In this article we aim to overview current and potential Mexican VAT issues involving the use of cryptocurrencies. Most analysis has been centered on income tax issues; however, there are relevant issues that also arise in indirect taxation. Issues in discussion include both speculative transactions that occur within exchange platforms, as well as the increased use in exchange for other goods and services.
Background
The first recorded transaction using a cryptocurrency (in this case Bitcoin) is said to have occurred in 2009; almost 15 years ago. The introduction of a decentralised ledger system using what has been denominated ‘blockchain technology’ opened a new frontier in terms of creating and utilising digital currencies. At first, it created a new paradigm perceived as a separation from the centralised banking system and fiat currency reserves.
Currently there are over 10,000 cryptocurrencies, each with its own characteristics, but they have at least the following characteristics in common:
The value of such digital assets is determined freely by the market forces of supply and demand. As a result, there is significant volatility resulting in price fluctuation against reference fiat currencies;
They utilise blockchain or other similar decentralised ledger systems, providing a high degree of security and traceability to users;
They are independent from the central banking system, which eliminates the use of intermediaries to settle transactions, potentially reducing costs and friction in commerce;
They are available 24/7; and
Because supply is limited, they are not subject to inflationary pressures that ultimately lead to currency debasing. If anything, their limited supply leads to deflationary pressures because the potential to appreciate disincentivises their use in commerce.
Apart from its undoubted technological and operational advantages, there are significant disadvantages that contribute to the lack of recognition by most nations as legal tender currency. Among the disadvantages:
Technology is complex and difficult to understand by both users and regulators;
There is significant price volatility in an asset that otherwise rewards speculative risk;
It is not backed or guaranteed by any underlying asset or institution;
The very low or total lack of government oversight attracts unwanted participants in terms of anti-money laundering and/or fraud.
Efforts to introduce regulation have been made by some countries to adapt to this new reality of widespread use of cryptocurrencies. However, isolated country-by-country efforts in a highly globalised cryptocurrency market generates voids and conflicts with respect to classification, privacy and user identification, and ultimately a taxation framework.
By way of example, Mexico (an OECD member state) has been adapting domestic law to these new paradigms. Recent examples include the enactment of the Fintech Law and making reforms to its anti-money laundering laws, as well as changes to its Financial Information Reporting Norms (known as NIFs in Spanish). Although NIFs are not considered laws, they serve as a reference for interpretation of certain aspects of domestic tax law and not just financial information.
In terms of taxation, the biggest challenge is in the absence of a harmonised classification that ultimately leads to a global taxation framework. In other words, are cryptocurrencies an actual currency? Should they be considered a security? Are they simply another intangible asset?
Current legislation in Mexico
As noted, Mexico has made some changes to its domestic legislation to keep up with developments with cryptocurrencies, other digital assets and fintech in general. Notwithstanding, we consider those efforts to be insufficient.
For instance, Mexico’s Fintech Law (Ley para Regular las Instituciones de Tecnología Financiera) published March 9 2018, contemplates regulation for financial services. This consists of the purchase and sale of cryptocurrencies provided through electronic platforms including websites, social media or mobile device applications.
Businesses that fall under the scope of the Fintech Law are subject to supervision by the Mexican Treasury, the National Banking and Securities Commission and the Central Bank. Such supervision does not include deposit insurance for deposits made by consumers in these fintech platforms.
The Mexican Central Bank and the agency that protects financial services consumers have issued recommendations and other publications that are designed to provide awareness to consumers, suggesting caution when using cryptocurrencies to avoid fraud and loss of investment value.
The entry barriers for regulated fintech business are still low and fall short of providing real guardrails for consumers participating in such platforms. The recent collapse of FTX proved that good intentions are not enough and Mexico must learn from those experiences. Mexico already has important players in the crypto exchange arena such as BITSO.
Another regulatory framework is Mexico’s Anti-money Laundering Law (Ley Federal para la Prevención e Identificación de Operaciones con Recursos de Procedencia Ilícita) that loosely considers the exchange of digital assets as vulnerable activities. Specifically, Article 17 item XVI, considers as a vulnerable activity the habitual and professional exchange of virtual assets through digital platforms that manage or operate by facilitating the purchase and sale of such assets, or otherwise provide the means of storage, custody or transfer of virtual assets not recognised by the Mexican Central Bank.
Categorisation as a vulnerable activity requires enhanced due diligence procedures to properly identify the ultimate beneficial owners participating in the exchange. In addition, it requires filing of periodic information returns with the Mexican Treasury in connection with such activities.
Finally, at the end of 2019, the Mexican Council for Financial Information Norms in charge of issuing NIFs approved the publication of “NIF-22 Cryptocurrencies”. The regulation came into effect in 2021.
Of particular relevance is numeral 32 of NIF-22, that defines the characteristics of cryptocurrencies for the purposes of financial reporting. Under NIF-22, a cryptocurrency is defined as a medium of payment or exchange, or else, subject to sale when markets recognise and assign an economic value.
