Establishing a business in Mexico under the pure Contract Manufacturer (Maquiladora) scheme.
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Establishing a business in Mexico under the pure Contract Manufacturer (Maquiladora) scheme.
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Companies interested in opening a business in Mexico may do so under several options, for example: creating a legal entity whereby they can market a product and/or manufacture it for sale in domestic territory, however, if the intent is only to manufacture a product to sell it outside the country, establishing a company under the modality Contract Manufacturing company (Maquiladora) in terms of the IMMEX decree (Industria Manufacturera, Maquiladora y de Servicios de Exportación) could be an interesting option for you.

Basically a Contract Manufacturer (Maquiladora) is a company incorporated for the purpose of becoming a sort of cost center to manufacture a product or render a service to be exported on a future date abroad.[1]

This way, the company in Mexico will act under the orders of its company abroad who shall also provide the machinery and inventory to execute the manufacturing process.  In the end, in consideration for this manufacturing service, the company in Mexico will charge a maquila service to its company abroad.

The following is a drawing showing how a maquiladora should operate in Mexico:
Maquiladora_Mexico_Negocios-102232.png
  1. The entity residing abroad provides the Mexican entity the machinery and equipment as well as the necessary raw material to execute the manufacturing process in Mexico without the need to pay duties nor importantion taxes[2] on the Value Added Tax (VAT) on the importation.
  2. The company in Mexico manufactures a final product with the inventory and machinery owned by the resident abroad based on its instructions.  The company in Mexico for this manufacturing process invoices the company abroad the total costs and expenses on the manufacturing process plus a determined markup established at 0% VAT.
  3. Once the finished product has been completed, the company in Mexico exports the return of the product to its related party abroad.
  4. The company abroad sells the product to the final consumer.
 There are several benefits of operating in Mexico under a Maquiladora scheme; as mentioned below:
 
Low manufacturing and operating cost 
-       Low manufacturing cost as labor in Mexico is of good quality and at a low cost compared to other world economies[3]
-       Allow the company in Mexico to use fixed assets owned by the company abroad without the need to sell them to the Mexican company as a gratuitous lease agreement shall be executed (in Mexico it is called commodatum agreement or “contrato de comodato” in spanish). 
-       Allow the company in Mexico the use of inventory owned by the company residing abroad without executing a sale as the owner continues to be the related party resident abroad (RP RA).
 
Benefits as to Income Tax (ISR)

-       No permanent establishment is generated for the resident abroad.  Without a maquila contract, the company abroad could be subject to the payment of taxes in Mexico by creating a permanent establishment in the country as it shall have the inventory, machinery and equipment free of charge, however, an agreement could protect the resident abroad from having a tax presence in Mexico and, therefore, said company is not obliged to pay taxes in the country. 
-       The company shall determine a minimum tax profit based on a proceeding called Safe Harbor[4] or shall have the possibility of it being less under an Anticipated Price Agreement (APA).  Determining a minimum tax profit allows for control as to Income Tax payment compared to the Income Tax to be generated in the event the company produces large profits. 
-       Benefit of deducing 100% of the exempt income paid to its employees[5], otherwise deductibility could be only 47% or 53% (depending on a specific calculation).

Benefits regarding Value Added Tax (VAT)

-       Machinery, equipment and inventory imported by the company in Mexico shall be exempt from the payment of VAT on the importation under IMMEX program provided the term for the return of the merchandise is met.[6] 
-       Income on the rendering of maquila services the company in Mexico shall charge the company abroad shall be at a rate of 0% of VAT as they are deemed export activities. 
-       Reduced terms to obtain VAT refunds in the case of companies Certified as to this tax. 
-       The following chart shows a summary of the benefits that may be obtained by the company in Mexico by obtaining one of the 3 VAT certifications[7]:
Table_Contract_Manufacturer-181429.png
Benefits as to Special Tax on Production and Services (IEPS)
-       Exemption on IEPS payment, subject to the person being under IMMEX Program and having IEPS certification granted by the Tax Administration Service.
 
