Is The Outsourcing Reform a Business Change Driver?By Hugo Hernández-Ojeda | Tue, 08/31/2021 - 09:11
The Labor Reform, which has been enforced in Mexico since April 24, 2021, prohibits outsourcing of personnel in Mexico and includes legal consequences in case of violations of the new subcontracting rules for the employers in the country.
This reform modified several laws in connection with subcontracting matters, including the Federal Labor Law (FLL); the Social Security Law (SLL); the Law of the National Housing Fund Institute for Workers (LINFO); the Federal Fiscal Code; the Income Tax Law; the Value Added Tax Law; and the Federal Law of Public Workers.
Although subcontracting labor structures were prevalent in Mexico for many years and even regulated under the former subcontracting regulation, several outsourcing schemes were also used for the underpayment of taxes and social security contributions, leading to massive tax frauds and reductions of the employee’s lawful compensation (including retirement and housing). Due to the foregoing, under the Labor Reform, subcontracting of personnel is now prohibited.
Subcontracting is defined as when an individual or legal entity provides its own employees for the benefit of another. That is, outsourcing and insourcing structures of personnel, per se, are prohibited as of the entry into force of the Labor Reform. Companies had 90 days to regularize and transfer employees into the operating/contracting parties. This deadline was deferred up to the last day of August 2021, for the employer to regularize their legal situation before the social security and labor authorities.
Subcontracting of specialized services or work will only be allowed when such services or work are not part of the corporate purpose or main economic activity of the beneficiary of the services, provided that the contractor has the corresponding registration before the Labor Ministry. Joint liability will exist for a contracting party in case of noncompliance of the service provider with its obligations.
The registry platform of the Labor Ministry has been available since May 25, 2021, and current service providers have a hard deadline of 90 days to obtain such registry (extended to Aug. 31, 2021). Service providers must demonstrate compliance with social security and tax obligations to obtain such registry, in addition to providing specific information, including by-laws that specify the specialized services. Specialized services agreements must include the purpose of the services, the register and folio before the Labor Ministry, and the estimated number of personnel involved in the execution of the services. Also, service providers must make available quarterly filings to the Mexican Social Security Institute and the LINFO regarding the agreements executed.
Complementary or shared services or works within the same corporate group will be allowed as long as they are not part of the corporate purpose or the main activity of the company receiving the services, subject to registration before the Labor Ministry. Typical examples of shared services could be IT, HR, treasury and payroll. We highlight that a shared service company must provide services to more than one company within the business group to be permissible.
There are several material consequences for using or benefiting from the subcontracting of personnel or not having the corresponding registration. These are administrative fines of up to 50,000 times the Unit of Measurement and Update (2021, fines of US$224,050), the non-accreditation of value added tax and non-deductibility for income tax purposes of the payments made for such services for tax purposes.
Criminal liability will be triggered for the use of simulated specialized services or specialized works or subcontracting of personnel and will be considered a qualified tax fraud crime (the penalty for qualified crimes will be increased by one half). The aforementioned is in addition to joint liability for labor, social security and tax purposes between the beneficiary of the services and the contractor in the event of non-compliance.
As you will gather from the analysis we have been assessing, the current subcontracting structure for many companies or business groups in Mexico will require revision. Any type of subcontracting, including internal services, such as insourcing, will imply a risk from the aforementioned prohibition. However, such risk may be mitigated by implementing certain measures. One of these suggested measures is to amend the companies’ by-laws to limit the corresponding corporate purposes to the core business only.
The goal is to narrow, as much as possible, the core business activities and “carve out” any other activity that is not a core business or the main economic activity of the companies. This will give companies more flexibility to subcontract to third parties specialized services that are not expressly included in the corporate purpose or carried out as a core business. It is crucial to run an internal analysis of which services or activities are actually rendered by each company and analyze which others could be eliminated and potentially carried out by a third-party provider, in accordance with the above and the Labor Reform.
As you can imagine, subcontracting services required for international companies that have a restricted headcount are not the only concern: profit-sharing is also a concern for the top management of companies in Mexico. Hence, the scenarios for the 2022 tax year are being analyzed by accounting firms and internal departments.
