Mexico

Except for sales of stock of public companies through the Mexico Stock Exchange, Mexico generally taxes gain recognized by a nonresident alien or foreign corporation on the sale of stock in a Mexican corporation or on the sale of Mexican real property. Furthermore, Mexico taxes the sale by a nonresident of shares of a nonMexican corporation if the majority of assets of the corporation consists of real property located in Mexico. As a general rule, tax on such gains is equal to 20 percent of the gross sales price; in some cases, however, nonresident persons may elect instead to pay tax at a rate of 30 percent on the net gain from the sale if the purchaser is given proper notification and the sale is made through a Mexican agent. Sales of capital assets not listed above by foreign persons generally are not taxed by Mexico.

Treatment of capital gains under the proposed treaty Under the proposed treaty, gains derived by a resident of one treaty country from the disposition of immovable or real property situated in the other country could be taxed in the other country (i.e., the country where the immovable property is situated). Immovable property for the purposes of this article would include (1) immovable property as defined in article 6 (Income for Immovable Property (Real Property)) situated in the other country, (2) an interest in a partnership, trust, or estate, to the extent that its assets consist of immovable property situated in that other country, (3) shares or comparable interests in a company that is, or is treated as, a resident of that other country, the assets of which company consist or consisted at least 50 percent (by value) of immovable property situated in that other country, and (4) any other right that allows the use or enjoyment of immovable property situated in the other country. Under paragraph 12 of the proposed protocol, the term immovable property situated in the other country would include, when the United States is the other country, a "U.S. real property interest" as defined under Code section 897. The proposed treaty, thus, would allow the United States to tax transactions of Mexican residents taxable under FIRPTA.

Gains from the alienation of movable property which are attributable to a permanent establishment which an enterprise of one country has (or had) in the other country, gains from the alienation of movable property which are attributable to a fixed base which is (or was) available to a resident of one country in the other country for the purpose of performing independent personal services, and gains from the alienation of such a permanent establishment (alone or with the whole enterprise) or of such a fixed base, could be taxed in that other country. The wording of this rule varies somewhat from the U.S. model treaty to clarify that any gain attributable to a permanent establishment (or fixed base) during its existence would be taxable in the country where the permanent establishment (or fixed base) is situated even if the gain is deferred until after the permanent establishment (or fixed base) has ceased to exist. Thus, the proposed treaty would give a taxing right to a country in which the other country's resident has or had a permanent establishment; the proposed treaty further would give a taxing right to a country in which a fixed base is or was available to

the other country's resident. As stated in the Technical Explanation, this language of the proposed treaty would permit the United States to impose tax under the rules of Code section 864(c)(7), as described above in connection with Article 7 (Business Profits). The proposed treaty would expressly permit a country to tax gains derived by a resident of the other country from the disposition of stock, participation, or other rights in the capital of a company or other legal person which is a resident of the first country if the recipient of the gain, during the 12-month period preceding the disposition, had a participation (directly or indirectly) of at least 25 percent in the capital of that company or other legal person. If this ownership threshold is not met, the source country would be precluded from taxing the disposition of such property by a resident of the other country (unless the property constituted an interest in immovable property as detailed above). Thus, Mexico would not be prevented from imposing its statutory tax on gains from the disposition of stock in a Mexican resident company by a resident of the United States that was a substantial shareholder in the Mexican company.

Under a special rule contained in the proposed protocol (paragraph 13), no tax under the preceding paragraph would apply in the case of a transfer of property between members of a group of companies that file a consolidated tax return, to the extent that the consideration received by the transferor corporation consists of participation or other rights in the capital of the transferee or of another company resident in the same country that owns (directly or indirectly) 80 percent or more of the voting rights and value of the transferee corporation as long as the following three conditions are satisfied. First, the transferor and transferee corporations must both reside in the United States or must both reside in Mexico. Second, before and immediately after the transfer, the transferor corporation or the transferee corporation must own (directly or indirectly) no less than 80 percent of the voting rights and value of the other, or a company resident in the same country must own (directly or indirectly) no less than 80 percent of the voting rights and value of the transferor and transferee corporations. Third, for purposes of determining gain on any subsequent disposition, either the initial cost of the asset for the transferee must be determined based on the cost it had for the transferor, increased by any cash or other property paid (i.e., carryover basis rules must apply), or the gain must be measured by another method that gives substantially the same result. Notwithstanding the foregoing rules, the proposed protocol mandates that if cash or property other than the participation or other rights is received, the amount of the gain (limited to the amount of cash or other property received), would be taxable by the source country.

