Manuel Padrón
Baker & McKenzie
View from the Top

Fallout of Recent Reforms on the Maquiladora Sector

Mon, 09/01/2014 - 10:17

Q: Which role does the maquiladora industry play in the development of the automotive industry in Mexico?

A: The automotive and maquiladora industries in Mexico are inextricably linked. The growth of the auto parts industry in Mexico has to a large extent been a result of the maquiladora program itself, and the largest portion of the value of manufacturing exports comes from maquiladoras. OEMs in Mexico did not grow as a result of the maquiladora industry, although some OEMs are now looking at the maquiladora and IMMEX program with interest. In fact, most major OEM companies have secured IMMEX registration just in case they need to use it.

Q: How heavily have the recent reforms affected maquiladoras?

A: The reforms have heavily impacted the maquiladora industry and have not been viewed positively in the eyes of traditional investors. Companies are very concerned and are looking for mechanisms to improve the situation. It seems that we are going back in time to when the industry was more heavily regulated, while we are seeing the removal of certain basic premises that enshrined the maquiladora industry. By eliminating presidential incentives for the income tax of maquiladoras and creating value added tax (VAT) on temporary importation, the Fiscal Reform has a tremendous impact on cost and on the management of company operations. Even though there are programs to avoid the disbursement of VAT on temporary importations by maquiladoras, the process to get the needed quality certifications to qualify for these is complex and difficult to maintain in the long run. The industry has not settled for the current conditions and discussions will continue surrounding these reforms. The situation cannot get any worse, so any revisions can only be positive.

Q: The maquiladora industry has been subject to change and evolution throughout its history. How is this different?

A: In the early days, all their production had to be exported outside of Mexico. What often happened was that a producer in Mexico would make goods needed inside the country, so these had to be shipped across the border and then shipped back in again to comply with regulations. However, the Ministry of Economy saw the necessity of establishing a value-added production chain in Mexico, and so created rules to allow some of the production to remain in the country. This triggered concerns from tax authorities, but the need for economic growth was held to be more important. It was envisioned as possible for maquiladoras to keep 100% of production within Mexico in order to enable them to supply the growing OEM base. But the recent changes seem to show that the tax authority is once again dictating the state of play. The tax authority does not want maquiladoras to keep their production in Mexico and continue enjoying the same benefits they used to enjoy. Those benefits are far removed from how they were originally conceived and maquiladoras are increasingly being pushed into becoming regular taxpayers. This is leading to a lower level of competitiveness for Mexico, especially as other countries are implementing tax incentives that could attract investors away from Mexico.

Q: What are the biggest risks for maquiladora companies operating in Mexico at the moment?

A: There are two different definitions of what a maquiladora is. One is for trade purposes, namely to govern import and export activities, and the other is for tax purposes. This is an important distinction. If a company fails to properly comply with taxation guidelines, the parent company is at risk of being legally held to have a permanent establishment in Mexico for tax purposes. The Mexican government could then consider the parent company to be an unregistered taxpayer in Mexico, and no company wants to be in that situation. Companies therefore have to be increasingly mindful of the structure of their business and the way in which they are conducting business in Mexico. Situations outside of a maquiladora’s control can also easily come about. For example, a maquiladora’s asset-holding related company might be acquired by an external company, triggering a permanent establishment when a maquiladora uses assets that were owned by a Mexican related party. Such a situation is now negatively regulated, and the punishment for such an action will scare investors away. There is no question that regulation is needed, but the concern is that the current regulations go too far. They are targeting a growing tendency for maquiladoras to participate in the Mexican market, and companies were not ready for the changes when they happened. Many of the conditions are impossible to meet for a lot of companies. For the time being, most companies are absorbing the additional costs. Mexico has good treaties in place to avoid double taxation, and if structured correctly, international firms can re-claim taxes paid in Mexico in another jurisdiction. A lot of companies simply will not have the cash to pay the 16% VAT payable on temporary importation, and will therefore have to acquire additional financing to cover the cost. There are around 6,000 IMMEX registrations, and the Treasury has predicted that at least half of those will not get the VAT disbursements exemption certification, meaning those companies will have to pay VAT. This is a negative sign as it increases the cost of doing business in Mexico.

Q: How easy is it to obtain an IMMEX registration and how quickly can it be lost?

A: Getting IMMEX registration is not difficult. A company just needs to have a legal vehicle in Mexico and a facility, along with evidence of the type of business activity being conducted. In theory, losing the IMMEX regulation is also fairly easy as a company only has to breach one of many requirements dictated by the customs program. In reality, we have seen that the Ministry of Economy is not hunting IMMEX-registered businesses for cancellation. Problems are addressed during audits, and the Ministry of Economy appears to be doing its best to foster growth in maquiladora operations. Companies should expect strict enforcement of rules and regulations, but they should not fear having their registrations cancelled.

Q: How positive have the amendments to the customs regulations been, and do you foresee any major changes following the recent announcement of a second review stage?

A: Customs transactions have been modernized by the recent regulatory changes, but what the legislation really achieved was to legally reflect what was already happening in the Mexican customs world. Eliminating the need for a second inspection and requiring electronic notifications were both very positive changes. Delaying tactics by importers in customs procedures were also reduced, making the system fairer and more efficient. There was perhaps an excessive enforcement in terms of the fines imposed, and the government is going to review one or two aspects of the legislation, but I do not think any radical changes will be announced.

Q: What role do OEMs play in creating an optimal environment for their auto part providers, and how is this impacting the uptake of the maquiladora scheme by auto parts companies coming here?

A: OEMs play an important part regarding the complexity of operations for the auto parts sector. Regulations mean that OEMs and maquiladoras benefit from being able to conduct virtual importations and exportations under the maquiladora scheme. However, many OEMs dislike the virtual importation and exportation approach, preferring to have domestic sales with the use of transfer certificates. That can complicate business for the maquiladoras, because they need to export 100% of their Mexico production in order to maintain permanent establishment exemption for the parent company. The transfer certificates require domestic sales, which creates an imbalance. Some OEMs do accept virtual importations, but the ones that do not are creating a situation where maquiladoras need to use a sister company to virtually import the goods and then sell the goods domestically to the OEM. This creates an unnecessary middleman, and the market could operate better if more OEMs agreed to accept virtual importations.

Q: What other issues should the manufacturing industry in Mexico be mindful of as the sector develops?

A: A major issue that requires consideration by the sector is international anti-trust regulation, which will undoubtedly be enforced more heavily in Mexico in the future. A lot of Mexican-produced parts are being exported globally and all industry players should play close attention to what is happening in the rest of the world regarding anti-trust regulation enforcement. Companies should be expecting the government to ramp up inspections, enforcement, and prosecutions in the near future. Recalls are another area of concern. The issue is one of basic consumer rights, as some of the parts currently subject to recalls may well have been made in Mexico. As the country increases production, this will become more of an issue.

Q: What does the future hold for the automotive sector in Mexico?

A: This is an interesting time for the industry. The impact of the regulations is not yet being fully felt as the government has allowed a two-year adjustment period. Therefore, we do not expect major changes in the industry over the next year. In the long-term, a suitable situation for both the government and the industry has to be reached. Mexico’s maquiladora industry is being looked to for inspiration by other countries, and they will take advantage of any reduction in the attractiveness of Mexico’s automotive industry by emulating what we have done in the past. Mexico should be picking up a lot of the production opportunities that are arising as a result of the growth of the North American industry and the reduction in competitiveness of traditional Asian manufacturing hubs. We should be doing whatever we can to foster growth, not hinder it.