Benefits regarding foreign trade
-       Possibility of temporarily importing[8] the goods necessary to be used in an industrial or service process for the manufacturing, transformation or repair or foreign merchandise without payment of General Tax on Imports (IGI). 
-       Agile customs procedures. 
The following steps shall be followed in order for a company to be established as a maquiladora and enjoy aforementioned benefits (including VAT): 
  1. Create a company in Mexico.
  2. Sign a Contract Manufacturing (Maquila) Agreement with its related party abroad.
  3. Apply for the IMMEX program before the Ministry of Economy.
  4. Obtain VAT certification based on requirements established by SAT[9].
Once the company in Mexico is established as a Maquiladora, the following requirements shall be fulfilled at all times: 
  1. Comply with the requirement to generate income from Exports for an annual minimum sum of $500,000 dollars (USD) or at least 90% of the annual income shall come from exports[10].
  2. Maintain control of merchandise imported and exported under IMMEX.  For this purpose, the company shall have a customs agent keeping adequate record of said inventory[11].
  3. Comply with the 4 requirements established by Income Tax Act for maquila companies:
 a)    Merchandise supplied by the resident abroad shall be subject to a transformation process[12] or repair, be imported temporarily and returned abroad, even though virtual transactions.

b)    Its total income from productive activity shall come exclusively from the maquila operation.  The company in Mexico may have other revenues (e.g. sale of fixed assets, among similar transactions) for an amount not to exceed 10% of its export revenues.

c)     When companies with a Program carrying out transformation or repair processes add domestic or foreign merchandise to their manufacturing process that are not temporarily imported, these shall be exported or returned together with the merchandise imported temporarily.

d)    The transformation or repair processes shall be carried out at least with 30% of the machinery and equipment owned by the resident abroad with whom companies with a Program have entered into a maquila agreement and provided they have not been property of the company executing the maquila operation or owned by another company residing in Mexico with whom it is a related party.

The most important aspects to consider before operating under a maquila scheme are the following: 
  1. *The finished product shall not be sold in Mexico as the purpose is to export it upon completion of the manufacturing process.
  2. *Merchandise shall be exported within the terms, otherwise the VAT and IGI not originally paid upon importation are triggered and must be paid.
  3. *A maquila agreement needs to be executed and maintained, in case this agreement is lost, the business structure would collapse leading to the loss of VAT certification and a possible risk of permanent establishment in the country for the person residing abroad.
  4. *Excellent control of the inventory temporarily in Mexico through Exhibit 24 and Exhibit 31.  For this, it’s important to have a person or service provider that carries out all the import/export and inventory control to handle this process.
  5. *The term of IMMEX Programs shall be subject to compliance with the requirements established for granting thereof and with the obligations established on the Decree by the holder.
  6. *Program authorization is granted under the commitment to make annual sales abroad for a value exceeding $500,000 dollars to the United States of America, or the equivalent thereof in domestic currency, or, invoice exports for at least 10% of its total invoicing.
 Conclusions
 
In summary, the maquiladora company scheme in Mexico is very attractive for foreign companies who intend to carry out a manufacturing process in the country at a low cost with good quality, however, it is important to bear in mind that the final product cannot be sold in the country but it shall be sold abroad in order to operate under this structure that in addition renders significant benefits as to taxes and foreign trade.
 

At JA del Rio with have a lot of experience serving companies of several sizes and industries in Mexico who operate under the maquiladora company mode, therefore we are pleased to advise you throughout this process.
 

Please contact our experts if you have any question or comment.

[1] An example of this business model would be where an automobile assembling company manufactures a part of the process in Mexico but upon completion, the intention is to export for sale abroad.
[2] General Tax Imports (IGI).
[3]The daily minimum salary in Mexico ranges from $100 – 180 MXN (approximately. $5 - $9 USD using an estimated Exchange rate of $19.5 MXN per USD
[4] Consists on considering the greater amount between comparing 6.5% of the total costs and expenses vs 6.9% of all financial assets as the annual tax profit.
[5] Benefit granted under a presidential decree. 
[6] Contingent upon having an IMMEX Program and a VAT certification granted by the Tax Administration Service. (SAT).
[7] VAT certifications may be in 3 categories: A, AA, or AAA where the last one has more requirements but at the same time provides more benefits.
[8] Temporarily imported goods under an IMMEX Program may remain in domestic territory without paying IGI during a period of 6 months, 2 years or the duration of the Program depending on the type of merchandise.  Before the term expires, the goods shall return abroad, case contrary IGI shall be paid.
[9] As long as the VAT certification is not obtained, the company may import merchandise under the temporarily import regime without paying IGI, but it shall pay VAT on the import.  Only until VAT is obtained the company may enjoy from the benefit of not paying VAT on the import.
[10] The income the company in Mexico shall charge the company abroad for manufacturing service is deemed “Export services”.
[11] This inventory control shall be constantly updated via Exhibit 24 and Exhibit 31, published by SAT.
[12] Transformation processes are those processes performed on merchandise consisting of: dilution in water or other substances; washing on cleaning, including removal of oxide, grease, paint or other coverings; application of preservatives, including lubricants, protective capsules or paint for preservation; adjustment, filing or cutting; conditioning into dosages; packaging, repackaging; testing and marking, labeling or classification, as well as product development, except, regarding trademarks, trade names and commercial notices.
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