In our previous updates, we’ve reviewed two main types of taxes and related costs which may influence timing when expanding to Mexico. These include:
- All the taxes related to the fixed assets needed for the operation
- Taxes which will be present in the day-to-day Mexican operations
Let’s examine the taxes that are part of the day-to-day operation, and which mainly affect manufacturing companies, system integrators, distributors, and are even applicable when setting up a sales office in Mexico.
Day-to-day taxes & other ancillary expenses
It is true that Mexico has a highly qualified and competitive labor market, and a young population; however, it is mandatory — and extremely important — to factor in the personnel-related requirements below when expanding or operating in Mexico.
- Payroll Tax – When talking about the different taxes related to hiring personnel, businesses need to consider the expense of payroll tax. Even though the payroll tax is a tax determined state-by-state in Mexico, the mechanics for the tax calculation is similar to the United States (i.e. base compensation before tax). What varies by state are the rates, such as:
- Guanajuato (2.3%)
- Queretaro (2%)
- Nuevo Leon (3%)
- San Luis Potosi (2.5%)
- Coahuila (2%)
CPAs such as Clayton & McKervey have been successful in negotiating reductions, or even an elimination, of the imposed taxes for a defined timeframe and circumstance, so it is always prudent to consult with a CPA doing business in Mexico. Specifically, our firm was able to obtain a five-year exemption on the payroll tax for one of our clients building a plant in Ramos Arizpe, Coahuila. The exemption represented a tax benefit of nearly $1.5M USD.
- Social Security Contributions – Other personnel-related taxes are Social Security contributions. In Mexico, Social Security contributions represent a significant expense to the operation. For background, the concept of Social Security in Mexico is more extensive than in the US, as it encompasses five different concepts: retirement, state tax, health insurance, daycare assistance, and housing. Even though social security contributions are shared by both employee and employer, the employer cost is typically an additional 25-30% of salary. As such, it is important to consider this in business cash projections.
- Fringe Benefits – Mexico is known for designing labor laws which are favorable to employees, which often mean additional costs for employers. A couple of examples are the Christmas bonus (15 days of salary, payable before Christmas) and a vacation premium (25% of the government-mandated vacation days).
- Severance – Another example of favorable labor laws is employee severance, which can be significant. If, after a testing period of up to three months, an employer decides to retain the employee, and then changes its mind after this time period – the severance of three months’ salary, plus 20 days per year of service, will be imposed.
- Maternity leave – During maternity leave, which is 42 days before the estimated due date and 42 days after the due date, the female employee will get paid through the Social Security service, and not by the employer.
- Paternity – Paternity leave is a similar concept, but more limited for male employees. Here, the coverage is five days after the due date, paid by Social Security service as well.
- Profit Sharing – Profit sharing uses, as its base, the taxable income of the company, and is distributed unequally depending on compensation and hire date (prorated), in a given year. The profit sharing rate is 10% of taxable income, and is not netted against net operating losses of previous years. This means if that for every year an employer has taxable income, they will be responsible for profit sharing.
- Value Added Tax – VAT is, and will always be, a difficult topic. Here’s a basic overview: Value Added Tax in Mexico has a 16% rate in all regions, except for an 11% rate at the border regions. The general rule is that all the transactions of goods, services or leases are taxed with VAT. Also, every item crossing the border into Mexico is taxed with a 16%, even if there are fixed assets (keep an eye on imports of machinery as there can be a significant cash impact). There are exceptions for exported goods and services. Companies pass along the 16% tax to customers for every domestic transaction. In addition, they are charged 16% by vendors. Monthly, all the tax that was paid will be compared, versus the tax that was received. Any amount in excess of what was received through VAT is remitted to the Mexican government. Obviously, any deficit in VAT would need to be reconciled. After discovering that your company could have a significant amount of VAT to be recovered, you might wonder how to recoup the taxes. There are two methods, businesses can compensate the VAT against future months, or businesses may also apply for a VAT refund, typically an extensive process requiring a significant investment of time. In fact, the first request could take up to nine months, making it imperative to request funds as soon as they are generated.
- Income Tax – The corporate tax rate in Mexico is 30% and, unfortunately, there are no initiatives to decrease this rate. Income tax in Mexico is an annual tax; however, companies make advance payments monthly towards the annual tax based on a coefficient. For companies that are registered as maquiladoras they have some options. Companies can adopt safe harbor rules, the greater of 9% of the value of its assets or 5% of its costs and expenses. Maquilas may also elect to negotiate and obtain an Advance Pricing Agreement (APA) from the Secretaria de Administracion Tributaria (SAT), the equivalent of the IRS in Mexico, via private letter ruling.
Clearly, there is much to consider during an expansion, and also during the day-to-day activities, as well as a few options to optimize resources and obtain tax incentives. If your business is looking to expand, or you simply would like to learn more about the operations and taxes in Mexico, contact Clayton & McKervey.