The main purpose of a merger or a spin-off is an administrative reorganization. In Mexico, from a commercial standpoint, mergers and spin-offs are always considered an assignment of assets. However, from a tax perspective this may not always be the case. This issue is relevant to in-house counsel because it is important to avoid negative tax impacts in such operations.
It is important to understand the difference of tax treatment between a regular transfer and an assignment (as result of a merger or a spin-off). In a regular transfer, there are Value Added Tax and Income Tax Impacts; in a merger or spin-off assignment there are no such impacts, as long as certain requirements are met. This article discusses the requirements that need to be met in order to avoid negative tax impacts. This article only concerns mergers and spin–offs of companies residing in Mexico where the company or companies resulting from such mergers or spin-offs are also Mexican residents.
Conditions for a merger not to be treated as an accumulation of revenue
The merger is a legal agreement by which commercial entities are dissolved (merged companies), and their net assets are transferred to another existing entity or an entity of new incorporation (merging company). However, Mexico’s Federal Tax Act establishes certain requirements for the assignment of assets not to be considered an accumulation of revenue by the merging company: (Art. 14-B Federal Tax Act). The requirements are as follows:
1. The merging company must submit a cancellation of Tax ID notice before the Federal Tax Registration regarding the merged companies, in order to comply with the merger notice.
2. If applicable, the new company resulting from the merger must submit a notice of registration before the same Federal Tax Registration, to obtain a new Tax ID. (Art. 24 Federal Tax Act Regulations)
3. After the merger, the merging company must continue to perform its regular activities and the activities carried out by the merged company before the merger, for a minimum period of one year immediately after the date on which the merge took effect. This requirement was established based on the idea that the merger is a corporate restructuring. This requirement is not mandatory if:
a. The income from the main activity of the merged company, corresponding to the immediate fiscal year prior to the merger, results from the lease of goods used in the same activity as that of the merging company; and
b. During the immediate fiscal year prior to the merger, the merging company received more than 50% of its income from the merged company, or that the merged company received more than the 50% of its income from the merging company (this requirement will not be mandatory when the subsisting company is liquidated before a year after the date in which the merger became effective). The typical example of this is when two different companies are merged due to the fact that they do not operate, in order to liquidate only one of them.
4. The subsisting company or the new company resulting from the merger, must submit the corresponding tax statements of the merged companies for that fiscal year in which the merger was effective, within a period that does not exceed three months from the date at which the merger was performed.
If the above requirements are not met, the transaction will be viewed by the tax authorities as a transfer of assets, and therefore, Income Tax and Value Added Tax will be applicable as a regular sale purchase transaction. In other words, it will be considered that the merging company has made profits, and the corresponding taxes will have to be paid by the merging company which will be considered to receive the assets as an income.
Other Tax Considerations for Mergers
1. Tax Losses:
- Tax losses are not transmitted through a merger.
- The right to deduct tax losses is a right only in favor of the taxpayer who suffers such losses and may not be transferred to another company, not even as a result of a merger.
2. Capital Contribution Account (CUCA):
- This is an account integrated by additional contributions to the capital stock, future capital increases, net premiums for share subscription and other contributions of the shareholders. The amounts so reflected in the balance sheet are tax free.
- The balance of CUCA may be transmitted by the merged company to the merging company. However, when the merging company is the same company whose shares were owned by a merged entity, the amount of the CUCA of the merging company must be the same as the CUCA amount that the merged company had before the merger, in order to avoid duplication in the CUCA account of the merging company.
- If a subsidiary company is merged with a holding company, the shares held by the holding company in the subsidiary must not be taken into account when determining the CUCA of the merging company.
3. Net Tax Profit Account (CUFIN):
- This account regroups the profits on which income tax has already been paid, as well as those profits that have been distributed to or received from other Mexican subsidiary companies.
