Mexico Maquiladoras and NAFTA
By: PATRICK J. KELLY
March 2001
In 1965, Mexico initiated its National Border Industrialization Program to help develop the infrastructure of its northern border, create employment and provide a means of transferring technology into the country. The Maquiladora Program, as it has come to be known, allowed foreign manufacturers to temporarily import duty free machinery, tools, equipment, replacement parts and raw materials necessary to assemble and manufacture products for re-export outside of the country. It has become a tool for U.S. manufacturers to take advantage of plentiful and comparatively cheap labor and low transportation costs.
Since its inception, the Maquiladora Program has undergone many changes, the most significant of which was necessitated by ratification of the North American Free Trade Agreement between Canada, the United States and Mexico, which became effective on January 1, 1994 ("NAFTA"). Article 303 of that agreement required that by January 1, 2001, Mexico permit all of a Maquiladora's production to be sold in Mexico, and further restricted the duty relief given by Mexico on goods used in the Maquiladora process.
A Brief History
When the Maquiladora Program started, Mexico did not want the influx of foreign equipment, parts, tools and raw materials to be sold in Mexico without being subject to duty. Because much of Mexico's manufacturing industry was not competitive with the United States, Mexico did not want to have its industries be overwhelmed by and have to compete with foreign goods. Thus, the Mexican government initially required that Maquiladoras not sell finished products within the Mexican market or run the risk of losing their Maquiladora registration and their continued ability to temporarily import goods free of duty. The government also restricted foreign ownership of Maquiladora operations. These regulations began to soften in the 1970s.
Changes to the Maquiladora Program As a Result of NAFTA
In October 1996, after the implementation of NAFTA, the Secretariat of Commerce and Industrial Development ("SECOFI"), which reviews applications and grants permits for Maquiladoras, was given the power to deny or cancel existing permits if SECOFI determined that the Maquiladora's operations would have an adverse affect on the Mexican national non-Maquiladora industry.1 This was a protective measure to mitigate the effects of allowing Maquiladoras to sell their products within the domestic Mexican market. That same year, Maquiladora operations became subject to taxation on the value of assets imported into Mexico, or, as an alternative, compliance with Mexico's income tax law provisions on transfer pricing.2 The transfer pricing law allowed a safe harbor if a Maquiladora can show a tax profit of equal to or greater than 5% of the value of all assets used in the Maquiladora operation, including financial assets, fixed assets and inventory.3 The biggest change resulting from NAFTA, however, was the requirement that Mexico pass regulations by January 1, 2001, restricting the duty drawback and deferral characteristics of the Maquiladora Program.
The new regulations, implemented to bring the Maquiladora Program into compliance with Article 303 of NAFTA, were announced in the Diario Official on October 30, 2000, and became effective on November 20, 2000 - two months ahead of the January 1, 2001 deadline. Article 303 restricts the use of drawback and duty deferral programs, including the Maquiladora Program in Mexico. It was included in NAFTA because the United States felt the Maquiladora Program offered an unfair advantage to foreign exporters, since domestic manufacturers do not receive a drawback or waiver of duties on materials imported to produce goods for sale into the domestic market. Also, the U.S. did not want producers who would benefit from duty-free entry of their products imported into another NAFTA country to also benefit from advantageous duty treatment of their inputs.4
As a result of Article 303, Mexico can no longer waive its duties for goods to be re-exported to the U.S. as long as re-exportation is a condition of the duty waiver. Foreign companies desiring to take advantage of lower production costs in Mexico must now pay Mexican duties for third-country components.5
In order to receive favorable duty treatment under the new regulations, companies must import goods having NAFTA content as defined in the treaty. Generally, the goods must either originate from within a NAFTA country, or undergo substantial conversion within a NAFTA country (so that it has at least 60% or 50% NAFTA regional content, depending on whether a value method or a cost method is used to determine origination.)6 If a foreign manufacturer is importing non-NAFTA originating goods into Mexico for ultimate export into the U.S., Mexico may only refund or waive import duties on the materials imported into its territory equal to those normally payable on the materials in Mexico, or the amount of duties paid on importation of the finished product into the United States - whichever is lower.7
Many experts believed Article 303 would be the death knell of the Maquiladora Program. Instead, Mexico found a way to comply literally with Article 303, but to continue to provide the Maquiladora Program and its benefits to foreign manufacturers. Article 303 provides that NAFTA states must eliminate drawback or deferral programs that condition the drawback or deferral on re-export of the goods to another NAFTA member. Mexico is proposing to get around this by creating the Programas de Promocion Sectorial ("Industry Promotion Programs"). The Program allows certain industries that historically have imported components and parts not available in NAFTA countries to import such components and parts into Mexico at a new maximum tariff rate of 5%. In most cases the tariff rate will be 0%. This effectively lowers tariffs on suppliers across the board. And, the finished products into which the components are incorporated meet NAFTA origin requirements, they will have the additional advantage of being subject to little or no duty upon entering the United States or Canada.
As part of the changes ushered in in October 2000, the Mexican government also changed the Tax Code to provide for different tax treatment of items imported into the country. The changes require importers to take specific affirmative steps in order to obtain preferential tax treatment.
The Mechanics of Establishing a Maquiladora
There are three ways to establish a Maquiladora Program in Mexico. The most common method is to establish a wholly-owned subsidiary in Mexico that would own and operate the Maquiladora. The second method is to use a shelter operation that invests in facilities, hires employees and manufactures product for a fee based on labor costs plus profit. The shelter operator generally relies upon the manufacturer to provide the equipment required for the plant. The third method is to use a subcontractor who charges based on unit cost rather than labor cost, and is usually responsible for obtaining equipment.
As Mexico continues to adjust its Maquiladora Program in response to NAFTA, further changes are expected in the Maquiladora Decree and tax and customs regulations. For more information on the Maquiladora Program, or on doing business in Mexico generally, please call Patrick Kelly at 612-347-7040.
Luis Reséndiz, a law clerk of Fredrikson & Byron joining the firm
as an associate in the fall, contributed content for this article. Luis
is licensed to practice law in Mexico and practiced with a law firm there
for five years before coming to the United States to attend U.S. law school.
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- Vargas, p. 207.
- Vargas, p. 214-215.
- Id.
- The National Law Center, Mexico: Maquiladoras and NAFTA
Beyond Year 2000, Carlos Angulo-Parra, Edmundo Elias-Fernandez and Carol Osmond. - Mexico: Trade Regulations, The Economist Intelligence Unit, Ltd., October 26, 2000.
- See, Article 401 of NAFTA.
- See, Article 303 of NAFTA.