MEXICO: U.S. INVESTORS ASK FOR INTERVENTION ON TAX

UNCLAS SECTION 01 OF 04 MEXICO 004236 SIPDIS SENSITIVE SIPDIS STATE FOR WHA/MEX, WHA/EPSC, AND EB/IFD/OMA USDOC FOR 4320/ITA/MAC/WH/ONAFTA/GERI WORD TREASURY FOR IA (ALICE FAIBISHENKO) TREASURY FOR TAX POLICY OFFICE NSC FOR RICHARD MILES STATE PASS TO USTR (MELLE) STATE PASS TO FEDERAL RESERVE (CARLOS ARTETA) E.O. 12958: N/A TAGS: ECON EFIN PGOV MX SUBJECT: MEXICO: U.S. INVESTORS ASK FOR INTERVENTION ON TAX POLICY REFORM REF: A. MEXICO 3246 ¶B. MEXICO 2518 ¶C. MEXICO 3859 ¶1. Sensitive but unclassified, entire text. ¶2. (SBU) This is an action message, see paragraph 2. ¶3. (SBU) Summary and Action Request. Representatives of U.S. real estate firms in Mexico contacted the Embassy August 6 to express their concern over the Calderon administrations tax reform proposal (refs. A-C) and ask the Embassy's help in lobbying the Mexican government to rescind those portions of the tax proposal they believe would cause most harm to U.S. investors. The request, received in the letter reproduced in paras 4 - 14, centers on three aspects of the proposal: (1) that taxes paid under the Single Rate Income Tax for business or CETU proposal will not be deductible in a foreign (U.S.) firm's country of origin; (2) while pension plans in Mexico are exempt from income taxes, they would not be exempt from the CETU; and (3) the proposal includes no "transitional regime" meaning that companies would not receive any tax deduction for capital expenditures made before the entry into force of the tax. Given these points, and the information included in refs A-C above, Embassy requests Washington agency guidance on whether post should engage with GOM officials/legislators on this issue, and the potential harm it would cause to U.S. firms. End Summary and Action Request. ¶4. (SBU) Begin letter text: August 6, 2007 Mr. Antonio Oscar Garza United States Ambassador to Mexico United States Department of the Treasury Dear Ladies and Gentlemen: The United States real estate companies set forth below are managers of and/or investors in real estate funds that hold and operate real estate properties in Mexico, including industrial, residential, retail and office properties. United States nationals, including private and public pension and retirement plans, foundations, endowments and private companies, participate in such real estate funds as investors and hold the majority of the equity in the funds. As you are aware, the Mexican Congress is currently discussing a tax bill. While we welcome a tax reform, as it will help Mexico grow at a faster pace and abate poverty, we have some observations to the tax bill that would like to share with you and that are described in the document attached to this letter. As you will note, our comments to the tax bill seek to maintain the tax conditions under which the aforementioned United States funds and investors made their investments, and we respectfully ask for your help in this regard. The participation of United States investors in the Mexican real estate market has been increasing in the recent past and this trend expected to continue going forward. According to data from the Mexican Association of Real Estate and Infrastructure Funds, a non-profit association formed by the United States real estate companies set forth below, the real estate funds that are currently active in Mexico have investments in Mexico of approximately US$6 billion. Such Association expects that the real estate investments in Mexico by real estate funds in the next 5 years will reach approximately US$21 billion. However, such projections may not materialize if the tax reform does not include the observations contained in the attached document. Should you have any comments or questions in connection with the foregoing, please feel free to contact any of the persons listed in the document enclosed to this letter as Exhibit A. Sincerely, Carlyle MEXICO 00004236 002 OF 004 La Salle Investment Management Hines O'Connor Capital Partners Prudential Real Estate Investors Walton Street Capital End Letter Text. Begin Exhibit A Text. THE IMPACT OF THE "CETU" ON REAL ESTATE INVESTMENTS BY FOREIGNERS -------------- Nonresident Pension and Retirement Fund Exemption -------------- -------------- ¶5. (SBU) The current Income Tax Law of Mexico establishes an exemption regime applicable to nonresident pension and retirement funds (the "Pension Plans") in the case of certain type of income similar to that afforded in their countries of residence in order to attract their investment. These regimes are applicable in several countries, thus establishing a competitive factor for purposes of attracting this type of investments. The recent tax amendment submitted to the Congress of Mexico, which includes the Business Tax at a Single Rate (Contribuci"n Empresarial a Tasa inica or CETU) (the "Flat Tax"),establishes that residents of foreign countries with a permanent establishment in Mexico that sell goods, render services and grant the temporary use of goods, will be subject to the Flat Tax. This proposal further provides that foreign beneficiaries of any trust in Mexico engaged in activities subject to this tax would constitute a permanent establishment in Mexico. ¶6. (SBU) In accordance with this presumptive situation, any foreign investor, including a Pension Plan, carrying out activities subject to the Flat Tax through a permanent establishment (including in the form of a legal entity, an "Asociaci"n en Participaci"n" or a Mexican trust),will be subject to this new tax. ¶7. (SBU) Based on the method of calculating the Flat Tax, Pension Plans will now become subject to a substantial additional tax on certain real estate activities in which they were previously fully exempt. This substantial additional tax will apply not only to future investments made by Pension Plans, but also to any existing investments held by them as well. The application of the Flat Tax to existing investments, in which Pension Plans invested based on an assumed exempt regime, creates a concern about future legal and fiscal certainty for investors. We believe also that the investments by these Pension Plans in real estate in Mexico will become substantially less attractive as a result of the Flat Tax application to them. We consider that the granting of a Flat Tax