The Manufacturing, Maquiladora and Export Services Industry in Mexico
Over the past decades, the Mexican export industry has achieved a reputation as one of the most dynamic economic sectors in Mexico. After the Great Recession of 2008 and 2009, Mexico has emerged as one of the most attractive places to invest in manufacturing.A February, 2010 study by the global business advisory firm AlixPartners LLP found that “Mexico continues to lead as the number one low-cost country (LCC) for outsourcing from the U.S., while China, improving considerably over last year’s study, still came in 6th.” Importantly, Mexico jumped ahead of both China and India to claim the top spot for sourcing manufactured goods to the U.S. market.Mexico’s surging manufacturing sector and success in attracting foreign investment results from its sound economic policies and healthy public finances. Mexico’s privileged geography, skilled and productive labor force, competitive exchange rate, improved infrastructure also contributes to this upward trend. Mexico has one of the broadest networks of free trade agreements in the world, which allows companies from Europe, Latin America or Asia to export goods to the U.S. and Canadian markets, and therefore benefit from the provisions of the North American Free Trade Agreement (NAFTA).Mexico has signed free trade agreements with the following countries: United States of America and Canada (NAFTA), Colombia and Venezuela (G-3), Costa Rica, Bolivia, Nicaragua, Chile, the European Union, El Salvador, Guatemala and Honduras, Iceland, Norway, Lichtenstein and Switzerland, Uruguay, and, most recently, Japan. Mexico has also signed international treaties for the promotion and mutual protection of investments with most of its major trading partners, including France, Italy, Portugal, the United Kingdom, Germany, Spain, Switzerland, Finland, Portugal, Sweden, Argentina, Panama, Uruguay, the Republic of Korea, Australia, India and China. Special provisions regarding protection of investment with Canada and the U.S. are contained in Chapter 11 of the NAFTA.With the United States – Mexico – Canada Agreement (USMCA), recently created and yet to be ratified by the Congress (by November, 2019) the aims are set to change the rules regarding the automotive industry, being the most relevant change that suppliers in Mexico will be required to raise the wages of their personnel contributing to the manufacturing process. If the higher wages are not granted, suppliers will pay a 2.5% tariff on all exports to the United States. It is important to consider that the only industry suffering significant changes would be the automotive, as the USMCA will not have an impact regarding the current trade regulations under NAFTA.According to the Mexican National Institute of Statistics, Geography and Information (INEGI), in August 2019, approximately 2.73 million people were employed in the Mexican Maquiladora export industry. Such statistics show the importance and size of the Mexican manufacturing industry, particularly in the northern region of the country.According to the General Criteria of Politic Economy for 2020, issued by the Secretary of Treasury and Public Credit (Secretaría de Hacienda y Crédito Público) the expectative of growth for the National Gross Income is between 1.5 and 2.5, even considering the international trade market circumstances, which will be translated in an expansion of the manufacturing production and the services related to international trade.
Benefits of Manufacturing in Mexico
Currently, numerous benefits are available to companies that establish manufacturing operations in Mexico. Examples of such benefits include:
- The ability to better compete in world markets by combining advanced U.S. technology with a qualified and cost effective Mexican technical staff and labor force;
- The ability to continue to employ U.S. personnel in U.S. facilities in administration, warehousing, product finishing, etc.;
- The ability to own 100% of and efficiently control and administer a Mexican entity and its operations;
- The ability to utilize U.S. technical and administrative personnel in Mexico operations (up to 10% may be non-Mexican and may obtain required working visas), and the ability of such U.S. personnel to reside in the U.S.;
- The ability to acquire, through a Mexican entity, fee simple ownership of land and buildings for industrial operations in Mexico’s border zone;
- The ability to import NAFTA origin raw materials, components, machinery, and equipment on a duty-free or NAFTA duty-rate basis;
- The ability to defer duties on imported raw materials until after the exportation of finished or semi-finished products, and the ability to take advantage of preferential duty rates under applicable Mexican Sectorial Programs;
- The ability to avoid non-tariff barriers;
- The ability to take advantage of preferential U.S. Customs and Border Protection programs which allow U.S. companies to import finished products and semi-finished products duty free or based on the value added in Mexico;
- State of the art infrastructure for the efficient cross-border transfer of goods, and simplified U.S. and Mexican customs clearance procedures;
- The ability to sell products in the Mexican market;
- Proximity to the U.S. market; and
- Access to Mexican and other Latin American market.
