Navigating the tax implications in acquisitions by Mexican FIBRA-E trusts

Recent global disruptions have triggered escalating costs and logistical challenges for traditional business models, which have prompted companies to look for manufacturing alternatives closer to their primary markets, such as the US. In this sense, Mexico's geographical proximity to the US – together with its trade agreements, tax treaty network, and competitive labour costs – positions it as an attractive nearshoring hub.

The nearshoring phenomenon that Mexico is experiencing has amplified the interest in infrastructure investments in Mexico. It has been propelled by several figures that promote investment in vehicles such as FIBRA-E trusts (trusts specialised in energy and infrastructure investments, or FIBRA-E, based on their acronym in Spanish).

Due to this phenomenon, Mexico requires significant infrastructure investment to bolster its capacity to meet the increasing worldwide demand and allow companies to mitigate supply chain risks.

This climate serves to fortify and increase the investments – through portfolio companies, in which FIBRA-E trusts may participate – given that the underlying companies of a FIBRA-E must conduct exclusive eligible activities dedicated to the energy and infrastructure sectors. Such sectors comprise oil and gas operations, electricity generation and distribution, infrastructure investment projects, and management activities related to FIBRA-E trusts.

These exclusive activities provide a framework for lucrative investment opportunities. However, navigating the tax implications associated with these companies and their acquisitions presents multifaceted challenges that investors, lenders, sponsors, and managers of FIBRA-E trusts, among others, should be aware of.

This article provides a general overview of the main complexities, focusing on the nuances of, and interplay between, corporate income taxes and the dynamics of acquisitions made by FIBRA-E trusts.

Primarily, a FIBRA-E trust functions as a tax benefit programme designed to encourage investment in Mexican infrastructure. A FIBRA-E trust, the trustee of which must be a Mexican tax resident banking institution or broker-dealer, is required to issue and publicly offer equity-like securities. The proceeds from these trust certificates must be utilised to invest in one or more of the exclusive activities within the specific sectors eligible under the FIBRA-E tax regime.

To qualify as a FIBRA-E, the trust certificates must be registered with the Mexican National Securities Registry (Registro Nacional de Valores) and be listed on a Mexican stock exchange. Holders of these securities do not possess creditor status against the FIBRA-E trust. Instead, they are beneficial owners of a portion of the FIBRA-E trust's estate, similar to shareholders in a company. As such, holders of the trust certificates do not possess legal or formal ownership of the assets comprising the FIBRA-E trust's estate.

Typically, a FIBRA-E trust is externally managed by a distinct legal entity, which is formally contracted by the FIBRA-E trust through the execution of a management agreement. In a standard arrangement, the entity serving as the settlor and/or manager would be a special purpose vehicle incorporated by the sponsor(s).

The primary objective of a FIBRA-E trust should be to invest in privately held corporations, established under Mexican corporate law, which are considered Mexican residents for tax purposes and engage in eligible activities (the Project Company).

Prior to the acquisition of a Project Company by a FIBRA-E trust, all the shareholders of the Project Company must be legal entities treated as Mexican residents for tax purposes. Following the FIBRA-E's investment in the Project Company, this requirement must be maintained for all subsequent shareholders.

At least 70% of the FIBRA-E trust’s estate must be directly invested in the shares of one or more Project Companies. The remaining 30% must be invested in securities issued by the federal government or in debt investment funds.

A minimum of 90% of a Project Company's taxable income must be derived from these exclusive activities/sectors: oil and gas; generation, transmission, and distribution of electricity; or infrastructure investment projects implemented through concession titles, services, or other contractual agreements between private parties and the public sector, such as roads, highways, railways, bridges, ports, maritime terminals, port facilities, civilian airfields, expansion of telecommunications networks in Mexico, public safety, social reinsertion, drinking water, sewerage, drainage, and wastewater treatment.

The Project Companies must generally be operating investments. This means that at the time of acquisition by a FIBRA-E trust, the projects owned by such Project Companies implemented through concession titles, services, or other contractual agreements between private parties and the public sector must have been operational for a minimum of 12 months, with a remaining term of at least seven years. Notwithstanding the above-mentioned, Mexican tax provisions allow Project Companies to have new assets (assets that have been in operation in Mexico for less than 12 months) if the new assets’ value does not exceed 25% of the average annual book value of the Project Company’s non-monetary assets. However, depending on the type of project developed by the Project Company, exemptions to the new assets threshold could apply.

Failure to adhere to these and other tax requirements outlined for FIBRA-E trusts could result in disqualification from the tax regime, leading to significant tax liabilities affecting trust certificate holders, trustees, and underlying Project Companies.

Under the FIBRA-E tax regime, Project Companies are subject to a special income tax regime, different from that applicable to all Mexican tax resident entities. Consequently, no corporate income tax is payable at the level of the Project Companies. Instead, and depending on the tax regime of the trust’s certificate holders, income tax is generally paid through withholding by the financial intermediary acting as custodian of the trust certificates, with funds derived from the FIBRA-E trust's underlying Project Companies.

As a result, Project Companies only compute, determine, and attribute their net tax profit to their shareholders, including the FIBRA-E trust (and any other Mexican tax resident entities).

