February 5, 2023

Trademarks: Tax implications in the US and Mexico

About 30% of the world market is connected to it intellectual property. While intangibles cannot be touched or seen, they are all too real. For companies around the world, brands are one of the most important intangible assets for commerce.

In practice, trademark owners often generate revenue by licensing their trademarks to other parties. The owner is referred to as the “licensor”. The other party, referred to as the “licensee,” pays the licensor “royalties” for use of the mark.

Investors often come to Mexico for basic legal advice on starting a Mexican company. But they shouldn’t overlook tax planning related to their brands. However, failure to undertake proper tax planning in relation to intangible assets can leave a lot on the table. Indeed, royalty payments are often an alternative to repatriating capital.

This article gives a general overview of the tax implications combined with cross border Use of trademarks and their impact on US tax residents investing in Mexico.

Trademark royalties paid to a US investor – Mexican tax implications

Under the Mexican Income Tax (IT) Law, non-Mexico resident individuals and entities with a permanent establishment (PE) in Mexico are subject to income tax (“IT”) with respect to income attributable to the PE. US tax residents are also subject to tax on Mexican source income.

License fees include, but are not limited to, payments for the temporary use of trademarks, trade names, patents, certificates of invention or improvement, copyrights in literary, artistic or scientific works under the Federal Tax Code (BFA). [1].

Specifically, revenue from royalties, technical assistance, or advertising is considered to be Mexican-sourced if (1) the goods or rights for which royalties or technical assistance are paid are used in Mexico, or (2) the amounts are paid by a Mexican resident or a foreign resident with a place of business in Mexico.

In general, tax is calculated by applying the applicable withholding tax rate (25% or 35%) to gross income. The payer is obliged to withhold the relevant amount. Royalties paid for use of trademarks are subject to a 35% tax rate [2].

Withholding tax rates can be reduced under the Mexico-US tax treaty if certain conditions are met. The withholding tax deduction may apply the reduced tax rate, if applicable. However, if the withholding party applies a higher tax rate, the foreigner can request a refund. In addition, the withholding party must issue a digital tax invoice to the foreign resident.

Under Mexico’s Value Added Tax (VAT) Law, individuals and entities are required to pay a VAT rate of 16% if such individuals conduct the following activities within the national territory: (i) transfer of goods; (ii) provide independent services; (iii) to grant temporary use or enjoyment of goods and (iv) to import services and/or goods.

The use of intangible goods provided by foreign residents on Mexican territory is considered importation of goods.

When importing intangible goods, the importer (taxpayer of the VAT) is entitled to a credit against the import sales tax. In certain cases, the import sales tax would not affect the importer.

In addition, where a Mexican subsidiary is incorporated, certain limitations may apply to royalties paid to its US parent company as new deduction limitations relating to payments to tax havens have been introduced into the Mexican tax regime.

In general, from a Mexican tax perspective, a country with a corporate tax rate of less than 22.5% can be considered a tax haven (a country or jurisdiction with low tax rates or no corporate taxes). In such a case, payments by a Mexican company to a company that has a tax rate of less than 22.5% or is a transparent vehicle may be subject to restricted royalty payments or an additional tax burden.

In addition, transactions performed between related parties must be at fair market value and supported by a transfer pricing study from the US and Mexico sides.

Therefore, a US-based licensor (with a 22% corporate tax rate) must pay a 35% withholding tax in Mexico on royalty income for licensing a trademark to a Mexican subsidiary at fair market value. However, if the US tax resident licensor is in compliance with the US-Mexico tax treaty, it will be subject to a 10% withholding tax. In addition, the licensee (Mexican subsidiary) can deduct royalties from its taxes if certain requirements are met. This reflects the control symmetry.

We recommend due diligence and thorough tax analysis before deciding which vehicle or jurisdiction will own the marks and from which vehicle and jurisdiction the licensor will receive royalty payments due to various US tax implications for the licensor and the licensee can be triggered in Mexico respectively. In addition, the economic tax burden for the taxpayer can be reduced.

Trademark royalties received from Mexico – US tax implications

Generally, royalties paid for use of property in the United States are US-source income and royalties for use of property outside the United States are foreign-source income. The place of use of the intangible asset is considered to be the place of economic activity from which the income is derived, regardless of where the intangible asset was developed. For example, if a trademark is used in the United States, the revenue is from the United States. The residency or nationality of the payer or recipient of royalties does not affect US procurement rules.

A royalty relates to the use of a valuable right. Royalties include the amounts paid for the use or privilege of using patents, copyrights, secret processes, formulas, goodwill, trademarks, trade names, franchises and other property.

Royalties received by US shareholders from a controlled foreign corporation (CFC) are treated as having the same character as the income from the CFC. In general, a US citizen’s income is treated as passive income. However, if the royalties received from a CFC are business income, they are treated by US shareholders as general restricted income rather than passive income.

Payments from “fixed and determinable annual or periodic” (FDAP) income from US sources, e.g. B. Royalties paid to foreign residents are subject to US withholding tax at a rate of 30% unless a reduced withholding rate or an exempt rate is claimed under an income tax treaty. Payment of royalties should be reported Form 1042-S.

[1] Section 15-B of the Federal Tax Code

[2] Article 167 of the IT Law

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