Maquiladoras’ TP compliance after the 2022 Mexican tax reform: what's on the horizon?
Simón Somohano and Francisco Díaz of Deloitte S-LATAM explain the changes for maquiladoras after the repeal of advance pricing agreements as a compliance option and the implications for Mexico’s competitiveness as a manufacturing location.
The maquiladora regime in Mexico refers to an export-oriented manufacturing programme that allows foreign multinationals to establish factories (maquiladoras) in Mexico.
Under Mexican Income Tax Law (MITL) regulations, maquiladoras operate in Mexico as manufacturers and import on consignment machinery, equipment, and inventory duty and VAT free, provide assembly services, then export the finished products to a principal operating company (POC) abroad.
Due to the nature of the legal and economic relationships under a maquiladora agreement, foreign POCs are deemed to have a permanent establishment (PE) in Mexico.
In 1999, under the terms of the tax convention between the governments of the US and Mexico to avoid double taxation and prevent tax evasion in relation to income tax, the competent authorities (CAs) of both countries reached an agreement on transfer pricing (TP) and other aspects related to the tax treatment of maquiladoras of US multinational companies.
Based on this arrangement, a set of safe harbours was introduced as part of the TP agreement between the US and Mexico that established what both governments determined was an arm’s-length result for a maquiladora operating in Mexico. Overall, maquiladoras that comply with TP provisions in Mexico would obtain an exemption of the PE determination for its foreign POCs.
The 2014 and 2022 tax reforms
In 2014, the Mexican tax laws were reformed, and as part of that reform, maquiladoras that fall into the definition provided in Article 181 of the MITL must comply with TP rules in Mexico through the safe harbour rule or an advance pricing agreement (APA).
Numerous maquiladoras selected the APA as the TP compliance option to cover the period 2014–18. As such, the Mexican Tax Authority (SAT) decided to determine a methodology that would allow faster processing of hundreds of maquiladoras’ APA requests; namely, the Qualified Maquiladora Approach (QMA).
The QMA was discussed with the US Internal Revenue Service (IRS) in 2016 and it was agreed that the results from the application of the QMA would be accepted in the US. Considering that not all maquiladora APAs are of US subsidiaries, the SAT has received observations from the CAs of other countries regarding the application of the QMA as an arm’s-length framework and, subsequent to review, the SAT and other CAs have agreed that the QMA provides certainty for foreign taxpayers regarding double taxation, foreign tax credits, and PEs in relation to transactions with their Mexican maquiladoras.
In September 2021, the executive branch of the Mexican government referred to the Mexican Congress a decree for approval that would reform various laws for FY 2022. The 2022 tax reform, approved by the Senate in October 2021, introduced changes to the maquiladora TP and PE compliance regime included in Article 182 of the MITL. The considered changes in TP dispositions for maquiladoras were aimed at limiting the compliance options only under the safe harbour rules.
Effective January 1 2022, the APA ceased to be an option for maquiladora compliance, limiting companies’ options to the safe harbour rules. Once the current APA process concludes, companies would not be able to renew their APA and must follow safe harbour rules, unless legislative action reinstates the APA. There is a transitory article in the decree that enforces vested rights for taxpayers that initiated any proceedings/procedures before the enactment of the 2022 tax reform. For maquiladoras, this would mean that if an APA request that covers five years (i.e., 2020–24) was submitted in calendar year 2021, the APA ruling for the five-year period would be governed under the 2021 MITL dispositions.
Guidelines of the Qualified Maquiladora Approach
The 2016 QMA agreement expanded the 1999 agreement to reflect the 2014 revisions to the Mexican tax laws. In November 2019, the QMA was renewed and updated for the 2018–22 APA programme. This 2019 renewal agreement maintains the core elements of the 2016 QMA agreement but makes certain modifications.
The 2019 QMA renewal framework addresses certain substantive features that were not present in the 2016 agreement or that have been updated. There are situations in which a maquiladora has an outstanding accounts receivable balance that the CAs have agreed is inconsistent with the TP profile of a maquiladora entity. A mechanism for addressing such situations was included in the 2019 renewal agreement. Specifically, maquiladoras with an average receivables turnover that exceeds 60 days will be required to report an additional profit component. This additional profit will be determined by applying a peso-denominated interest rate to the receivables balances.
Similarly, certain changes are made to the term ‘qualifying taxpayer’. Under the 2016 QMA agreement, large taxpayers (i.e., Mexican maquiladoras with revenues in excess of MXN $1,200 million, or approximately $68 million) were excluded from the definition of qualifying taxpayer and were therefore not eligible for the QMA. This limitation no longer applies.
