By Michael W. Durham
Caplin & Drysdale, Chartered
Fifteen years after they took effect, the provisions of the U.S.–Mexico Treaty and its first protocol (collectively, the “Treaty”) still provide more favorable rules for private foundation grants to eligible Mexican charities than for any other foreign grants.
1 While a variety of obstacles have kept the promise of those provisions from being fully realized, several recent developments suggest that forward progress may soon be possible.
A. Potential Benefits to Grantmakers under the Treaty
Normally, a private foundation making a foreign grant must either (a) gather information sufficient to determine that a proposed grantee is the equivalent of a U.S. public charity; or (b) treat the grant as made to a noncharitable organization and exercise “expenditure responsibility” over it. This second option would require a pre-grant inquiry, various restrictions in the grant agreement, and annual reporting from the grantee to the foundation and from the foundation to the IRS.
Under the Treaty, an organization that the Mexican authorities found to satisfy former Article 70-B of the Mexican Income Tax Law is automatically treated as a U.S. section 509(a)(1) or 509(a)(2) organization. Thus, private foundations making grants to Mexican Article 70-B organizations can do so without making an equivalency determination or exercising expenditure responsibility. Instead, as the IRS confirmed in a 2003 information letter, they may simply confirm the grantee’s Article 70-B status by reviewing a copy of the official letter granting that status or the listing of Article 70-B organizations that appears periodically in Mexico’s Official Gazette.
The Treaty can also lighten grantmakers’ nonresident withholding obligations when foreign grantees use grant funds to attend meetings or conduct other activities in the United States. Normally, a private foundation must withhold tax on such grants absent an IRS letter or an opinion of counsel concluding that the grantee is a tax-exempt organization. However, a private foundation can avoid withholding grant funds from a Mexican Article 70-B grantee if the grantee provides a Form W-8BEN claiming exemption under Article 22 of the Treaty. Nonetheless, the foundation would still have some documentation and reporting obligations.
B. Current Obstacles to Realization of the Treaty’s Promised Benefits
Up until now, several practical obstacles have prevented effective use of the Treaty by U.S. private foundations making grants in Mexico:
1) Article 70-B (now Article 97) has been renumbered and substantively modified.
Changes in Mexican law since the Treaty was signed have made it harder for U.S. grantors to rely with confidence on the Treaty. The most noticeable change occurred in 2002, when Mexico enacted a new version of its Income Tax Law that renumbered many of its provisions (including Article 70-B, which became Article 97). Furthermore, both before and after the renumbering, various substantive changes have been made to the text of Mexican Article 70-B/Article 97. For instance, provisions allowing schools, universities, hospitals, and medical research organizations to qualify for public charity status without meeting a public support test were deleted, and more detail has been added to the definition of scientific and cultural organizations that can qualify under Article 97.
None of the substantive changes to Article 97 broaden it in ways that would necessarily undermine the Treaty’s determination that Mexican charities meeting the requirements of old Article 70-B/new Article 97 are essentially equivalent to U.S. public charities. Nevertheless, they do raise uncertainty, and while Mexican tax publications continue to announce that Article 97 organizations will qualify for benefits under U.S. law, the IRS has been unwilling to confirm that point without confirmation from the Mexican authorities that the changes to Article 97 are not material. Grantmakers have understandably been reluctant to rely on the Treaty given this apparent hesitation by the Internal Revenue Service.
2) Relatively few Mexican charities have obtained the required status.
Article 70-B and the regulations interpreting it were drafted specifically to match U.S. legal requirements, and Mexican charities need not meet their requirements unless they wish to obtain Treaty benefits. This, coupled with lack of familiarity with the new tax status, has meant that relatively few Mexican charities have even requested Article 70-B or Article 97 status.
Not all types of Mexican charities are eligible for Treaty benefits. For instance, although Mexico has revised its tax code to add certain environmental organizations to its list of charities entitled to receive tax-deductible contributions, it has not updated Article 97 to extend Treaty benefits to such organizations. Organizations eligible for Treaty benefits are:
- Welfare organizations and other charities working to improve conditions of indigenous communities and groups that are vulnerable by reason of age, sex, or disability
- Schools established by Presidential decree or recognized under Mexico’s Federal Education Law
- Organizations registered in Mexico’s National Registry of Scientific and Technological Institutions
- Certain Mexican charities fostering the arts, supporting libraries, or engaging in cultural preservation
To qualify under Article 97, organizations in these classes must also meet a public support test and an organizational test modeled on U.S. law.
3) No mechanism exists for a qualifying Mexican charity to appear on Publication 78.
Despite Mexico’s initial enthusiasm for the Treaty’s reciprocal recognition of exemption, the IRS has found it difficult to reach a competent authority agreement on the Treaty’s implementation with its Mexican counterparts. Thus, while a Canadian organization seeking benefits under the U.S.–Canada Treaty can follow a clear procedure to be included on Publication 78 (the official IRS list of charities), no analogous procedure exists for Mexican organizations. As a result, each individual grantmaker bears the burden of obtaining and translating Mexican tax documents and determining eligibility for Treaty benefits.
