In recent years, Mexico’s international tax landscape has undergone a significant transformation, driven by a combination of OECD-led reforms (particularly the base erosion and profit shifting (BEPS) Project), increased audit activity by tax authorities, and structural economic developments such as nearshoring and supply chain reconfiguration.
These developments have resulted in a more substance-oriented, enforcement-driven and internationally aligned tax environment, in which traditional tax planning structures are subject to increasing scrutiny.
The following trends reflect the most relevant developments currently shaping tax practice in Mexico, particularly in cross-border scenarios.
Interest Deduction Limitations and Financial Structuring
One of the most significant developments in Mexican tax practice has been the strengthening of interest deduction limitation rules, reflecting Mexico’s alignment with BEPS Action 4 (limiting base erosion involving interest deductions and other financial payments).
As a starting point, interest expenses must comply with general deductibility requirements under Mexican tax law, which requires that expenses be strictly indispensable for the taxpayer’s business activity, duly supported by tax invoices, properly recorded in the accounting records, and effectively paid through authorised means.
Earnings-stripping rule
The most relevant provision is contained in Article 28, section XXXII of the Mexican Income Tax Law (MITL), which establishes an earnings-stripping rule. Under this rule, net interest expense is deductible only up to 30% of the taxpayer’s adjusted taxable profit (tax EBITDA). Any excess interest is disallowed in the relevant fiscal year but may generally be carried forward for up to ten fiscal years, subject to certain limitations.
This rule applies broadly to both domestic and cross-border financing. It represents a shift from transactional analysis to a global limitation approach, as it considers the taxpayer’s overall financial position rather than individual transactions.
Thin capitalisation rule
In parallel, Mexico maintains a thin capitalisation rule under Article 28, section XXVII of the MITL, which specifically targets related-party debt. This provision limits the deductibility of interest when the taxpayer’s debt-to-equity ratio exceeds 3:1, effectively disallowing interest attributable to excess leverage. This rule is particularly relevant in multinational group structures where debt is concentrated in Mexican entities.
Limitations on deductions
Additionally, Article 28, section XXIII of the MITL introduces limitations on deductions in cases involving: (i) hybrid mismatch arrangements, where differences in tax treatment between jurisdictions result in double non-taxation; and (ii) payments to entities subject to preferential tax regimes.
Importantly, these rules do not operate in isolation but rather apply cumulatively, creating a complex framework in which multiple limitations may simultaneously restrict the deductibility of a single financing arrangement.
Layered limitation framework
From a practical perspective, these rules operate cumulatively, creating a layered limitation framework. Taxpayers must therefore analyse interest deductibility from several angles simultaneously, including:
- quantitative limitations (EBITDA test);
- structural limitations (thin capitalisation); and
- anti-avoidance provisions (hybrids and low-tax jurisdictions).
Mexican tax authorities have increasingly focused on intra-group financing arrangements, particularly in audits involving multinational groups. Areas of scrutiny include:
- whether the borrower has the capacity to assume and service the debt;
- whether the financing structure reflects a genuine business need; and
- whether the interest rate complies with the arm’s length principle.
In many cases, the authorities have challenged financing arrangements on the basis that they lack economic substance or business purpose, particularly where debt appears to be artificially introduced to generate tax deductions.
As a result, taxpayers have begun to restructure financing models, moving towards:
- increased use of equity funding;
- more conservative leverage ratios; and
- enhanced documentation to support the commercial rationale of financing transactions.
In practice, this reflects a broader shift towards a substance-over-form approach, where legal structuring alone is no longer sufficient to sustain tax benefits.
Real Estate Investment and Nearshoring Dynamics
Mexico has emerged as a key destination for foreign direct investment in real estate, largely driven by nearshoring trends and the strategic relocation of manufacturing and logistics operations closer to North American markets.
This shift has resulted in a significant increase in demand including industrial and logistics infrastructure, particularly in northern and central regions, warehousing and distribution facilities; and commercial and hospitality developments linked to industrial expansion.
From a tax perspective, Mexico offers a relatively attractive framework for real estate investment, combining structural flexibility with specific tax incentives.
One of the most important features of the Mexican system is the widespread use of trusts (fideicomisos) as investment vehicles. Trusts are generally treated as tax transparent, meaning that income is attributed directly to the beneficiaries rather than taxed at the trust level. This allows investors to structure investments in a flexible manner while maintaining tax efficiency.
In addition, Mexico has developed a sophisticated market for real estate investment trusts (Fideicomisos de Infraestructura y Bienes Raíces or FIBRAs), which are publicly traded vehicles designed to facilitate investment in income-generating real estate.
FIBRAs offer several tax advantages, including:
- deferral of taxation upon contribution of assets;
- access to capital markets; and
- a single level of taxation at the investor level.