exemption to Pension Plans, including United States funds, is advisable because: a) It promotes tax competitiveness in Mexico for purposes of capturing investments from Pension Plans that are currently the most important investors at a worldwide level. b) Provides legal certainty in Mexico. c) The impact on tax collection would be low since the Pension Plans are not captive taxpayers; therefore, in the event that this exemption is not granted, Mexico may lose these investments as well as potential future investments. ¶6. (U) Please note that the income tax exemption granted under the Income Tax Law of Mexico is not applicable to entities that are not pension plans, even though they may be tax exempt in their countries of residence. MEXICO 00004236 003 OF 004 CETU Credit Abroad -------------- ¶8. (SBU) It is not clearly established whether a foreign taxpayer subject (either directly or indirectly) to the Flat Tax will be entitled to claim a credit in its country of residence, as in the case of Mexican income tax. Moreover, the tax treaties that were entered into by Mexico with other countries refer exclusively to the income tax and in some specific cases to taxes on wealth. Hence, the Flat Tax will be excluded from application under such treaties. ¶9. (SBU) To avoid that the same income be taxed by both the Flat Tax as well as the income or other relevant tax in the relevant investor's country of origin, it would be necessary that, with the international mechanisms for the avoidance of double taxation, the possibility for the nonresidents to credit the Flat Tax paid in Mexico be established, thus granting legal certainty to avoid a double taxation situation. ¶10. (SBU) We believe that the Flat Tax should qualify as a tax that may be applied as credit against U.S. tax for U.S. taxpayers because, although the Flat Tax is not computed on net income as the existing Mexican income tax is, the general basis of the Flat Tax is income based (that is, the Flat Tax will be generally calculated in the same manner the Mexican income tax is, with the exception that certain deductions are disallowed under the Flat Tax law). We believe the foregoing situation would be very important in the case of investments made by U.S. investors due to the magnitude thereof. If this foreign tax credit were not granted to the U.S. investors, a double taxation would be triggered. Also, it is expected that a significant number of U.S. taxpayers will pay Mexican tax under the Flat Tax rather than under the regular Mexican income tax, with the expected result that many U.S. taxpayers who currently receive foreign tax credits will no longer do so. Failure to obtain the creditability of the Flat Tax in other countries, such as the United States, will likely result in reduced investments in Mexico that will generate less employment in Mexico, thus increasing the pressure for migration of Mexican workers to the United States. ¶11. (SBU) The creditability of the Flat Tax will become more relevant in the event that the transitional regime referred to below is not included in the tax reform. Also, it is known that the Mexican government plans to substitute the income tax with the Flat Tax in a few years and, if so happens, the creditability of the Flat Tax in the United States will be critical. ¶12. (SBU) We also believe that, although the creditability of the Flat Tax in the United States, and the granting by Mexico of a tax exemption to Pension Plans similar to the one existing for income tax, may imply less income tax collection in the short term in both countries, the investment from the United States investors in Mexico will continue to increase and, in the medium and long term, will generate more wealth and thus more tax collection in both countries. Transitional provisions for investments -------------- ¶13. (SBU) As in the case of the rest of the economy, the real estate sector will be affected by the lack of a transitional regime in the application of the Flat Tax. Nevertheless, the impact on the real estate sector would be especially strong because it is a sector that requires substantial capital investments. ¶14. (SBU) Most specifically, the lack of transitional provisions will result in real estate companies not receiving any benefit for capital expenditures made prior to the effective date of the Flat Tax. Upon sale of a pre-Flat Tax MEXICO 00004236 004 OF 004 real estate asset, the seller would be taxed based on the total proceeds received and will not receive any reduction in gain for any un-depreciated asset cost. As an example, in a given conservative fiscal period for a real estate fund whose investment period was between 2005 and 2007 and that would sell its assets in 2010, if there were no transitional regime, the Flat Tax would be 4 times greater than the applicable income tax. The lack of transitional provisions for the acknowledgement of the disbursements set forth herein would prevent imposing the tax on each taxpayer in accordance with their actual capacity to bear the tax burden. Consequently, it would be necessary to include a transitional regime that would allow the acknowledgement of expenses incurred on the investments made prior to the date in which the new Flat Tax law becomes effective. Mexico City August 6, 2007 End text. Comment -------------- ¶15. U.S. firms remain concerned over various aspects of the CETU, chief of which is the idea that the CETU is not creditable against U.S taxes. Nevertheless, despite these worries, as Washington agencies determine whether USG engagement on this issue is appropriate, we should keep in mind the following points. First, the CETU is a minimum tax. For many firms, though admittedly not all, it would likely be possible to adjust deductions to ensure that normal income taxes are greater than the minimum dictated by the CETU, and deductible from U.S. taxes. Second, because the proposal is very much under debate by the Mexican Congress, interjecting a lone U.S. opinion into the fray, even one that warns of disinvestment, may be counterproductive. If warranted, a multilateral approach by interested countries may be more effective. GARZA Visit Mexico City's Classified Web Site at http://www.state.sgov.gov/p/wha/mexicocity and the North American Partnership Blog at http://www.intelink.gov/communities/state/nap / GARZA