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Maquiladora income tax rationale

March 01, 2009. 20:01

A key challenge for tax executives working in multinational enterprises (MNEs) is keeping up with the proper interpretation of transfer pricing rules and permanent establishment definition. The good news here is that Mexico shares the same earnings taxation principles with US taxing authorities and its partner members of the Organization for Economic Co-operation and Development (OECD).

Higher-level holding companies, by general rule, constitute Permanent Establishment in Mexico because of their activities performed by using their lower-level subsidiary company in Mexico. However, for Maquiladora companies the Income Tax Law (second to last paragraph of Article 2 and Article 216-Bis) states that the foreign associated company will not constitute Permanent Establishment in Mexico, as long as it resides in a country which Mexico has celebrated a treaty to avoid double taxation, and the Treaty’s requirements are fulfilled. In addition to this, certain requirements are observed for the Mexican entity:
-To operate under the Transfer Pricing principles and prove that the prices are not affected because of the association between companies, in that case the Maquiladora company reports its real financial results (gain or loss);
Stated simply, local taxing authorities will assert that the Mexican entity is reporting its real benefit in its financial statements, while preventing that the revenues or losses generated in a country are not artificially transferred to the other associated company.

or,

-To report a minimum revenue amount by following the Safe Harbor scheme;
Safe Harbor is a set of rules under which the observance of the obligation of operating by Transfer Pricing would be overviewed and automatically accepted Mexican Authorities. It is a disposition that can be used by Maquiladora companies and that releases them of certain obligations, replacing them by simpler obligations. In order to apply for this option, it is necessary to present a notice to the government within the first three months of each year. Note that this circumstance is only valid for Maquiladoras that operate under a consignee scheme.

The Safe Harbor scheme has three variables that could be simplified in two options; the highest of the following amounts is the one that must be used as an amount to be affected by the applicable Income Tax Rate of 28%:
A.- Revenue of 6.9 % over assets. In this case all the assets used in the Maquiladora operations, including those assets that are property of the foreign companies will be taken into account for calculations.
B.- Revenue of 6.5 % over operations cost. In this case the total costs and expenses, including the ones made by the foreign related companies will be considered.

Finally, according to the Maquiladora Act, any company that holds a registration as Maquiladora for manufacturing or supplying services is beneficiated by these income tax schemes.

Background
Until December 1994 Transfer Pricing and Permanent Establishment (PE) were not required by the Mexican Authorities for Maquiladora companies sourced by foreign investment. In 1995, the Mexican Income Tax Law and the several Treaties signed by the Mexican government with other countries to avoid double Income Tax effect created the concept of non-PE for the foreign associated companies. Such dispositions have been coherent with the OECD (Organization for Economic Cooperation and Development) rules, since Mexico is one of the OECD members.
A series of provisional legal dispositions were applicable from 1995 to 1999 and suspended the Permanent Establishment characterization as long as the Maquiladora company complied with the guidelines defined by the Mexican Income Tax Law.
Between years 2000 and 2002 the Mexican Authorities developed new rules for Transfer Prices in order to avoid the Permanent Establishment for the foreign associate and to stimulate a more fare Income Tax payment. These new rules created the option for the Maquiladora companies for operating under a Safe Harbor scheme: the need to generate at least an amount of earnings of 6.9 % of the asset value or 6.5 % of the expenses value; the one that defines the highest amount. On December 30th 2002, the Mexican Ministry of Treasury published a modification to the Article 2 of the Income Tax Law to include the assumption that a foreign associated company may constitute a Permanent Establishment in Mexico as a result of their economic and legal relationship associated to its local subsidiary, the Maquiladora company. All this changes caused some uncertainty for the Maquiladora companies, related to the way they should be paying taxes. Then, in the year 2003 the Mexican Income Tax law included new rules. Article 216-Bis established 3 different options for the Maquiladora to avoid the permanent establishment to the foreign associated company. Finally, in year 2004, the Mexican government gave the benefit of lowering the percentages mentioned in this paragraph (6.5% and 6.9%) to a standard rate of 3%.

DoingBusinessInMexico Staff
Published: March 01, 2009. 20:01 | Last updated: March 01, 2009. 20:09
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