What You Need to Know About Permanent Establishment in Mexico04.24.19
A permanent establishment (PE) “is the fixed place of business through which the business of an enterprise is wholly or partly carried on,” as defined by the Organization for Economic Cooperation and Development (OECD). Essentially, if a foreign company maintains any locally created revenue, the host country is allowed to tax the revenue at a local rate according to a permanent establishment.
PE in Mexico, specifically, is imposed on companies that create value in Mexico based on business activities that fall into income or value-added tax liability. PE may result in double taxation on a company’s profits by the host and home countries, depending on the country. However, international tax credits, treaties, and trade agreements may help to alleviate the burden depending on the tax policies in place.
To avoid PE when carrying out operations and manufacturing in Mexico, foreign companies must consider how to establish a legal presence so the basis for income tax can be determined and submitted to Mexico’s Treasury Department for approval. Developing a business relationship with a shelter company allows foreign companies to establish a legal presence in Mexico by operating under the shelter’s business license, while still maintaining full control over manufacturing processes.
Standard Permanent Establishment Criteria
There are varying standardizations countries follow to tax companies and implement PE status. Although not legally enforced, many countries model their economic policies, treaties, and tax laws by the OECD guidelines. Below illustrates part of OECD criteria most commonly used:
- A fixed place of business, address, bank account or other physical presence. This usually includes a company branch, an office, a factory, or a workshop.
- A sufficient timeframe to trigger PE under local law or a tax treaty. For example, building a facility in a host country can begin the process of PE after approximately 6 months, depending on the country.
- Actual control and direction of the employees’ activity by the parent company.
- Activity by employees in a country that relates directly to revenue creation. This could be a sales agent with foreign company authorization who closes a contract or an employee’s job title or description indicates he or she performs activities related to revenue generation in the host country for a prolonged period.
It’s important to understand the host country’s PE tax law and prepare for any potential tax liability by reviewing additional indicators of PE that could trigger taxation such as:
- Tax treaties between the host country where business is being conducted and the company’s home country. The tax treaty may have more lenient criteria for implementing PE or offer a lower corporate rate to treaty members.
- Each country’s domestic tax law govern corporate tax. This subjects any PE activity to local corporate tax rules and rates.
Foreign companies can avoid permanent establishment taxation by manufacturing in Mexico under a shelter company, which by law exempts the foreign company from PE. Additionally, in the first four years of operations, the foreign company is exempt from paying income tax.