Foreign companies are said to have Permanent Establishment in Mexico when they carry out certain activities that create value and wealth in Mexico without first establishing an income tax framework. In practical terms, foreign companies will want to avoid having permanent establishment status (PE) in Mexico because they may be taxed by the Mexican Government on the value and wealth they create outside of Mexico.
To avoid PE, foreign companies must consider how to establish a legal presence in Mexico to carry out their manufacturing and/or commercial activities in Mexico so that the basis for an income tax can be determined and submitted to Mexico’s Treasury Department (in Mexico known as Hacienda) for acceptance.
Foreign companies have several options for avoiding PE in Mexico. One is to initiate its manufacturing presence through a shelter company which by law exempts the foreign company from PE and from having to pay income taxes in Mexico for the first four years of operating in Mexico. Another options is for foreign manufacturers to operate in Mexico under the Maquiladora program which requires that certain conditions be met in order to establish an income tax based on a small percentage of the value of assets or costs. Because many foreign companies manufacture in Mexico and do not invoice sales in Mexico, the asset vs. cost method of establishing an income tax base is known as Safe Harbor. A third method for avoiding PE is for the foreign company to establish an Advance Pricing Agreement (APA) with the Mexican Treasury Department. In summary, PE is avoided by either operating under the legal framework of a shelter company for at most four years and/or by paying income taxes in Mexico based on a number of methods that may or may not include income in the tax calculation.