Corporate advisory guide to the US-Mexico tax treaty

The Convention Between the United States of America and the United Mexican States for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income is the primary legal instrument governing cross-border taxation between US companies and their Mexican operations. Signed in 1992 and in force since January 1, 1994, the treaty has been modified by protocols in 1999 and 2002 that updated dividend rates and clarified certain provisions.

For US companies with Mexican subsidiaries, branches, or investment income from Mexico, the treaty determines withholding rates, permanent establishment risk, and the availability of relief from double taxation. Using it correctly requires documentation and planning. Ignoring it means paying domestic withholding rates that can be two to five times higher than treaty rates.

Current-law note: Treaty rates are not automatic and may depend on residence, beneficial ownership, limitation-on-benefits rules, holding periods, and documentation. Schöndube recommends validating the current treaty, protocols, domestic law, and transaction facts before applying a reduced rate.

Related issues may require complementary legal analysis, depending on the transaction and operating structure.

What taxes the treaty covers

The US-Mexico treaty applies to federal income taxes in both countries. In the United States, this includes the federal income tax under the Internal Revenue Code. In Mexico, it covers the ISR (Impuesto sobre la Renta) under the LISR. The treaty does not cover state or local taxes in the US or state-level taxes in Mexico, nor does it apply to LIVA (Mexico's value-added tax).

Permanent establishment rules

A US company is subject to Mexican ISR on its business income only if it has a permanent establishment (PE) in Mexico. The treaty's PE definition is narrower than domestic Mexican law, which is advantageous for US companies.

Under the treaty, a PE requires either a fixed place of business in Mexico (office, branch, factory, workshop, or mine) or a dependent agent who habitually concludes contracts in Mexico on behalf of the US company.

Construction projects: A building site or construction project creates a PE only if it lasts more than six months. Under domestic Mexican law, there is no treaty-based time limit, so the treaty's six-month rule provides meaningful protection for US contractors executing short-term projects in Mexico.

Excluded activities: The treaty excludes from PE status activities that are preparatory or auxiliary in character—maintaining a stock of goods solely for storage, display, or delivery; purchasing goods; collecting information. A US company that maintains a warehouse in Mexico to deliver goods ordered from the US does not, by that fact alone, have a PE.

Subsidiary is not PE: A Mexican subsidiary of a US parent is not, by reason of that relationship alone, a PE of the US parent. The subsidiary must act as a dependent agent—habitually concluding contracts on the parent's behalf—to trigger PE status.

Dividend withholding

Mexico imposes a 10% withholding tax on dividends paid by Mexican companies to foreign shareholders under domestic LISR. The US-Mexico treaty modifies this:

• 5% withholding applies when the beneficial owner is a company that has directly owned at least 10% of the voting shares of the Mexican company paying the dividend for the 12 months preceding the dividend payment.
• 10% withholding applies in all other cases.

The 5% rate requires that the US recipient own at least 10% of the Mexican payer's voting stock for a full 12 months. Newly established subsidiaries or recently acquired stakes therefore receive the 10% rate until the holding period is met.

Interest withholding

Domestic LISR rates on interest paid to foreign recipients range from 4.9% to 35% depending on the lender type. The treaty provides:

• 4.9% on interest paid to financial institutions (banks, insurance companies, and certain securities dealers) that are residents of the US and are the beneficial owners of the interest. This rate matches Mexico's domestic rate for qualified banks, so the treaty's primary benefit here is confirmation of eligibility rather than a rate reduction.
• 15% on all other interest paid to US residents.

Interest paid to related parties is subject to additional scrutiny under Mexico's transfer pricing rules and thin capitalization provisions (LISR Art. 28 fr. XXVII), which limit deductible interest on related-party debt to a 3:1 debt-to-equity ratio.

Royalty withholding

The treaty caps withholding on royalties paid by Mexican licensees to US licensors at 10%. Domestic LISR imposes 25% withholding on royalties paid to non-residents in the absence of a treaty. The 10% rate applies to royalties for the use of copyrights, patents, trademarks, designs, secret formulas, know-how, and payments for the use of industrial, commercial, or scientific equipment.

Royalty arrangements between related parties are subject to transfer pricing analysis. SAT has increasingly challenged royalty rates paid to foreign IP holders, treating them as excessive deductions.

Capital gains

Capital gains derived by US residents from the sale of real property located in Mexico are taxable in Mexico under the treaty. "Real property" includes shares in companies whose assets consist principally of real property in Mexico (more than 50% of assets), which means US investors selling shares of a Mexican real estate holding company are subject to Mexican capital gains tax.

For non-real-estate share sales, capital gains are generally taxable only in the US for US residents, subject to conditions.

Limitation on benefits

The LOB clause in the US-Mexico treaty is a principal protection against treaty shopping—the use of US entities by third-country residents to access treaty benefits. The LOB clause requires that the beneficial owner of treaty-protected income be a "qualified person," which includes:

• US or Mexican government entities
• Publicly traded companies listed on recognized stock exchanges
• Companies at least 50% owned by qualified US residents
• Companies that meet an active trade or business test in the US with a sufficient nexus to the income earned from Mexico

US holding companies with no substantial US business activity, or whose ultimate owners are not US residents, will not automatically qualify under the LOB clause. Analysis is required before relying on treaty rates.

Claiming treaty benefits

To receive treaty withholding rates, the US recipient must provide the Mexican payer with the following:

• Evidence of US tax residence, typically IRS Form 6166 (a residency certification letter from the IRS, requested on IRS Form 8802)
• For corporate recipients, evidence of share ownership percentage when claiming the 5% dividend rate
• A W-8BEN-E form for the Mexican payer's files (required under US tax rules if the payer is also subject to US reporting obligations)

The Mexican payer retains these documents and applies the treaty rate when making the payment. If documentation is not provided before payment, the payer must withhold at domestic rates. Refund of over-withheld amounts requires a Mexican tax return or refund application.

REFIPRE treatment under the treaty

REFIPRE (Mexico's CFC regime) generally taxes Mexican residents on income earned through entities in preferential tax regimes on a current basis. The US-Mexico treaty does not override REFIPRE because REFIPRE applies to Mexican residents, not to the cross-border payments themselves.

Continue your legal review

Broaden the analysis with our guide to international tax law and cross-border corporate structures.

Prepare for the next stage with key legal rules on transfer pricing regulations in Mexico.

Frequently asked questions