Permanent establishment taxation on foreign residents for manufacturing activities in Mexico following the 2022 tax reform

Wednesday 1 December 2021

Pedro Ángel Palma Cruz

Sanchez Devanny Eseverri, Mexico City


Yamile Pérez-Moreno Chiapa

Sanchez Devanny Eseverri, Mexico City


Under Mexican law, foreign residents conducting manufacturing transactions with Mexican related parties (maquilas) were not considered to have a permanent establishment (PE) in Mexico if the maquila:

  • determines its profitability under a safe harbour (6.5 per cent over cost, or 6.9 per cent over assets); or
  • submits a unilateral advance price agreement (APA) before the Mexican Tax Authority.

However, the Mexican tax reform for 2022 has eliminated the APA option. Now, Mexican maquilas should determine their profitability under the safe harbour methodology. This will lead to a significant increase in taxes for asset-intensive maquilas and expose foreign residents to PE taxation in Mexico under domestic law.

Under this scenario, foreign residents would face double taxation for the manufacturing services rendered by Mexican maquilas. The Mexican consideration for the controlled transaction would increase significantly due to the safe harbour methodology application, varying from what is expected to be an arms-length deduction on the foreign side.

For some foreign residents, it could be feasible to restructure their manufacturing or maquila activities to reduce the higher profitability and Mexican tax resulting from the Mexican safe harbour application. This could risk a PE creation under Mexican domestic law, in which case, the tax treaties signed by Mexico would apply.

Under Article 5 of the Organisation for Economic Cooperation and Development (OECD) Model Convention, a PE means a fixed place of business through which the business of an enterprise is wholly or partly carried out. The commentaries to the OECD Model Convention stress that the fixed place of business should be ‘at the disposal’[1] of the foreign resident. This requirement is relevant to the extent that, if a foreign resident does not carry out business ‘through which’[2] the foreign resident can dispose of a fixed place of business, no PE taxation should be triggered.

Furthermore, Article 5, paragraph 4 of the OECD Model Convention provides for a list of exceptions to the PE definition. In particular, the following sub-paragraphs are relevant:

  • sub-paragraph A: the use of facilities for storage, display, or delivery of goods or merchandise belonging to the enterprise;
  • sub-paragraph B: the maintenance of a stock or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery; and
  • sub-paragraph C: the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise.

Under this scenario, sub-paragraph C should suffice to consider the manufacture or maquila activities as an exception to the PE definition. Attention should also be paid to Article 5, paragraph 4, sub-paragraph F – ‘the maintenance of a fixed place of business solely for any combination of activities mentioned in subparagraph a) to e),’ – since, based on the facts and circumstances of the case, a combination of the exceptions listed under Article 5, paragraph 4 could lead to PE taxation under the applicable treaty. This situation should also be considered under a potential restructuring.

Modifications to the OECD Model Convention based on the base erosion and profit shifting (BEPS) project suggest that the activities listed under Article 5, paragraph 4 of the Model Convention should not trigger PE taxation to the extent they are auxiliary and preparatory in nature; this intent is materialised under the Multilateral Instrument (MLI), which is not in force in Mexico at the time of writing.

Many countries have reserved the application of the MLI provision to PE. Therefore, if the MLI enters into force for Mexican tax purposes, it is possible that the PE modifications have been reserved for the Mexican treaty counterparty.

The topic has generated much discussion in Mexico, to the extent that a transitory provision was included in the law to provide that APA requests submitted by 31 December 2021 will be resolved using the applicable 2021 law. This means the statutory exclusion provision for the creation of a PE for foreign residents should apply for the years covered by the APA (the year of submission, one year before and three years after).

The practical effect is a deferral to 2024 for PE taxation for foreign residents that do not wish to apply the Mexican safe harbour methodology. Multinational groups with manufacturing activities in Mexico have plenty of time to restructure their activities, reducing the profitability for the Mexican manufacturing company and avoiding PE taxation for the foreign resident.


[1] Commentaries to the OECD Model Tax Convention, Art 5, para 12.

[2] Commentaries to the OECD Model Tax Convention, Art 5, para 20.