A US Headquater Entity For Mexican Operations?
Mexico is quickly resurging as one of the world’s top destinations for manufacturers looking to open or expand their operations. With a well-trained workforce, competitive rates and a stronger protection and enforcement of intellectual property rights many manufacturers have already began migrating their manufacturing operations to Mexico. The move was accelerated by the COVID restrictions set in place in other manufacturing countries that aggravated the already existing supply chain and logistics issues caused by COVID.
Josh Maxwell
Hone Maxwell LLP
Tax Attorney
The move to Mexico comes with added benefits such as a renewed Maquiladora Program known as IMMEX (Industria Manufacturera, Maquiladora y de Servicio de Exportación) and the option of establishing manufacturing operations through a U.S. headquartered entity, an option that provides multiple benefits including more favorable tax rates, benefits under USMCA, potential for U.S. financing for Mexico operations, a flexible business culture and a location that is attractive for top executives to live.
Overview of Manufacturing Operations in Mexico
The process of foreign investment in manufacturing operations in Mexico has become known locally as “maquiladoras.” “Maquiladora” comes from the Spanish word “maquilar” which means to perform a task for another. Today it refers to a Mexican corporation, wholly or predominantly owned by foreigners, that assembles products primarily for export. This process often is known as the “twin-plant system” or “production sharing” because many maquiladoras have a companion plant or distribution center in the U.S. Over the years, as the number of maquiladoras grew, the Mexican government provided certain benefits and protections to incentivize the rising number of plants.
Maquiladoras and IMMEX.
Today, maquiladoras are known as IMMEX for the initials of the government permit program providing foreign manufacturers with these benefits. The primary benefit of an IMMEX permit is in the area of U.S. and Mexican customs duties. With an IMMEX permit, machinery, technology and other “means of production” may be temporarily imported into Mexico duty and tax-free so long as the Maquiladora exports all finished goods out of Mexico within a government-mandated time frame. Likewise, component parts, raw materials and other manufacturing inputs can be temporarily imported duty-free and tax free, if the materials are consumed or re-exported within the required time frame. This provides manufacturers with the ability to transport materials and goods across the U.S.-Mexico border without incurring Mexico’s value added tax, keeping the cost of goods produced comparatively low.
Types of Maquiladoras
Maquiladoras are typically operated in one of two forms: (1) as a wholly owned and operated subsidiary, or (2) as a contractually owned operation established and managed by a third-party service provider known as a Shelter Operator that is already authorized to operate as an IMMEX. There are advantages and disadvantages to each of these models.
Wholly Owned Maquiladoras
The advantages of wholly owned maquiladoras are in the areas of control and cost savings. In most cases, vertical integration through complete ownership will save money for a company in the long run. Complete ownership also ensures total control over foreign operations, making it easier for the parent company to regulate quality standards and environmental compliance. This structure also avoids the transition from shelter operator to wholly owned subsidiary, a transition almost certain to occur if manufacturing in Mexico continues. As such, a long-term commitment to Mexican manufacturing is critical and the foreign company must be ready to engage in “hands- on” management of the Mexican plant. Starting operations through vertical integration can be a lengthy process and foreign companies looking to enter the market can expect the process of securing a location, hiring employees, and obtaining all necessary permits and visas to take anywhere from six months to a year.
Contractually Owned Maquiladoras
For companies looking to test the waters of Mexican manufacturing, contracting with Shelter Operators can be an enticing option. Perhaps the biggest advantage of operating through a Shelter Operator is that it provides a turnkey solution to manufacturing in Mexico. This is due to the fact that Shelter Operators are already authorized to operate as an IMMEX, which is not always a quick and easy process, and have the personnel and experience of operating in Mexico. Under this model, the foreign entity forgoes the need to establish a Mexican operating company because the relationship with the Shelter Operator is established through service agreements. The Shelter Operator undertakes all manufacturing services, including hiring and managing employees, ensuring proper administration of imports and exports, and securing adequate facilities by entering into leases on behalf of or guaranteed by the foreign entity. With this model, however, come higher costs in the long-term due to Shelter Operators charging a premium for the services provided. Nevertheless, this may still be a good option for those foreign companies that are looking to test out the Mexican manufacturing model and then transition to a full ownership model.
Transitioning from a shelter operator to a wholly owned manufacturing company takes time and planning. For this reason, it is essential to partner with a Shelter Operator that from the beginning understands the foreign companies’ short- and long-term goals and is on board with assisting in the transition. During the transition phase, the foreign company should analyze its production alternatives, whether it still wishes to work with a shelter operator in some capacity, such as for accounting or payroll services, or whether it wants to be completely on its own. However, even in the stand-alone operation, the foreign company may want to make use of a shelter operator or other service provider with respect to hiring personnel, bookkeeping and payroll services, and perhaps other services that may not be practical for the foreign company undertake immediately.
Mexico's Value Added Tax
For those looking to establish manufacturing in Mexico, it is imperative to understand Mexico’s value added tax (VAT) and its impact on imported and exported goods. Colloquially known as the “impuesto al valor agregado” tax, Mexico’s VAT applies a tax on goods imported and sold in Mexico and is applied at each break in the supply chain. Maquiladoras were traditionally exempt from VAT on temporary goods imported and exported by the manufacturer, however changes to the laws surrounding duties and customs now require the Maquiladoras to obtain a certification from the “Servicio de Administración Tributaria” Mexico’s tax administration service that allows them to continue to be exempt from VAT.