To illustrate the application of the rule set forth in paragraph 13 of the proposed protocol, assume, for example, that a U.S. corporation owns all of the stock of a Mexican subsidiary corporation. Further assume that the U.S. corporation establishes a new, whollyowned, U.S. subsidiary corporation (with which it files a U.S. consolidated income tax return). If, in capitalizing the new company, the U.S. parent transfers all of the stock of the Mexican corporation to the U.S. subsidiary in exchange solely for stock of the U.S.

subsidiary, no U.S. tax would be imposed (as a result of either section 351 or 368(b) of the Code), and the U.S. subsidiary would take as its basis in the stock of the Mexican company the basis that the U.S. parent had in such stock. Under the proposed protocol, Mexico also would not impose tax on this transaction even though it involved the disposition of stock of a Mexican company by a substantial nonresident shareholder.

Gains from the alienation of ships, aircraft, or containers (including trailers, barges, and related equipment for the transport of containers) used principally in international traffic, would be taxable only in that country. Gains described in Article 12 (Royalties) would be taxable only in accordance with the provisions of that Article.

Gains from the alienation of any property other than that discussed above would be taxable under the proposed treaty only in the country where the person disposing of the property is a resident.

Source rule for certain capital gains

With respect solely to the provisions of the proposed treaty (and the proposed protocol) relating to the taxation of gains from the alienation of stock, participation, or other rights in the capital of a company or other legal person, the proposed treaty provides that to the extent necessary to avoid double taxation, such gains would be deemed to arise in the country of residence of the company or other legal person whose ownership rights are so disposed of. Thus, the United States would treat gain taxed by Mexico under those provisions as foreign source income (if not already so treated under the Code; see section 865(f)) to the extent necessary to permit a credit for the Mexican tax, subject to the limitations of U.S. law (i.e., Code sec. 904). In such a case, if the Mexican tax on the gain does not exceed the U.S. tax on that gain, then the U.S. generally would be required to grant a full credit for the Mexican tax.

Article 14. Independent Personal Services

Internal rules regarding services income in general United States

The United States taxes the income of a nonresident alien at the regular graduated rates if the income is effectively connected with the conduct of a trade or business in the United States by the individual. (See discussion of U.S. taxation of business profits under Article 7 (Business Profits).) The performance of personal services within the United States can constitute a trade or business within the United States (Code sec. 864(b)).

Under the Code, the income of a nonresident alien individual from the performance of personal services in the United States is excluded from U.S. source income, and therefore is not taxed by the United States in the absence of a U.S. trade or business, if certain criteria are met. The criteria are: (1) the individual is not in the United States for over 90 days during a taxable year, (2) the compensation does not exceed $3,000, and (3) the services are performed as an employee of or under a contract with a foreign person not engaged in a trade or business in the United States, or they

are performed for a foreign office or place of business of a U.S. per

son.

Mexico

Mexico generally imposes a 30-percent tax on gross income of nonresidents derived from the performance of personal services within Mexico for Mexican residents or for the Mexican permanent establishment of a nonresident.

Treatment of independent personal services under the proposed treaty

The proposed treaty would limit the right of a country to tax income from the performance of personal services by a resident of the other country. Under the proposed treaty, income from the performance of independent personal services (i.e., services performed as an independent contractor, not as an employee) would be treated separately from income from the performance of dependent personal services.

