Mexico: New tax regime for maquiladoras by Luis E. Natera, NATERA

President Peña Nieto’s administration took office in December 2012 andprepared their tax bill during 2013, which was approved in the last quarterand came into effect in 2014. The tax bill brought relevant changes toMexican tax laws, including a new Income Tax Law (Ley del Impuesto sobre laRenta, hereinafter ITL) that surprised many tax payers, among them themaquiladora industry. The new tax regime for maquiladoras, which is setforth in Chapter II of Title IV of the (new) ITL, is substantially different tothe one in force until 2013. We hereby present briefly the main changes tothe tax regime.

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BackgroundThe Mexican government has been promoting themaquiladora industry since the early 1980s due tothe many beneficial effects that such industry maybring, such as the creation of jobs, the training ofMexican employees, economic growth, developmentof communities in border zones, increasing thecountry’s exports, etc.

Increasing Mexican exports became one of themain goals in the 1980s, especially because at thetime, Mexican exports were highly dependent on oiland other primary goods, so the governmentdecided to adopt an industrial policy that wouldturn the exports to depend on manufacturingactivities rather than oil. Accordingly, in the 1980s,two different Presidential Decrees were issued forthis purpose: the Maquiladora Decree

1and the

PITEX Decree;2although both Decrees aimed to

promote manufacturing activities for exportprojects, the first one was designed for thetraditional maquiladora industry, while the other onewas designed for an industry with a differentbusiness model, but also involved in export orientedmanufacturing activities.

During the early stages, the promotional benefitswere mainly customs oriented. The benefits aimedto allow maquiladoras to import raw materials,components, moulds, machinery and equipment, etc.under a temporary import regime, allowing theimporter to avoid disbursement of customs dutiesand other import taxes, such as value-added tax(impuesto al valor agregado, hereinafter VAT). Lateron, the benefits evolved to include some additionaltax issues.

Historically, the promotion of the maquiladoraindustry has been regulated in Presidential Decreesmainly. The current Decree, commonly known asthe IMMEX Decree,

3was issued in 2006 and

amended in 2010. There are some relevant points ofthe IMMEX Decree that are worth mentioning asbackground for the proper understanding of theapplicable income tax (impuesto sobre la renta)regime.• The old Maquiladora and PITEX Decrees were

merged into the IMMEX Decree, causingcompanies with very different business modelsto operate under a single IMMEX programme.

• Due to the integration of different schemes intoa single Decree and programme, it wasnecessary to create and regulate differentspecies of maquiladoras, such as industrial,services, outsourcing and shelter, among others.

• The IMMEX Decree also regulated the possibilityof outsourcing with third parties some of thedifferent processes or activities carried out inthe manufacturing process, while still consideringthe outsourced process or activity as part of theauthorised manufacturing activity for exportpurposes.

• Finally, although some maquiladoras had beensubject to a special income tax regime for manyyears, the IMMEX Decree included for the firsttime a special definition of “maquila operation”that was only applicable for tax purposes (mainlyincome tax). In order to qualify as an eligiblemaquila operation for tax purposes, additionalrequirements and conditions had to be met bythe maquiladoras. Failure to meet saidrequirements and conditions excluded themaquiladora from the special tax regime.

What has been the main purpose ofthe maquiladora income tax regime?The special regime created for income tax purposesfor a certain type of maquiladoras was designed forachieving two main purposes: first, clarifying that the

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Safe harbour optionsHaving taken care of the maquila operation scopeand definition, the new regime focuses on themaquiladora again; specifically, on its profit level. Forthis purposes, the safe harbour options have alsobeen changed in order to increase tax revenue.Two commonly used safe harbour options thatwere available until 2013 have been eliminated: • preparing a transfer pricing study and adding to

the arm’s length value determined therein, anamount equivalent to 1% of the net book valueof machinery and equipment used in themaquila operation that is owned by the foreignprincipal; and

• preparing a transfer pricing study under thetransactional net margin method, considering areturn on the machinery and equipment ownedby the non-resident principal that is used in themaquila operation.Furthermore, the significant reduction in the

safe harbour thresholds granted in the October2003 Presidential Decree is no longer applicable tothe new regime.

The new safe harbour rules would allow themaquiladora to determine its taxable (net) incomein an amount equivalent to the higher of thefollowing: • The 6.9% of the value of the total assets of the

maquiladora. • The 6.5% of total costs and expenses of the

maquila operation. Although these alternatives have been around

for a long time, the result may seem too high formany maquiladoras, especially when comparedagainst the profit levels that they have beenreporting since 2003 due to the reducedthresholds granted in the 2003 PresidentialDecree.

