Related with this, last September 8, 2013, the Mexican Government sent to the Mexican Congress the Economic Package that includes the proposed Tax Reforms, for its review and approval. It is important to point out that this Economic Package is subject to review and that there could still be changes; therefore, the comments include in this document are subject are based in this Economic Package and are not definitive but they show the possible effects for the maquila industry.
Income Tax (IT)
Maquila Operation Definition
It is included a new definition of maquila operation since the current Mexican IT Law refers this definition to the one included in the Decree for the Development and Operation of the Export Maquiladora Industry (Decreto para el Fomento y Operación de la Industria Maquiladora de Exportación).
The new definition is similar to the one included in the Decree for the Development of the Manufacturing, Maquiladora and Export Services (Decreto para el Fomento de la Industria Manufacturera, Maquiladora y de Servicios de Exportación) but, the description proposed, among other requirements, states that it is required to export at least 90% of the total income generated by the maquila entity, it is not clear yet how this percentage should be computed but it is strongly focused on the exportation by the maquilas; if this proposal is approved it could impact several maquilas that do not comply with this percentage.
Additionally, the new definition proposed is somehow different than the one currently in effect in connection with the use of machinery and equipment to be owned by the foreign resident (minimum percentage to be owned by the foreign resident and protection for entities operating as maquilas before January 1, 2010); a careful review and analysis should be performed if the new definition is approved.
Leaving this regimen could trigger an increase in the IT for the maquila and a Permanent Establishment exposure for its related party resident abroad for which it carries maquila services, since it is required to comply with the definition of “maquila operation” in order to grant protection against Permanent Establishment for the foreign resident.
Some foreign residents maintain business relationships with Shelter Maquilas and the only cost that they have is the payment for the services rendered by the Shelter Maquilas related with the manufacturing operation and logistics services, among other services.
Under the terms of this tax proposal, the foreign residents would be able to continue obtaining protection against a Permanent Establishment in Mexico but only for three years under this Shelter scheme.
It is not clear yet how the three-year period would be computed but it looks this period is linked to the usual terms in which this type of agreements are usually executed.
Entities that comply with the new definition of maquila operation being proposed, in order to comply with transfer pricing rules, would have to do it through the scheme known as “Safe Harbor” (to obtain a minimum taxable income based on assets or costs) or request an Advanced Pricing Agreement (APA) from the Mexican tax authorities. The economic studies options, established in the current Mexican IT Law, would not be longer available if the proposal is approved. Under this scheme and, assuming the income tax exemption (granted through the Presidential Decree in 2003) would continue to be in effect, there would be a minimum tax effect. If the tax exemption does not continue, the level of IT to be paid by the maquilas in Mexico would be higher.
Income Tax Exemption
Unfortunately, the terms of the Income Law and the Transitory Articles of the Mexican IT Law are not clear in concluding if the Presidential Decree that grants the IT exemption (Presidential Decreed issued on 2003), would continue to be in force. We are of the opinion that considering the new definition of maquila operation and all the explanation that supports this proposal, the scope being taken by the Mexican Government is to repeal all type of tax incentives and tax exemptions. This should be clarified in the definitive economic package, once the same is approved.
10% IT over the payment of dividends
It is being proposed to charge the profits and dividends distributed to Mexican individuals and foreign residents with an additional 10% of IT, which should be paid when these profits or dividends are paid. It is worth mentioning that this is not a tax withholding and it is additional to the general tax over the companies’ current taxation. This new tax is applicable to all Mexican entities and not only to maquilas.
It is being contemplated to establish some limits to the current deductions; among these limits it is important to consider the following ones:
- Salaries and benefits paid to employees, that are totally or partially exempted, under the terms of the Mexican IT Law, such as savings funds, food coupons, social welfare, Christmas bonus, Profit Sharing, etc., would be only deductible up to 41% of the amount considered as exempted. Obviously, this would have an important effect in all maquilas since one of the most important costs of the same is precisely salaries and benefits
- Social Security quotas paid on behalf of the employees and that are exempted for the employees would not be deductible for IT purposes
- The immediate deduction of fixed assets is being eliminated.
These reforms would have an increase in the taxable income for IT and Profit Sharing purposes for the maquilas.
Value Added Tax (VAT)
VAT on temporary importations of goods
It is being proposed to eliminate the VAT exemption on the temporary importation of goods (raw materials and fixed assets) into Mexico, as long as the sales between foreign residents with physical transfers / deliveries among maquilas and the sales by foreign residents to entities with a maquila program when the goods are physically located in Mexico and were imported on a temporary basis. If this proposal is approved there would be important financial costs for the maquila, since the same would have to devote an important portion of their working capital to pay the VAT upfront and then request a refund from the tax authorities. Additionally, mechanisms should be established to impose the tax to the sales between foreign residents which would be subject to this tax.
VAT on border zones
Under the argument that the level of income obtained by the residents on the border zones is higher than the one obtained in the rest of the country, a proposal to increase the VAT on the border zone from 11% to 16% is being included. As in the previous comment, this increase would represent and additional financial costs for the maquilas related with the time to recover this tax from the tax authorities.
Flat Tax Law
The Flat tax Law is proposed to be repealed starting as of January 1, 2014.
We strongly recommend start evaluating the possible effects that the proposed changes are going to have in the operation and taxation of the maquila entities in Mexico.
As always, the Tax & Legal Practice at KPMG in Mexico is at your service to analyze in detail the effects that this reform could have on your business operations.