In practice many people want to incorporate, transform, merge or spin off a company and try to do it on their own, but:
How much do they know about the implications, responsibilities, risks, costs, obligations, rights, requirements, advantages and disadvantages of incorporating a company and that it be of a particular kind?
Do they really know all the types of companies that exist and if they are appropriate to their business needs or are designed for the activity that will be carried out?
Do they know the tax implications and obligations for the company and for the Partners or Shareholders that a particular operation or the exercise of a certain activity entails?
Do we lawyers truly understand the real and business needs of our client, that motivate him to incorporate a company and based on which to recommend the creation of a certain type of company and draft its bylaws in a particular form?
Many times the incorporation of a company of a particular kind follows fashions or trends, but do we really know if a particular type of company is going to function for a specific business model or activity?
While the dynamics of the business can change depending on the circumstances, to have these aspects in mind from the beginning can save a lot of money, time and problems for our clients, since depending on their activity: they can take advantage of certain counting or tax treatments; avoid, prevent or resolve conflicts between their Partners, Associates or Shareholders; find resources; attract investment; avoid expenses for sometimes unnecessary movements such as -transformations, mergers, spin-offs, liquidations, change of purpose, change of name, domicile, capital structure and in the administrative body; pay taxes correctly; make use of certain tax advantages under the law; and even often avoid sanctions by the authority.
It is important to take into account that our Mexican law comes from Spanish, Italian and French Law and therefore from Roman Law, and thus one of the first errors is trying to encapsulate an exact equivalency of our types of companies with the types of companies existing in Common Law. There may be similar concepts, but not exactly the same, such as the S. de R.L. (Sociedad de Responsabilidad Limitada) which became fashionable because of its similarity to (but not equivalence) the LLC (Limited Liability Company), but taking into account that the S. de R.L. is a company of persons and not of capital.
The majority of companies that we know are governed by the General Law of Business Organizations (LGSM for its initials in Spanish), which has seen numerous reforms; however, there are civil corporations that are regulated in the Civil Code (CC) such as the Civil Association (Asociación Civil) (A.C.), the Civil Corporation (Sociedad Civil) (S.C.), and there are other companies in the Agrarian Law (LA) such as the Rural Production Corporation (Sociedad de Producción Rural) (S.P.R.), in the General Law of Cooperative Corporations (LGSC), in the Securities Market Law (LMV), etc.
In our Law there are various types of companies which can be civil or commercial and the latter may be of persons or capital, and may have several forms such as with or without Variable Capital (Capital Variable) (C.V.) and according to special regulation, be: of Rural Production, the Stock Market (S.A.B.), Limited Financial Purpose (S.O.F.O.L.), Full Purpose (S.O.F.O.M), Unregulated (E.N.R.), Private Assistance (I.A.P.), etc.
Among the commercial companies, we identify the following:
General Partnership [Sociedad en Nombre Colectivo] (S.N.C.)
Limited Partnership [Sociedad en Comandita Simple] (S.C.S.)
Stock Partnership [Sociedad en Comandita por Acciones] (S.C.A.)
Limited Liability Company [Sociedad de Responsabilidad Limitada] (S. de R.L.)
Stock Corporation [Sociedad Anónima] (S.A.)
Cooperative [Sociedad Cooperativa] (S. Coop.)
Profit-Sharing Agreement [Asociación en Participación] 1 (A. en P.)
Public Company [Sociedad Anónima Bursátil] 2 (S.A.B)
Private Equity Firm [Sociedad Anónima Promotora de Inversión] (S.A.P.I)
Publicly-Traded Private Equity Firm [Sociedad Anónima Promotora de Inversión Bursátil] (S.A.P.I.B.)
Simplified Stock Corporation [Sociedad por Acciones Simplificada] 3 (S.A.S)
Commercial companies may be incorporated before a Certifying Public Official (Notary or Commercial Notary), except the S.A.S. which may be incorporated without the involvement of a Certifying Public Official, the “S. Coop” whose formalization is established in the law and the “A. en P.” which in reality are not legal entities with their own legal capacity and assets, but that can be formed with or without the ratification before a certifying public official.
To decide the type of company we are inclined to form and correctly draft bylaws that are adequate or functional, we should consider:
The corporate purpose: What activity will the company pursue? This is fundamental and is relevant for the matter of Foreign Investment, since depending on the activity of the company, there may be a particular percentage, limits or even a prohibition on Foreign Investment. It is also very important to know if the Company is subject to special regulations or with what other requirements, permits, authorizations, etc., it must have, for example: If it is intended to form a Bank, the requirements indicated in the applicable laws must be complied with.
Do we want it to be a commercial company or a civil company (A.C. or S.C.)?
How much capital will be required and how much will each Partner or Shareholder be required to invest?
How will the capital be distributed?
How many Partners or Shareholders will the company have?
