What Are the US Mexico Tax Treaty Withholding Rates?

The United States and Mexico maintain a tax treaty to manage how income is taxed between the two countries, preventing double taxation. A primary function of this agreement is to establish lower withholding tax rates on specific types of income paid from a U.S. source to a resident of Mexico. Without the treaty, this income is subject to a 30% withholding tax, but the agreement provides a way for eligible individuals and companies to benefit from reduced rates on payments like dividends, interest, and royalties.

Determining Eligibility for Treaty Benefits

To qualify for the benefits in the U.S.-Mexico tax treaty, an individual or company must first be considered a “resident” of Mexico for tax purposes. For an individual, residency is determined by where they have a permanent home available to them. For a company, residency is established in the country where it is incorporated or managed.

A more complex set of requirements is in the treaty’s “Limitation on Benefits” (LOB) article. This provision is designed to prevent “treaty shopping,” where residents of third countries structure their affairs to improperly gain access to the treaty’s benefits. To be eligible, a Mexican company must satisfy at least one of several specific tests that ensure a substantial connection between the entity and Mexico.

One of the most straightforward LOB tests is the publicly traded company test. If a company’s principal class of shares is substantially and regularly traded on a recognized stock exchange, it generally qualifies for treaty benefits. This test is based on the assumption that a publicly traded company has a genuine link to its country of residence.

Another path to eligibility is the ownership and base erosion test. This two-part test requires that more than 50% of the company’s ownership is held by residents of Mexico who are themselves entitled to treaty benefits. It also requires that less than 50% of the company’s gross income is paid out as deductible payments to persons who are not residents of either Mexico or the U.S. This ensures that income is not simply being funneled through the Mexican entity.

The active trade or business test provides an alternative for companies that may not meet the other criteria. Under this test, a Mexican company can claim treaty benefits on income that is derived in connection with the active conduct of a trade or business in Mexico. This test requires a genuine business presence, preventing entities that are merely passive investment vehicles from qualifying.

Treaty Withholding Rates by Income Type

The U.S.-Mexico tax treaty specifies distinct withholding rates for different categories of income. The applicable rate depends on the nature of the income being paid from a U.S. source to a resident of Mexico.

Dividends

For dividends, the treaty outlines two primary withholding rates. A 5% rate applies to intercompany dividends, where the beneficial owner is a company that owns at least 10% of the voting stock of the U.S. corporation paying the dividend. For all other dividends, a 10% withholding rate applies. This tiered structure provides a greater tax reduction for significant corporate investors.

Interest

The treatment of interest income is more varied, with several potential rates depending on the specific circumstances.

• Interest on loans by banks and insurance companies, or on publicly traded securities, has a 4.9% rate.
• Interest paid by banks or by the buyer of machinery and equipment on credit has a 10% rate.
• Most other types of interest have a 15% rate.
• Certain interest, such as payments to specific government entities, may be exempt from withholding.

Royalties

The treaty establishes a uniform withholding rate of 10% for royalties. The definition of a royalty under the treaty is broad, encompassing payments for the use of copyrights, patents, trademarks, designs, or secret formulas. It also includes payments for industrial, commercial, or scientific equipment and for technical assistance.

Required Documentation to Claim Treaty Rates

To benefit from the reduced withholding rates under the U.S.-Mexico tax treaty, the Mexican recipient of the income must provide specific documentation to the U.S. payer. This paperwork serves as certification of the recipient’s foreign status and their eligibility for treaty benefits.

The primary forms used for this purpose are from the Internal Revenue Service (IRS). Individuals must use Form W-8BEN, “Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting (Individuals).” Entities, such as corporations or partnerships, must use Form W-8BEN-E, “Certificate of Status of Beneficial Owner for United States Tax Withholding and Reporting (Entities).” These forms are given directly to the U.S. withholding agent.

A key part of these forms is the section for claiming tax treaty benefits. In this section, the recipient must certify that they are a resident of Mexico. They must also cite the specific article of the U.S.-Mexico treaty that provides for the reduced rate and specify the rate being claimed.

The recipient must also identify the specific provision of the Limitation on Benefits (LOB) article they satisfy to be eligible for the claimed benefits. This requires the entity to have determined its eligibility based on tests like the publicly traded company test or the ownership and base erosion test.

How to Provide Documentation and Apply Rates

The Mexican income recipient must deliver the completed Form W-8BEN or W-8BEN-E to the U.S. withholding agent. This should be done before the first payment is made to ensure that the reduced rate is applied from the outset. The form remains valid for the year it is signed and for three subsequent calendar years.

Upon receiving the completed W-8 form, the U.S. payer is responsible for reviewing it to ensure it appears complete and accurate. The payer is not required to conduct an independent legal analysis of the recipient’s treaty eligibility but must check that all necessary fields are filled out. The payer is then authorized to apply the reduced withholding rate specified on the form.

The U.S. payer does not send the W-8 form to the IRS. Instead, the payer must keep the form on file as part of their own tax records. This documentation serves as the justification for withholding less than the statutory 30% rate and substantiates the information reported on their own filings.