Introduction

In June 2023, the Federal Tax Court (Tribunal) addressed the application of the "business profits" clause (Article 7) of the Double Taxation Treaty (DTT or the Treaty) signed between Mexico and the Kingdom of the Netherlands to income obtained by residents of both jurisdictions.

Indeed, on that aforementioned date, Jurisprudence IX-J-SS-70 was issued by the Tribunal, the heading of which is as follows: “TECHNICAL ASSISTANCE. CASE IN WHICH IT DOES NOT CONSTITUTE A BUSINESS PROFIT FOR THE PURPOSES OF THE DOUBLE TAXATION AVOIDANCE AGREEMENT IN MATTERS OF INCOME TAX CELEBRATED BETWEEN THE UNITED MEXICAN STATES AND THE KINGDOM OF THE NETHERLANDS.”

In that Jurisprudence regarding business profits, it is established that "since the concept of technical assistance is not contemplated within the DTT, we must resort to the meaning given to it by Article 15-B of the Federal Tax Code, which consists of the rendering of independent personal services by which the provider undertakes to provide non-patentable knowledge, which does not imply the transmission of confidential information related to industrial, commercial or scientific experiences, being obligated to the provider to intervene in the application of such knowledge.”

The legal and practical effect of this sentence means that any payment made for technical assistance by a resident of Mexico to a resident of the Kingdom of the Netherlands will be subject to a 25% withholding tax, with no deductions. This means that the payment will not be deductible for the Mexican resident if this withholding is not applied.

Indeed, the Tribunal refers to the concept of technical assistance to domestic legislation (i.e., the Federal Tax Code), since the terminology of the concept of technical assistance per se is not defined in the Treaty. This was based on the provisions of Article 3, Paragraph 2, of said Treaty, which establishes that any term not defined therein, unless the context otherwise requires, (emphasis added), must be followed in accordance with domestic legislation.

This being the case, the Tribunal finds that income from technical assistance received by a company resident in the Kingdom of the Netherlands, without a permanent establishment in Mexico, is taxable under Article 167 (overlooking what the Treaty context provides), Paragraphs 1 and 2, Section II, and Paragraph 7 of the Income Tax Law (in force in 2015). It should be noted that this provision, in turn, refers to Article 15-B of the Federal Tax Code, which defines technical assistance as the provision of independent personal services with certain characteristics mentioned by the Tribunal.

On the other hand, the Tribunal also mentioned that Article 210, Section VI, of the Income Tax Law considers income from business activities as those indicated in Article 16 of the Federal Tax Code and excludes those provided for in Articles 179 to 207 of the Income Tax Law; thus, technical assistance, being contained in Article 167 (within Articles 179 to 207) could not be considered in any way a business profit.

It should be noted that this provision (Article 210, cited above) has its justification, as there were interpretations in the past that tended to consider any type of activity or operation (i.e., derivative financial transactions, financing income, etc.) as business activities whose treatment under the corresponding tax treaty could be exempt from withholding in Mexico, thereby violating the text and spirit of the tax treaties. This is not the case here, as we will discuss below.
 

Comments

According to the Income Tax Law (Domestic Law), technical assistance is the provision of independent personal services, defined by three specific characteristics:

1. The provider is obligated to provide non-patentable knowledge.
2. They do not involve the transmission of confidential information relating to industrial, commercial, or scientific experience.
3. The provider is obligated to the receiver to intervene in the application of said knowledge.

From our perspective, this Tribunal ruling overlooks several very important legal and interpretive considerations.

First, from our perspective, the resolution did not adhere to the interpretation methodology consistent with the Treaty, given that although the concept of technical assistance is not defined by such international instrument, its treatment is regulated by the Treaty through the commentaries to the OECD Model Convention, which are applicable as a means of interpretation. This has been established in the following case issued by same Tribunal.
 

