Explaining outsourcing in Mexico for Canadian companies looking to expand their business to Mexico.
After talking a bit about the costs and taxation of doing business in Mexico I will now talk about the recent outsourcing law in Mexico. I will try to be as practical as possible in order to go from the big picture to the smaller details. So, this post is for people who want outsourcing in Mexico explained in an easy and simple way.
Explaining outsourcing in Mexico: What is “Mandatory profit sharing?”
Basically, in Mexico we had, or better said; We still have a labour law which regulates what is called the “mandatory profit sharing,” and the mandatory profit sharing mandates the obligation for every entity to distribute to all the existing employees of said entity, a 10% of the pre-tax profit.
There is a very particular way of calculating this in accordance with the labour law. But there are different ways of distributing this 10% share through all the different employees, depending on how many years they’ve been working for the company, on the number of days they work during the year, etc.
So, this 10% mandatory profit sharing has been existing in law since the late 1960s. It escalated to law as a way to give a little carrot to certain important unions that aligned with the policies of the state at that time.
Explaining outsourcing in Mexico: How companies in Mexico used to circumvent “Mandatory profit sharing”
For the last 20 years or so, that was what the law stated, and most of the companies in Mexico complied with that law. But in order to circumvent said law the following happened (and I will use the following example to better explain the situation).
Let’s say for example, Ford Motor Company, which is not our client, but for the purposes of explaining outsourcing in Mexico, I’m using a big name that everybody knows.
So, the way that everybody operated in Mexico was the following:
A “Ford Motor Company” had an operating company in Mexico, called “Ford Motor Company in Mexico,” and “Ford Motor Company in Mexico” was an operative company that handled all the sales of the cars in Mexico.
And then, “Ford Motor Company” had another company, which was the “Ford Motor Company Servicing Entity,” and the purpose of the “Ford Motor Company Servicing Entity” was to hire all the employees that worked in “Ford Motor Company in Mexico” and as a result, that employment company had zero income.
The only income the employment company (“Ford Motor Company Servicing Entity”) received on a monthly basis was an invoice for rendering services to the operating company (“Ford Motor Company in Mexico”), which invoiced Ford Motor Company, with a markup. So, at the end of the fiscal year, the employment company, had zero profits to distribute, but tons of employees; whereas the operating company had a big income to distribute with zero employees.
That is the way that all these companies were set up. And that was the legal structure, and all the companies were operating that way.
Explaining outsourcing in Mexico: When did it changed?
The new administration was not happy with the way these entities were structuring themselves, so last year they passed a law, that came into effect; which basically aimed at trying to avoid this particular scheme, which was completely legal.
And the way to avoid it was basically to prohibit outsourcing and insourcing in Mexico as a general concept.
The Labour Law amendments were published in April 2021, and it took a while until they had a tax bylaw to this mandate. And now these laws have become effective as of August 22nd. And as a consequence, there was a 3-month period, where all the companies were trying to prepare themselves in order to be compliant with this law.
So now that I’ve given the explanation of what are the goals of this law I will just try to talk more of the fine details.
Explaining outsourcing in Mexico: Can I still outsource my employees?
The first big concept is that subcontracting personnel, whether outsourcing or insourcing as a general rule is strictly prohibited, except for specialized services which may be continued to be subcontracted.
So, subcontracting specialized services for the execution of specialized projects is permitted, provided that such services are not included within the corporate purposes of the entity.
So let me give you an example.
For instance, you are a cheese producer in Mexico; whose corporate purpose, is to produce cheese, and for the purposes of producing cheese, you will be able to carry out specific set of activities relating to cheese manufacturing. Now, every corporate sophisticated law firm in Mexico would include a scope of activities that would go all the way from renting, importing, exporting, merchandising, marketing, developing relationships with cheese producers, so on and so forth. And you’d end up with a 2 pager of everything that could be achieved.
Today, a company with such a broad corporate purpose, in other words, a broad scope of services; would not be able to subcontract anything, because the core business of this company is to: produce business, to market business, to hire people to do the cheese producing services, to transport the cheese from point A to point B, etc.
