Maquiladoras, or inbound cost centers, are Mexican assembly plants capable of maintaining equipment, machinery and inventories provided by their foreign-owner corporation, for their transformation into semi-finished and finished goods destined for export to the US market. Parent corporations also grant maquiladoras free use of patents and technology to carry out the manu- facturing process. Ever since its initial stages dated back in the late 1960s, the maquiladora in- dustry has contributed to the expansion of Mexican manufacturing exports. However, this contri- bution reached meaningful levels in the decade of the 1990, especially since the adoption of the North American Free Trade Agreement (NAFTA) with the U.S. and Canada in 1994. The contri- bution of the maquiladora industry to the Mexican economy has been substantial. For 2005, the value of total maquiladora exports was US$ 96.75 billion, equivalent to 55 percent of total manu- facturing exports, and 45 percent of total exports, mainly to the US market. The number of ma- quiladora plants has risen to 2,811, from 1,703 in 1990, mainly located along the border zone
17
with the US. Currently the industry employs 1.17 million. Part of the expansion of this export sector is explained by the tax incentives granted by the Mexican Government to assembly plants carrying on maquiladora activities, as defined and recognized by the Secretariat of Economy. Capital required to perform maquiladora activities in Mexico is considered in-bound for their export. Therefore, duty free and VAT exemption to the temporary imports of machinery, equip- ment, parts and material are granted, provided they are designated to be transformed into export products, according to the Maquiladora Program regulations. Also, inventories considered to be in-bound for export are exempt from Asset Tax.
The income tax treatment to the maquiladora activities has spurred special attention to policy-makers and members of the industry for the last decade, especially since 1995 when Mexico joined the Organisation for Economic Co-operation and Development (OECD). The continuous set of reforms introduced to the maquiladora regime since then, has responded to the changing economic conditions surrounding their activity, in Mexico and abroad, and also to the develop of the transfer pricing practice in Mexico. The continuous coordination and mutual agreement between tax authorities from Mexico and the US has played a key role in shaping the
maquiladora tax regime. Before 1995, the Mexican Income Tax Law offered no special treatment to the maquiladora activity. Thus, maquiladoras constituted a permanent establishment of for- eign residents, subject to the general regime of corporate income tax in regard to their business activities carried out in Mexico. Also, the income tax legislation required maquiladoras to charge foreign corporations a profit-margin from 2 to 5 percent above operation cost as transfer price.
By the mid- 90s, as a response to the need to enlarge the income tax base for the maquila- dora industry, the Mexican tax legislation developed for the first time special rules applicable to their activities. The key issue was the exemption of the permanent establishment status for the foreign residents owners of Mexican-based maquiladoras, provided that they comply with in- come tax requirements, either by adopting a safe harbor rule of 5 percent on all assets, or by abiding to an Advance Price Agreement (APA) ruling. However, the economic dynamism shown by the sector during the past decade, threatened the ability of these transfer pricing rules to ade- quately reach the tax base originated by the maquiladoras activity in Mexico. To address this concern, maquiladora rules were modified as of FY 2000 following the Mexico-US Mutual Agreement on the Tax Regime applicable to Maquiladoras (MAP agreement), reached in Octo- ber, 1999, allowing the exemption of permanent establishment status to maquiladoras owned by
18
foreign residents, when satisfying one of the following requirements: (1) Adopt a safe harbor
rule, whereby maquiladoras consider a taxable income by the amount greater between 6.5 per- cent of total cost and expenses, or 6.9 percent of total assets used in connection with their opera- tion, or (2) Apply and obtain an APA , following procedures set forth by the Mexican Fiscal Code. By 2003, the Mexican Congress approved reforms to the Income Tax Law, including some additions to the rules applicable to the Maquiladora activity. This reform was important for two reasons. Firstly, the addition of the applicable tax rules, including the permanent establishment exemption assumption, into the text of the law provided a sense of certainty to the business community. Previously, those rules were subject to annual confirmation. Secondly, a wider set of methods was offered for the maquiladora industry to comply with Mexican transfer pricing regulations, in accordance with OECD Transfer Pricing Guidelines (Table 5).
Table 5
Current options for Maquiladoras to comply with transfer pricing requirements I. Arm´s length principle, plus fixed assets net value
Declare income and deductions according to prices determined by arm´s length methods described by the Income Tax Law, in accordance to OECD Guidelines, plus 1 percent of the net value of the machinery and equipment owned by foreign residents, devoted to the maquila activity (APA is not mandatory, but transfer pricing study records should be kept).
II. Safe Harbor
Declare as taxable profit the greater of: (a) 6.5% of total cost and expenses, and (b) 6.9% of total assets used in the maquila operation.
III. TPM Predetermined Methodology
Declare taxable income as resulted from arm´s length prices obtained following the Transactional Profit Margin (TPM) Method, considered within the transfer pricing methods allowed by the Income Tax Code, in accordance to OECD TP Guidelines, accounting for the machinery and equipment transferred by the foreign resident to the maquiladora to carry out assembly activities. (APA is not mandatory but transfer pric- ing study records should be kept).
In an effort to adequate the maquiladora tax rules to a relatively recessive economic period in the export market, by the end of 2003 President Fox signed a tax relief decree granting maquiladoras
a partial exemption, equivalent to 50 percent of the taxable income assessed upon the current rules. This tax benefit has been enacted without time limit.
19