Those maquiladoras that find these safe harbouroptions to be high enough to make them non-viable still have the possibility of trying to obtainan advanced pricing arrangement from thecompetent authority in the terms of Article 34-Aof the Federal Fiscal Code (Código Fiscal de laFederación), whereby the appropriate profit levelon which they must pay income tax in Mexicowould be determined.

Given the impact of the new safe harbouralternatives, we expect a large number ofmaquiladoras to pursue an APA. This scenario canturn out to be a serious complication for taxpayers and the tax authorities, since under theircurrent capacity it can result in very long periodsfor resolving the APAs with the consequentuncertainty for tax payers.

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non-resident principal of the maquiladora would notbe deemed to have a permanent establishment (PE)in Mexico with respect to the maquila operation;and second, that the maquiladora would be deemedto comply with its transfer pricing obligations if itadopted any of the safe harbour options that wereavailable.

The 2014 maquiladora tax regimeThe new rules are still designed for the same twomain purposes: securing that the non-residentprincipal would not create a PE in Mexico inconnection with the maquila operation, and grantingthe maquiladora some safe harbour options forcomplying with its transfer pricing obligations.Over the last few years, Mexican tax authorities hadbeen raising their concerns about some tax payersthat were abusing the maquiladora regime. In thisregard, they were of the view that the regime hadbeen designed only for maquila operations destinedfor export. Therefore, it came as no surprise thatthe new rules raised the requirements andconditions for qualifying as a maquila operation forincome tax purposes accordingly.

In this sense, the changes to the maquiladoraregime for 2014 aimed at two main objectives: (i)redirecting the benefits only to those maquiladorasthat are exclusively engaged in manufacturingproducts for export; and (ii) reducing the benefits ofthe safe harbour options available to themaquiladora in order to increase tax revenue.

Qualifying as an eligible maquilaoperationRegarding the first objective, while still using thedefinition of maquila operation provided for in theIMMEX Decree as a starting point, Article 181,Section II of the ITL introduced new requirementsand conditions for the maquila operation to beeligible for the special tax regime:• All of the maquiladora’s income from its

productive activity, must be generated solelyfrom its maquila operation. This new elementimmediately excludes from the special tax regimeany non-industrial maquiladoras, such as theservice or outsourcing variety.

• The transformation or repair of goods sold inMexico and not documented in an export entrywould not qualify as a maquila operation.

• The maquiladora should use in its manufacturingactivities, machinery and equipment owned andprovided by its non-resident principal in at least30%.

4Such machinery and equipment could not

have been previously owned by the maquiladoraor its related parties.

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For those who cannot meet thenew standardsThose who cannot meet the new conditions andrequirements of the new definition of maquilaoperation, as well as those maquiladoras whowould not choose any of the safe harbouralternatives nor obtain an APA confirmation fromthe tax authorities, would create a permanentestablishment in Mexico (PE) for the non-residentprincipal.

In terms of Mexican law, the PE in Mexico isdeemed to be a related party of its head office andany other PE located abroad. Therefore, theattribution of profits to the PE in Mexico shouldcomply with the arm’s length standard, determiningits taxable income and allowable deductions byusing the prices or consideration that would havebeen used with or between independent parties incomparable transactions, in order to comply withexisting transfer pricing regulations in Mexico.

It is important to remember that on June 22,2010, the OECD issued a report containinggeneral guidelines for carrying out the attributionof profits to permanent establishments. Thisdocument presents the possibility of treating thePE as a separate and independent entity forpurposes of determining its business profits byapplying the arm’s length principle. This isparticularly relevant if the principal resides in acountry with which Mexico has a tax treaty inforce.

For those cases where the maquila operationgives rise to a PE in Mexico, it may be convenientto seek treaty protection and attribute the profitsto the PE in accordance with the OECD guidelinesset forth in the abovementioned report in orderto avoid double taxation. Furthermore, in order toobtain certainty and avoid potential confrontationwith tax authorities, it may be worth exploring thepossibility of getting an APA or a bilateralagreement (BAPA) on the proper attribution ofprofits to the PE.