It is a fact that there is no legal criteria stated by the Mexican labor, tax and social security authorities regarding the interpretation of the new rules; officers of such authorities have expressed different and, in some cases, contradictory criteria about what should be considered as specialized services and which companies and services must be registered before the Ministry of Labor.
Conservative advice for companies and investors, regardless if they are local or international, is that they initiate a business inquiry in Mexico prior to incorporation of a Mexican entity to define the specific activities that will be part of the corporate purpose of the company to avoid risk while contracting specialized services required for business operations.
As noted above, profit sharing is another issue that companies must take into consideration as decision-makers. Along with the subcontracting reform, the entire process of calculation of profit-sharing and caps has been amended.
Before talking about the consequences of the Labor Reform regarding profit-sharing, I would like to provide background regarding this concept according to Mexican law:
- All employees in Mexico (except as noted below) have the right to share in the profits of the business in which they work, as provided by Article 123, section A, paragraph IX, of the Mexican Constitution.
- The National Commission / last set the percentage for employees’ profit sharing on Jan. 1, 2009 at 10 percent of each employer’s business pre-tax profit. It also establishes that profit-sharing payments shall be made to employees within 60 days after the date on which income tax is paid.
- To calculate profit-sharing, profits shall be divided into two equal parts. The first part shall be distributed equally among all employees in accordance with the number of days worked by each employee during the year, irrespective of the amount of each employee’s salary. The second part shall be distributed proportionally to the salary earned by the employees during the year.
- Thereafter, so as to determine each employee’s individual profit-sharing, a joint committee integrated by the employer’s and employees’ representatives should prepare a draft agreement with the calculation, which shall be placed in a public place in the company to enable employees to challenge the draft.
- Employees are generally entitled to profit-sharing. The managing director, general manager, administrator or chief executive officer of the company (or the equivalent highest position of the company, regardless of the title given) is not entitled to participate in profit-sharing.
- The rest of the salaried/non unionized employees are entitled too, but if the salary earned by those employees is higher than the higher hourly or unionized employee’s salary, said salary increased by an added 20 percent should be considered as the maximum salary for all calculations. In the event there are no unionized employees, the salary used as a cap for this calculation should be the salary of the employee with the highest salary who does not perform functions such as supervising, directing, or management, or the employee eligible for union membership whose salary is the highest, as applicable.
- Working mothers, during the period of pregnancy and after the birth of the child, along with employees who have suffered an injury or illness on the job and who are recovering before returning to work, are deemed to be actively employed during such periods for profit-sharing purposes.
- Temporary employees have the right to profit-sharing in the business when they have worked in it for at least 60 days during the calendar year. Therefore, the employees hired for an indefinite period of time (regardless of how many days they have worked during the year) are entitled to be considered for the payment of profit-sharing.
- Furthermore, certain corporations are not obligated to share profits during specific time periods, such as:
- New corporations during their first year of operation (tax year, which in Mexico is the same as the calendar year).
- New corporations, devoted to the production of a new product, during the first two years of operations; and
- New corporations devoted to an extractive industry during the exploration period.
- The right of the employees to participate in the profits of the employer does not imply the right to interfere with the administration or direction of the business.
- It should be noted that the majority of the employees, or the union responsible for the interests of the employees, might appeal the amount paid by a company as profit-sharing. If the tax or labor authorities consider that it was not correctly calculated, the company may be subject to pay fines and/or additional profit-sharing payments.
The Labor Reform establishes that individual employees’ profit-sharing distribution will be capped to three months of salary or the average of the profit sharing received in the last three years, whichever sum is more beneficial to the employee.
The first problem that we find here is that for new employees, it is not possible to consider any amount for the last three years that work or not for other employer.
Secondly, due to the fact that the method to calculate the payment of profit-sharing was not amended, the terms mentioned above apply, so the employer will not be obligated to pay an equivalent of three months of full salary of the entire workforce, which is a considerable difference.
The wording of the Labor Reform is not easy to interpret, especially in profit-sharing matters. The original 10 percent stated by the National Commission in 2009 is still in place; in other words, the employer’s obligation is to share up to 10 percent. In the event that the calculation of the three months of salary stated by the Labor Reform is less than the 10 percent, that surplus will remain as part of the employer’s profits.
/ The percentage of share participation is determined every 10 years by the National Commission on Profit Sharing, a government body comprised of representatives of employees, employers and the government itself.