Positive changes to awkward original bill By Luis Carbajo Martinez and Juan Carlos Valles
The Pena Nieto Administration set an ambitious plan of economic and social reforms which included very important structural changes on the labor, competition and education sectors. For such purposes, the Executive Branch secured broad political support as the main political parties endorsed the " Pacto por Mexico", which included among others, the basic steps to reform the educational system, the labor rules, the energy sector and tax system to raise long-term economic growth.
On May, 2013 the Organization for the Cooperation and Economic Development (OECD) published an economic survey for Mexico. According to the OECD, Mexico needs to accelerate productivity and factor accumulation, needs to implement structural reforms across multiple institutional domains to raise long-term economic growth. Specifically, the OECD established that the government budget is overly dependent on oil and that in order to decrease such dependence the government needed to evaluate and remove tax expenditures and special tax regimes, especially those that in its view erode the corporate income tax base, such as for the maquiladoras. Therefore, the OECD recommended, in particular, re-evaluating and removing special tax regimes, such as the one regulating maquiladora operations.
It is important to note that the OECD recommended several changes to the tax systems that were not finally implemented, such as the termination of the zero sales tax or value added tax (VAT) rates for food and medicines, for education and medical services. But the Mexican government included, in the original 2014 reform bill, the termination of a reduced VAT at the border, which will be raised to 16% in 2014.
In addition, the OECD also recommended some sort of VAT taxation to maquiladoras in connection with the temporary importations.
The OECD mentioned that in connection with the VAT, maquiladoras were abusing the system and that VAT should be levied on all imports and prompt refunds should be given when re-exported.
Based on the "Pacto por Mexico" and on the OECD recommendations, on September 8, 2013 the President of Mexico submitted a bill that would have been catastrophic for the maquiladora industry because it included the elimination of many advantages and tax incentives that maquiladoras, undertaking manufacturing activities on behalf of foreign residents, use to have. In the original bill submitted by the Mexican executive branch, the following was included:1
.The increase of the overall tax burden for maquiladoras by increasing the statutory tax rate from 17.5% to 30%.2
. A new definition of maquiladora operations in order to get a permanent establishment exemption for the foreign principals of the maquiladoras. Two specific requirements were creating a lot of complications for existing maquiladoras operations to comply with: the first requirement dealt with the 30% ownership by the principals of the machinery and equipment used by the maquiladora which could be supplemented with machinery equipment of other third parties. With the exception of machinery equipment previously owned by the maquiladora or any other Mexican related party of the maquiladora. The other requirement that was creating a lot of noise was that the maquiladora needed to physically export the finished product and, thus, virtual customs operations were not included in the requirements for the definition of a maquiladora operation.3
. Under the 2014 income tax law transfer pricing studies cannot be used to avoid a permanent establishment exposure; safe harbor and advanced pricing agreements would be the only options to avoid the permanent establishment exposure.4
. Under the 2014 bill to reform the income tax law, a limitation was included on the deductions for tax-exempted benefits to employees with a 53% threshold.5
. The VAT to be levied on all temporary importations undertaken by the maquiladoras.6
. The VAT application on sales by non-residents, with inter-maquiladora transfers and sales by non-residents to maquiladoras with inter-maquiladoras transfers.
Based on many discussions and negotiations between the President, the Chairman of the Tax Committee and the rest of the members of tax committee of the National Council of the Manufacturing and Export Maquiladora Industry ("INDEX") with members of Congress and with Revenue Policy Officials of the Executive Branch, some of the foregoing modifications were not included in the 2014 tax reform package finally approved by the Mexican Congress. The main changes were as follows:1
.Virtual customs operations are now included in the maquiladora operations definition and, thus, finished products can be deemed returned abroad, without the need for the maquiladora to perform a physical exportation.2
.The VAT on temporary importations would enter into force one year after additional secondary VAT credit rules are published. We are expecting those rules to allow the credit of the VAT to be assessed on the temporary importations under a certification mechanism for maquiladoras ("Certification Program").3
. The obligation to levy VAT on sales by non-residents with inter-maquila transfers is not included and, thus, will not be taxed under the 2014 tax reform.
