Key Highlights of the U.S.–Mexico Tax Treaty on Income Tax

The Convention between Mexico and the United States to Avoid Double Taxation and Prevent Tax Evasion on Income Tax, signed in 1992 and in force since 1994, remains one of the most relevant bilateral agreements for cross-border investors, entrepreneurs, and professionals. Below is a practical overview of the treaty’s most important provisions.

Scope and General Principles

• The treaty applies to income taxes in both countries (Mexico’s ISR and U.S. federal income taxes).
• The U.S. maintains a special “saving clause,” meaning it can still tax its citizens and former citizens on a worldwide basis, even if they reside in Mexico.
• Residency is determined by each country’s domestic rules, but the treaty provides “tie-breaker rules” for dual residents (e.g., permanent home, center of vital interests, habitual abode, nationality).

Permanent Establishment (PE)

• TO PE exists when a business has a fixed place of business (office, branch, factory, workshop, mine, oil well, etc.) in the other country.
• Construction or drilling projects create a PE if they last more than six months.
• Certain preparatory or auxiliary activities (storage, display, purchasing, advertising) do not by themselves create a PE.

Dividends (Article 10)

• Withholding tax is limited to:
  • 5% if the recipient company holds at least 10% of the voting stock.
  • 10% in all other cases.
• Important: Special limitations apply to dividends from U.S. REITs or regulated investment companies.

Interest (Article 11)

• Interest paid from one country to a resident of the other is generally subject to a 10–15% withholding tax, depending on the nature of the loan.
• Exemptions apply for government entities, public banks, and recognized pension funds.
• Back-to-back loan arrangements are excluded from reduced treaty benefits.

Royalties (Article 12)

• Royalty payments (use of patents, trademarks, know-how, or equipment) are subject to a maximum 10% withholding tax.
• The definition includes payments for scientific, industrial, or commercial information.

Capital Gains (Article 13)

• Gains on the sale of real estate located in the other country may be taxed in the source country.
• Shares in companies deriving 50% or more of their value from real estate are also taxable in the source country.
• If a seller held 25% or more of a company’s shares within the 12 months before selling, the source country may tax the gain.
• All other capital gains are generally taxable only in the country of residence.

Elimination of Double Taxation (Article 24)

• Both Mexico and the U.S. allow their residents to credit foreign taxes against domestic income tax, subject to domestic limitations.
• The treaty also assigns source of income rules to ensure credits are properly applied.

Limitation on Benefits (Article 17)

• To prevent treaty abuse, benefits are available only to qualified persons: individuals, governments, publicly traded companies, certain subsidiaries, non-profits, or entities that meet ownership and base erosion tests.
• Discretionary relief is possible if a taxpayer can prove genuine business activity.

Exchange of Information and MAP

• Tax authorities of both countries cooperate through exchange of information (Article 27).
• TO Mutual Agreement Procedure (MAP) allows disputes over interpretation or double taxation to be resolved between tax authorities, and arbitration may apply in certain cases.

Practical Implications

1. Investors should carefully analyze whether gains from U.S. or Mexican shares are subject to source-country taxation, especially when real estate is involved.
2. Companies must confirm they meet the Limitation on Benefits (LOB) article before claiming reduced withholding rates.
3. Cross-border employees and professionals must consider the 183-day rule to determine tax liability.
4. Pension funds and charitable organizations can benefit from special exemptions, provided they meet treaty definitions.

This treaty continues to be a cornerstone for structuring cross-border investments and avoiding double taxation. Correct application requires not only knowledge of the treaty’s provisions but also compliance with domestic law requirements (such as residency certificates, beneficial ownership tests, and LOB compliance).