treaty are met basedon all facts and circumstances.

This article is the 15th in a series of articles2 thatprovide flowcharts to assist taxpayers and tax practitio-

ners in determining companies’ eligibility for tax treatybenefits under the LOB provisions of specific U.S. in-come tax treaties and, when applicable, determiningeligibility for a 0 percent withholding tax rate on cross-border intercompany dividend payments to the com-pany. ◆

(Flowcharts start on next page.)2See Jason Connery, Ron Dabrowski, and Jennifer Blasdel-Marinescu, ‘‘Eligibility for Treaty Benefits Under the Denmark-U.S. Income Tax Treaty,’’ Tax Notes Int’l, June 29, 2015, p. 1219;Connery and Blasdel-Marinescu, ‘‘Eligibility for Treaty BenefitsUnder the Belgium-U.S. Income Tax Treaty,’’ Tax Notes Int’l, Feb.10, 2014, p. 563; Connery and Blasdel-Marinescu, ‘‘Eligibility forTreaty Benefits Under the Ireland-U.S. Income Tax Treaty,’’ TaxNotes Int’l, June 17, 2013, p. 1223; Connery, Douglas Poms, andBlasdel-Marinescu, ‘‘Eligibility for Treaty Benefits Under theSweden-U.S. Income Tax Treaty,’’ Tax Notes Int’l, July 23, 2012,p. 359; Connery, Poms, and Blasdel-Marinescu, ‘‘Eligibility forTreaty Benefits Under the Australia-U.S. Income Tax Treaty,’’Tax Notes Int’l, Dec. 12, 2011, p. 843; Connery, Poms, andBlasdel, ‘‘Eligibility for Treaty Benefits Under the Switzerland-U.S. Income Tax Treaty,’’ Tax Notes Int’l, May 9, 2011, p. 505;Connery, Poms, and Blasdel, ‘‘Eligibility for Treaty Benefits Un-der the Japan-U.S. Income Tax Treaty,’’ Tax Notes Int’l, Sept. 6,2010, p. 789; Connery, Poms, and Blasdel, ‘‘Eligibility for TreatyBenefits Under the 2009 Protocol to the France-U.S. Income TaxTreaty,’’ Tax Notes Int’l, Apr. 12, 2010, p. 149; John Venuti, Con-nery, Poms, and Blasdel, ‘‘Eligibility for Treaty Benefits Under

the Netherlands-U.S. Income Tax Treaty,’’ Tax Notes Int’l, Nov.23, 2009, p. 601; Venuti, Connery, Poms, and Alexey Manasuev,‘‘Eligibility for Treaty Benefits Under the Canada-U.S. IncomeTax Treaty,’’ Tax Notes Int’l, June 15, 2009, p. 967; Venuti, Dab-rowski, Poms, and Manasuev, ‘‘Eligibility for Treaty Benefits Un-der U.K.-U.S. Income Tax Treaty,’’ Tax Notes Int’l, Mar. 23, 2009,p. 1095; Venuti, Connery, Poms, and Manasuev, ‘‘Eligibility forTreaty Benefits Under the Luxembourg-U.S. Income TaxTreaty,’’ Tax Notes Int’l, July 21, 2008, p. 285; Venuti, Dabrowski,Poms, and Manasuev, ‘‘Eligibility for Treaty Benefits Under theFrance-U.S. Income Tax Treaty,’’ Tax Notes Int’l, Feb. 11, 2008, p.523; and Venuti and Manasuev, ‘‘Eligibility for Zero Withholdingon Dividends in the New Germany-U.S. Protocol,’’ Tax NotesInt’l, Jan. 14, 2008, p. 181.

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(Footnote continued in next column.)

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Does the Mexicancompany satisfy theactive trade orbusiness test?

(See Chart 2.)

No

Yes

4

Does the Mexicancompany satisfy thepublicly tradedcompany test?(See Chart 3.)

3

No

No

Does the Mexicancompany satisfy thesubsidiary of a publiclytraded company test?(See Chart 4.)

Yes

Yes

Does the Mexicancompany satisfy theownership/base erosiontest?

6

No

2

Yes

8

Yes

No

Yes

Has a discretionarydetermination beengranted by U.S.competent authority?

(See Chart 8.)