Finally, some foreign companies prefer tostructure their manufacturing activities in Mexicothrough a shelter maquiladora, which is usually anindependent contractor. This manufacturing schemecould be used for four more years withoutcreating a PE for the non-resident entity as long asthe shelter maquiladora fully complies with its taxobligations, including all applicable filings. The four-year term will start on 2014 or when the non-resident company initiates operations under thisscheme. After the four-year term, the companyshould analyse if it may be deemed to have a PE inMexico for its manufacturing activities.

Other relevant changesA relevant change that is applicable to all taxpayers and not only maquiladoras, was the limitationof the deduction of some benefits paid toemployees. In essence, any benefit paid toemployees that is tax exempt (even partially) forthe employee would not be fully deductible for theemployer. Given the high level of employees hiredin the maquiladora industry and the fact that thesecompanies usually grant additional benefits to theemployees, this reform had a relevant impact in thisindustry.

Therefore, by means of a Presidential Decree,5

maquiladoras performing eligible maquila operationsare entitled to the full deduction of said benefitspaid to their employees as long as they maintaindetailed accounting records and payrolldocumentation that would allow them todistinguish benefits paid to employees working inthe maquila operations from those paid toemployees involved in the rest of the activitiesperformed by the maquiladora, having also tosubmit information required by SAT on a yearlybasis.

There was also good news. The elimination ofthe single-rate business tax (impuesto empresarial atasa única) was well received by tax payers,especially the maquiladora industry.

Value-added taxAnother very important change to the maquiladoratax regime is related to value-added tax (VAT).

As said before, one of the main incentives tothe maquiladora industry was to allow them thetemporary importation of goods into Mexico inorder to use them in their manufacturing activitiesand subsequently export a finished product. Underthe temporary importation of the goods, thecompany did not have to pay import duties norVAT, allowing the maquiladora to reach higherefficiency in its manufacturing activities, thusmaking it more price competitive in theinternational markets.

In terms of the reforms to VAT, the tax shouldbe paid for temporary imports unless the importerobtains a special certification from the competentauthority or offers satisfactory financial guaranteeof the VAT payable upon the temporaryimportation. It is important to mention that thisreform will become effective in 2015.

This reform could have a significant effect onthe maquiladora’s financial performance if it has tofinance the VAT (16% general rate) on thetemporary importation, even if the maquiladora isentitled to credit such tax as input VAT that would

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ultimately give rise to a VAT refund. The relevantpoint here is the need to use financial resources topay the VAT on the temporary imports, whilewaiting afterwards for the government to pay theVAT refund to the maquiladora.

Conclusions and final commentsGiven the substantial effect that the new income taxregime may have on the maquiladora industry, taxpayers need to act immediately in order to properlyassess such an effect and their possibilities ofcomplying with the new rules and evaluate if theycan actually bear the burden of the new safeharbour options or if they should explore thepossibility of pursing an APA.

Those tax payers that would not be able toadapt their maquila operations in order to complywith the new rules, should also take decisive actionsfor determining the best way to deal with the PEarising from the maquila operations.

New VAT on temporary imports is not a minorissue. It may represent a significant financial cost forthe maquila operation which could seriously affectthe maquiladora competitiveness. Although thecertification of VAT purposes may be a burdensomeand complicated process, it could still be the bestoption for those maquiladoras operating in a highlyprice-competitive environment.

Finally, we believe that the Mexican government,especially the tax authorities, should be paying closeattention to undesired effects that may be caused bythe 2014 tax bill, since it is significantly increasingnot only the income tax as it was intended, but alsothe compliance costs, and could also be seriouslycomplicating the operation of the maquiladora

industry in Mexico. We still hope for someadministrative regulations or guidance that couldsimplify compliance with the new rules as it willultimately increase the competitiveness required bythe industry to face its fierce competitors aroundthe world.

Note:1 Decreto para el fomento y operación de la

Industria Maquiladora de Exportación.2 Decreto que establece programas de importación

temporal para producir artículos de exportación.3 Decreto para el fomento de la Industria

Manufacturera, Maquiladora y de servicios deExportación.

4 By means of a Presidential Decree published onDecember 26, 2013, a two-year term (starting onJanuary 1, 2014) for meeting the 30% thresholdhas been granted for some maquiladoras.

5 Published in the Official Gazette on December26, 2013.

Author:Luis E. Natera, Partner

Natera Consultores, S.C.Montes Pirineos 410

Lomas de Chapultepec11000 México, Distrito Federal

MexicoTel: +52 55 5249 4400Fax: +52 55 5249 4401

Email: lnatera@natera.com.mxWebsite: www.natera.com.mx

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