Residency under the new U.S.-Mexico treaty.

All countries have their own definitions of residence for income tax purposes and, generally, there is no consistency from country to country. The United States and Mexico are no exceptions. The United States defines residency for individual income tax purposes under the following alternative tests: * Green card test: A resident is any person who has the legal right to reside in the United States (such as a citizen or a permanent resident), regardless of where the person lives; or * Substantial presence test: Under this test, an individual is a U.S. resident if he is present in the United States at least 31 days during the current tax year and a total of 183 days during the current year and two preceding years, based on the following formula: The number of days spent in the United States ("days") in the current year is weighted by 1, days in the first preceding year by 1/3 and days in the second preceding year by 1/6. Days as a teacher, trainee or student generally are not counted.

According to this formula, if an individual is never present in the United States for more than 121 days a year, he cannot be a U.S. resident under the substantial presence test. (See the Tax Clinic item, "Recent Reporting and Disclosure Requirements May Apply to Certain Nonresidents After 1991," TTA, May 1993, at 311.)

Mexico defines residency with reference to the place where the individual has his home, but also treats those who spend more than 183 days in Mexico as residents. There are special rules for high-level management and certain other professionals in the Maquiladora program.

However, both countries tax their residents on worldwide income.

One of the benefits of the new U.S.-Mexico treaty is that Article 4 provides for tie-breaker rules that allow individuals, such as U.S. business people, who spend more than 183 days during any 12-month period in Mexico, to avoid being taxed on worldwide income in both countries.

Under the treaty, if an individual meets each country's definition of resident, he is deemed a resident for income tax purposes of the country in which he has a permanent home available to him. If he has a permanent home in both countries (or in neither), he is considered a resident of the country that is the center of his vital interests - where his personal and economic relations are closer.

If this question cannot be resolved under these rules, the individual is deemed a resident of the country in which he has his "habitual abode." If this cannot be determined, or if he has a habitual abode in both countries, his nationality determines residency. If this last test cannot be used because the individual is a citizen of both countries (or neither), both countries' competent authorities must resolve the question.

The U.S. business or professional person who spends time in Mexico and thus meets both definitions of residency now has more tools to plan his affairs if he wishes to be taxed only in the United States on his worldwide income and limit Mexican taxation to income earned in Mexico. Nevertheless, he must pay taxes in Mexico if he is working there - even though his compensation may be paid by a U.S. employer.

Sometimes an allocation must be made, based on the number of days worked in each country, or on any other reasonable basis, to determine Mexican source income when the person performs services for the same employer in both countries. A ruling may be obtained from the Mexican Treasury Department (Director of Legal Procedures) regarding this allocation, method of tax payment, etc. This procedure is rather simple and can be performed in a relatively short time.

Mexico is in the process of revising the methods under which a U.S. individual, who has never been subject to Mexican tax, can be taxed. Perhaps the simplest way is for the individual to personally register as a taxpayer and pay his taxes monthly through the Mexican banking system. Mexican income tax can be credited, subject to limitations, against U.S. income tax.

Article 15 of the treaty covers taxation of employees' salaries or other remuneration; except as noted, each country reserves the right to tax employees for the work done in its own territory. For example, if an employee is present in Mexico for less than 184 days during a 12-month period and his compensation is paid by a U.S. employer and not claimed as a deduction by a Mexican permanent establishment, this compensation is not subject to Mexican tax.

Employee rotation may provide an opportunity for continued Mexican involvement without causing the employee to be subject to Mexican income taxes.

It should be noted that the treaty counts the number of days in any 12-month period (instead of the number of days in any tax year). Therefore, straddling tax years will not break the counting of days to meet the treaty's exceptions.

If a dual resident individual who is not a U.S. citizen is determined under the treaty's tiebreaker provision to be a Mexican resident, he still must determine his U.S. tax liability as if he were a nonresident alien. Pursuant to Regs. Secs. 301.7701(b)-7 and -8, he must file Form 104ONR, U.S. Nonresident Alien Income Tax Return, and attach a statement captioned "Treaty-Based Return Position Disclosure Under Sec. 301.7701(b)-7(b) and Section 6114." This statement must disclose that the individual is claiming a treaty benefit as a U.S. nonresident, the facts relied on to support the position taken, the nature and approximate amount of income, and the specific provision for which the taxpayer is claiming a treaty benefit. If an individual fails to disclose a treaty-based return position, he is subject to a $1,000 penalty for each separate payment or income item, in addition to any other penalties imposed by law (Regs. Sec. 301.6712-1).

Although this individual is regarded as a nonresident for U.S. withholding purposes, he is treated as a U.S. person for all other U.S. tax purposes, such as those relating to controlled foreign corporations or personal holding companies.

Finally, as most treaties do, the U.S.-Mexico treaty has a "saving" clause. Under this provision, each country may tax its citizens as well as certain residents and former citizens as if the treaty were not in effect. For example, a U.S. citizen (but not a resident alien) who would be deemed a Mexican resident under Article 4's tie-breaker rules may be subject to U.S., as well as Mexican, income tax on a worldwide basis - regardless of the treaty's determination of residency.

However, a U.S. resident alien who holds a U.S. green card and is a Mexican resident under Article 4's tie-breaker rules is not subject to U.S. tax on worldwide income. This may be good news to many Mexican citizens holding U.S. green cards. On the other hand, this position may have implications for an alien's standing before the Immigration and Naturalization Service. Therefore, an immigration attorney should be consulted before taking this position. Likewise, Mexican citizens who live in the United States may avoid Mexican taxation on income from sources outside Mexico if they are U.S. residents under the treaty.