Even putting aside the difficulty caused by the renumbering and revision of Article 70-B, this determination is not always easy for grantmakers to make. Mexican tax administration letters applying Article 70-B (now Article 97) do not always state that the organization in question is an Article 70-B (or Article 97) organization. Instead, even the official Mexican list of recognized charities simply designates such organizations as ones that are “entitled to receive deductible contributions from abroad.” At least on its face, this may leave grantmakers uncertain about whether the required determination has been made.
4) Foundations must meet general requirements for relying on a tax treaty.
While the Treaty was clearly meant to simplify cross-border grantmaking, reliance on the Treaty imposes some additional requirements on a private foundation. First, in addition to obtaining documentation of the grantee’s Mexican tax status, a private foundation must also verify that the grantee qualifies for the Treaty’s benefits under its limitation of benefits provisions. Under Article 17(1)(e) of the Treaty, a majority of the “beneficiaries, members or participants” of the organization must be Mexican residents or other entities eligible for Treaty benefits. Furthermore, a foundation relying on the Treaty must submit a Form 8833 (Disclosure of Treaty-Based Return Position) explaining why the grantee qualifies for Treaty benefits. Given the legal questions surrounding the Treaty’s application to the current Article 97 charities, many U.S. private foundations are reluctant to take that position, at least without consulting competent counsel first.
The foregoing difficulties are not insuperable, and some foundations may decide to apply the Treaty despite the attendant legal uncertainty. Alternatively, foundations may wish to consult their counsel about relying directly on the similarities between Article 97 standards and U.S. public charity standards. Those similarities, recognized by the Treaty, can provide much of the necessary support for a U.S. foundation’s good faith determination that an Article 97 grantee is the equivalent of a public charity. Ironically, for the time being, such an equivalency determination may actually be easier than the supposedly simpler alternative offered by the Treaty.
C. Potential for progress toward realizing the Treaty’s promised benefits.
Currently, groups on both sides of the border are working to seek improved implementation of the Treaty from their respective governments. On the U.S. side, the Council on Foundations and Caplin & Drysdale have been working to obtain confirmation from the IRS that the Treaty still applies to Article 97 Mexican charities, and the IRS is attempting to obtain clarification of that issue from its Mexican counterparts. In Mexico, a coalition of several organizations have gathered input from a large variety of Mexican organizations to develop a comprehensive agenda for reforming the fiscal laws governing the Mexican civil society sector. That agenda, published in January 2007, stresses the need to improve the administration of Article 97 to make Treaty benefits more easily accessible.
While it is too early to tell whether these U.S. and Mexican efforts will be fruitful, they do indicate continued interest in the Treaty provisions on the part of both charitable sectors. Hopefully Mexico’s new administration, elected in the fall of 2006, will clarify the relationship between Article 97 and Article 70-B. This, in turn, would clear the way for the IRS to affirm the application of the Treaty to Article 97 charities, and potentially for a competent authority agreement that would allow Mexican charities to be listed in IRS Publication 78.
Other developments in Mexico also promise to aid application of the Treaty. First, a growing number of Mexican charities are qualifying as “organizations entitled to receive deductible contributions from abroad” under Article 97. Second, Mexico’s Official Gazette, which periodically prints the authoritative list of charities qualified for Treaty benefits (section L of Annex 14 to the Miscellaneous Fiscal Resolution) is now available online at www.dof.gob.mx, and the most recent version of Annex 14 can be viewed at www.sat.gob.mx/sitio_internet/servicios/donatarias/autorizadas/default.asp.
Thus, if the questions about current Article 97’s equivalence to former Article 70-B can be resolved, applying the Treaty should be easier than ever. Hopefully, we are nearing the time when the Treaty will finally fulfill its promise of facilitating and simplifying U.S. grants to Mexican public charities.
About the Author
Michael W. Durham received his J.D. from Yale Law School in 2002 and is an associate in Caplin & Drysdale’s Washington, DC, office. He is a member in the exempt organizations practice group and devotes a significant part of his practice to international grantmaking.
Convention Between the Government of the United States of America and the Government of the United Mexican States for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income (Sept. 18, 1992), art. 22, 3 Tax Treaties (CCH) ¶ 5903, as amended; Final Protocol to the Convention (Sept. 18, 1992), art. 17(b), 3 Tax Treaties (CCH) ¶ 5912, at 137,059.
Iniciativa Ciudadana y Desarrollo Social (Incide Social), A.C., Centro Mexicano para la Filantropía, A.C., Instituto Tecnológico Autónomo de México & International Center for Not-for-Profit Law, Definition of a Fiscal Agenda for the Development of Civil Society Organizations in Mexico 78-79 (2007), available (in Spanish) at