Mexican factories manufacturing goods for export were broadsided earlier this year by tax law changes that could affect their competitiveness just as they had begun to recoup some of the business lost to Asia over the past decade. Affected companies include the more than 500 maquiladoras that produce about $8.3 billion in textiles and apparel each year, most of which is destined for the U.S. and other markets. These maquilas now face increased costs and tougher requirements for receiving tax benefits, potentially changing the sourcing calculus for many of their customers.
The statutory changes were enacted to combat what Mexican tax authorities believe was an abuse of the popular IMMEX and income tax breaks, which have helped drive the success of maquilas. These benefits included temporary imports of raw materials, parts and components, and machinery and equipment free of value-added tax; a lower VAT in border states; flat income and corporate tax rates; and “permanent establishment” protection. Normally a foreign company operating in Mexico would be considered to have a “permanent establishment” in Mexico and thus taxed at the same rate as a Mexican entity. “Permanent establishment” protection allows the foreign company to pay a lower income tax rate than a domestic, Mexican company. The Mexican government now insists on more stringent requirements to qualify for this protection from domestic income tax.
The most significant change for maquilas is the elimination of the VAT exemption for temporary imports as of January 1, 2015. As a result, maquilas will be required to pay VAT on these items for the first time, and those payments must be made at the moment of import. However, under a VAT certification program, the Mexican government will allow for a 100% VAT tax credit at import and return any VAT payments within 10-20. Without certification, delay of VAT reimbursement could create a difficult cash-flow problem for affected businesses.
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Other provisions in the new law could also take a financial toll on maquilas. The VAT in Mexican border states, where many of these factories are located, has been increased from 11% to 16%. And revenue associated with production must now be derived solely from maquila activities, which is problematic for maquilas whose goods are sold domestically in addition to being exported.
The law also imposes onerous new requirements on maquilas to qualify for existing tax benefits. For example, a revised definition of maquilas for income tax law purposes requires all imported goods to be exported, either physically or virtually. Foreign residents must own at least 30% of the machinery and equipment used in the maquila and cannot simply transfer those assets to their books to meet this requirement. In addition, Mexico no longer accepts transfer pricing studies to demonstrate arms-length transactions required for “permanent establishment” protection. Instead, companies must use a safe harbor or create an advance price agreement (APA) with the Mexican tax authority.
To remain viable in this new environment, maquilas will need to take a close look at how the new law impacts their business and consider what changes they need to make to remain eligible for tax benefits that are still viable. Auditing internal operations can help ensure compliance with current requirements, and a feasibility analysis can help determine whether an APA with the Mexican government is warranted. Facilities with both domestic and export sales may need to be restructured, and all maquilas should obtain certification from Mexican tax authorities so they can receive the VAT tax credit and expedited tax reimbursement.
MIRSHA SAYNES is the General Manager of Sandler & Travis Trade Advisory Services Mexico, resident in the Mexico City office. He has more than 12 years of international trade experience in both the public and private sectors in areas such as international trade consulting, audits, business development, public policy, international agreements, negotiation and public strategies.