Is the Maquiladora Regime Coming to an end in Mexico

Lately, there has been a lot of worry about how the new regime of President Peña Nieto will view and treat maquiladoras in the context of the country's re-engineering.

The newly inaugurated presidency started in a very positive gang-ho move with the famous "Pacto por Mexico", achieving in a few months what the twelve-year conservatives' regime (PAN) of Presidents Fox and Calderon were not able to obtain: The badly needed "structural changes" that Mexico craves to catapult its economic growth, taking advantage of its strategic location, export industry power house, and the globalized economy, where China has become a major player, Brazil is loosing its charm, and the U.S. and Europe are struggling to get their economies in shape.

Since the mid-nineties, there has been a powerful group of bureaucrats in Mexico, principally at Hacienda (Mexico Treasury Department), that have been fighting the special rules that Mexico has establish to nurture its maquiladora industry. This economic sector has in one way or another spearheaded Mexico to become a major player in the export industry of the global economy.

These feds view maquiladoras as a cost for Mexico, with a very narrow perspective, alleging that maquiladoras only contribute to create cheap, unskilled jobs with a high cost of Mexican tax resources such as the employment subsidy, generating very little tax revenue income and not adding value to the Mexican economy.

The good news is that since the years of PRI's Presidents Salinas and Zedillo, and PAN's Presidents Fox and Calderon, these maquiladora opposing voices have not been heard. The Mexican government, has clearly understood that maquiladoras have contribute to the generation of the principal flow of foreign currency into the country, by being the most important factor of the development of the non-petroleum related exports. And with its two million plus work force, they have indirectly created a lot of supporting jobs that have helped the Mexican economy cope with the biggest financial crisis of this century.

So far, the government has understood that maquiladoras are a key component for the development of the fast growing automotive industry in Mexico, and are very important in the growth of the aeronautics industry among others, providing skilled and productive labor with a long industrial culture and experience that has become part of the overall landscape of Mexico.

Today, through the "Pacto por Mexico", which is an agreement that involves the three major political parties of the country and the newly elected President Peña Nieto, Mexico is in the process of making deep economic transformations necessary for the development of education, government, elections, political structures and the economy.

These main reforms have been in:

• Labor law, making more flexible labor contracts, labor litigation less tortuous and opening labor union to scrutiny and democratic procedures of its members.
• Education, by establishing a wide range of education evaluation system, with direct intervention of government and parents.
• Antitrust, by granting wide regulatory powers to the authority, to split a number of monopolies that have badly harmed consumers and impeded the growth of the Mexican economy by preventing more players to come into the market.
• Telecommunications, by developing regulations to promote new players to come in to the open television market, braking out telecommunications monopolies and opening these markets to foreign investment.
• Government accounting, by harmonizing and modernizing government related accounting at the Municipal, State and Federal levels, helping with budget controls and making expenses transparent.

These past weeks, the parties in Congress have announced that two special congressional sessions will be held to carry out further structural reforms in:

• A national transparency system.
• Anti-corruption reform.
• A National criminal procedure system, to move forward with the establishment of the adversary oral procedural system, similar to the existing one in the U.S.
  Municipal and State debt controls, to avoid over exposure of Municipal and State revenues due to uncontrolled government borrowing.
• Establishment of an Education Evaluation Institute, and
• Electoral and political reform, to widen the scope of Mexican democracy.

The last reform above mentioned is a key factor for the continuation of the "Pacto por Mexico", because is the "consideration" that the opposing parties PAN and PRD will get, for making the structural changes that Mexico needs. This will establish a fair and level political playing field for democracy to flourish in Mexico, securing that the old PRI authoritarian system does not come back.

With this political background, maquiladoras could expect that their business will continue to flourish. However, there is a cloud in the sky that most maquiladora planners have in their radar scope. This is the most recent OECD report that has been published as "Getting it Right, OECD Perspectives on Policy Challenges in Mexico". The report makes a series of recommendations to the Mexican government related to the structural changes needed for the development of the economy. The worries of maquiladoras start when the OECD states in its document the following:

"Mexico should also make an additional assessment of the costs and benefits of its numerous special tax regimes. There are special regimes for maquiladoras, agricultural and transportation businesses, cooperatives and medium and small business, which benefit on reduced rates, simplified accounting, differed tax payments, accelerated depreciation and other forms of fiscal reductions. These regimes, in addition of causing a direct reduction of tax revenues, complicate the tax code and facilitate companies to enter into aggressive tax planning skims or tax evasion, by unlawfully declaring less income. Special regimes also distort allocation of resources to areas or sectors which do not benefit with these regimes. The cost and benefits of all special tax regimes for commercial activities should be carefully evaluated, and maintain only those which effectiveness has been proven.

