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The 2014 Mexican Federal Budget as submitted by President Peña Nieto includes significant changes to the country’s tax structure. For those of us here in Baja it will mean a 5% sales tax increase to most purchases bring our IVA on par with the rest of Mexic at 16% Jamuary 1, 2014.

October 17, 2013 (updated 10/29/13) Since before Baja California Sur became a state of Mexico in 1974, it has enjoyed a ‘frontera‘ status and exceptions to some federal taxes. Now, under a sweeping tax reform proposed by Mexico’s President Peña Nieto, Baja’s 11% value added tax (IVA) may jump to 16% by the end of the year. But that’s not all; the proposed tax changes will also affect fuel prices, soft drinks, junk food, banking, automotive imports and real estate transactions across Mexico.

Just like any other country, unseated political parties, particularly the PAN of former presidents Calderon and Fox, raised objection, but on October 29th the Diputados passed the measure and n October 29, 2013 the Senate of Mexico approved the tax reform package which includes the 5% IVA tax increase for border states, but removed the IVA from tuition and mortgage payments. With minor changes the package is returned to the Diputados for ratification, then it will be passed to the president for signature, which is likely.

The tax reform bill designers in the PRI claim the proposals will increase revenue while equalizing and stream lining the system. It is a wide ranging reform with many changes, but here are the biggest of those changes that will most affect North Americans in Mexico.

What are the changes?

5% IVA Increase - For us here in on Baja peninsula, the first impact will be the increase of 5% to the value added tax. In the years prior to 1984 Baja was exempt from import duties on foreign goods. La Paz became a shopping Mecca for mainland residents looking for electronic and other goods manufactured in the Orient. Hotels sprang up and airline routes from the mainland were more available than they are today. When this status was repealed in 1984 it caused a significant drought in tourism for La Paz that has lasted decades. In the meantime Cabo San Lucas sprang up from a dusty fishing village to become a strictly recreational destination and La Paz became the touristic backwater. But we were still allowed an IVA rate 6% lower than the rest of Mexico.   In 2009 they raised the rate by 1% in Baja to 11%. The proposed change would bring Baja’s taxes in line with the rest of Mexico.

Applications of IVA to Real Estate & Banking - This one brings huge repercussions to the real estate market in Baja.

The real estate market has been in virtual shut-down since the crash of 2007 and only in the past year have we seen the return of North American investors in any numbers. Across Mexico the IVA would be applied to real estate transactions, loans and interest charges.  Previously, real estate transactions were subject to just a 2% federal acquisition tax, payable by the buyer.

As of October 25, 2013 the codicils for taxes on tuition and mortgage interest have been removed from the bill.

Renters can expect to pay 16% more right off the bat, if the bill becomes law. Homeowners expecting to sell will take time to accept that their home price is now 16% higher, so to be internationally competitive prices will have to fall. It will take time for the market to shake out to something like housing values falling by 8% to making Mexican real estate 8% more expensive. But that will take time, I expect it will put the brakes on the Mexican real estate market, particularly here in Baja, for another 12 to 18 months as the market adjusts.

There is a flurry of information about this pending act and just like everywhere else, newspapers slant their info to support their views and not every reporter is a math wiz. Now in authoring this article I tracked down the actual document and I think El Economista is being a little bit alarmist. The addition of IVA would in fact add 16% to the cost of buying a home right off the bat. So at least for the short term look at the value of your Mexican property to fall as much as 16%.

But after reading the law their claim that it would add another 16% through taxes on payments doesn’t seem to be correct. The IVA should apply to the gain of the bank, or the interest payment. In the early years of a mortgage it would be painfully, adding almost that full 16% to the payment. But as the loan matures the amount of the taxable portion of the bill will decrease, to virtually nothing at the end of the loan.

In 2005 the second largest export from Mexico following agricultural products was Mexico itself, in the form of real estate purchases by foreign nationals. Real estate organizations in Mexico like AMPI are fighting this tooth and nail, proclaiming it would be the virtual death knell for the Mexican real estate business, struggling since 2007.

There would be other changes in where IVA was applied as well, including, pet food and entertainment (concert tickets)

Update 10/25/13

We have received unconfirmed information from one of our Insider real estate contributors that the application of IVA to real estate purchases has been dropped from the tax law changes. We have been unable to verify this information.