So, if this cheese company wants to outsource transportation, because it wants to hire a company to transport the cheese that it produces from its manufacturing company to all the retailers and distributors; it will not be able to outsource its transportation services because its core activities (corporate purpose) cannot be outsourced to a third party.
So, in order for them to hire someone to distribute the cheese, they would have to modify or amend their corporate bylaws. Therefore, erasing those activities that are not part of their core services, in order to hire third party specialized services.
And because of this law, all Mexican companies are revising their corporate bylaws, and they’re basically keeping just the core activities, and they are shedding everything they were not doing. They have to amend their bylaws so that they are eligible to hire the services of a specialized third party that will be able to help them in those ancillary matters.
So that is basically the core of the outsourcing law in Mexico passed during 2021. But we still need to talk about specialized services in Mexico and how companies will be moving forward.
Explaining outsourcing in Mexico: What exactly constitutes as specialized services?
Contracting or outsourcing specialized services is permitted, but provided that such services are not included within the corporate purposes of the business or entity that receives the services.
Now, the providers of specialized services must be registered and authorized by the Ministry of Labour and Social Security, and this authorization must be renewed in a three year basis and said outsourcing company must have paid and be up to date with its Tax and Social Security obligations.
Most of the companies in Mexico providing specialized services will have to register in this particular registry. Some companies are trying to avoid it, but other companies in order to continue carrying out their core businesses, because they were providing services to different entities before, will have to register here.
And the most important thing is that the mandatory profit sharing will now be capped up to the greater of three months of salary or the average of the mandatory profit sharing perceived by the employees within the last three years.
As you can see, this law states that, you will not be able to outsource your employees. Because your employees will now be part of the operating entity, and when time comes to make a “mandatory profit sharing,” then all these employees will be able to receive the “mandatory profit share.”
That, of course is an additional cost of doing business in Mexico, however it’s a small cost. And besides, this has always been in the law to begin with, so there isn’t a big change, it’s basically trying to avoid the circumvention of this existing feature that has been present in the law of Mexico since the 1960s.
Explaining outsourcing in Mexico: The key takeaways
- Viewed from a tax standpoint, if you violate these outsourcing rules, or if you do not comply with the rules, you will not be able to make these payments tax deductible.
- The beneficiaries of outsourcing services projects will be jointly liable for unpaid tax contributions. So basically, this is a very important way of weaving the whole chain and to ensure that nobody wants to be jointly viable for paid tax services.
- Corporate employees will need to put very special attention to specialized services. There are particular penalties, and these penalties will be considered as tax fraud. A simulation of specialized services will be deemed as qualified tax fraud, so that is a way of putting a lot of teeth into the new provisions of the law. This is to make sure that all employers, all companies, whether Mexican; wholly owned by Mexicans, or other entities that are fully controlled by foreign investors i.e., Canadian, will have to comply with the law.
Explaining outsourcing in Mexico: Our recommendations
- All companies operating in Mexico should review their contractual relationships with employees, clients, and suppliers, as well as the corporate purposes of their operating and services companies to make sure that they’re compliant.
- Conduct particular legal analysis regarding the existing agreements with providers, clients, vendors and suppliers to confirm that the provision of services they depend on complies with the new outsourcing regulations.
- Change in employment structure either by an employer substitution or through a reverse merger of the operating company of the Services company for insourcing services.
- Special attention should be put to corporate purposes of the company in the bylaws because, as I mentioned, broad corporate purposes, which is usually standard, should be narrowed down to the actual pulse of the company.
- And finally, immigration matters, just to make sure; all the employees that are outsourced, must be compliant with immigration law.
Explaining outsourcing in Mexico: Final thoughts
This has been a very hot topic for the last year, it completely came to change the way businesses are being structured in Mexico. It has given, as you can imagine, a lot of work to law firms and to tax consulting firms.
Initially the current administration wanted to go even deeper. There were two years of negotiations between the industrial sector and the current administration in order to achieve this.
From a labour standpoint, I think in the end, improves the conditions of the employees and it’s a good thing. But it’s a new way of operating and the owners of businesses have to get used to restructuring, and the new businesses, or Canadian companies looking to expand to Mexico to commercialize their products and services, or to start manufacturing in the country, must make sure that they are compliant with this new Labour law mandates.
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