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Patrick J. Kelly

Patrick J. Kelly International

pkelly@fredlaw.com
612.492.7040
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Manufacturing In Mexico

By: PATRICK J. KELLY

April 2010

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. As a result of the maquiladora program, plants sprouted up all along the Mexican border. The most popular maquiladora locations have traditionally been Tijuana, and Mexicali in Baja California; Ciudad, Juarez, Chihuahua; Nuevo Laredo, in Nuevo Leon and Reynosa and Matamoros in Tamaulipas. While these locations remain hubs of maquiladora activity, maquiladoras are now found throughout Mexico in Monterrey, Nuevo Leon; in Saltillo, Coahuila; in Guadalajara, Jalisco; Aguascalientes, Aguascalientes and Queretaro, Queretaro, among other locations. The maquiladoras have survived despite concerns about violence in Mexico, because they still provide advantages to manufacturers who seek efficient, plentiful, and comparatively cheap labor and low transportation costs. While many U.S. manufacturers have left Mexico to establish operations in China, increases in wages and other manufacturing expenses and high transportation costs in China have motivated many U.S. manufacturers to return to Mexico to manufacture their products. This article discusses the benefits of establishing a maquiladora, and outlines the process for applying for and obtaining a permit to operate a maquiladora.

Benefits of the Maquiladora Program


Since its inception, the maquiladora program has undergone several changes, one of the most significant of which was necessitated by ratification of the North American Free Trade Agreement (NAFTA) between Canada, the United States and Mexico, which became effective on January 1, 1994. 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. The Mexican government made another significant change to the maquiladora program in November 2006, with the implementation of the decree to promote the Manufacturing, Maquiladora and Exportation Services Industry (IMMEX). The IMMEX decree consolidated the older maquiladora program (which provided incentives to manufacturers exporting outside of Mexico) and the Temporary Import Programs to Produce Export Articles (the “PITEX” program, which provided incentives to manufacturers selling in the domestic market) into one program. Manufacturers continue to generically refer to plants operating under the IMMEX regime as maquiladoras.

The IMMEX program provides may advantages to U.S. manufacturers manufacturing in Mexico. Currently Mexican Customs Law establishes two distinct customs regimes, permanent importations and temporary importations. Permanent importations are accomplished outside of the maquiladora or IMMEX program, or in some cases, a good that is imported temporarily under the maquiladora program may have to be re-characterized as a permanent importation because the good remains in Mexico beyond the temporary deadline. A good imported on a permanent basis may remain in Mexico for an unlimited amount of time. Permanent importations, however, must pay Mexico’s value added tax (IVA), which as of January 1, 2010, is 11 percent in the border regions of Mexico and 16 percent in the interior of the country; pay anti-dumping duties; comply with non-tariff restrictions; and pay the normal applicable Mexican import duties at one of the following rates: (1) general import duty rate, as provided by the Law of General Duties of Importation and Exportation; (2) preferential duty rate available under a free trade agreement (i.e., NAFTA rates for goods originating in Canada or the United States); (3) preferential duty rate under a Prosec authorization (“Prosec” is a federal program that provides reduced import duties for certain industrial sectors); or (4) “Rule Eight” duty, which allows an importer to classify all of its goods under one tariff classification and under one tariff rate (this is rarely available).

The IMMEX program allows manufacturers to temporarily import goods and materials into Mexico for 18 months or more, which is usually more than sufficient time for the manufacturers to turn the goods and materials into finished products. Under the IMMEX program, manufacturers enjoy benefits that include a streamlined system for importing goods, avoidance of Mexico’s general import tax, avoid paying IVA, and, in most cases, low or no import duties on equipment and materials used for the manufacture or assembly of goods in Mexico. Furthermore, manufacturers using the IMMEX program can avoid paying compensatory quotas (i.e. anti-dumping penalties) and are able to avoid paying taxes for domestic purchases incorporated into goods that are exported. Upon completion of the manufacturing process, the finished goods that are exported from Mexico into other NAFTA countries will not be subject to duties. Any goods sold in the Mexican market will be subject to normal rules relating to duties. It is important to keep in mind, however, that goods originating in a NAFTA country and imported into another NAFTA country will generally be subject to low or no duties. Furthermore, since Mexico has also substantially reduced its duties for goods from non-NAFTA countries, imports from those countries imported into Mexico also generally enjoy low duty treatment.