Importation of Vehicles - As many of you know who have imported your car or truck to Baja, when you travel to the mainland you must pay more. Importation taxes to mainland Mexico are higher than our Frontera region. The new tax code would eliminate this difference as well as raise the importation fees.

unk-food tax - In 2013 Mexico surpassed the United States as the most overweight nation in the world, according to the World Health Organization. Believe it or not, Mexico consumes more soft drinks per capita than does the U.S. and Mexican health official’s blame this, along with general junk food consumption as the cause of obesity. Since the Mexican taxpayer pays for the healthcare of fat folks it is considered a federal financial problem.  The proposed changes would levy a tax on high sugar and fat products commonly lumped into the ‘junk-food’ category.

By the way, Baja California Sur ranks as the fattest of the fat, being the most overweight state in Mexico. (THE fattest women and the 3rd fattest men in Mexico according to Secretary of Health, Mexico) Why? One speculation is the popularity of flour tortillas in Baja. A flour tortilla is nothing more than a golf ball sized wad of shortening (usually vegetable fat today) and enough flour to bind it all together. In most other parts of Mexico the corn tortilla is far more popular. Corn tortillas are made with corn and water.

Green Taxes - In travel, jet fuel would have the tax raised to 18.7 cents on a liter of aviation fuel.  A 1 peso per liter increase in the diesel tax is also part of the plan. There are a few other tax increases in this category, admittedly, not all of them bad. The increased taxes on fuel and the removal of the subsidies are allegedly designed to promote conservation.

Elimination of the Simple Basic Income Tax - For small businesses and self-employed it would eliminate the “simple tax structure”. This will affect many North Americans which operate small businesses or rent their properties. If you barely make anything it will mean a tax reduction (and I mean barely anything in pesos terms, not American terms) But even several hundred dollars a month in rental income will put you in a higher tax bracket. It will make monthly taxes more complicated and slightly to dramatically more expensive, depending on your income level. This will still be a little more palatable than State-side taxes. I will be affected by this tax hike, but right now I pay about 14% income tax.

Why Tax Reform Now?

Parts of these reforms encompass the move toward increased transparency and equality in the system. Other increases are designed to help direct the development of the country, like decreasing energy consumption. This was also the excuse when Mexico began the removal of fuel subsidies by a stepping method that by the end of the year will have increased the cost of fuel by 1.3 pesos per liter (or about $0.40 per gallon)

Just like the United States and many other countries around the world, the economic slow-down of the last decade has left the Federal government wanting for cash. But unlike up north, where as much as 25% of that tax money goes to blowing up people on the far side of the planet, Mexico has been funneling money into the future. Increased investments in education and healthcare, as well as new plans for temporary unemployment insurance and old age pensions introduced all require more money. Here in Baja we have benefited from a great deal of Federal assistance, such as the new 4 lane highway from La Paz to Los Cabos. Now the Fed’s want us to pay our share of the bill. And just like pretty much everywhere else, the burden will be shouldered by the middle class.

What are the chances of this happening?

Updated: October 29, 2013 It looks imminent that the border states will see IVA raised to 16%. The tax reform bill has passed the Diputados and Senate and will likely soon be law. The application of IVA to tuition and mortgage payments was removed. We had received information that the IVA application to real estate had been dropped from the bill. As of this date we have been unable to confirm that, although we were able to confirm the other amendments to the bill mentioned above. At this point the most significant impact will be the addition of 5% to our IVA here on the Baja peninsula.

The Effects

Tax increases are generally looked on by economists as a “temporary” impediment to growth. This is particularly true in Mexico, where nearly all the increase in tax monies will flow back to the economy in time, rather than be paid to foreign debt holders, foreign defense contractors and foreign aid. Most of the investments from the increased taxes are aimed to boost the country’s earning potential… in the long run.

The reform also includes a ‘slush fund’ to assist individual states that run into balance sheet problems during hard economic times. Unfortunately, we know what most politicians do when they discover a bank account with a positive balance – they find a way to spend it.

If the IVA on real estate tax is enacted, it will certainly affect real estate. In a very competitive international real estate market Mexican real estate values may fall by as much as the tax increase. It is speculated that the recreational/2nd home market will be the hardest hit.

Should the bill pass by the 15th of November also look for a flood of large item purchases in Baja before the end of the year. A minimum of a 5% savings on big ticket items, from televisions to autos will disappear on January 1, 2014.