What rights and obligations with the Partners or Shareholders have? In light of this, there can be various classes of shares (capital corporations).
Who will have control and how will it be exercised?
What rights will the minorities have?
Where are the Partners or Shareholders located?
What nationality do they have?
Will the Partners or Shareholders be individuals or entities?
Will it be possible or desirable for new Partners or Shareholders to join in the future?
How rigid or flexible should the entry and/or exit of Partners or Shareholders be?
Who will direct and manage the company and how?
What powers will those administrators have (Legal Representatives)?
Do we want/need additional representatives? With what powers and for what purposes?
What responsibilities with the Partners or Shareholders have?
In the case of Civil Associations (A.C.), will they be authorized donees?
Do we want the Company to be overseen by a third party (Examiner)?
What agreements between the Partners or Shareholders can there be? (“Non-Voting Shares”, “Tag Along”, “Drag Along”, Right of First Refusal, “Capital Calls”, Non-Compete Agreements, etc.)
It is also important to:
Determine if restrictions on the transfer of Shares should be established or not and in what terms.
Distribution of dividends policies.
Corporate Governance Rules. In general they are not binding (except for particular business such as Credit Institutions) but they are advisable in order to avoid conflicts of interest, or among the Partners or Shareholders to keep better control, better management, comply with certain ethical standards and for corporate compliance.
The obligations of the Partners or Shareholders will depend on the type of company and the capital invested since in general, the majority Partner or Shareholder will have greater responsibilities in the company. Therefore, it is important to define the applicable rules for the exercise of the vote and decision making and to create dispute resolution mechanisms among the Partners or Shareholders, as well as the rules for the entry and exit and the causes of exclusion of the Partners or Shareholders, from the beginning.
In principle, capital companies are identified with a corporate name (unrelated to or different from the names of their Shareholders) and companies of persons with a firm name. Currently this distinction has been lost (there is no sanction for not doing it this way) and the Ministry of Economy (SE) authorizes corporate names or firm names that a Company may use regardless of its type.
Notwithstanding having obtained from the SE the authorization to use a company or firm name, it is very important that this name not violate rights previously granted to third parties in relation to industrial or intellectual property (trademarks and/or trade names). In addition, names cannot be used that are reserved for specific activities according to law, such as: “Bank”, “Insurer”, “Broadcaster”, etc.
As can be appreciated, the choice of one type of Company goes beyond an order, a trend, a fashion or a replica and must be consulted on with a legal professional that has full knowledge of the existing types of companies and the federal laws, taking into account all the elements mentioned to be able to suggest the appropriate type of company and design the bylaws according to the needs of the business and in accordance with the law.
Furthermore, from the tax point of view, there are various questions that must be taken into account to choose a particular type of company or carry out certain operations such as mergers, spin-offs or a sale of shares. In principle, all companies are legal entities and therefore all have the same tax obligations; however, depending on its activity, they can have certain benefits or tax treatments, such as:
VAT (Value Added Tax) rate 0% (zero), for companies engaged in exporting services outside of Mexico, or engaging in the production of food or medicine.
The use of the S. de R.L. for companies whose Partners are foreigners (above all from the United States) because for them, the S. de R.L. incorporated in Mexico can be given effects of a transparent entity (not as a corporation, -equivalent to the Mexican S.A. -) and the foreign Partner entity of the Mexican entity can take the losses of the latter (S. de R.L.).
The benefit of not paying 10% (ten percent) in tax for distribution of dividends, in an S.C., since it is a civil corporation of persons.
The differentiated treatment of the S.O.F.O.M. in which the “rules of insufficient capitalization” do not apply; a lower withholding rate is applied for interest payments: 4.9% (four point nine percent) to residents abroad, 0.60% (zero point sixty percent) for individuals and exemption from the Value Added Tax (VAT) for interest received.
Furthermore, to understand some tax implications for the companies, it is important to know what the Integration Regime is, which has been substituting the previous Tax Consolidation:
The Integration Regime is an optional regime for groups of companies with common interests (normally controlled by a “Holding” or Integrating company), which must be authorized by the Ministry of Finance and Public Credit (SHCP) and the purpose of which is to grant organizational flexibility and general competitiveness that attracts foreign investors. In this regime, the Income Tax (Impuesto Sobre la Renta) (ISR) can be deferred in a limited form for up to three fiscal years. To be an Integrator:
It must have more than 80% (eighty percent) of the shares with voting rights of those integrated.
The following cannot form part of this regime: companies belonging to the financial system, foreign companies, in liquidation, S.C., A.C., S. Coop., A. en P., among others.
These companies present an integrated result with profits and losses of the Integrator and those integrated.
Other special regimes that exist depending on the activity performed by the company are:
Regime of farming, livestock, forestry and fishery activities (unless they pay taxes in the Integration Regime). It was what was previously known as the Simplified Regime. Your basis is the cash flow, with exemption or reduction of the ISR depending on the amount of your income and it has fewer formal charges (receipts).