Nevertheless, numeral 32 goes on to define what is not considered a cryptocurrency for the purposes of financial reporting:
It is not considered cash because it is not considered legal tender, and as such is not backed by a Central Bank or the government of the country where it is exchanged or negotiated;
It is not a cash equivalent, because it not easily converted to cash and is subject to significant risk from change of value;
It is not a financial instrument, even if to its holder it represents a right over certain economic value, as there is no counterparty obligated with such holder to liquidate its value or respond for its liquidation;
It is not inventory, regardless if a cryptocurrency could be held essentially for resal. It is not correct to categorise them as inventory under the NIF because it would need to be valued at the lesser of its cost of acquisition and its net realisation value, being the latter, an amount determined by the holder considering both internal and external factors. In other words, NIF-22 considers that cost of acquisition and the net realisation value do not represent an accurate realisable value for a cryptocurrency because this asset class is negotiated in terms of market price (reasonable value); and
It is not an investment property, because it not a real asset in terms of NIF C-17.
As mentioned, NIF-22 provides an initial step in the interpretation of Mexican tax laws by excluding the different classifications of cryptocurrencies. However, it is not a definitive step because the use and technology behind this asset class keeps evolving, potentially changing the exact application of the law.
For example, the BTC has been recognised as legal tender in El Salvador (September 2021) and the Central African Republic (April 2022). Senator Indira Kempis introduced a similar initiative in Mexico, attempting to reform its Monetary Law in order to recognise BTC as legal tender on April 20 2022. The proposal did not find any traction and remains in discussions.
Mexican VAT
From the previous discussion, we can infer that cryptocurrencies are currently seen under Mexican law as intangible assets. Under NIF-22 it is clear that for financial reporting purposes they are not considered currency, a financial instrument or even a security. This can lead to several issues under the Mexican VAT law.
In general, Mexican VAT applies to the sale of goods, services, the temporary use and enjoyment of property as well as the importation of goods and services in Mexican territory. As an indirect tax, the economic burden is usually transferred to the purchaser or user of the of the goods and services. In Mexico, VAT is levied on a cash flow basis when consideration is deemed effectively received.
Mexican VAT legislation considers as an intangible any good that lacks any of the following characteristics: touch, weigh or measure. In addition, Mexican tax laws consider any transfer of ownership as a taxable sale unless it is specifically exempted or afforded non-recognition treatment. As a result, the transfer of ownership of any cryptocurrency that is considered to take place in Mexican territory could potentially be subject to VAT. As an intangible asset the transfer does not fall within any of the exemptions provided under the VAT law.
A sale is considered to take place in Mexican territory in the case where both buyer and seller are Mexican tax residents. The transfer of intangibles does not consider elements such as place of delivery or custodianship. The transfer is potentially subject to the general VAT rate of 16%.
The sale of intangibles by a Mexican resident seller to a foreign resident is considered an export sale subject to VAT at a 0% rate. An export sale is still a transaction subject to VAT, and thus it carries all the obligations of conducting activities subject to taxation even if at a null rate.
On the contrary, the transfer of a cryptocurrency from a foreign resident seller to a Mexican resident buyer is considered an importation of goods and is generally subject to VAT in Mexico. The importation is deemed to take place when consideration is effectively paid by the Mexican resident buyer. Under Mexican VAT Regulations, the VAT technically due from the importation of intangibles is allowed as a credit against the same VAT due from such importation. This is generally referred to as a “virtual importation” because it does not provide for a cash remittance of tax, however, it does not relieve from complying with all other formal obligations.
Further, transactions not settled in cash, such as barter exchanges, are considered as if two separate transfers of property take place. In other words, exchanges of cryptocurrencies for other cryptocurrencies, or the payment of other goods and services with cryptocurrency should be treated as separate transactions. This could potentially lead to situations where one transaction is VAT exempt (land, securities, etc.) while the transfer of cryptocurrency could potentially be subject to VAT.
Finally, another important issue within the Mexican VAT law relates to the provisions regulating the rendering of services through digital platforms or applications by foreign residents with no permanent establishment in Mexico. Services considered by the Mexican VAT law include the intermediation between a seller and a buyer of goods and services. Cryptocurrency exchanges should be mindful of such legislation because it imposes an obligation to identify the residency of its participants with indicative factors including IP address and telephone number provided to the digital platform.
The rules mentioned above provide several formal requirements in order to continue operating in Mexico both in terms of registration as well as disclosure within the platform. Failure to comply with such rules can lead to penalties and cancellation of the service to Mexican residents.
Most importantly, transactions where the foreign resident platform acts as an intermediary in transfers of goods subject to VAT, there is a withholding obligation that goes from 50% to 100% of the VAT due. As a withholding agent, remittance and liability is transferred to the digital platform.
Conclusions
The absence of definitive regulation providing for the correct classification of cryptocurrencies leads to several tax contingencies. In the case of VAT, the potential issues have often been overlooked and much of the attention has gone to the income tax implications.
In our view, the current positioning by Mexican law can subject the transfer of cryptocurrencies to Mexican VAT. It is particularly relevant in domestic transactions, however, where there is a foreign resident involved as a seller or purchaser, it can lead to particular filing for the Mexican resident. Particular attention has to be paid to transactions that are structured as a barter exchange where the VAT implications of each good being transferred must be assessed. This is the case where there is mismatch between taxable and exempt goods being transferred.
Finally, rules governing digital platforms operated by foreign residents that provide for the exchange of goods subject to Mexican VAT is another topic of analysis. As discussed, the foreign platform may be subject to registration and even withholding obligations.
