Tax Strategies

Repositioning of Auto Parts Operations from China to Mexico

Covid-19 has impacted global business in an unprecedented fashion.  There are virtually few industries immune to the impact, especially when you consider their position in the global supply chain.  As with any disruption of normal business operating processes, Covid-19 has created both winners and losers.  In pondering who the winners and losers are it becomes clearer when we consider an example, the automotive parts industry.      

The Chinese business model of producing quality products at a reduced cost has been very seductive to a countless number of industries, resulting in manufacturing jobs leaving the U.S. and relocating to China.  The automotive parts industry embraced this business model, however Covid-19 and the resulting disruption to their supply chains is likely resulting in a reevaluation of this position.  So, while it is likely China will experience a reduction in its manufacturing base over time, the question is who will benefit from the repositioning of manufacturing assets.  While there are several candidates to consider, we need to look no further than our neighbor to the south, Mexico.

Mexico has been a direct competitor to China in the auto parts industry for several decades.  The attractiveness of Mexico, as a center to place manufacturing and assembly activities is based on factors including lower wages and logistics costs, infrastructure and the favorable trade agreement with the U.S. and Canada (USMCA).

To appreciate the size of the auto parts industry in Mexico, we can look at recent data provided by the National Auto Parts Industry Association.  In a pre Covid-19 forecast, the value of auto parts manufactured in Mexico during 2020 was expected to exceed USD100 billion.  What will the actual results show once the full impact of the repositioning of manufacturing assets from China to Mexico becomes clearer? 

There are over 30,000 parts in a typical automobile.  Many of those parts including wire harnesses, seats and their parts, motors, gearboxes, die-cut parts, axles, braking mechanisms, lighting appliances, airbags, seat belts and many other components are manufactured or assembled in Mexico.  It is important to note that 80 percent of this production will be consumed in the U.S. marketplace.  Thus, it is a natural extension for Mexico to gain more auto parts manufacturing and assembly operations as the result of Covid-19 and the repositioning of manufacturing or assembly assets from China.

For U.S. auto parts manufacturers with current facilities in China, the repositioning of these assets to Mexico is typically undertaken by utilizing the Mexican maquiladora or IMMEX program. It is important to understand both the benefits and operations of a maquiladora.

Benefits of Utilizing a Maquiladora

  1. Ability to better compete in world markets by combining advanced U.S. technology with a qualified and cost competitive Mexican labor force and technical staff;

  2. Ability to continue to employ U.S. personnel in U.S. facilities in administration, warehousing, product finishing, etc.;

  3. Ability to own 100% of and efficiently control and administer a Mexican entity and operations;

  4. Ability to utilize U.S. technical and administrative personnel in Mexico operations (up to 10% may be non-Mexican and may obtain the required working visas), while providing U.S. personnel the ability to live in the U.S.;

  5. Ability to acquire, through a Mexican entity, fee simple ownership of land and buildings for industrial operations typically along Mexico’s border with the U.S.  Typical sites include Empaime, Guaymas, Hermosillo, Guanajuat, Monterrey, Queretaro, Saltillo, and Tijuana;

  6. Ability to import NAFTA origin raw materials, components, machinery, and equipment on a duty-free or NAFTA duty-rate basis;

  7. Ability to defer duties on imported raw materials until after the exportation of finished or semi-finished products, and the ability to take advantage of preferential duty rates under applicable Mexican Sectorial Programs;

  8. Ability to avoid non-tariff barriers;

  9. Ability to take advantage of preferential U.S. Customs and Border Protection programs which allow U.S. companies to import finished products and semi-finished products duty free or based on the value added in Mexico;

  10. State of the art infrastructure for the efficient cross-border transfer of goods, and simplified U.S. and Mexican customs clearance procedures;

  11. Ability to sell products in the Mexican market;

  12. Proximity to the U.S. market; and

  13. Access to Mexican and other Latin American markets.

The Maquiladora (IMMEX) Program

A maquiladora is an import/export program granted by the Department of Economy under the Decree for the Promotion of the Manufacturing, Maquiladora and Export Services Industries (IMMEX Decree) to a Mexican company that allows it to import, on a temporary basis, assets generally owned by its foreign maquila principal (FMP) to be manufactured and returned/exported. Raw materials temporarily imported under such regime are exempted of paying duties (IGI) upon its importation. In addition, the company must obtain a VAT Certification granted by the Service Tax Administration (SAT) in Mexico to avoid the payment of value added tax (16%) upon the temporary importation of machinery, equipment, and raw materials. Some IMMEX also obtain a PROSEC program which allows for the temporary importation of certain raw materials under preferential duties for the manufacturing of a specific sectorial product.

