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Tuesday, November 20, 2012

I.R.S. concludes Mexican landholding trust is not a trust ...

1.         Understanding the Mexican Landholding Trust

 Under Article 27, Section I, of the Mexican Constitution, all land is the property of the Nation, and legal capacity to acquire ownership of lands and waters from the Nation is limited to Mexicans by birth or naturalization and Mexican companies. The federal government, through the Ministry of Foreign Relations, may grant the same right to foreigners provided they agree to consider themselves as Mexican nationals with respect to such property and bind themselves not to invoke the protection of their governments in matters relating thereto.  Noncompliance with such agreement would result in forfeiture of the property to the Nation.  This “agreement,” commonly known as the Calvo Clause or Calvo Doctrine, is named after the Argentine diplomat and historian Carlos Calvo, who propounded it in his 1868 book “Derecho Internacional Teórico y Práctico de Europa y América,” justifying it as necessary to protect the jurisdiction of weaker nations from those more powerful.  Further, the Constitution of Mexico provides that “under no circumstances may foreigners acquire direct ownership of lands or waters within the ‘Restricted Zone’”, which is the area located one hundred kilometers along the international borders and fifty kilometers along the shores. 

The Foreign Investment Law, which implements Article 27, Section I, of the Mexican Constitution, elaborates on how an interest in real property in Mexico may be acquired by foreigners and Mexican corporations that allow foreign investment.  Under this framework, two key questions arise: (i) whether the real property is located within the Restricted Zone, and (ii) whether the property is intended for residential or non-residential purposes. Foreign individuals and entities may acquire title to real property located outside the Restricted Zone, provided that they previously submit to the Ministry of Foreign Affairs a statement agreeing to the terms of Section I of Article 27 and obtain the corresponding permit from that Ministry.

If the property is located within the Restricted Zone, foreign nationals as well as Mexican corporations that allow foreign investment but intend to use the property for residential purposes may only acquire real property rights as beneficiaries of a trust or fideicomiso.   A Mexican trust or landholding trust is similar to a trust in the United States, with one significant difference: under Mexican law, only banks and financial institutions may act as trustees.  Theoretically, a trust is a fiduciary agreement under which the grantor, acting in good faith, transfers to the trustee legal title (i.e. not whole ownership) to certain property in order to accomplish a specific purpose. Technically, it is a contract that must meet the formation requirements established by law. Legally, where a grantor segregates certain assets to accomplish a definite and legal goal, and the trustee is responsible for achieving the goal, there is a trust. Mechanically, in a trust (a) a person (grantor) decides to segregate all or part of his or her assets to accomplish a particular goal; (b) the goal may only be acquired through a trustee, who is granted legal title over the assets; (c) the assets then form an independent and segregated trust corpus, as whole ownership is not held by the grantor, the trustee, nor the beneficiaries; (d) the trust agreement will specify the rights and/or benefits that each beneficiary has with respect to the assets; and (e) once the goal has been accomplished, the trustee will dispose of the trust corpus in the manner  provided in the trust agreement.

2.         Form 3520 - Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts

U.S. persons (and executors of estates of U.S. decedents) are required to file Form 3520 to report certain transactions with foreign trusts, ownership of foreign trusts under the rules of sections 671 through 679, and Receipt of certain large gifts or bequests from certain foreign persons.  Until now, there had been some uncertainty as to whether a Mexican land holding trust or fideicomiso would classify as a foreign trust.

To offer some clarification, I.R.S. just released PLR 201245003 (http://www.irs.gov/pub/irs-wd/1245003.pdf).  Based solely on the information submitted and the representations made, the I.R.S. concluded that the Mexican Landholding Trust or fideicomiso described therein was not a trust within the meaning of § 301.7701-4(a) (the term “trust” as used in the Internal Revenue Code refers to an arrangement created either by a will or by an inter vivos declaration whereby trustees take title to property for the purpose of protecting or conserving it for the beneficiaries under the ordinary rules applied in chancery or probate courts. Usually the beneficiaries of such a trust do no more than accept the benefits thereof and are not the voluntary planners or creators of the trust arrangement. However, the beneficiaries of such a trust may be the persons who create it and it will be recognized as a trust under the Internal Revenue Code if it was created for the purpose of protecting or conserving the trust property for beneficiaries who stand in the same relation to the trust as they would if the trust had been created by others for them. Generally speaking, an arrangement will be treated as a trust under the Internal Revenue Code if it can be shown that the purpose of the arrangement is to vest in trustees responsibility for the protection and conservation of property for beneficiaries who cannot share in the discharge of this responsibility and, therefore, are not associates in a joint enterprise for the conduct of business for profit)  and that the U.S. beneficiary of such trust shall be treated as the owner of the real property for federal income tax purposes. 

The sole purpose of the Mexican Landholding Trust or fideicomiso, the I.R.S. considered, is to satisfy the Mexican Federal Constitution by vesting legal title to the property in the name of the trustee. The trustee’s sole responsibility for the property is to hold and transfer title at the exclusive direction of the taxpayer. The trustee has no duty and no right to defend, maintain, or manage the property. Taxpayer retains sole authority to manage and control the property, the direct right to collect any rents or proceeds generated by the property, and the direct obligation to pay all taxes and liabilities related to the property. If there is no arrangement to utilize the condominium in an activity for profit, the Mexican landholding trust or fideicomiso should not be classified as a business entity.  Accordingly, the beneficiaries of a Mexican landholding trust or fideicomiso may not need to file Form 3520 or 3520-A.  Notwithstanding the above, taxpayers shall consult with their legal counsel to determine whether they should not file a Form 3520 or 3520-A. I.R.S. Written Determinations cannot be used or cited as precedent.

Mauricio Leon de la Barra is an international law attorney licensed to practice law in Mexico and California, and has more than 15 years of experience representing clients in cross-border business and real estate transactions and litigation involving international, U.S. and Mexican laws.