Once a manufacturer has determined that it makes sense to manufacture in Mexico under the maquiladora program, the manufacture must decide how to structure its Mexican manufacturing. The two most common ways for manufacturers to structure their maquiladora manufacturing in Mexico are: (1) to contract with a shelter operator; or (2) to establish their own Mexican subsidiary and obtain a maquiladora permit. While this article focuses primarily on a manufacturer establishing their own maquiladora operation, it is helpful to know what the shelter operation option involves so that the manufacturer has a basis for comparison.

Shelter Operation


Under a shelter operation, the manufacturer contracts with a third-party shelter operator who will own or lease the maquiladora facilities, hire the workforce, obtains the maquiladora permit (and Prosec, if necessary), and administer customs and accounting functions. The client may provide its own management staff, raw materials, and equipment. The operator typically charges the client based upon a per-hour labor and administration fee. This usually amounts to a pass-through of the operator’s actual costs, plus a markup of some agreed-upon percentage for profit. Because of the number and differences in quality control of shelter operators, it is recommended that a manufacturer choosing this option solicit competitive bids from three or four operators. A shelter operator can generally have a new operation up and running within two to three months.

We assist manufacturers in selecting shelter operators from whom they can solicit bids. Once the manufacturer has selected an operator, we can assist in negotiating the shelter operator contract, and reviewing the maquiladora application to make sure that it covers the manufacturer’s intended activities.

Process for Establishing a Maquiladora


Most of the manufacturers we represent elect to establish their own subsidiary and maquiladora program so that they can control the operations. The process for registering a maquiladora is essentially the same whether the maquiladora is established by a shelter operator or by the manufacturer directly. In either case, the process is as follows:

  1. Formation of a Mexican Entity. In most cases with U.S. manufacturers establishing a maquiladora in Mexico, we recommend establishing a Sociedad de Responsabilidad Limitada de Capital Variable (Srl), which is essentially the equivalent of a limited liability company in the United States, to own the permit for the maquiladora operation. The Srl can be treated as a disregarded entity for U.S. tax purposes. The Srl may be 100 percent foreign owned, requires a minimum of two owners (i.e., members), and has a capitalization requirement of 3,000 Mexican pesos (currently about $246). Note that foreign-owned Srls must obtain a permit authorizing the foreign investment. The capital of the Srl may be increased or decreased without amending the articles and bylaws of the entity. The Srl is formed when the incorporation deed (the Acta Constitutiva, which is a combination of what in the United States are known as the articles of organization and the operating agreement) must be executed before a Mexican notario (a notario is a lawyer in Mexico who is licensed by the State to protocolize documents and agreements, and company formation documents, and to register them in the public registry) and filed with the public registry of commerce in the jurisdiction in which the entity is located. Upon registration, the entity will need to apply for a federal tax identification number. There is no requirement that officers or directors of the Srl be Mexican citizens or residents. However, officers, managers and employees of the Srl who execute contracts or need to interact with banks or Mexican government agencies in Mexico will need a power of attorney from the Srl authorizing them to act on behalf of the company. Without the power of attorney, third parties and government agencies will not recognize the authority of these officers, managers and employees. Foreign officers, managers and employees will need to obtain a Mexican business visa before being able to exercise the power of attorney. Note that we can assist clients with tailoring the powers granted to officers, managers and employees to ensure that the powers are not overly broad.

  2. Selection of Location. The manufacturer will need to determine where in Mexico it wants to manufacture or assemble its products. As mentioned above, there are numerous locations that serve maquiladoras, both along the Mexico-United States border and in Mexico’s interior. Some important factors to consider in choosing a location include labor cost and availability (perhaps labor with specialized skills), proximity to transportation (ports, rail lines, highways), and the location of industry clusters (e.g., automobile manufacturers). The manufacturer will need to select their location and either enter into a lease or purchase a site. Before purchasing or leasing a site, the manufacturer will need to confirm that the zoning laws allow manufacturing on the site. Foreign owned Mexican entities are allowed to own real estate

  3. Draft, Execute, and Formalize Maquiladora Agreement. The manufacturer must next draft a Maquiladora Agreement detailing the duties and responsibilities of the maquiladora and the owners of the maquiladora (i.e., the U.S. parent company).