Not eligible fortreaty benefits.

No

Eligible fortreatybenefits.

Does the Mexican companysatisfy the subsidiary of apublicly traded NAFTAcompany test?

(See Chart 5.)

5

Yes

7

YesDoes the Mexicancompany satisfy thelimited derivativebenefits test?

(See Chart 7.)

No

1

Is the company aresident of Mexico?

Eligible fortreaty benefits.

Not eligiblefor treatybenefits.

No

The term “resident of a Contracting State” means anyperson who, under the laws of that state, is liable to taxtherein by reason of his domicile, residence, place ofmanagement, place of incorporation, or any other criterion ofa similar nature. Article 4(1) of the treaty.

Tax-Exempt OrganizationsAn entity that is a not-for-profit organization (including apension fund or private foundation) and that, by virtue of thatstatus, is generally exempt from income taxation in its state ofresidence, is eligible for treaty benefits, provided that morethan half of the beneficiaries, members or participants, if any,in such organization are entitled, under article 17 (LOB), to thebenefits of the treaty. Article 17(1)(e) of the treaty.

Chart 1. Eligibility for Treaty Benefits Under Article 17 (LOB)of the Mexico-U.S.Tax Treaty

(See Chart 6.)

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Does the Mexican companysatisfy the active trade orbusiness test?

2

Is the income under consideration derived by theMexican company in connection with, orincidental to, such trade or business in Mexico?Article 17(1)(c) of the treaty.

Not eligiblefor treatybenefits. (Goto Chart 3.)

Eligible for treatybenefits.

Yes

The terms “trade or business,” “inconnection with,” and “incidental to” arenot defined in the treaty.

Yes

No

No

Is the Mexican company engaged in Mexico in theactive conduct of a trade or business (other thanthe business of making or managing investments,unless these activities are banking or insuranceactivities carried on by a bank or insurancecompany)? Article 17(1)(c) of the treaty.

Chart 2. Active Trade or Business Test Under Article 17(1)(c) (LOB)of the Mexico-U.S.Tax Treaty

(Only applies if an item of income is derived in connection withor incidental to an active trade or business in Mexico)

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3

Does the Mexicancompany satisfy thepublicly traded

company test?

Is there substantial and regular trading of theMexican company’s principal class of shares on arecognized securities exchange located in eitherMexico or the United States? Article 17(1)(d)(i) ofthe treaty.

“Recognized securities exchange” means:

1) the NASDAQ System owned by theNational Association of SecuritiesDealers, Inc., and any stock exchangeregistered with the Securities andExchange Commission as a nationalsecurities exchange for purposes of theSecurities Exchange Act of 1934;

2) stock exchanges duly authorized underthe terms of the Stock Market (“Mercadode Valores”) Law of January 2, 1975;and

3) any other stock exchange agreed uponby the competent authorities of thecontracting states.

Paragraph 15(b) of the protocol to thetreaty.

The terms “substantial and regular trading”and “principal class of shares” are notdefined in the treaty.

No

Yes

Eligible for treatybenefits.

Not eligible fortreaty benefits.(Go to Chart 4.)

Chart 3. Publicly Traded Company Test Under Article 17(1)(d)(i) (LOB)of the Mexico-U.S.Tax Treaty

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NoIs the Mexican company wholly owned, directly orindirectly, by a resident of Mexico that satisfies thepublicly traded company test (see Chart 3)? Article17(1)(d)(ii) of the treaty.

Eligible for treaty benefits.

Yes

4

Does the Mexican companysatisfy the subsidiary of apublicly traded company

test?

Example

A Mexican company not publiclytraded but wholly owned by aholding company that is a residentof Mexico whose shares arepublicly traded on a recognizedexchange in the United States orMexico (i.e., it satisfies thepublicly traded company test( )) will qualify undersee Chart 3the subsidiary of a publiclytraded company test. U.S.Treasury technical explanationto the treaty.

Not eligible for treatybenefits. (Go to Chart 5.)

Chart 4. Subsidiary of a Publicly Traded Company Test UnderArticle 17(1)(d)(ii) (LOB) of the Mexico-U.S.Tax Treaty

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5

Does the Mexican companysatisfy the subsidiary of apublicly traded NAFTAcompany test?