In particular, the maquiladora regime (IMMEX) should be limited and evaluated, because it is probable that some of its tax concessions may now be excessively generous. In addition of correcting some faults in the system, an option could be to establish a set expiration date of these regimes, and reconsider the amount of these tax concessions. However, this should be done as soon as possible so that businesses can have certainty over the amount of taxes that potentially should be paid. In addition, the extension of these regimes could have opened opportunities of abuse, such as, the VAT fraud known as "carrousel", in which maquiladoras transfer the tax benefit derived from importations to goods sold in Mexico that should be paying VAT. To correct the foregoing, VAT should be paid in all importations and rapidly reimbursed upon re-exportation thereof. Although some justification may exist to maintain such regime, the double taxation issues that existed with the United States are not present anymore, and the international competitiveness position that Mexico has with respect to costs has improved. More so, import duties have been reduced for all kind of businesses."

As it can be seen, OECD analysts are putting maquiladoras in the same level as other special tax regimes existing in Mexico that apply to business activities that are carried out within the Mexican economy.

We believe that this view is bluntly wrong, for many reasons. First the OECD over dimensions the increase in maquiladora competitiveness, not making a complete analysis of the fact that maquiladoras are competing in a world wide basis and the United States is a partner of Mexico and not a competitor of Mexico, neglecting the high sensitivity of maquiladoras total cost of doing business, that when a cost increase occurs, a number of worldwide locations enter into play to relocate the maquiladora activities elsewhere and out of Mexico.

Also the OECD over states the impact of companies abusing the exempt VAT status of maquiladora temporary importations. We believe that companies that bluntly are breaching the law using the maquiladora regime to avoid payment of VAT upon selling into the Mexican market, are a lot more exposed to scrutiny of the tax and customs authorities than pure contraband, and that there is no hard evidence to consider that companies that have abused the system are in a number that would justify changing the VAT free system of temporary importations.

An area where there may be some need in having to review the tax benefits related to maquiladoras to avoid the danger of having the government over react to an issue that exists, is related to the income tax structure, that the OECD did not expressly addressed.

This is the special system establish by law for maquiladoras that in combination of several Presidential decrees, many maquiladoras may end up paying non or small amounts of income taxes, in detriment of the Mexican tax revenues, and having the lions share of maquiladora business benefits located in the countries where the goods assembled/manufactures by maquiladoras are sold. Thus, a thorough review of the necessary fair bottom line rate applicable to maquiladoras should be done, by legislating in a definitive basis on the special income tax regime applicable to maquiladoras, upon expiration of the Presidential decrees.

In conclusion, maquiladoras should carry out a high profile approach before the Mexican government and legislators, as well as with the general pubic, of the virtues that this industry has brought to Mexico, and the great opportunities that exports represent to maintain the Mexican economy stable and to connect Mexican small and midsize businesses to the global economy.

The threat that exists of having maquiladoras just wait and react, like in the past, is high. The leadership of maquiladoras is mature enough to design and act upon, with profound vision to expose to the Mexican government at all levels and to the public opinion, that maquiladoras are a reality that has represented one of the most successful programs in Mexican history, that have generated millions of jobs, has created a technological basis that has permeated to the maquiladora workers, and is the biggest opportunity, combined with the other political and economic structural changes, to spearhead Mexico to full development in the twenty first century.

Most of all, we have the needed human capital to make it happen, encompassed by good trained people that is in its second generation of industrial experience. If this is combined with the capital investment opportunities for both foreign capital and repatriated Mexican capital, resulting from the eradication of private and public monopolies, the positive consequences on the economy of Mexico can be enormous.

However the risks of derailing this opportunities are high if we do not act immediately in the political and economic arenas. Maquiladoras now have not only a business responsibility; maquiladoras have an historic duty for making the NAFTA countries the strongest economic block of the world.