On the surface, there are many compelling reasons for CEOs to expand
their business operations into Mexico.
A plentiful labor supply and lower operating
costs are among the most frequently mentioned advantages. But doing business in
Mexico can be frustrating, confusing and, at
times, impossible for the foreign business
person. Most importantly, without adequate
preplanning and knowledge of the specific
laws that will impact a Mexican business
operation, CEOs may find that their rate of
return doesn’t measure up to their expectations.
“Before you decide to expand your business operation into Mexico, think about
your exit strategy. For example, think how
are you going to repatriate your earnings, the
corresponding tax implications and the rate
of return you expect to receive from your
business investment,” says Enrique
Hernández, partner with the International
Practice Group at Procopio, Cory,
Hargreaves & Savitch LLP. “The way the
business is initially set up determines many
of the variables that affect profitability. Your
rate of return can be substantially less than
you anticipated if your Mexican expansion is
not planned properly from the outset.”
Smart Business spoke with Hernández
about what CEOs should know before
launching a business in Mexico.
How does the type of business entity affect
the U.S. tax rates?
Many CEOs mistakenly think that the tax
treaty between the U.S. and Mexico eliminates double taxation. That is only a partially true statement if you structure the venture
properly. Mexico has a similar tax system to
the U.S. and businesses are taxed at a fixed
rate of 28 percent on net earnings. However,
when you transfer the profits back to the
U.S., now Uncle Sam wants to tax it again.
The combined worldwide effective tax rate
will differ depending upon whether earnings
are transferred back to the U.S. as partnership distributions or as dividends.
Here’s an example: If the Mexican company is operating under an S.A. structure and
the U.S. parent company is structured as a
partnership, you’ll currently pay U.S. federal taxes on any dividend income you bring into
the U.S., on top of and after paying Mexican
business taxes. If the Mexican company has
been effectively structured as a pass-through
entity and you repatriate Mexican profits,
you’ll pay income taxes in the U.S. at the
applicable U.S. federal rate, but you will likely be able to apply the paid Mexican income
tax as a foreign tax credit, thus effectively
avoiding a double-tax scenario. CEOs need
to estimate how much money they’ll be repatriating, look at the tax rates and see which
structure is most advantageous.
The choice of Mexican business entity will
largely depend on the desired U.S. tax result.
The proper choice of cross-border tax structure may reduce the combined amount of
taxes paid on the Mexican-sourced earnings.
How are labor laws affected by the Mexican
business entity?
Mexican labor laws are very protective of
employees; for example, there’s a mandatory profit-sharing law requiring employers to
share 10 percent of corporate profits with
employees. Setting up one entity that acts as
a service company for the employees that
generates minimal profits, another company
to hold the company’s assets and a third
operating company, which generates all the profits, will help reduce the amount of profits that are subject to the employee profit-sharing statute. Anticipating how much
money the company will make and how
large the operation will become is vital to
structuring the Mexican entity properly in
order to manage employee profit-sharing
expenditures.
How does the Mexican legal system differ
from that in the U.S.?
Mexico’s legal system operates under a
civil law system as opposed to the common
law system, which is the basis for our legal
system here in the U.S. That foundational
difference has an impact on everyday business protocol. For example, in the U.S., facsimile copies of signed contracts are generally considered legally binding. In Mexico, a
facsimile copy of a contract is not sufficient
evidence that the contract exists. You always
need to execute contracts with an original
signature and retain them, in case you need
to go to court to enforce any of the terms and
conditions. There are a number of other differences as well, so CEOs should educate
themselves before launching the operation.
How can CEOs obtain the proper advice to
plan for an expansion to Mexico?
The best way to avoid surprises as a result
of a Mexican business expansion is to plan
ahead and get competent advice on both
sides of the border. It’s important to have
your U.S. and Mexican attorneys communicate with each other because they should
collaborate using their knowledge of each
country’s laws to ensure that the result is
seamless. There are tax considerations that
drive the business decisions, so one of the
keys to success is knowledge of the tax laws
and proactive planning. CEOs need to
become knowledgeable in this area in order
to avoid ROI disappointment.
ENRIQUE HERNÁNDEZ is an attorney licensed to practice in
Mexico and in California and is a partner with the International
Practice Group at Procopio, Cory, Hargreaves & Savitch LLP.
Reach him at (619) 515-3240 or [email protected].