Is the Mexican company wholly owned, directly orindirectly, by residents of any state that is a party to theNorth American Free Trade Agreement (NAFTA) inwhose principal class of shares there is such substantialand regular trading on a recognized securitiesexchange (see Chart 3 for definition)? Article17(1)(d)(iii)(A) of the treaty.

Is the Mexican company more than 50 percent owned,directly or indirectly, by residents of either Mexico or theUnited States in whose principal class of shares there issuch substantial and regular trading on a recognizedsecurities exchange (see Chart 3 for definition)located in such a state? Article 17(1)(d)(iii)(B) of thetreaty.

Example

A Mexican company will qualify if it isowned 51 percent by publicly tradedU.S. and/or Mexican companies and49 percent by a publicly tradedCanadian company. U.S. Treasurytechnical explanation to the treaty.


Not eligible for treatybenefits. (Go to Chart 6.) Yes

Yes

No

No

Chart 5. Subsidiary of a Publicly Traded NAFTA Company Test UnderArticle 17(1)(d)(iii) (LOB) of the Mexico-U.S.Tax Treaty

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6

Does the Mexican companysatisfy the ownership/base

erosion test?

Noteligible for

treatybenefits.(Go to

Chart 7.)

“Qualified persons” means:

1) individuals resident in Mexico or theUnited States (article 17(1)(a) of thetreaty);

2) Mexico, the United States, or a politicalsubdivision or local authority of Mexicoor the United States (article 17(1)(b) ofthe treaty);

3) Mexican or U.S. resident companiesthat satisfy the publicly tradedcompany test (see Chart 3), thesubsidiary of a publicly tradedcompany test (see Chart 4), and/orthe subsidiary of a publicly tradedNAFTA company test (see Chart 5);and/or

4) certain Mexican or U.S. not-for-profitorganizations (see Chart 1) (article17(1)(e) of the treaty).

The term “gross income” means grossreceipts, or where an enterprise is engagedin a business that includes the manufactureor production of goods, gross receiptsreduced by the direct costs of labor, andmaterials attributable to such manufactureor production and paid or payable out ofsuch receipts. Paragraph 15(c) of theprotocol to the treaty.

Yes


Base Erosion Test

Is less than 50 percent of the Mexican company’sgross income used, directly or indirectly, to meetliabilities (including liabilities for interest or royalties)to persons that are not qualified persons? Article17(1)(f)(ii) of the treaty.

Ownership Test

Is more than 50 percent of the number of shares ofeach class of the Mexican company’s sharesowned, directly or indirectly, by qualified persons?Article 17(1)(f)(i) of the treaty.

No

No

Yes

Chart 6. Ownership/Base Erosion Test Under Article 17(1)(f) (LOB)of the Mexico-U.S.Tax Treaty

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7

Noteligible for

treatybenefits.(Go to

Chart 8.)


A resident of a state that is a partyto NAFTA shall only be consideredas owning a share under thelimited derivative benefits testthat state has a comprehensiveincome tax convention with thecontracting state from which theincome is derived (in this case, theUnited States) and if the particulardividend, profit, or income subjectto the branch tax, interest, orroyalty payment, in respect ofwhich benefits under this treatyare claimed, would be subject to arate of tax under that conventionthat is no less favorable than therate of tax applicable to suchresident under articles 10(dividends), 11 (interest), 11A(branch tax), or 12 (royalties) ofthis treaty. Article 17(1)(g) of thetreaty.

Ownership by residents of aNAFTA state other than the UnitedStates and Mexico (currentlyCanada) will be taken into accountonly if the resident of the NAFTAstate qualifies for the benefits ofthe treaty between its state ofresidence and the source state (inthis case, the United States) underits terms (e.g., its LOB article).U.S. Treasury technicalexplanation to the treaty.

No

Yes

No

Yes

Derivative Benefits TestIs more than 60 percent of the number of shares of each class of theMexican company’s shares owned, directly or indirectly, by personsresident in a state that is a party to NAFTA? Article 17(1)(g)(ii) of the

treaty.

Does the Mexican companysatisfy the limited derivativebenefits test?