  4. Prepare and Submit the Application for the Maquiladora Permit. Once the manufacturer chooses a location and forms a Mexican legal entity, the Mexican legal entity will apply for a maquiladora permit with the Mexican Ministry of Economy. The application process generally takes three to five weeks. In the maquiladora application, the manufacturer needs to include a detailed description of the machinery and equipment to be imported, as well as the raw materials, parts, and components to be used in the integration of the products to be exported. Also, the tariff classification of the goods to be imported for the manufacturing process is required. It is important to note that prior to applying for a permit, the manufacturer needs to have chosen a facility to either rent or purchase for the manufacturing process.

  5. Draft a Form of Employment Agreement or Negotiate a Collective Bargaining Agreement with the Labor Union if Applicable. We generally prepare a form employment agreement in English and in Spanish to be presented to and executed by each maquiladora employee. Note that the Mexican Labor Law requires employers to pay severance to terminated employees. Especially in the case of a termination without cause, the severance payments can be very expensive (see my article entitled “Basic Labor Law Concepts, Non-competes, Non-disclosures and Employee Inventions,” which is found on our website at www.fredlaw.com/articles/international/Mexico.pdf, for more detail on Mexican labor issues). Since the burden of proving the terms of the labor relationship is born by the employer, it is extremely important to have a written employment agreement that details the terms of employment. Furthermore, maquiladoras in many locations in Mexico are unionized. If the manufacturer is in an area where a union will likely be present, the manufacturer will want to negotiate the terms of the collective bargaining agreement before progressing very far in the process of establishing the maquiladora. Finally, in order to reduce the risk of labor claims threatening the assets of the maquiladora operation and to manage the requirement that employers share 10% of their profits with their employees, it is common in Mexico to form two separate Srls. One Srl will own the assets of, and operate the maquiladora, while the other Srl will hire the employees and provide and manage the labor services to the maquiladora operation. In the event that the manufacturer elects to establish a separate services company, it will be necessary to have the maquiladora Srl enter into a services agreement with the services company detailing the duties and responsibilities of each party. The services Srl will pass through to the maquiladora Srl the cost of providing the workers, plus a fee for its profit. The services Srl will then pay profit sharing to its employees based upon this fee.

  6. Prosec Authorization. In addition to the maquiladora permit, depending on the products to be produced, the company might need to apply for an authorization as importer under a special industry program or Prosec. This application process usually takes another three to five weeks.

  7. Zoning and Environmental. The manufacturer will need to obtain zoning and environmental permits for the build out and operation of the plant. The zoning permit is obtained from the local municipality. The environmental permit is reviewed and approved by both municipal and federal authorities.

  8. File Application for Maquiladora Permit with the Mexican Secretaria de Economia. The manufacturer must prepare applications for both authorization and registration of the maquiladora and then submit the application to the Mexican Secretaria de Economia, together with the following documents: Articles and By-laws of the Srl; copy of the lease or evidence of ownership of the plant; registration with the Social Security Office; form of Employment Agreement duly approved by the Labor Board; tax registration and tax identification number; Maquiladora Agreement duly formalized; and the zoning license. File applications with, and obtain authorization and registration from, the Mexican Secretaria de Economia, including expected comments to applications and answers thereto. The law provides that the Secretaria de Economia must review and respond to the application within ten (10) business days. Once the application is approved, the Secretaria de Economia will notify the Mexican Treasury Department so that the maquiladora operation can be registered in the Importers Registry (Padron de Importadores). Once the permit is approved and the manufacturer is registered in the Importers Registry, the manufacturer can begin importing its equipment, raw materials, and parts into Mexico.

Takeaway


There are many factors to consider when determining the best way to undertake manufacturing in Mexico. This article is not meant to be an exhaustive guide to structuring manufacturing operations in Mexico. It is important to consult with competent legal counsel, accountants, and customs agents. For assistance in reviewing options for manufacturing in Mexico, for establishing a Mexican subsidiary, and for preparing and filing an application to register a Mexican maquiladora, please contact Patrick Kelly at 612-492-7040 or at pkelly@fredlaw.com.