The FIBRA-E trust must recognise as accrued income the net tax profit attributed by each Project Company in which it participates for the purpose of determining its own net tax profit. The FIBRA-E trust may also consider any applicable tax deductions, including the deferred expense that may result from the acquisition of Project Companies' shares. The net tax profit determined by the FIBRA-E trust serves as the basis for the minimum distribution requirement (i.e., at least 95% of its tax result, at least once a year, no later than March 15).

Furthermore, specific rules apply to the sale of trust certificates. For example, if the sale of such certificates is conducted by individuals or non-Mexican tax residents through recognised markets, the gain resulting from the sale is exempt from income tax.

In this context, the acquisition of companies by a FIBRA-E has certain implications for the FIBRA-E trust, investors, and lenders involved, as described below.

When a Project Company is acquired by a FIBRA-E trust, it undergoes a transformation in its income tax treatment, becoming a transparent vehicle for income tax purposes. This shift carries the following main effects that are relevant to consider during the acquisition process.

Sellers of shares in an entity intended to become a Project Company must calculate gains or losses considering the tax treatment applied to the transfer of their proportional participation in the underlying fixed assets, deferred expenses, land, and associated debt.

This shift in the tax treatment could lead to significant variations in outcomes for the seller. While the computation of the tax basis for a sale of shares typically considers the acquisition cost adjusted for inflation, the balance of corporate profits already subject to taxes, net operating losses, and capital redemptions, the sale of assets generally only factors in the original investment amount adjusted for inflation and reduced by already depreciated amounts.

Furthermore, it is important to acknowledge that the presence of debt at the level of the Project Company associated with the acquisition of fixed assets, deferred expenses, and land would increase the price for the calculation of the income tax liability upon the sale of shares. Thus, considering a higher price for the tax computation will potentially elevate the resulting gain that would be taxable, and probably affect the overall tax liability of the seller.

If the sellers of Project Companies' shares receive trust certificates instead of cash for their participation, they may be eligible to defer the accrual of a gain (or loss) resulting from the sale of shares.

The result obtained by the seller of shares of a Project Company to a FIBRA-E trust will directly impact the computation of the net tax profit at the level of the FIBRA-E. That is, the FIBRA-E trust shall consider the gain or loss deriving from the acquisition of the relevant shares as accrued income or as a deductible expense.

In light of the rationale that the Project Company will transition to income tax transparency akin to a transparent vehicle, the FIBRA-E regime requires that if the target company holds more than 5% of monetary assets in relation to the total assets, a capital redemption should be deemed to take place for income tax purposes prior to the acquisition. This potential scenario could trigger income taxes on the distributable profit that would derive from such deemed capital redemption.

Therefore, in the acquisition of a Project Company by a FIBRA-E trust, the potential tax implications for the seller must be evaluated with consideration of this potential tax treatment shift. Depending on the seller's final tax liability position, a prior corporate restructuring might be necessary to minimise the tax impact for the sellers or for the target companies.

Acquiring a leveraged company through a FIBRA-E may require restructuring the credit facilities previously obtained by the target company to accommodate the unique tax framework, as generally described below.

Lenders may find it necessary to adjust the financial model projections related to companies that would become Project Companies, particularly in light of potential changes in income tax liabilities for the target.

Project Companies and the FIBRA-E trust generally do not have the obligation to pay income taxes, as they should only compute, determine, and attribute their net tax profit to their FIBRA-E trust certificate holders, whose income tax liability should be paid by means of a withholding tax made by the financial intermediary acting as custodian of the trust certificates, funded by cash flow distributions from the underlying Project Companies.

This situation can lead to discrepancies in the cash flow requirements of individual Project Companies to cover their attributable taxes, potentially altering the initially agreed-upon waterfall structure before the Project Company’s creditors.

For instance, distributions to holders of trust certificates, such as Mexican pension funds, may be exempt from income tax, thus increasing the available cash flows that could service the debt. Another situation that may create these distortions relates to the fact that cash flows used to cover tax liabilities may come from one or more Project Companies, regardless of whether the tax liability is directly attributable to them.

The absence of provisions allowing shares of Project Companies to be held by intermediate guaranty trusts poses a risk. If shares of leveraged Project Companies are secured through such trusts, tax authorities may question compliance with the FIBRA-E regime, despite the possibility of interpreting guaranty trusts as transparent vehicles from a tax perspective. Therefore, credit facilities originally secured by guaranty trusts may need to be modified to eliminate this exposure to interpretation.

Consequently, lenders of Project Companies and the FIBRA-E trust should conduct thorough analyses to determine whether a debt restructuring is needed to tailor the debt and service debt capacity of the borrower.

The recent uptick in nearshoring activities has sparked a heightened interest in infrastructure investments in Mexico, such as FIBRA-E trusts. This context creates a virtuous cycle for existing FIBRA-E trusts to act as investors of additional Project Companies to fortify their portfolios.

Given that failure to adhere to the FIBRA-E tax requirements could result in disqualification from the tax regime, leading to significant tax liabilities affecting trust certificate holders, trustees, and underlying Project Companies, such parties must consider the nuances and complexities of the unique tax framework applicable to the FIBRA-E trusts during acquisitions of Project Companies and, if applicable, plan and perform corporate and debt restructures.