VIII-J-SS-90

DOUBLE TAXATION. THE COMMENTARIES ON THE MODEL CONVENTION FOR THE AVOIDANCE OF DOUBLE TAXATION AND PREVENTING TAX EVASION OF THE ORGANIZATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT (OECD), CONSTITUTE ONE OF THE INSTRUMENTS TO INTERPRET THE PROVISIONS EXISTING IN THE CONVENTION ITSELF. The use of the Commentaries of the Model indicated in the section, has the purpose of interpreting the provisions existing in the Convention itself and its application to the specific cases, since they constitute one of the instruments formulated and accepted by the contracting countries, to apply in a uniform manner the provisions of the tax conventions entered into by the countries, because this is expressly recognized in points 28 and 29 of the introduction to the OECD Model Convention, insofar as this guarantees that the treaty is being interpreted in the fair terms in which it was conceived and for which it was designed, since it is applicable to all conventions following the OECD model, the tax authorities of each country are prevented from interpreting the treaties based on individual assessments and perhaps using different methods, since the existence of commentaries forces them to adjust their actions to the guidelines provided therein and, consequently, to resolve, if not always in identical terms, at least in a similar manner.

(Jurisprudence thesis approved by agreement G/5/2019)

R.T.F.J.A. Eighth Period. Year IV. No. 33. April 2019. p. 92

VII-J-2aS-48

DOUBLE TAXATION.- APPLICATION OF COMMENTARIES TO THE OECD MODEL, ACCORDING TO THE VIENNA CONVENTION.- The Vienna Convention establishes rules for the interpretation of international treaties, which, having been signed and ratified by Mexico, become Mexican domestic law and, consequently, are binding on the judge. For its part, Article 31 of said Convention states, among other rules, that a treaty must be interpreted in good faith, in its context and taking into account its object and purpose; the context includes, among other elements: a.) Every agreement that refers to the treaty and has been made by all the parties on the occasion of its conclusion,b.) Every instrument formulated by one or more parties on the occasion of the conclusion of the treaty and accepted by the other parties as an instrument referring to the treaty. Thus, in accordance with the aforementioned provision, one of the purposes of the agreements entered into between the governments of different countries to avoid double taxation and prevent tax evasion in the area of income and capital taxes is accepted precisely to prevent two or more countries from simultaneously imposing such taxes on a person for the same taxable event. Since these agreements were agreed upon in accordance with the model developed by the Organization for Economic Cooperation and Development (OECD), they are a privileged source for the interpretation of the aforementioned treaties and not a mandatory rule, provided that the governments of the residents of the countries subject to the dispute participated in the drafting of this instrument without expressing any reservation regarding the commentary in question or the provision discussed. Consequently, if the United States of North America and Mexico accepted the aforementioned Model, the commentaries contained therein must be considered a privileged source for the interpretation of the Treaty signed between them to Avoid Double Taxation and Prevent Tax Evasion. This is without prejudice to the fact that, in cases where the individual benefits from the application of these commentaries, and provided that the current general provisions related to such mandatory application are maintained, they are considered mandatory under the terms of the precedent, which reads: DOUBLE TAXATION - MANDATORY APPLICATION OF THE COMMENTARIES TO THE OECD MODEL.

(Jurisprudence dissertation approved by agreement G/S2/02/2014)
 

In fact, the Commentaries on the Model Convention regarding Article 12, Paragraph 2, particularly Paragraphs 11.2 to 11.4, clearly establishes that the services of technical assistance fall under Article 7 of the treaties to avoid double taxation.^[1]

In this regard, in applying Article 3, Paragraph 2, of the Treaty, before considering domestic legislation, the Tribunal should have analyzed the "context" of the Treaty in order to apply the Commentaries and reach the logical conclusion that technical assistance is regulated in Article 7 of the Treaty and therefore had the treatment as Business Profits.

In addition to the above, the Tribunal did not consider that the legal nature of technical assistance is part of independent personal services. Therefore, it should have been analyzed if the independent personal services, regardless of their technical nature, were regulated in an article different than Article 7, such as Article 14, which regulates professional services. This article also does not generally require withholding in Mexico.

Furthermore, the Tribunal also failed to analyze whether the income qualified as "others income" as referred to in Article 21 of the Treaty. In that case, a withholding rate of 17.5% would be applicable.

In other words, the Tribunal's decision rushed into said what the Income Tax Law establishes, without conducting a proper and in-depth analysis of the treaty's provisions, rendering the treaty’s application null.

Another implication of the ruling in question is that, if 25% withholdings are applied, the foreign resident, who is the direct taxpayer, will not be able to claim the tax credit, since the authorities of the other country could argue that, based on the commentaries, there should not apply a withholding for technical assistance payments.