Structure of a Mexican Manufacturing Operation
Choice of Entity and Practical Considerations.Planning an appropriate corporate structure in Mexico generally involves the same types of factors that one would consider in forming a U.S. company: primarily limitation of liability and tax considerations. However, the international nature of such a Mexican operation requires the consideration of a broader base of applicable U.S. and international laws, and certain special factors including customs and tax matters. These issues include permanent establishment, transfer pricing, special taxes, mandatory employee profit-sharing, as well as issues related to the financing and capitalization of Mexican entitites. For example, U.S. tax considerations may be a determining factor in deciding which specific type of Mexican entity is suitable for a company’s operations, as further explained below.Many forms of entities for conducting business in Mexico exist, some of which are similar to the choices available in the U.S. The traditional investment vehicle for direct foreign investment in Mexico is the Sociedad Anónima de Capital Variable (S.A. de C.V.), which is similar to the standard business corporation in the U.S. Another common choice of entity is the Sociedad de Responsabilidad Limitada de Capital Variable (S. de R.L. de C.V.), which is similar to a U.S. limited liability company (L.L.C.). A Mexican manufacturing operation typically features one or the other of such types of entities, depending on the tax considerations present in a specific case. Each entity affords limited liability protection to its shareholders or owners.For U.S. income tax purposes, and in particular the so-called “check-the-box” rules,the S.A. de C.V. is considered under U.S. law to be a corporation per se, whereas the S. de R.L. de C.V. is an entity which may be classified as a partnership for U.S. tax purposes, if such treatment is elected. If the parent company is a limited partnership, limited liability company or other entity that has elected partnership tax treatment in the U.S., it is possible for such entity to effectively consolidate its Mexican operations in its U.S. tax return and thereby improve its ability to take U.S. tax credits for the taxes paid in Mexico by its foreign subsidiary.For purposes of Mexican taxation, the S.A. and the S. de R.L. are treated identically. From a corporate and legal standpoint, the two types of entities are similar. Both require a minimum of two shareholders or members. Both, the S.A and the S. de R.L. do not require a minimum capital, enabling the shareholders in absolute freedom to establish the society with any amount and it is fair to conclude that none of them may be incorporated without an initial capital contribution of at least $2.00 pesos ($1.00 peso per each founding shareholder or member), although initial capital and minimum capital will normally be determined by the founding shareholders or members based on business needs. Each type of entity may be administered by a board of directors/managers, or by a sole administrator/manager. Although it is only mandatory for S.A. de C.V., it is standard practice for both types of entity to appoint an inspector or a board of inspectors - typically individuals who work with the company’s auditors - to perform the oversight function for the shareholders/owners; and S. de R.L. may opt for having it or not. Both may be structured as variable capital companies, as shown by the C.V. designation. The primary differences are as follows: (i) an S. de R.L. may not have more than fifty members, whereas an S.A. may have an unlimited number of shareholders; and (ii) interests in an S. de R.L. are represented by contribution certificates as opposed to stock certificates in the case of the S.A. In other words, the S. de R.L. may not appear as a publicly traded company in Mexico. This is generally not an issue for a Mexican manufacturing operation, although it may be an issue for non-manufacturing businesses.As indicated above, beside the widely used S.A. de C.V. and S. de R.L. de C.V., there are many other types of entities regulated under Mexican laws, some of which are not suitable for business operations and some others which could be a better fit for certain types of business operations. For example: (i) the Sociedad de Acciones Simplificadas (S.A.S.), which is the only sole proprietorship type of entity existing in Mexico intended for micro-business entrepreneurs caped to $5,000,000.00 pesos annual revenue, but is generally not recommended or used for larger business; (ii) the Sociedad Anónima Promotora de Inversión (S.A.P.I), which is similar to an S.A. but regulated and intended for participation in stock exchange (although not obligated), allowing accommodation special rights and restrictions among shareholders (i.e.. drag or tag along rights) commonly used in joint ventures; and (iii) the Sociedad Financiera de Objeto Múltiple (S.O.F.O.M) which is a type of entity designed and regulated to offer credit, leasing and financial factoring services without a standard bank setup.In connection with the financing and capitalization of the Mexican entity, one should consider various factors relating to whether debt or equity will be used to fund the Mexican entity’s operations. Although Mexican subsidiaries have traditionally been funded by equity financing, debt financing may be beneficial in certain ways, such as reducing the Mexican company’s employee profit sharing and income tax liabilities from interest payment deductions, assuming that the company can obtain a deduction for such interest payment. Some of the factors to consider in choosing between equity and debt financing are: i) the effects of inflationary accounting in Mexico; ii) the interest rate of the debt for debt denominated in foreign currency; iii) fluctuations in the value of the Mexican peso relative to foreign currency ; iv) the rate of inflation in Mexico; v) the Mexican income tax withholding rate that applies to the interest payment; and vi) foreign tax implications to the foreign shareholder/owner.Another planning aspect to consider in connection with a Mexican operation is whether more than one entity should be created in Mexico. For example, Mexico’s mandatory ten percent (10%) employee profit-sharing payment imposed on employers may be addressed by creating a separate employment services company in Mexico in order to contract with the project’s operating company to provide labor services to such operating company. In this manner, the amount of employee profit sharing payments would be based on the gross profit generated from furnishing personnel to the maquiladora at an “arms-length” price, as opposed to the gross profit generated by the maquiladora from its manufacturing operations.One should also consider whether it would be prudent from a liability and tax standpoint to create a separate real estate holding company to acquire real state as part of the project (i.e. offices or industrial facility), if the company chooses to own its premises rather than simply leasing.For manufacturing businesses, additional considerations apply in connection with planning the structure of the company, as further explained in the next section below.
