Cablegate: Mexico: U.S. Investors Ask for Intervention On Tax

VZCZCXRO6051
PP RUEHCD RUEHGD RUEHHO RUEHMC RUEHNG RUEHNL RUEHRD RUEHRS RUEHTM
DE RUEHME #4236/01 2211448
ZNR UUUUU ZZH
P 091448Z AUG 07
FM AMEMBASSY MEXICO
TO RUEHC/SECSTATE WASHDC PRIORITY 8353
INFO RUEHXC/ALL US CONSULATES IN MEXICO COLLECTIVE
RHEHNSC/NSC WASHDC
RHMFIUU/CDR USSOUTHCOM MIAMI FL
RHMFIUU/CDR USNORTHCOM
RUEHC/DEPT OF LABOR WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RHMFIUU/DEPT OF ENERGY WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC

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

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GARZA

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