Recent government initiatives, particularly the “Infrastructure Investment Plan for Development with Wellbeing 2026–2030” programme, have further enhanced the attractiveness of real estate and infrastructure investment by introducing tax regimes for certain types of assets, including construction and infrastructure investments. The programme also outlines potential use of specialised funds and structures aimed at attracting institutional capital, reducing financing costs, and enhancing transparency standards.
Despite these advantages, real estate investments in Mexico involve a high degree of complexity due to the interaction between: (i) federal taxes (income tax and VAT); and (ii) local taxes, including property taxes and transfer taxes, which vary significantly across states and municipalities.
VAT treatment can be complex in cases involving mixed-use properties, where some activities are taxable, and others are exempt. This may result in non-creditable VAT, which can significantly impact project profitability.
Furthermore, real estate structures must carefully consider the potential creation of a permanent establishment (PE), particularly where foreign investors are involved in active management or development activities.
Under domestic law, a PE is deemed to exist when construction, installation, or related activities exceed a period of 183 days within a 12-month period. Notably, this threshold is broadened by rules that require the aggregation of time spent by subcontractors, significantly increasing the likelihood of triggering a PE.
Overall, while Mexico presents significant opportunities for real estate investment, it also requires a highly structured and multidisciplinary approach, integrating tax, legal and operational considerations.
Substance, Materiality and Related-Party Transactions
A defining feature of the current Mexican tax environment is the increasing emphasis on economic substance and materiality, particularly in relation to related-party transactions.
General Anti-Avoidance Rule (GAAR)
This approach is anchored in the introduction of the General Anti-Avoidance Rule (GAAR) under Article 5-A of the Federal Fiscal Code (FFC), which allows tax authorities to disregard or recharacterise transactions that lack a valid business purpose and generate a tax benefit.
Transfer pricing rules
In addition, transfer pricing rules under Articles 179 and 180 of the MITL require that transactions between related parties be conducted in accordance with the arm’s length principle, consistent with OECD standards.
Scrutiny of intercompany transactions
In practice, Mexican tax authorities have significantly increased their scrutiny of intercompany transactions, particularly those involving:
- place of effective management (POEM) and administrative services, where the benefit to the recipient is often questioned;
- royalties and licensing arrangements, especially in cases involving intangible assets with unclear ownership or value creation; and
- financial transactions, including loans and guarantees.
A key aspect is the concept of materiality, which requires taxpayers to demonstrate that transactions have a real economic impact and are not merely formal arrangements designed to achieve tax benefits.
This has led to a more substance-driven analysis, where tax authorities evaluate:
- whether the transaction would have been entered into by independent parties;
- whether it generates a measurable economic benefit; and
- whether it aligns with the functions, assets and risks (FAR analysis) of the entities involved.
This approach is closely aligned with OECD transfer pricing guidelines, particularly the emphasis on value creation and DEMPE functions (development, enhancement, maintenance, protection and exploitation) in relation to intangible assets.
In cross-border contexts, this has resulted in increased challenges to structures involving:
- low-substance entities in foreign jurisdictions;
- back-to-back arrangements; and
- centralised service or IP holding structures.
As a result, taxpayers are increasingly required to maintain adequate documentation and functional analyses, and to ensure that their structures reflect genuine economic activity.
Evolving Interpretation of “Business Activities”
Another important development in Mexican tax practice is the evolving interpretation of “business activities”, which plays a central role in determining the tax treatment of cross-border income.
Under Articles 14 and 16 of the FFC, business activities are broadly defined to include commercial, industrial, financial and service activities, among others. This broad definition has allowed tax authorities to adopt an increasingly expansive interpretation of what constitutes business activity.
This concept is particularly relevant in the context of:
- the determination of business profits under tax treaties;
- the identification of a PE; and
- the classification of income as active or passive.
In recent years, Mexican tax authorities have adopted a more substance-oriented approach, focusing on the actual conduct of the taxpayer rather than formal legal structures. This has led to the recharacterisation of passive income as business income, particularly where the taxpayer is actively involved in generating such income; a broader interpretation of dependent agent permanent establishments, particularly where local agents play a key role in contract negotiation or conclusion; and increased scrutiny of digital and remote business models, where economic presence may exist without a traditional physical footprint.
In practice, this is consistent with broader international developments, including the OECD’s work on the digital economy and nexus rules, although Mexico has not fully implemented all aspects of these initiatives.
In practice, foreign investors must carefully assess:
- their level of activity in Mexico;
- the role of local personnel or intermediaries; and
- the risk of being deemed to carry out business activities in Mexico, thereby triggering tax liability.
Failure to properly assess these factors may result in the unexpected recognition of a taxable presence (PE) and the recharacterisation of income, with significant tax implications.