by

David Armstrong

Significant changes to the Mexican tax laws were announced in the Diario Oficial (the Mexican equivalent to the Federal Register) on December 27, 1996. Among the most important changes are efforts to crack down on the use of offshore tax havens for the purpose of tax evasion. The new law imposes an obligation for Mexican nationals to report annually their investments in certain tax haven countries. Failure to report such investments may result in penalties and potential criminal sanctions. In addition, Mexico will add to its tax code an assumption that transactions conducted with offshore companies from certain tax haven countries will not be determined to be arms-length transactions. The taxpayer will then have the burden of proving that the transaction is arms-length. If the taxpayer does not meet this burden of proof, then any deductions taken with regard to the transaction will be denied.

The law dovetails the attack on tax havens with new laws regarding time-share projects. For many years, certain time-share resorts in Mexico have used offshore tax haven corporations as part of a tax planning strategy. The new law severely restricts the ability to continue this practice. Under the new law, a tax of 21%, with no deductions, will be assessed on income from the sale of Mexican time-share properties by any non-Mexican entity. The tax increases to 35% if the non-Mexican entity resides in certain traditional tax haven countries. The list of "bad boy" tax havens includes over 85 countries. The tax is to be withheld by either (i) those who make the payments, if they are residents of Mexico, or (ii) those who manage the Mexican time-share property, if payments are made by non-Mexican residents.

The following example illustrates how the new law may be implemented: Playa Rica Spa and Resort is a hypothetical resort in Mazatlán, Mexico. The rights to market and sell the time-share intervals of Playa Rica is held by Offshore Limited, a Cayman Islands corporation. Offshore Limited sells $1,000,000 worth of time-share intervals in February 1997 to mostly U.S. buyers. Under the new law, a tax of $350,000 would be due and owing from such sales. If Offshore Limited were a U.S. corporation, the tax would only be $210,000. There would be no deductions available to offset the sales income.

The new law is a positive step by Mexico to prevent tax abuse. It does, however, present some unique problems to those who have been using offshore corporations in their tax planning activities.

For additional information, contact David K. Armstrong via telephone at (801) 237-1981, via fax (801) 237-1950, or via e-mail/Internet at armstrd@swlaw.com.