Yes

No

No

Yes

Base Erosion Test (Part 1)Is less than 70 percent of the gross income (see Chart 6 fordefinition) of the Mexican company used directly or indirectly to meetliabilities (including liabilities for interest or royalties) to persons that arenot qualified persons (see Chart 6 for definition)?Article 17(1)(g)(iii)(A) of the treaty.

Base Erosion Test (Part 2)Is less than 40 percent of the gross income (see Chart 6 fordefinition) of the Mexican company used directly or indirectly to meetliabilities (including liabilities for interest or royalties) to persons that areneither qualified persons (see Chart 6 for definition) nor residents ofa state that is a party to NAFTA? Article 17(1)(g)(iii)(B) of the treaty.

Ownership TestIs more than 30 percent of the number of shares ofeach class of the Mexican company’s shares owned,directly or indirectly, by qualified persons (seeChart 6 for definition)? Article 17(1)(g)(i) of thetreaty.

Chart 7. Limited Derivative Benefits Test Under Article 17(1)(g) (LOB)of the Mexico-U.S.Tax Treaty

(Only applies to dividends, interest, branch tax, and royalties)

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YesNo

The “U.S. competent authority” isthe secretary of the Treasury or hisauthorized representative. Article3(1)(e)(ii) of the treaty.

Requesting competent authority

assistance – A taxpayer may requestthe assistance of the U.S. competentauthority under Rev. Proc. 2015-40.The U.S. competent authority maydetermine in its own discretion that thetaxpayer qualifies for certain benefitsunder the LOB article of the treaty.

There is a US $32,500 user fee forrequesting a discretionarydetermination under the LOBprovision for requests filed prior toSeptember 30, 2016. The user feeincreases to US $37,000 for requestsfiled on or after September 30, 2016. Ifa request is submitted for more thanone entity, a separate user fee ischarged for each entity. Rev. Proc.2015-40, section 14.02.

Not eligible fortreaty benefits.


Has a discretionary determinationbeen granted by the U.S. competent

authority?

A Mexican resident company that is not entitled to the benefits of thetreaty under the provisions of the LOB article may, nevertheless,demonstrate to the U.S. competent authority that such company shouldbe granted the benefits of the treaty. For this purpose, one of thefactors the U.S. competent authority shall take into account is whetherthe establishment, acquisition, and maintenance of the Mexicancompany and the conduct of its operations did not have as one of itsprincipal purposes the obtaining of benefits under the treaty.Article 17(2) of the treaty.

8

This discretionary provision is included in recognition that, with theincreasing scope and diversity of international economic relations,there may be cases where significant participation by third-countryresidents in an enterprise of a contracting state is warranted by soundbusiness practice and does not indicate a motive of attempting toderive unintended treaty benefits. U.S. Treasury technicalexplanation to the treaty.

Chart 8. Discretionary Determination by U.S. Competent AuthorityUnder Article 17(2) (LOB) of the Mexico-U.S.Tax Treaty

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Not eligible toclaim 0 percentwithholding taxrate on dividends.

“Dividends” means income from shares or other rights,not being debt claims, participating in profits, as well asincome from other corporate rights that is subjected to thesame taxation treatment as income from shares by thelaws of the state of which the company making thedistribution is a resident (in this case, the United States).Article 10(4) of the treaty.

The term “dividends” is intended to cover allarrangements that yield a return on an equity investmentin a corporation as determined under the tax law of thestate of source (in this case, the United States), as wellas arrangements that might be developed in the future.U.S. Treasury technical explanation to the 2002protocol to the treaty. “Dividends” includes incomefrom shares, or other corporate rights that are not treatedas debt under the law of the source state, that participatein the profits of the company. The term also includesincome that is subjected to the same tax treatment asincome from shares by the law of the state of source.Thus, a constructive dividend that results from a non-arm’s-length transaction between a corporation and arelated party is a dividend. U.S. Treasury technicalexplanation to the 2002 protocol to the treaty.

In the case of the United States, the term “dividend”includes amounts treated as a dividend under U.S. lawupon the sale or redemption of shares or upon a transferof shares in a reorganization. See, e.g., Rev. Rul. 92-85,1992-2 C.B. 69 (sale of foreign subsidiary’s stock toU.S. sister company is a deemed dividend to extent ofsubsidiary’s and sister’s earnings and profits). Further, adistribution from a U.S. publicly traded limitedpartnership, which is taxed as a corporation underU.S. law, is a dividend for purposes of article 10.However, a distribution by a limited liability company isnot characterized by the United States as a dividend and,therefore, is not a dividend for purposes of article 10,provided the limited liability company is not taxable as acorporation under U.S. law. U.S. Treasury technicalexplanation to the 2002 protocol to the treaty.

