Mexico’s Role in the USMCA-Driven Consolidation of the North American Auto Industry

This article was republished by Global Trade in its April 28, 2021 edition.

It’s the beginning of a new year! 2020 is over, COVID-19 vaccines are being administered, the USMCA is in effect, and there is an apparent unofficial understanding that the auto industry is essential in North America (Mexico, the United States and Canada).

Building upon the findings of Foley´s September 2020 Global Supply Chain Disruption and Future Strategies Survey Report, it is clear that supplier relationships will be strengthened, likely by means of increasing transparency of both OEM needs and suppliers’ ability to fulfill them, bolstering provider resilience over lean inventories, and preapproving alternate purveyors over a race to the lowest cost option.

In that context, we should not lose sight of the ways Mexico contributes to strengthening the North American auto industry: (i) quality outputs at the lowest cost in the region, (ii) free trade agreements with more than 60% of the world´s GDP (52 countries); (iii) near–shoring advantages, (iv) skilled workforce with low absenteeism and in greater availability as Mexico´s population ages, and (v) between a pandemic and ongoing trade wars, Mexico translates into predictable access to the North American market, under a solid foundation.

That said, with your company either already doing business in Mexico, or considering doing business in the country, here are a number of relevant issues to keep in mind in 2021:

I. COVID-19 Vaccines

Just as with labor (i.e., determination of essential or nonessential business activities), and mandatory health measures (i.e., establishment of on-site sanitary protocols), both the Mexican federal government and the Mexican states have concurrent jurisdiction regarding vaccinations.

As of the date of this writing, the federal government has issued a national vaccination policy, under which the government plans to immunize the entire population in a span of 18 months, beginning late last year (2020) with frontline health care workers, followed by those 60 and older, then those in their 50s, 40s, and lastly, those 18 and older. (Progress to date casts doubt upon whether this is achievable.)

On January 25, 2021, the Mexican Ministry of Health issued high-level guidelines for individual Mexican states, as well as private entities, to acquire and administer vaccines as long as they comply with and contribute to the National Vaccination Policy, with more details likely forthcoming.

Furthermore, compliance with evolving health and labor regulations in manufacturing facilities will still be an important matter to consider, both in terms of continuing production and preventing lawsuits due to real or imaginary risk exposure.

II. Outsourcing/Insourcing Ban

On November 11, 2020, the Mexican president presented an initiative to, in practical terms, ban the current practice of outsourcing and insourcing in Mexico, through which companies avoid their 10% profit-sharing obligations by distancing themselves from their workforces through separate or related companies.

In a nutshell, the initiative would exclusively allow for “specialized services” to be outsourced, meaning those that are not part of the economic activity of the intended beneficiary; the Mexican Labor Department would have to grant a renewable authorization to specialized service providers in Mexico. In addition, simulated renderings of specialized services would constitute elements of proof towards the commission of criminal tax fraud.

This initiative will likely pass early in 2021, as the president´s political party (MORENA) controls both houses of Mexico’s Congress; a number of hypotheses are being discussed as to how companies will change their operations to comply with this initiative.

Most automotive businesses in Mexico use outsourcing operations to manufacture in the country. The new outsourcing rules will impose a need to reassess and restructure a number of labor, corporate and tax structures and short-term strategies.

III. VAT-Certified Maquila Benefits Diluted & Maquilas in the Spotlight

Maquila (aka IMMEX) companies in Mexico function under a governmental authorization that includes preferential conditions, both operational and fiscal. The highest degree of preferential treatment is granted to maquila companies that are VAT (Value Added Tax)-certified, which allows them to avoid paying otherwise applicable VAT upon the importation of goods used in their manufacturing operations (either raw materials or machinery and equipment).

Such preferential treatment will automatically be changing as soon as each individual maquila company renews its VAT certification, which occurs every one to three years, depending on the number of workers and machinery and equipment involved.

Upon VAT certification renewal, companies will, among other things: (i) no longer have the ability to obtain expedited 16% VAT refunds on their operational balance (capacity to continue temporarily importing without paying VAT remains, however); (ii) have a reduced time frame to use most temporarily imported goods (from 36 months to 18 months), although longer periods will apply to certain products, such as containers, machinery and equipment; (iii) no longer be automatically enrolled in sectorial import programs (steel, motor vehicles, textiles, others); (iv) have to file weekly pedimento submissions, instead of monthly, and will not be able to temporarily import products without declaring serial numbers.

IV. Mandatory Technical Standards (NOMs) No Longer Exempted

Prior to October 1, 2020, the importation of certain materials to be utilized in production processes, or which would not be sold to the public in the same shape or form as imported, were permitted to enter under “exemption letters” that would allow them to be imported without proof of NOMs compliance (not all imports are subject to NOM compliance, as per their relevant import tariff numbers).

Consequently, as of this date, importers are no longer allowed to use such exemption letters and, upon importation, are obliged to demonstrate compliance with relevant NOMs either prior to the importation process, or afterward.

A number of procedural rules apply to each of the aforementioned options, and some other requirements must be previously fulfilled in order to benefit from them.  Also, Mexican authorities have issued, and continue to issue, administrative criteria to clarify their practical applications of this measure.

V. Labor Enforcement of USMCA Obligations

Mexico has amended its relevant labor laws to comply with USMCA, most importantly to guarantee the basic rights of freedom of association and collective bargaining, with the non-stated objective of increasing wages in the country.

There are immediate and intermediate obligations for employers pertaining current collective labor contracts. Regarding the former, (i) i.e. as of today, such contracts shall be free of “interference” from employers (it is considered interference to promote the establishment of workers’ unions dominated by an employer or an employers’ organization and to support, economically or otherwise, workers’ unions in order to place them under the control of an employer or an employers’ organization). Pertaining the latter, (ii) labor contracts need to be “legitimized” by May 1, 2023 at the latest, as per the process already issued by the Mexican Labor Secretary.¹

Because of the foregoing, there will be real, working unions, meaning that collective contracts signed with employer-friendly unions (commonly known as “protection” contracts, or contracts with “white” unions) will soon be eliminated, which will likely bring new leadership and more than one union to a company.

Determination of denial of freedom of association and collective bargaining rights may be made by a Facility-Specific Rapid Response Labor Mechanism; if such a denial of rights determination is made, the covered facility´s goods or services could face a suspension of preferential tariff treatment, or the imposition of penalties. It would be convenient for employers to inoculate themselves (a timely term) against potential arguments from competitors, that such basic labor rights are being denied in their Mexico manufacturing plants.

VI. Permanent Establishment Tax Rules

Recent tax reforms have expanded the scope of application of the permanent establishment rules in Mexico. This is a sensitive issue because foreign companies that are deemed to have a permanent establishment in the country for tax purposes shall be subject to levies (with respect to the revenue attributable to said permanent establishment). Therefore, companies already doing business, or that are considering setting up operations in Mexico, should evaluate these changes to the Mexican tax legislation to assess any potential risk of being considered to have a local taxable presence.

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¹ See Diario Oficial de la Federación of July 31, 2019.