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Unconstitutionality of the employees’ profit sharing limit provision in Mexico?

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Santiago Llano, Eric Palacios, and Alfredo Sampayo of Ritch Mueller report on an isolated but notable District Court precedent that has emerged in the dynamic landscape of Mexican labour and related taxation legislation.

Embedded within Mexico's legal framework is the fundamental constitutional right for employees to receive a share of their employer company's profits, commonly known as employees' profit sharing (participación de los trabajadores en las utilidades de la empresa, or PTU). Its principal objective is to acknowledge and compensate employees for contributing to a company's prosperity.

In the past, the employees’ profit sharing amounted to 10% of a company's taxable profit. However, to mitigate labour-related risks and restrict the payment of the employees’ profit sharing, businesses frequently established a separate company that exclusively employed individuals (an ‘employees’ company). This subsidiary would then provide services to the primary company responsible for generating the majority of the business's profits (the ‘profitable’ company), charging the costs and expenses incurred, plus a small mark-up.

Reform introduces a cap

In 2021, a reform was introduced to curb abusive or simulated practices that infringed upon workers' rights. Beyond labour-related implications, this reform introduced substantial tax-related considerations, disallowing deductions for income tax purposes and the offsetting of VAT payments made under the aforementioned schemes.

In a nutshell, this reform prohibits companies from subcontracting services that correspond to their main business purpose, as it should be understood that the employees needed for the main business purpose should be hired directly. However, companies are allowed to hire specialised services if labour and tax requirements are met. Lately, labour and tax authorities in Mexico have been very active in scrutinising companies, reviewing if they comply with all the related provisions.

As a result of this reform, many companies in Mexico undertook corporate restructures, including merging the service companies with the profitable company. The impact of the additional PTU was diminished as the reform introduced a cap for the amount of the profit sharing that would be most favourable to the employee. This cap could be:

  • A maximum limit of three months' worth of the employee's salary; or

  • The average participation received in the last three years.

However, this cap has recently come under constitutional scrutiny.

Recent precedent on constitutionality of the PTU limit provision

According to the public version of a ruling issued by the Eighth District Court in Labour Matters in Mexico City in August 2023, Article 127, Section VIII, of the Mexican Federal Labour Law has been declared unconstitutional. This provision encompasses the limit imposed on employees’ profit sharing payments by companies.

The analysis presented in the precedent contends that the imposition of a maximum limit on employees’ profit sharing contradicts the Mexican Constitution. Rather than establishing limitations, the Constitution safeguards and guarantees the constitutional right of the workforce to share in the profits of the employer or company, provided those profits are generated.

Furthermore, the precedent underscores the following legitimate constitutional objectives:

  • Employees' profit sharing constitutes a crucial obligation in labour affairs for companies, striving to achieve social justice and an equitable distribution of profits. This distribution involves capital and labour, exemplifying a collaborative approach.

  • The historical foundation of this right was originally conceived as a form of recompense for workers' contributions to the companies they serve. This notion aligns with fundamental social justice principles by allowing a share of the economic profits derived from their labour while incentivising heightened productivity.

  • The provision contradicts the goals of the 2021 reform. While the reform's intent is to prevent employers from evading labour, social security, and tax obligations, the provision fails to meet this criterion. Instead, it appears to foster adverse practices and simulated schemes that exploit workers through inadequate compensation, subsequently sidestepping fair remuneration.

According to the District Court’s analysis, secondary regulations must uphold constitutional guarantees, regardless of their subject matter or the substantive or procedural institution they pursue. These constitutional principles set the baseline criteria that secondary regulations must adhere to, ensuring their unwavering compliance. These norms thus serve as a boundary that all authorities, legislative bodies included, are obliged to honour in the execution of their duties.

At the time of writing, the competent tribunals are yet to issue a ruling in the appeals process. Given the considerable economic and social ramifications of the case, the authors expect that the Mexican Supreme Court will review the case and deliver a ruling that comprehensively evaluates the precedent set by the Eighth District Court in Labour Matters in Mexico City.

Moving forward

Considering the potential impact of the ruling, it is important that Mexican companies review if they are compliant with the current labour and tax provisions and follow up on the developments of this case.

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