Income from the performance of independent personal services in one country by a resident of the other country would be exempt from tax in the country where the services are performed (the source country) unless the individual performing the services crosses either of two thresholds in the first country. The individual could be taxed in the first country if he or she has a fixed base which he or she regularly makes use of in that country in the course of performing the services.74 In that case, the source country would be permitted to tax only that portion of the individual's income which is attributable to the fixed base. In addition, if the individual is present in the first country for a period or periods exceeding 183 days within a 12-month period, the first country would be permitted to tax the income from the performance of independent personal services in that country during that period. This latter rule represents a departure from the U.S. model treaty, which would permit the source country to tax the income from independent personal services of a resident of the other country only if the income is attributable to a fixed base regularly available to the individual in the source country for the purpose of performing the activities.

The Technical Explanation specifies that under either the fixed base or 183-day test, it is understood by the parties to the proposed treaty that the taxation of income from independent personal services would be governed by the principles set forth in Article 7 (Business Profits); that is, the tax base would be net of expenses incurred in generating the income.

Paragraph 14 of the proposed protocol provides that the provisions of Article 14 would also apply to income derived by a U.S. corporation from the furnishing of personal services through a fixed base located in Mexico. In such a case, the corporation could compute the Mexican tax on the income from such services on a net basis as if the income were attributable to a Mexican permanent establishment. This rule is necessary because under Mexican law,

74 According to the technical explanation, it is understood that for purposes of the proposed treaty, the concept of a fixed base is to be interpreted consistently with the concept of a permanent establishment.

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a personal service company is not considered to earn business profits, so such a company would be taxed by Mexico under Article 14 rather than under Article 7.75

For purposes of this article, personal services include independent scientific, literary or artistic activities, educational or teaching activities, as well as the independent activities of physicians, lawyers, engineers, architects, dentists, and accountants. According to the Technical Explanation, this Article would apply to personal services performed by an individual for his or her own account, whether or not as a sole proprietor, where he or she receives the income and bears the risk of loss arising from the services.

It is understood that no change to the model treaty language is necessary to conform the treatment of income derived from independent personal services with Code section 864(c)(6), under which, as described above, any income or gain of a foreign person for any taxable year which is attributable to a transaction in any other taxable year will be treated as effectively connected with the conduct of a U.S. trade or business if it would have been so treated had it been taken into account in that other taxable year. An analogous rule applies to income for a taxable year from independent personal services performed in another year in which a fixed base was available.76

Article 15. Dependent Personal Services

Under the proposed treaty, wages, salaries, and other similar remuneration derived from services performed as an employee in one country (the "source country") by a resident of the other country would be taxable by the source country unless three requirements are met: (1) the individual must be present in the source country for fewer than 184 days in a 12-month period; (2) his or her employer must not be a resident of the source country; and (3) the compensation must not be borne (i.e., deductible) by a permanent establishment or fixed base of the employer in the source country. This degree of limitation on source country taxation is similar to the U.S. and OECD model treaties. The principal difference between the proposed treaty and the U.S. model treaty is that under the model, the first criteria listed above is based on a fixed measurement period-that period being the taxable year concerned.

The U.S. model treaty provides that compensation derived from employment as a member of the regular complement of a ship or aircraft operated in international traffic may be taxed only in the employee's country of residence. The proposed treaty contains no such limitation on the source country. Hence, such persons would be subject to the general rules detailed above for the taxation of dependent services income.

This article is modified in some respects for directors' fees (Article 16), pensions, annuities, alimony, and child support (Article 19),

75 The United States would apply Article 7 (Business profits) to the service income earned by a Mexican company.

76 If a treaty country resident receives income for independent activities rendered by that resident, and the activities were performed in the other treaty country in a year during which the resident was present in the second country for more than 183 days (or the resident maintained a fixed base in the second country), then that income is taxable by the second treaty country, regardless of whether payment for the activities was deferred to years in which the resident had no presence in the second country. (See, Rev. Rul. 86-145, 1986-2 C.B. 297.)