Regime of Non-Profit Entities. Applicable to Unions, Chambers of Commerce and Industry, Associations, Teaching Institutions, Research Institutions, Foundations, Religious Associations, Authorized Donees, etc. They do not pay the ISR. They may have the obligation of determining the distributable remainder of members or partners, taking deductions from income (title II, of the Income Tax Law (Ley del Impuesto Sobre la Renta) (LISR), and if the members are Individuals, the remainder is distributed according to the provisions for Individuals of the LISR).
For the corporate operations of merger and spin-off or alienation of shares or assets, it is important to take into account certain tax questions.
Merger. It is considered that there is an alienation of goods and the profit is accruable unless:
A merger notice is presented before the tax authority.
The surviving company continues with the activity that the disappearing company did for at least one year. This requirement does not apply when: i. the activity of the disappearing company is the lease of goods used in the activity; ii. In the prior fiscal year, more than 50% (fifty percent) of the income of the disappearing company comes from the surviving company or vice versa. This requirement does not apply if the surviving company is liquidated in less than one year.
Informative tax declarations of the disappearing company are filed.
Spin-Off. It is considered that there is no alienation provided that:
The Partners or Shareholders are owners of at least 51% (fifty-one percent) of the shares with voting rights (or the partnership interests) of the original company and the spun-off company and they are the same Partners or Shareholders for three years beginning from the year prior to the date of the spin-off.
When the original company disappears, the company that assumes the obligation to present the declarations of the fiscal year and the informative declarations corresponding tot eh original company is the spun-off company.
The tax effects and obligations resulting from a merger (apart from those corresponding to the certifying public officials) are:
The early termination of the fiscal year of the disappearing company(ies).
Authorization must be requested from the SHCP when it is intended to carry out a merger within the 5 (five) years after a prior one has been carried out. Furthermore, the requirement of shareholder permanency (in merger and spin-off) is not violated when the transfer of ownership of the shares is the result of death, liquidation, judicial award or donation. This will only apply for the merger or spin-off of companies residing in Mexico and provided the company the results also resides in Mexico.
Presentation of notices and declarations before the tax authorities.
According to the Supreme Court of Justice of the Nation (SCJN), the moment the merger takes place (physically) is from the signing of the merger agreement regardless of whether or not creditors’ rights are guaranteed, since the tax aspects are independent from the economic or legal reality of the companies participating in the merger and the tax aspect does not depend on the recordal of the agreement in the Public Registry of Commerce (RPC).
Other considerations in mergers:
The original amount of investment of assets for the surviving company will be the value of acquisition for the disappearing company.
The losses resulting from the merger will be transferrable because the surviving company did not generate the losses. In the spin-off they can be subtracted between the original company and the spun-off company because the one that generated them is part of the business.
The surviving company may only subtract the tax loss pending subtraction as of the date of merger, against its tax profit corresponding to the exploitation of the same businesses in which it was produced (accounting record of the loss in order to detect the business).
Regarding the alienation of shares:
Tax-wise, the accruable profit or the deductible loss must be calculated (subtraction of the average cost per share from the income obtained per share).
The losses for sale of shares will only be deductible up to the amount of the profits the taxpayer obtains for the same concept in the fiscal year or in the 10 (ten) following and complying with certain requirements to prevent tax evasion.
Finally, before incorporating a company or carrying out any operation such as a merger, spin-off or alienation of shares, and in order to implement corporate schemes to prevent investigations, it is important to be aware of the joint tax liability of Partners and Shareholders.
With respect to the taxes caused by the activities of the Company, Partners and Shareholders are liable from their income for the tax interest that cannot be guaranteed with the assets of the Company. There will also be joint liability when the Company:
Does not request its recordal in the RFC.
Does not present a notice of change of name, provided the change is made once the investigation powers of the tax authority has begun and before the final ruling is issued, or after a liability is determined or before it is paid.
Does not keep accounts, hides or destroys them.
Vacates the premises where it has its tax domicile without filing a notice.
The joint liability will not exceed the percentage of participation that the Partners or Shareholders have in the corporate capital during the period in question at the time the taxes are caused. In addition, only those who have effective control will be liable, which is to say: i. impose decisions on the General Meetings; ii. Have the right to vote with respect to more than 50% (fifty percent) of the corporate capital; and iii. Direct the administration.
We hope these considerations together with adequate advice for each specific case, we hope will serve as a guide for choosing the type of company and designing the appropriate bylaws for the needs of the business, and to be able to make correct decisions before carrying out any merger, spin-off or alienation of shares.
To learn more about this topic, please contact: Lic. Kathy Angélica Zúñiga Torres: kzuniga@samanosc.com.mx