Mario Hernández
Leading Partner of the IMMEX Segment
KPMG México
View from the Top

VAT Taxes Mexico's Competitiveness

Thu, 09/01/2016 - 15:36

Q: As the Tax Reform directly impacts the IMMEX segment, what effect has this had on the automotive industry?

A: The benefits the government granted in the past have significantly improved the quality and quantity of foreign investment. Prior to 2014, the effective tax rate applicable in Mexico for some of the entities in the supply chain was internationally competitive at 17.5 percent. KPMG prepared a comparative study in 2012 to pinpoint the differences between Mexico’s IMMEX tax regime and comparable countries such as Costa Rica, China and South Korea, which showed that most countries granted several years of exemption to companies that allocated resources to manufacturing processes. In some instances, countries were spared tax payments over five-year spans, followed by tax rate reductions to 50 percent for the following years. The study taught us that, even during its most successful years, Mexico’s IMMEX program was not competitive enough. To further aggravate matters, the Tax Reform modified Mexico’s tax rate to 30 percent. Although an effective tax rate is not the sole deciding factor as to whether a company invests in a foreign country, it certainly affects the competitiveness of Mexican automotive producers.

Q: What issues for foreign companies has KPMG seen as a result of the Tax Reform?

A: The tax environment is changing worldwide and Mexico is no exception, which will directly affect the automotive industry. The most notable outcome of the reform is destined to be companies deciding not to settle in Mexico. In contrast, countries like Guatemala and Honduras have established IMMEX programs similar to ours and are creating mechanisms that will attract the foreign investment that Mexico is forfeiting.

An additional issue in Mexico relates to the value-added tax (VAT). Before 2014, companies were authorized to import goods on a temporary basis. Raw materials, for example, could remain within the country for 18- 36 months as long as they were eventually exported as part of a finished product. Now that the law has changed, temporary importation is no longer exempt and companies are required to pay VAT, despite the fact that it could dramatically increase costs for investors. To soften the impact, Mexican authorities delayed the enforcement of these practices by one year, allowing companies to brace themselves for the change. After long discussions, the Mexican government devised a new plan. Companies can now obtain a reliable taxpayer certification if they can produce documentation that demonstrates their good practices, including the compliance of their suppliers as part of an indirect auditing process. This certification program gives companies the option to open a tax credit that remains valid until eventual exportation of goods. If such stock is not exported, then companies will effectively have to pay the VAT. So far, around 3,500 companies under IMMEX, including the most important manufacturers, have chosen to adopt the certification program and are responsible for around 94 percent of all temporary imports.

Mexico still struggles with this approach, as goods bound for manufacturing processes can get lost in the market. The way in which the IMMEX program is handled enables companies within IMMEX to trade goods between each other, making it almost impossible to efficiently track these transfers. If you include VAT evasion, the result is a flagrant negative competence for the Mexican market.

Q: What can companies do to ensure they legally opt for more favorable customs payments?

A: Before NAFTA came into effect, the government gave companies a 10-year warning to prepare themselves for change. The idea was to either incentivize companies to transition to NAFTA-based suppliers or to develop the market in Mexico but the efforts were fruitless. Once NAFTA was fully implemented in 2004, and in response to the realization that companies had failed to adapt effectively, the government implemented the Sectorial Promotion Programs (PROSEC). This program grants companies involved in manufacturing processes a fixed 0-5 percent import duty rate if purchasers can prove that the imported goods cannot be obtained in Mexico. In addition, “Rule Eight” of the General Law of Import and Export Taxes allows a company to avoid paying duties by proving that the imported goods are destined to manufacturing processes. Through PROSEC and multiple free trade agreements, companies rarely pay duties on imported goods, demonstrating that the real concerns derived from legal changes have nothing to do with customs, but with VAT payments. Mexico has lost some of its competitiveness with the VAT increment, especially when the temporary importation of goods continues to be exempt from payment in other countries.

Q: Is Mexico’s long-term position as a manufacturing hub likely to be altered given competition from countries with more favorable taxation rates than Mexico?

A: Recent global tendencies have divided the market into blocks, forcing companies to reallocate their manufacturing, distribution, logistics and design processes to specific countries or risk being excluded from certain markets. A few years back, companies migrated from Mexico to countries like China. But the realization that low human capital costs do not necessarily guarantee sustainable profit growth made many reconsider their location. Vehicle, component and auto parts distribution became problematic, forcing companies to maintain larger stock volumes to cover the local market’s demand, which evidently led to larger costs.

Manufacturing in Mexico makes distributing directly to our northern neighbor more straightforward and costeffective. Companies seek to control their environment by staying close to their target market, which allows them to have a clearer insight into the delivery timeframe. Similar time zones teamed with cultural similarities and a dual understanding of both currencies also make Mexico a more attractive market for these companies. In the meantime, the US is experiencing a near-shoring and reshoring phenomenon, leading to a need to stimulate the creation of manufacturing jobs once again. In 2015, certain manufacturing plants based in the north of Mexico were moved to the US. The US’ attention is fixed on this development and measures will be implemented to redistribute the manufacturing processes of their industries, the aftermath of which will be felt in Mexico.

Q: Will fiscal changes attract domestic and international companies devoted to sourcing raw materials?

A: The market and the opportunities are here but industries use enormous volumes of raw materials each year and domestic availability is generally insufficient. Interestingly, the automotive industry is the exception. Automotive products are manufactured with close to 30 percent of domestic raw materials, while other industries fall short at 5 percent. The automotive industry has been historically protected in commercial treaties around the world, reflected in the 30 percent minimum requirement imposed in Mexico. Failing to comply with this might lead to any entity’s allowance to temporarily import goods being revoked. The willingness to expand the industry is tangible, but the Mexican government must take action and set up a plan to understand the needs of the industry, to locate suppliers and to assist them in providing the necessary local raw materials.

Q: How does KPMG add value and help automotive companies that are involved with IMMEX overcome difficulties in tax legislation?

A: KPMG has been evaluating the possible effects of the decisions taken by countries involved with Base Erosion and Profit Shifting (BEPS) recommendations. Difficulties often arise because countries have different taxation laws. Because of this, tax treaties must come into play to avoid double taxation. However, in recent years we have been in a state of double-nontaxation, in which entities are not paying their fair share of taxes anywhere. As a result, the Organization for Economic Co-operation and Development (OECD) in collaboration with the G-20 are taking steps to prevent these BEPS practices. Continuous information sharing allows them to efficiently modify tax treaties and tax legislations, which subsequently helps countries impose the correct payment according to the company’s profit.

The aftermath of current taxation changes could lead companies to adjust their supply chain establishment. KPMG advises them on how to efficiently complete this transition based on local and international changes that affect their agenda. Our company’s global reach and communication between each of its branches is essential for foreign enterprises entering the country.

Q: What is the most urgent change the IMMEX segment and the Tax Reform should sustain to incentivize foreign investment?

A: Firstly, although VAT certifications have helped the government gather in-depth information about the processes and aptitudes of the biggest players in Mexican manufacturing, I would expect the certification program to provide companies more benefits, such as accelerated tax returns. Secondly, returning to a 17.5 percent tax rate would be beneficial for everyone involved in exported goods manufacturing. The 30 percent quota is not attractive enough to compete with countries such as Guatemala, Honduras and Costa Rica, which can offer similar benefits and enough proximity to the NAFTA region. The IMMEX segment is here to help Mexican companies and to identify control mechanisms that should be implemented. Pushing for a higher level of Mexican content in products is just the beginning, but the provision of grants for companies that ensure this would be a solid start