The Tribunal could have even analyzed a Contracting State's concept of an enterprise, established in Article 2 of the treaty's definitions, to conclude whether the nature of the service is businesslike or not.

It should be noted that the Treaty, like any international treaty, has superior status to the law in Mexico, as established by the Supreme Court of Justice of the Nation (SCJN).

It is important to mention that there has been no conclusive ruling from the Federal Judicial Branch, whether from the Collegiate Tribunals or the SCJN.

The Tribunal could have even considered the provisions of Rule 2.1.34 of the Miscellaneous Tax Resolution^[2] and the Internal Criteria 55/2020/N, for the purpose of analyzing the nature of the services in question, and concluded that technical assistance could be considered, for tax treaty purposes, as business profits not subject to withholding, as they are included in Article 7 of the Treaty. It is certainly a well-known fact that this rule was intended to be an antidote to the strict application of the provisions of Article 210, Section VI, which defines income from business activities.

Conclusions

This Tribunal ruling may be applicable to other cases of technical assistance payments from Mexico to other countries, such as the United States of America or some European countries.

Some tax treaties do not address this issue, as they expressly establish that technical assistance must be considered a business benefit subject to the provisions of Article 7 of the agreements.

This ruling is not final, as it may still be challenged in collegiate tribunals, or, where appropriate, in the Supreme Tribunal of Justice of the Nation. Or, the matter could even be submitted to a mutual agreement procedure (MAP), which we believe may be the most viable solution.

An important element to consider is that taxpayers' transactions often do not comply with the established legal form. Therefore, it is important to review technical assistance payments to corroborate their materiality, their essence, the contract that supports them, their supporting documentation (tax receipts), and verification of other requirements established by tax treaties (proof of residence), as well as the possibility that there is an intangible element involved in technical assistance.

There is a recent court case (issued by the Collegiate Court, with digital number 2030270) that supports that an activity is considered commercial, based on both, the nature of the activity and purpose of the entity who’s is rendering the services.

[1]11.2 This type of contract (know-how) thus differs from contracts for the provision of services, in which one of the parties undertakes to use the customary skills of his calling to execute work himself for the other party. Payments made under the latter contracts generally fall under Article 7.

11.3 The need to distinguish these two types of payments, i.e., payments for the supply of know-how and payments for the provision of services, sometimes gives rise to practical difficulties. The following criteria are relevant for the purpose of making that distinction:

— Contracts for the supply of know-how concern information of the kind described in Paragraph 11 that already exists or concern the supply of that type of information after its development or creation and include specific provisions concerning the confidentiality of that information.

— In the case of contracts for the provision of services, the supplier undertakes to perform services that may require the use, by that supplier, of special knowledge, skill, and expertise but not the transfer of such special knowledge, skill, or expertise to the other party.

— In most cases involving the supply of know-how, there would generally be very little more that needs to be done by the supplier under the contract other than to supply existing information or reproduce existing material. On the other hand, a contract for the performance of services would, in the majority of cases, involve a very much greater level of expenditure by the supplier in order to perform his contractual obligations. For instance, the supplier, depending on the nature of the services to be rendered, may have to incur salaries and wages for employees engaged in researching, designing, testing, drawing, and other associated activities or payments to sub-contractors for the performance of similar services.

11.4 Examples of payments which should therefore not be considered to be received as consideration for the provision of know-how but, rather, for the provision of services, include:

— payments obtained as consideration for after-sales service,

— payments for services rendered by a seller to the purchaser under a warranty,

— payments for pure technical assistance,

— payments for a list of potential customers, when such a list is developed specifically for the payer out of generally available information (a payment for the confidential list of customers to which the payee has provided a particular product or service would, however, constitute a payment for know-how as it would relate to the commercial experience of the payee in dealing with these customers),

— payments for an opinion given by an engineer, an advocate, or an accountant, and

— payments for advice provided electronically, for electronic communications with technicians or for accessing, through computer networks, a trouble-shooting database such as a database that provides users of software with nonconfidential information in response to frequently asked questions or common problems that arise frequently.

[2]Business profits for the purposes of double taxation treaties

2.1.34. For the purposes of Article 7 of the double taxation treaties that Mexico has in force, the term "business profits" shall be understood as income obtained from the activities referred to in Article 16 of the Federal Tax Code.