With the new administration of President Andrés Manuel Lopez Obrador, Mexico is currently facing numerous political and economic changes. These changes will have a direct impact on business activities in Mexico including the manufacturing industry. From a legal perspective, we have identified some “hot topics” that should be taken into consideration by foreign companies doing business in Mexico, particularly in the manufacturing sector.
Piercing of Corporate Veil
Mexican law and Courts have always respected the corporate veil, which separates the legal personality of an entity or company from its shareholders. This means that foreign investors doing business in Mexico through Mexican subsidiaries have traditionally been protected from liability for the Mexican subsidiary’s debts or obligations. Although the piercing of the corporate veil in certain cases is something that is commonly seen in other jurisdictions, until recently Mexican Courts had been reluctant to rule in favor of plaintiffs seeking to hold shareholders of Mexican companies personally liable. On August 2013, an Appeals Court ruled in favor of a plaintiff and determined that the shareholders were liable with respect to the obligations of a Mexican company. This case resulted in the issuance of 11 legal precedents that can at any time become mandatory case law. Foreign investors should review their corporate structures to make sure that they are properly protected from potential liabilities arising from their Mexican subsidiaries. At least two issues should be reviewed by counsel to help prevent the piercing of the corporate veil. First, the financial independence of the Mexican subsidiary, which can be achieved by proper funding and capitalization; and second, any overlaps in membership on the Board of Directors of the Mexican subsidiary and its parent company.
Personal Injury Cases (Punitive Damages)
Recent guidance from courts in Mexico has included new criteria that departs from their traditional (more than 100 years) approach of denying consequential and punitive damages and the practice of limiting or minimizing indemnification in personal injury cases. The current Chairman of the Mexican Supreme Court of Justice was the Justice who has issued these new criteria (prior to his current position). Investors should review their current structures to make sure they are properly protected against these new Court precedents. Insurance policies and employment agreements should also be revised to reduce potential exposure to personal injury indemnification.
U.S. – Mexico – Canada Agreement (USMCA)
As we have written on before, the USMCA (designed to replace the current NAFTA) is under consideration by the legislatures of the U.S., Canada and Mexico. Many believe USMCA will be approved as early as 2020 (the Mexican Senate has recently approved the agreement). The USMCA retains many of NAFTA’s provisions but includes important changes to the Rules of Origin applicable, among others, to the automotive industry. Companies should be aware of these changes and should take the opportunity to work with legal counsel to carry out preventive compliance audits with the incoming USMCA´s Rules of Origin, even before the USMCA is approved.
Out-sourcing and In-sourcing
Mexico has a mandatory 10% profit sharing that must be paid annually to the employees. To reduce the exposure of the profit sharing, many companies structure their operations in Mexico by placing their employees in either an out-sourcing company (an unrelated third party), or in an in-sourcing company (an affiliate company). By doing this, the profit sharing to be distributed to the employees corresponds to the profits of the out-sourcing or in-sourcing company and not to the profits of the operating company. The Mexican Congress has recently enacted several stringent rules with which companies using these structures must comply. Failure to comply with these rules can result in: (i) a requirement that the profits of the operating entity be used as the profits for calculating the mandatory profit sharing; and (ii) the operating entity could lose the ability to take the deduction of the payments made to the out-sourcing or in-sourcing companies as well as to credit the VAT resulting from these payments. Mexican companies should consult with counsel to ensure that they are properly managing their risks in this area.
U.S. Tax Reform
As a result of the Tax Cuts and Jobs Act of 2017 (TCJA) that was adopted in the U.S., the structures used by many U.S. companies operating in Mexico may no longer be as tax efficient as they were before the TCJA was enacted. As an example, provided several requirements are met, as a result of the TCJA, U.S. corporations that own 10% or more of a foreign corporation can receive dividends without any U.S. taxation. This benefit, by itself, should make investors review their current investment structures in Mexico to determine if those structures continue to be efficient.