Foreign manufacturers operating in Mexico have additional tax requirements. The most notable requirement applies to importers who are required to obtain an Authorized Economic Operator (AEO) certification to receive the VAT benefits. Along with exemption from VAT, maquiladoras holding an AEO certification benefit from an increased length of time for which temporarily imported goods can remain in Mexico. Under Mexican law, temporarily imported goods are generally limited to a stay of 18 months in the country in order to benefit from the VAT exemption. AEO certification holders, however, are granted favorable treatment, allowing the temporary goods imported into Mexico to reside in the country for up to three years. This allows manufacturers to produce more products without fear of over importing raw materials. Due to this VAT exemption, manufacturers can have U.S. operations and sales without additional VAT.
Benefits of Operating Out of the U.S.
Recent changes in U.S. tax laws that resulted in more favorable tax treatment compared to other countries have many foreign manufacturers looking to establish their Mexico manufacturing operations through a U.S. headquartered entity that in turn owns the Mexican subsidiary. A U.S.- Mexico manufacturing structure is aided by favorable U.S. income tax laws. The current corporate tax rate is 21%, which is generally lower than the Mexican rate. Therefore, a manufacturing operation based out of the U.S., may with appropriate tax planning, shift earnings to the U.S. thereby reducing its overall income tax. This already competitive rate may be further reduced through the new laws surrounding foreign derived intangible income that allow for a tax reduction for purchases and sales of inventory that occur outside the U.S. Lastly, the U.S. has an extensive tax treaty network, which includes many Asian countries, including China. These treaties allow profits of the U.S. entity to be repatriated to a foreign owner at favorable rates as well.
Ease of oversight is another benefit of a U.S.-Mexico joint manufacturing venture. The U.S., as the world’s largest economy, has made foreign investment a staple of its system for decades. With the close proximity of Mexico to the U.S., establishing offices and distribution centers in the U.S. can allow for convenient supervision over the maquiladoras without entangling the foreign entity in additional red tape. Because of the large number of exports to the U.S., many maquiladoras are built close to the U.S.-Mexico border, allowing directors and executives to live north of the border while still being able to easily commute for work. U.S. based operations may also serve to secure U.S. based financing for the purchase of equipment and operations in Mexico. Finally, with an estimated annual gross domestic product of nearly $23 trillion USD, establishing headquarters and distribution centers in the U.S. allows the manufacturer to reach an established, large and diverse market.
Flexible corporate laws is another major benefit of a establishing a Maquiladora through a U.S. holding. Whether the operation is established as a partnership, corporation, or limited liability company, operating the maquiladora through a U.S. holding company can allow foreign investors to avail themselves to the benefits of the North American market while also retaining limited liability. In the U.S., such companies can elect to operate as a partnership, in which individuals jointly own and operate the business while passing through profits and losses to the individual partners. Holding companies, especially ones owned by foreign investors, commonly take the form of a corporation. These corporations issue stock to investors and pass through profits by way of dividends. One of the most common forms of corporations in the U.S., the C corporation, taxes the income at both the corporate and individual level. While this form of ownership may result in more taxes being paid, many investors like this form of ownership as their liability is only limited to their capital contributions. Additionally, for already established foreign businesses looking to enter the U.S. market, C corporations make entry considerably easier by making financing more readily available. For these reasons, there are many options to have creative investment agreements, ventures, or be set up to raise capital, and all can be set up or formed with relative ease.
Nearshoring is Real.
For investors looking to reduce the costs of manufacturing and limit supply chain concerns, while gaining access to a large percentage of the world’s market, moving manufacturing to Mexico has quickly become the trend. With a well-trained workforce, competitive labor costs, and its proximity to the U.S., Mexico has grown to be the preferred location for foreign manufacturers. This, coupled with a U.S. holding company structure, that provides favorable tax rates, low duties and many, easy investor options, has resulted in more manufacturers electing a U.S.- Mexico structure to establish or expand their manufacturing operations.
How can we help?
Contact DBM or Hone Maxwell LLP so that we can guide you through the complexity of Mexico’s business environemnt.
About Hone Maxwell LLP
Hone Maxwell LLP is a U.S. based law firm, with international tax and business experience to oversee the venture, as well as provide all the corporate and tax support in the U.S. Also, we have a Mexican office, Mexican licensed and Spanish speaking attorneys, as well as many connections and colleagues in Mexico, to ensure everything is done properly and with excellent professionals. Furthermore, we work closely with CW CPA, a Hong Kong-based accounting firm, to ensure that we can communicate seamlessly with our clients in China, regardless of the differences of time and cultural background. Additionally, we travel frequently to Hong Kong and Asia, and have Mandarin speaking attorneys to assist us in meeting your needs. Collaborating with CW CPA, we can put together a team that possesses comprehensive knowledge of business practices in China, the U.S., and Mexico. This enables us to help our clients overcome any potential obstacles and ensure success. Therefore, we can provide excellent service to cover all of your needs from start to finish and into the future.