A payment denominated as interest that is made by athinly capitalized corporation may be treated as adividend to the extent that the debt is recharacterized asequity under the laws of the source state. Paragraph 9 ofthe treaty’s first protocol clarifies this by providing thateach contracting state may apply its statutory rules fordistinguishing debt and equity or for preventing thincapitalization in defining dividends for purposes of thisarticle. In the case of the United States, these rulesinclude Internal Revenue Code section 163(j).U.S. Treasury technical explanation to the 2002protocol to the treaty.

**The treaty provides that the competent authorities of thecontracting states shall consult each other with a view todevelop a commonly agreed application of when togrant a discretionary determination providing for a 0percent withholding rate on dividends. If a commonapplication is agreed upon, the competent authoritiesshall publish regulations or other public guidance. U.S.Treasury technical explanation to the 2002 protocolto the treaty.

Dividends received by a taxable Mexican company fromU.S. real estate investment trusts and U.S. regulatedinvestment companies are not eligible for a 0 percentwithholding tax rate. Article 10(4) of the treaty.

Eligible to claim 0percent withholding tax rateon dividends.

Yes

Yes

No

Is one of the following satisfied on the date of receiptof such dividends:

1) prior to October 1, 1998, the Mexican residentcompany owned, directly or indirectly, sharesrepresenting 80 percent or more of the votingstock of the U.S. company paying the dividends(article 10(3)(a)(i) of the treaty);

2) the Mexican company satisfies either the publiclytraded company test (see Chart 3) or thesubsidiary of a publicly traded company test(see Chart 4) (article 10(3)(a)(ii) of the treaty);

3) the Mexican company satisfies with respect todividends the limited derivative benefits test(see Chart 7) (article 10(3)(a)(iii));

4) the Mexican company obtained a discretionarydetermination (see Chart 8) from the U.S.competent authority providing for a 0 percentwithholding tax rate on dividends** (article10(3)(a)(iv)); or

5) the Mexican company is a tax-exempt trust,company, or other organization operatedexclusively to provide pension, retirement, or otheremployee benefit plans (see Chart 1), providedthat such dividends are not derived from thecarrying on of a business, directly or indirectly, bysuch company (article 10(3)(b))?

Is the Mexican companythe beneficial owner ofdividends from U.S.sources?

9

Yes

No

The term “beneficial owner” is notdefined in the treaty, and is, therefore,defined as under the internal law of thecountry imposing the tax (i.e., thesource country). The beneficial ownerof the dividend for purposes ofarticle 10 is the person to which thedividend income is attributable for taxpurposes under the laws of the sourcestate. Thus, if a dividend paid by acorporation that is a resident of one ofthe states (as determined underarticle 4 (residence)) is received by anominee or agent that is a resident ofthe other state on behalf of a personthat is not a resident of that other state,the dividend is not entitled to thebenefits of this article. However, adividend received by a nominee onbehalf of a resident of that other statewould be entitled to benefits.U.S. Treasury technical explanationto the 2002 protocol to the treaty.

A trust, company, or otherorganization described in article10(3)(b) does not need to haveowned shares representing80 percent or more of the votingstock of the U.S. company payingthe dividends for a 12-month periodending on the date the dividend isdeclared to qualify for a 0 percentwithholding rate on dividends.

No

Has the Mexican company ownedshares representing 80 percent ormore of the voting stock of theU.S. company paying thedividends for a 12-month periodending on the date the dividend isdeclared? Article 10(3)(a) of thetreaty.

Chart 9. Eligibility for 0 Percent Withholding Tax Rate on Dividends UnderArticle 10(3) of the Mexico-U.S.Tax Treaty

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Eligibility for Treaty Benefits Under the Mexico-U.S ... · Eligibility for Treaty Benefits Under The Mexico-U.S. Income Tax Treaty by Jason Connery, Ron Dabrowski, and Jennifer Blasdel-Marinescu