Further efforts were carried out by the INDEX in order to bring additional competitiveness to the maquiladora industry. As a result, on December 26, 2013, the Ministry of Finance and Public Credit published in the Federal Official Gazette a Decree Granting Tax Incentives to Companies of the Manufacturing and Export Maquiladora Industry ("Decree"). In summary, the Decree grants the following additional benefits to the maquiladora industry:1
. The neutralization on the limitation to deduct tax-exempted benefits to employees through an additional deduction to maquiladoras.
Specifically, IMMEX companies with a maquila operation (as defined in the Income Tax Law) will have an additional deduction of up to 47% of the payments made to employees that are exempt income for them, so that, if the benefits provided to a worker are not less than the benefits provided in the next preceding fiscal year, 100% of such payments shall be deductible for the maquiladora (the tax incentive would be limited to a deduction equivalent to 94% of the payments made to the employees only when the benefits provided by the maquiladora to the employees in a given year are less than the benefits paid in the next preceding fiscal year).
This incentive is given to maquiladora companies that determine their own tax profit pursuant to the so-called safe harbor methodology, as well as to those that determine their tax profit pursuant to advanced pricing agreements (known as "APAs").2
.Includes an extension of the so-called "grand-father clause" with respect to the requirements to utilize in the maquila operation machinery equipment owned by the non-resident principal in at least 30% that must not have been owned by the maquiladora company or by a related party of the maquiladora company resident in Mexico. However, this extension of the grand-father clause is granted exclusively for a term of two additional years for maquiladoras that secured an IMMEX authorization prior to December 31, 2009, and provided that they have been complying with their transfer pricing obligations in terms of the special rules set forth for that purpose in the Income Tax Law (the grand-father clause will expire on December 31, 2015, and maquiladoras would be required to comply with the statutory requirements as of year 2016).
Notwithstanding the above, the Decree is silent with respect to the prior ownership requirement concerning the remaining 70% of the machinery and equipment that may be used to supplement the 30% of machinery and equipment property of the non-resident principal. This is a subject that should be clarified now in order to grant absolute certainty to the manufacturing operations of all maquiladora companies3
.The Decree includes a mechanism that will allow maquiladoras, or companies of the automotive industry, to credit the withheld VAT within the same month of the VAT withholding, rather than crediting the respective VAT in the month following the month when the withheld VAT is paid to the tax authority. However, it should be noted that as of January 1, 2015, this benefit will apply only to those companies that obtain the new special certification for VAT purposes to be published by the Tax Administration Service ("Certification Program").
The Certification Program would also clarify the mechanism that maquiladoras must meet to avoid VAT disbursements on temporary imports, and not only for the credit of VAT on sales from nonresidents to maquiladoras.
According to information communicated by the INDEX, the Certification Program will be based on a tax and customs compliance approach, where the company’s “reliability” will be the key factor, based on taxpayer compliance and performance issues (this certification will be different from the current certification of maquiladora companies for other customs benefits). It is expected that the Certification Program will be developed for companies that 1) create jobs, 2) engage in exports, and 3) invest in Mexico, evidencing tax and customs compliance. Also, it is expected that the program will segment enterprises on different levels with different benefits for each level. The sole benefit of basic certification is nonpayment of the VAT on temporary importations, and companies that meet the additional requirements to be established would be expected to enjoy other benefits to be confirmed, which might include the following:
•Expedited VAT refund for purchases or services,
•Closing of consolidated customs declarations in extended periods,
•Voluntary correction in preventive audits with a self-reporting mechanism and compliance grace period due to lack of liquidity,
•Right to receive an official audit invitation to comply with tax and customs obligations before being notified of an audit, and
•Waiver of requirement to report serial numbers on electronic customs validations.
In summary, even though the original bill proposal could have been catastrophic for the maquiladora sector, the good news to report is that even if the statutory income tax rate increased from 17.5% to 30%, multinational principals undertaking business activities with maquiladoras should get sound tax advice to make sure the additional taxes to be borne in Mexico would be creditable in their country of origin.
In connection to the maquiladora operation definition, maquiladoras must make an analysis to ascertain that they qualify for the specific definition to exempt their principals from the permanent establishment exposure, the grandfather provision will, without doubt, minimize the risk for multinational firms from the permanent establishment exposure.