The Traditional Legal Structure for Manufacturing Entities.
The traditional legal structure for a maquiladora manufacturing company is a simple structure whereby the U.S. or Non-Mexican parent company forms an S.A. de C.V. or S. de R.L. de C.V. subsidiary. Such foreign parent acquires virtually all of the stock/ownership interests, together with a second shareholder/owner as required by Mexican law, which acquires a nominal interest.The parent company furnishes the machinery, equipment, raw materials, components, and supplies on a consignment basis, pursuant to the terms of a bailment contract, for assembly or manufacture by the maquiladora manufacturing operation. The parent company retains title to all such materials, supplies, and equipment, as well as the semi-finished or finished products. The maquiladora operation invoices the parent company periodically and charges a service fee for assembly or manufacturing services, based on its costs, plus a markup on an “arms-length” basis, in compliance with Mexican transfer pricing rules. The parent company funds the maquiladora manufacturing operations by advancing funds for capital and operating expenses to the maquiladora on an as needed basis, in addition to paying the agreed upon manufacturing service fees from time to time. An intercompany payable in favor of the parent company usually accumulates; however, this may need to be capitalized from time to time in order to avoid potential phantom Mexican income, and applicable Mexican income tax, on any resulting inflationary gains.
Formation, Administration and Management of a Mexican Entity.
The formation of a Mexican S.A. de C.V. or S. de R.L. de C.V. involves a process that is relatively similar in nature and time as that required to form a company in the U.S. The first step of such process is to request and obtain a permit from the Mexican Secretary of Economy to organize the entity under the proposed name, and ends with the recording of the new entity’s formation documents with the local or state Public Registry of Commerce (Registro Publico de Comercio). It is very important to determine the shareholders or owners of the Mexican entity. Such may be individuals and/or entities. Mexican law requires a minimum of two (2) shareholders or owners, and once their identities have been determined, special powers of attorney for incorporation are prepared. The Spanish versions of the special powers of attorney for incorporation must to be formalized and delivered to the notary public in Mexico prior to incorporation.The articles of incorporation/formation and bylaws of the company are similar in scope to those of a U.S. company. They include the structure for the governance of the company by the shareholders/owners, provisions for the administration of the company by a board of directors/managers, as well as the specific powers of attorney (e.g. powers for acts of ownership, acts of administration, lawsuits and collections, banking matters, labor matters, etc.) available to the board/sole administrator and other individuals invested with the authority to represent the company.Certain practical considerations should be taken into account when deciding whether it is more appropriate for the company to be managed by a board or a sole administrator, such as the decision-making structure of the U.S. parent company, furthermore, the tax liability for the sole administrator as opposed to a board needs to be properly considered.Under applicable Mexican laws, S.A. de C.V. and S. de R.L. de C.V. entities must keep the following accounting books and records:
- General ledger;
- Shareholders/owners minute book;
- Shareholders/owners registry; and
- Registry Book of capital increases and decreases.
- Board minute book, if the S.A. or S. de R.L. has a board instead of a sole administrator/manager.
According to the Commerce Code, the first and second books can be stored in paper or using any kind of technology such as electronic files, as long as it complies with what the Official Mexican Standard 151 (NOM-151-SCFI-2016) establishes for storing relevant data. Said rule establishes that the electronic document must be compared with the hardcopy by an authorized third party, certified by the Secretary of Economy, and also, comply with quality standards such as a clear enough image for graphic electronic representations.Mexican Companies must issue a financial report that will be submitted at the end of each fiscal year for the consideration and approval by their shareholders/owners. The annual financial report must contain the following:
- Financial statements for the fiscal year;
- Balance sheet;
- Income statement;
- Statement of changes in financial position;
- Statement of changes in stockholder/owner equity; and
- Notes to the financial statements.
For legal, tax and accounting purposes in Mexico, a company’s fiscal year must end on December 31, in accordance with Mexico’s General Law of Business Organizations and Federal Tax Code.