In addition, under the 2016 QMA agreement, maquiladoras with a POC located in a country other than the US were excluded from the definition of qualifying taxpayer. Under the 2019 QMA agreement, maquiladoras with a non-US POC are evaluated on a case-by-case basis.
Under the 2019 QMA renewal agreement, and similar to the 2016 QMA agreement, taxpayers continue to have the following guarantees:
If a maquiladora meets the definition of a qualifying taxpayer, it may elect to apply the 2019 QMA in a unilateral APA with the SAT. The US and Mexican CAs have agreed in advance that the method adopted pursuant to the new framework will produce arm’s-length results.
For Mexican tax purposes, TP adjustments from the application of the QMA would be telescoped into 2019.
The 2019 QMA renewal agreement has several important procedural features:
The SAT has agreed to issue an APA through 2019 only. This means that in most cases there will be APAs covering just one or two years (i.e., 2018 and 2019). For 2020–24, taxpayers should have applied for a new APA programme.
The current QMA agreement commits the CAs to begin working on another renewal of the QMA to cover the tax years 2020–24 and to take into account in those discussions the impact of current economic, commercial, and public health conditions affecting taxpayers and workstreams within the OECD’s Working Party 6 and the Forum on Tax Administration (FTA) Mutual Agreement Procedure (MAP) Forum, including the recommendations contained in the Guidance on the transfer pricing implications of the COVID-19 pandemic report published in December 2020.
Recognising that the recent commercial and economic situation may have an impact on determining the results of taxpayers for FY 2020, the CAs of Mexico and the US have agreed that the following factors will be essential to determine the reasonableness of the results of the maquiladoras for FY 2020:
The amount by which it deviates from the taxable income that the maquiladora should report if it applied the QMA renewed in 2020;
The information that supports the tax position of the taxpayer corresponding to tax year 2020, under the 2017 OECD Transfer Pricing Guidelines and any complementary guide issued by the OECD, regarding the economic conditions that arise as a result of the COVID pandemic; and
The information and documentation that supports the tax position of the taxpayer corresponding to FY 2020, including the detailed identification of all financial and accounting conditions extraordinary to the COVID pandemic, and their corresponding accounting records.
TP compliance requirements for maquiladoras after 2024
The 2022 tax reform eliminated the APA as a compliance option for maquiladoras, leaving the safe harbour as the only framework for a maquiladora to comply with TP requirements and maintain the benefits of this operating structure for income tax purposes. Only the taxpayers with an APA ruling in force or an APA programme in progress may still use the APA until its expiry, which in all cases will be no later than December 31 2024.
Bearing in mind the uncertainty of the maquiladora TP compliance derived from the 2022 tax reform, it would not come as a surprise that multinational companies are exploring the benefits and challenges of scenarios that maquiladoras would encounter from FY 2025 onwards, which could be the following:
Remain under the maquiladora income tax regime and apply the safe harbour rules; or
Exit the maquiladora income tax regime and have a business reorganisation of the company into an IMMEX programme manufacturer under a different operating model; i.e., toll manufacturer, contract manufacturer, licensed manufacturer, etc.
Based on industry figures, on average, the safe harbour rules usually increase the tax burden in comparison with an APA, especially in cases of asset-intensive maquiladoras; therefore, taxpayers have begun evaluations of the potential tax liabilities under the safe harbour rules and how they would compare with other manufacturing business models. This assessment will allow maquiladoras (and the multinational companies) to identify, in a timely manner, the best option to be implemented in terms of financial results, taxes, customs regulations, business operations, value chain alignment, and group processes.
Moreover, considering that if companies decide to modify their business model, the transition would require several legal and operational changes that usually take various months to be implemented, and in all cases should be completed before the end of the 2020–24 APA programme on December 31 2024.
The SAT repealed APAs as an option within the maquila regime, with the consequence that existing maquiladoras will default into the safe harbour rules applicable to such regime. These safe harbour rules will most likely result in a higher taxable profit in Mexico, which may lead to a loss of competitiveness compared with other manufacturing locations.
The changes in Mexican TP regulations for maquiladoras seem to offer a narrow(er) compliance process for the industry. Even though there has been confirmation from the SAT of meetings with the IRS during 2023 to review TP and other aspects related to the tax treatment of Mexican taxpayers (including maquiladoras) of US multinational companies, the main focus of the SAT is to continue solving APA rulings of the current 2019 APA inventory, leaving at an impasse the guidelines for compliance of FYs 2020 through 2024.
While the SAT has shed some light on the consideration of potentially applying an APA after 2024 as a TP compliance option for maquiladora companies, the intricacies, as well as the likelihood, have yet to be disclosed.