- The law allows transferring the balance of the CUFIN from the merged company to the merging company as a result of a merger (without imposing any additional taxes since this account has already paid the corresponding taxes)
4. Fiscal Value by Which the Assets are Transmitted to the Merging Company:
For tax purposes, the fiscal value of the merged company’s assets is transmitted to the merging company, therefore, their fiscal value will be the same in the merging company. See particularities below:
- Real Estate assigned as a result of a merger or spin-off: their fiscal value will be considered as the original amount of the investment the value of its acquisition by the merged company, and its acquisition date will be deemed the date on which the merged company acquired them. (Art. 19 Income Tax Act)
- Assets: When the assets are acquired as result of the merger or spin-off, the date corresponding to the merger or the spin-off will be considered as the acquisition date. (Art. 31 Income Tax Act)
- Shares: The shares acquired by the merging companies, as part of the assets assignment, will have as real cost of acquisition the average cost per share in the merged companies at the time of the merger or spin-off. (Art. 23 Income Tax Act).
- When participating in transactions regarding corporate reorganizations involving Mexican entities, international in-house counsel should take into account the effects of mergers in Mexico, to avoid negative tax implications.
- When dealing with Mexican entities, in-house counsel must take into account that a transaction involving shares can be considered to be a taxable source of income.
- Therefore, having a Mexican legal counsel assisting in the Mexican part of the transaction will be critical to avoid unnecessary tax liabilities.
Conditions for a spin-off not to be treated as a transfer of assets
A spin-off is a corporate action through which a company “splits off”, in two or more parts, all or part of its assets, liability and capital stock. The company that conducts the spin-off may or may not be extinguished, and it transfers to pre-existing or newly created companies its assets and obligations.
Mexican tax law establishes certain requirements for this corporate operation not to be considered a transfer of assets: (Art. 14 - B Federal Tax Act)
1. The shareholders who own at least 51% of the shares or equity interests with voting rights of the company that performed the spin-off, and the shareholders who own at least 51% of the shares or equity interests with voting rights of the pre-existing or new company, must remain the same for a period of at least three years as of the year immediately preceding the date on which the spin-off was executed (e.g., if the spin off is conducted on November 20, 2019, the start of the three-year period is November 20, 2018). Also, the company that performs the spin-off must maintain the same proportion in the capital stock of the pre-existing or new company, for the same period of time. (i.e. the shareholders having 20% of the capital stock of the company that performs a spin-off shall have the same 20% in the new company resulting from the spin-off)
2. When a company disappears as a result of the spin-off, the company that performs the spin-off shall designate the company that will assume the obligation of submitting the tax statements for such fiscal year and the information that, under the terms established by the tax laws, corresponds to the company performing the spin-off. The designation must be made through the shareholders/partners meeting that approves the spin-off.
- Same considerations as for mergers apply here. In-house counsel should always take into account the possible tax impacts and effects that spin-offs can have in Mexico.
- In-house counsel should communicate with both the finance and operations departments during mergers and spin-offs, to lessen any negative tax or shareholder impact.
Other Tax Considerations for a Spin-Off
1. Tax Losses:
- The tax losses pending to be decreased must be divided among the company that performed the spin-off and the new companies, in the same proportion of the sum of the total value of the inventories and the receivable accounts related to the commercial activities of the company that performed the spin-off(when it carried out these activities in a predominantly manner), or in the same proportion of the fixed assets (when the spinner carried out other activities).
- Based on this provision, the newly companies resulting from the spin-off may be created with tax losses.
2. CUCA and CUFIN:
- The CUCA and CUFIN balances are divided among the spinner and the new companies, in the same proportion in which the accounting capital in the statement of financial position approved by the shareholders' meeting was divided, and which served as the basis for the spin-off.
• Mergers and spin-offs have become very relevant in recent years as they serve to carry out corporate restructuring. Therefore, it is important to review the framework of the applicable tax provisions to avoid tax liabilities.
• Prior to the restructuring, it is important to analyze the fiscal situation of the companies involved, in order to determine the most appropriate structure for the operation.
• It is also important to keep in mind that there are certain cases in which the merger or spin-off must comply with specific tax provisions that have not been addressed in this article, such as those involving holding companies residing abroad.