Key Provisions of the U.S.-Mexico Tax Treaty

An income tax treaty is an agreement between two countries designed to prevent the double taxation of income and combat tax evasion. The United States and Mexico entered into such a treaty, first signed in 1992 and updated by subsequent protocols, to establish rules for how income earned by a resident of one country is taxed by the other. This agreement provides a framework for resolving potential tax disputes and reducing tax barriers to cross-border trade and investment. The treaty clarifies which country has the primary right to tax certain income and provides relief through reduced tax rates or exemptions that would not otherwise be available.

Determining Residency for Treaty Purposes

The benefits of the U.S.-Mexico tax treaty are exclusively available to individuals and entities defined as “residents” of one or both countries. A resident is any person who, under the laws of that country, is liable to tax there based on their domicile, residence, place of management, place of incorporation, or any similar criterion. An individual merely earning income from sources in a country without meeting its residency criteria is not considered a resident for treaty purposes.

When an individual is considered a resident of both the U.S. and Mexico under their domestic laws, this “dual resident” status triggers a series of tie-breaker rules. The treaty uses these rules sequentially to assign residency to a single country for applying its provisions. The first test is the “permanent home” test; if the individual has a permanent home available in only one country, they are deemed a resident of that country.

If the individual has a permanent home in both countries or neither, the next test considers their “center of vital interests.” This analysis examines where personal and economic ties are closer, weighing factors like family, occupation, and social relationships. If the center of vital interests is not determinable, the treaty looks to the individual’s “habitual abode,” the country where they spend more time.

If an individual has a habitual abode in both countries or neither, the final tie-breaker rule is citizenship. If the person is a citizen of only one of the two countries, they are considered a resident of that country. If the individual is a citizen of both nations or neither, the “competent authorities” of the U.S. and Mexico resolve the matter by mutual agreement.

Key Treaty Provisions for Individuals

The U.S.-Mexico tax treaty addresses the taxation of income commonly earned by individuals. For income from employment, or “Dependent Personal Services,” the earnings are taxable in the country where the employment is exercised. An exception, known as the 183-day rule, can exempt this income from tax in the source country.

This exemption applies if the individual is present in the source country for 183 days or less in a 12-month period. It also requires that the remuneration is paid by an employer who is not a resident of the source country. Finally, the pay must not be borne by a permanent establishment of the employer in the source country.

For self-employed individuals like freelancers and consultants, the treaty addresses “Independent Personal Services.” Income from these activities performed by a resident of one country is taxable in the other country only if the individual has a “fixed base” regularly available to them there for performing their activities. If such a fixed base exists, only the income attributable to that base can be taxed by the source country.

The treaty also provides guidance on the taxation of retirement income. Pensions and other similar remuneration received by a resident of one country for past employment are taxable only in that country of residence. In contrast, Social Security benefits paid by one country to a resident of the other are taxable only in the country making the payments.

Key Treaty Provisions for Businesses and Investments

For businesses, a key concept in the U.S.-Mexico tax treaty is the “Permanent Establishment” (PE). The business profits of an enterprise from one country are not taxable in the other country unless the enterprise carries on its business through a PE situated there. If a PE exists, the source country can tax the profits, but only to the extent they are attributable to that PE. A PE is defined as a fixed place of business, such as a branch, office, factory, workshop, or mine.

The treaty also specifies activities that do not create a PE, even if conducted through a fixed place of business. These exceptions include using facilities solely for the storage, display, or delivery of goods; maintaining a stock of goods for processing by another enterprise; or maintaining a fixed place of business for purchasing goods or collecting information.

Beyond business profits, the treaty reduces withholding taxes on certain types of investment income. For dividends paid by a company in one country to a resident of the other, the treaty caps the withholding tax at 10%, a reduction from the 30% statutory rate the U.S. often imposes. The rate can be further reduced to 5% if the beneficial owner is a company that owns at least 10% of the voting stock of the dividend-paying company. In some cases, such as dividends paid to a parent company that owns at least 80% of the subsidiary, the withholding tax may be eliminated.

Similarly, the treaty limits the withholding tax on interest payments. The rate is capped at 10%, but lower rates are available for certain types of interest, such as that paid to banks. For royalties, which are payments for the use of patents, trademarks, or copyrights, the treaty sets a maximum withholding tax rate of 10%.

Claiming Treaty Benefits

Individuals and businesses entitled to the protections of the U.S.-Mexico tax treaty must take specific steps to claim them. The method for claiming benefits depends on the type of income and whether the tax is being collected at the source or addressed on an annual tax return. For payments of U.S. source income to a resident of Mexico, benefits are claimed at the source to receive a reduced rate of withholding tax. This is accomplished by providing a valid Form W-8BEN, “Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting (Individuals),” to the U.S. paying agent.

By completing Form W-8BEN, the Mexican resident certifies that they are not a U.S. person and are the beneficial owner of the income. The form also allows the individual to claim residency in a country with which the U.S. has an income tax treaty, thereby qualifying for the reduced withholding rates on items like dividends, interest, or royalties. The paying agent is then authorized to withhold tax at the lower treaty rate instead of the full statutory rate.

In other situations, a taxpayer may need to claim treaty benefits on their tax return. A U.S. taxpayer, for instance, might use the treaty to exempt certain income earned in Mexico from U.S. taxation. To do this, they must disclose their treaty-based return position to the IRS by attaching Form 8833, “Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b),” to their tax return. This form is required whenever a taxpayer takes a position that a U.S. tax treaty overrules or modifies an internal revenue law, resulting in a reduction of their tax.