A New Era of Taxation in Mexico for the Digitalized Economy

(Artículo publicado originalmente en International Tax Review: https://www.internationaltaxreview.com/article/b1svm4s5vj7hwx/una-nueva-era-de-tributaci243n-en-m233xico-para-la-econom237a-digitalizada)

In October 2015, the Organization for Economic Cooperation and Development (OECD) released an action plan to combat tax evasion and profit shifting (BEPS, short for Base Erosion and Profit Shifting). The BEPS plan consists of 15 measures aimed at redesigning the international tax system, establishing mechanisms to combat aggressive tax practices, and ensuring that taxpayers are taxed where they generate value. However, at the time the plan was issued, Action 1 (addressing tax challenges arising from the digitalization of the economy) remained incomplete.

At the beginning of President Biden’s administration in the United States, the OECD’s Center for Tax Policy and Administration advanced its Unified Approach Proposal (Pillar 1 and Pillar 2) to a new phase of negotiation. This process eventually led to a preliminary agreement and a joint statement signed by 132 out of the 139 countries in the OECD Inclusive Framework on July 1, 2021 (OECD/G20 Base Erosion and Profit Shifting Project. Statement on a Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy. July 2021).

The proposal involves the redistribution of taxing rights from the countries where multinational companies are headquartered to the countries where they generate revenue, regardless of physical presence (Pillar 1). Additionally, it establishes a global corporate tax rate of at least 15% (Pillar 2). It is important to note that the Unified Approach Proposal does not specifically target digital companies but rather seeks to impose taxation on large multinationals—the OECD estimates that the world’s top 100 corporate groups would be affected by these new tax rules.

Under Pillar 1, multinational groups with revenues exceeding €20 billion and a profitability rate of at least 10% (pre-tax profit/revenue) would be subject to the new tax rules, excluding companies in the financial and extractive sectors. The countries eligible for taxation (nexus) under Pillar 1 will be those where multinational groups generate at least $1 million in revenue, or €250,000 for countries with a GDP lower than €40 billion.

Pillar 2 has a much broader scope, covering multinational groups with revenues exceeding €750 million, using the same threshold established for country-by-country reporting under Action 13 of the BEPS Plan. The only exception is for international maritime transport companies. Pillar 2 operates through a set of Global Anti-Base Erosion Rules (GloBE), which function as follows according to the joint statement:

Subject to Tax Rule (STTR) – Allows jurisdictions to impose a limited tax on certain cross-border related-party payments subject to low taxation. The STTR would be creditable under the GloBE rules.

Income Inclusion Rule (IIR) – Assigns a top-up tax to the parent company concerning undertaxed income from a subsidiary.

Undertaxed Payments Rule (UTPR) – Denies deductions or requires adjustments if an entity’s income is undertaxed and is not subject to taxation under the IIR.

Expected Revenue from Pillars 1 and 2

The implementation of Pillar 1 is expected to generate at least $100 billion in revenue, while Pillar 2 could yield $150 billion. If negotiations conclude successfully by October (noting that some EU countries, including Ireland, Estonia, and Hungary, have abstained from signing the OECD Inclusive Framework’s joint statement), this long-awaited reform of the international tax system could be implemented by 2023.

Potential Benefits for Mexico

Estimated Revenue Gain for Mexico from Pillar 1

Mexico’s benefit from Pillar 1 would stem from the net difference between tax outflows attributed to Mexican companies and tax inflows from foreign companies covered under the proposed regulations. To identify eligible multinational groups, a search was conducted in the Bureau Van Dijk Osiris database for companies reporting revenues exceeding €20 billion and an operating margin above 10% (excluding mining and financial sector companies).

The analysis focused on the 2019 fiscal year to avoid distortions caused by the COVID-19 pandemic. Among the sampled companies, only one Mexican corporation (América Móvil) exceeded the OECD’s Pillar 1 thresholds. On the other hand, 146 foreign multinational groups were included in the analysis. Each of these companies was assigned a percentage of sales to Mexico, based on its country of origin (data sourced from the OECD AMNE 2016 database). In cases where no data was available, the global percentage of sales to Mexico was used.

Three key variables were considered for each group:

• Revenue
• Operating margin
• Research and development expenses (2019)

The increase in tax revenue was estimated using Equation 1.

Estimated Revenue Gain for Mexico from Pillar 2

For Pillar 2, the analysis involved searching the Bureau Van Dijk Osiris database for foreign companies with revenues exceeding €750 million in 2019. Maritime transport companies and Mexican multinationals were excluded since Mexico’s corporate tax rate is already above the global minimum tax threshold. Each company was assigned the corporate tax rate of its home country, sourced from taxfoundation.org.

The estimated revenue increase from implementing Pillar 2 was calculated using Equation 2.

Results

Given the status of Pillar 2 negotiations and parameters such as routine activity returns, intangible asset generation returns, and the minimum tax rate, various scenarios were assessed for the potential increase in tax revenues for Mexico under both Pillar 1 and Pillar 2.

Estimated Tax Revenue Increase for Mexico from Pillar 1

Estimated Tax Revenue Increase for Mexico from Pillar 2

The results indicate that, under an intermediate scenario, Mexico could gain $1.553 billion in additional revenue. In the best-case scenario, this figure could increase to $1.884 billion. Notably, higher revenues for Mexico could be achieved if:

• Lower remuneration is set for routine activities
• Intangibles are minimally or not remunerated
• The minimum tax rate is set at a higher level

Final Considerations

The implementation of the Unified Approach Proposal would generate a net benefit for Mexico, considering the small number of Mexican multinational companies exceeding the Pillar 1 thresholds. The maximum expected benefit of $1.884 billion (over 37 billion pesos) could easily cover:

• Three times the budget of the National Council of Science and Technology (322%)
• Almost twice the budget of the National Electoral Institute (189%)
• Up to 119% of the budget allocated to the Ministry of Environment and Natural Resources (based on 2020 federal budget data).

Of course, Mexico must compare the projected revenue gains under Pillars 1 and 2 against potential revenue that could be captured through a local digital tax or alternative proposals, such as Article 12-B of the United Nations Model Tax Convention.

In any case, the approval of Pillars 1 and 2 seems imminent, marking a shift towards formula-based taxation, supplementing the arm’s length principle in response to the challenges of the digitalized economy—thus ushering in a new era of international taxation.

[1] Jesús Aldrin Rojas y José Chamorro Gómez