Focus, Banking & Finance, and Manufacturing

Costs heading north, south of the border

Changes in Mexican tax law make manufacturing more costly.

January 10, 2014
| By Pete Daly |
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Plante Moran mexico car
Many suppliers to the auto industry have plants in Mexico, where changes in the tax laws are eating into profits. Courtesy Thinkstock

(As seen on WZZM TV 13) Changes to Mexican tax law that went into effect Jan. 1 will affect West Michigan auto suppliers and other manufacturers with operations south of the border.

Joel Mitchell, a partner at Plante Moran in Grand Rapids, said the 2014 Mexican Tax Reform covers a broad range of issues, from dividends and corporate tax rates to manufacturing requirements and value-added tax, or VAT. Mitchell said there are two specific changes West Michigan companies need to pay particular attention to: elimination of the flat tax and a new tax on dividends.

Mexico’s flat tax, which is commonly known as IETU, was repealed in its entirety. Mitchell said the net effect will be favorable for taxpayers, eliminating a complicated calculation in terms of tax planning and projections.

But the Mexican government also added a new 10 percent tax on all dividend payments, which Mitchell says will mean an additional layer of difficulty for U.S. corporations trying to move cash out of their Mexican operations. He said each taxpayer will need to determine the extent to which the new tax will be creditable so they won’t be taxed twice on the same income by both Mexico and the United States.

“The new tax changes in Mexico signal that the country is taking steps to raise revenue,” said Mitchell, who concentrates his practice on international tax. “West Michigan manufacturers with operations in Mexico will need to take the new dividend tax into account when planning for cash flow needs.”

Additional changes in the 2014 Mexican Tax Reform include:

  • The Mexican corporate tax rate, which had been reduced over the years, will remain at 30 percent.
  • Individual income tax rates for individuals will increase to a maximum rate of 35 percent.
  • The 11 percent VAT that applies in certain border areas will be eliminated; the general 16 percent will apply nationwide.
  • The zero percent VAT applied to the temporary importation of materials and equipment by maquiladora operations has been eliminated, although the change will not apply until 2015. (The maquiladora program gives a foreign-owned company special customs treatment, allowing duty-free temporary import of machinery, materials and other business equipment that will not remain in Mexico permanently.)
  • The maquiladora program has been redefined, requiring that 100 percent of income result from the exportation of goods. Mitchell noted it will be more difficult for West Michigan companies to have a mixed-use business, making or assembling products for both the Mexican and American markets.

“If you look at the whole (tax change) package together, what they’re really doing is increasing taxes,” said Mitchell. He added that the new dividend tax “is brand new” and actually operates differently.

Nations that allow foreign investments generally enter into reciprocal treaties with caps on individual income taxes so that a person doing business in another country — and paying taxes to both — is not subject to rates that equal double taxation. A double-tax liability would obviously tend to discourage foreign investment.

But Mitchell said the change in Mexico is a tax on the Mexican company paying the dividend — “so it’s not actually subject to this treaty or any cap from the treaty.”

He said India does the same thing, although the practice is still unusual on the world stage.

Many mid-level businesses in the U.S. have “some sort of flow-through structure, if privately held,” with the tax system providing a foreign tax credit so the investor is not paying more than the higher of either the foreign rate or the U.S. rate.

The U.S. is “a very high-tax country,” Mitchell said, with most foreign corporate tax rates being much lower, so most Americans with manufacturing businesses in other countries end up paying, at most, the higher U.S. tax rate. However, the change in Mexico could result in a tax liability higher than the U.S. rate.

Dozens of companies in West Michigan have some manufacturing in Mexico. Mitchell said some of those that are clients of Plante Moran already have expressed concern about the changes in Mexico.

“I actually have one that’s trying to go through an acquisition of a pretty substantial Mexican business” and tax issues are “a pretty big part of it because the sellers are Mexican owners, and their tax footprint has changed dramatically from what we were hoping to have in a 2013 transaction to what we are now looking at in a 2014 transaction,” he said.

“It’s changing the dynamics of the deal because they are now looking at a much higher tax bill.”

The changes are most relevant to the auto industry because the large OEMs with plants in Mexico want a local supplier, he said, which leads to even more factories there owned and operated by U.S. companies.

The growth of the Chinese economy is having a positive impact on Mexico.

“There has been a trend in automotive to actually shift some production from China back to Mexico,” said Mitchell, because a lot of the historic cost savings in Chinese manufacturing have been eroded as Chinese wages have gone up. “And you add the shipping and freight and all that on top of it. Mexico has stayed pretty constant, so it has turned into a more attractive manufacturing location.”

Mitchell said there is also an awareness in Mexico that the government there collects far less of the tax it is legitimately owed by the wealthier classes than does the U.S. government in its tax collection efforts in America.

The Mexican government has “changed to be a little bit more to the left. There are more taxes being put on the wealthier folks,” said Mitchell.

“If you have manufacturing or assembly operations in Mexico, these new regulations could have tax implications for your company,” Mitchell said. “It’s a good idea to talk with your tax advisor to understand and determine ways to minimize the impact.”

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