 The IMMEX Decree provides that companies may file for one program authorization (an “IMMEX Program”) to carry out export-related operations under one of several different IMMEX Programs.  The five programs include 1) Holding (Controladora de empresas); 2) Industrial; 3) Services; 4) Shelter; and 5) Third party company (Terciarización).  These programs are intended to allow Mexican companies greater flexibility to be more innovative and competitive in a globalized economy.

 Under the IMMEX degree, a U.S. company will qualify to operate under maquiladora status only if it has a corporate presence in Mexico.  The typical structure utilized by a U.S. parent company in the establishment of a maquiladora company is to form an S.A. de C.V. or an S. de R.L. de C.V.  The U.S. parent company can own 100% of the maquiladora. 

From an operations perspective, the U.S. parent company furnishes the machinery, equipment, raw materials, components, and supplies in consignment, pursuant to the terms of a bailment contract, for assembly or manufacture by the maquiladora. The U.S. parent company retains the title to all said materials, supplies, and equipment, as well as the semi-finished or finished products.  The maquiladora charges the parent company and invoices the parent company periodically a service fee for these assembly or manufacturing services based on its costs, plus a markup on an “arms-length” basis, in compliance with Mexican transfer pricing rules.  The U.S parent company funds the maquiladora operations by advancing funds for capital and operating expenses to the maquiladora on an as needed basis, in addition to funds paid for the service fees from time to time.  An inter-company payable in favor of the parent company usually accumulates; however, this may need to be capitalized periodically to avoid a potential phantom Mexican income tax on inflationary gains.

Next Steps

Before embarking on relocating auto parts manufacturing or assembly from China or the U.S. to Mexico, it is important to spend up-front time understanding the cost-benefit of utilizing the maquiladora program.  The best path forward is to engage a team of seasoned professionals to assist you from a legal, tax and supply chain perspective.  The team at Global Tax Focus LLC and our Global Collaboration Partners are available to assist you in evaluating the possibilities of doing business in Mexico.  Please reach out to us to schedule a time to speak to our team.

Final U.S. Anti-hybrid Provisions – The Impact To Multinational Groups with an Italian Subsidiary and Italian Groups with a U.S. Subsidiary

On April 7, 2020 the U.S. Treasury Department and Internal Revenue Service issued final regulations implementing the anti-hybrid provisions enacted by the Tax Cuts and Jobs Act (TCJA).  These rules apply with respect to notional interest deductions (NID) taken as from the fiscal year beginning on or after December 31, 2018.

These final regulations are of interest to multinational groups with an Italian subsidiary and Italian groups with a U.S. subsidiary.  The rules are focused on hybrid dividends, hybrid transactions and other transactions with hybrid entities. The U.S. rules are comparable to the hybrid mismatch rules as outlined under the OECD’s BEPS project.  The U.S. rules provide that deductions related to equity are considered a “hybrid deduction.”  The impact of these regulations on the Italian NID regime will likely result in a higher tax burden for U.S. companies while reducing the overall tax benefit available under the Italian NID regime.  This is due to the deductibility or inclusion in taxable income of payments made between Italian and U.S. related parties.

The Italian NID Regime

On December 24, 2019, the Italian Parliament approved the Budget Law for 2020, which contained a package of tax increases and decreases with varying effective dates.  One important enacted law reinstated the NID system that was repealed by the 2019 Budget Law. The NID rate provided for by the Budget Law for 2020 is 1.3%.  Under this regime, Italian resident companies and permanent establishments of non-resident companies may deduct notional interest from their corporate income taxable base. The NID is calculated according to the equity increase (ie, new equity rate) from the end of fiscal year, multiplied by a rate determined annually.    

Impact of the New Regulations to U.S. Groups with an Italian Subsidiary

Under U.S. tax law, a U.S. company is allowed a full “dividend received deduction”(DRD) for the foreign source portion of dividends received by the U.S. corporation from a foreign corporation in which the U.S. corporation is at least a 10 percent shareholder (CFC).  The rules disallow the DRD for any amount of the dividend received from a CFC for which the CFC receives a deduction or other foreign income tax benefit.

Starting with fiscal years beginning on or after December 20, 2018, the U.S. shareholder of the CFC must track all hybrid deductions claimed by the CFC.  The U.S. shareholder is allowed a DRD only to the extent that the DRD exceeds the total of the hybrid deductions tracked.  The result of the new regulations to U.S. group with an Italian subsidiary is the partial taxation of the dividend received.

Impact of the New Regulations to Italian Groups with a U.S. Subsidiary

Under U.S. law, certain deductions for related party payments made in connection with a hybrid transaction or made by or to a hybrid entity is disallowed.  In addition, the law addresses cases in which income attributable to an intercompany payment is either directly or indirectly offset by a hybrid deduction.  This limitation typically applies where the Italian company is receiving payments as a shareholder of the U.S. company or if the transaction is between brother-sister companies owned by a non-US Parent entity, including an Italian entity.

Multinational groups with an Italian subsidiary and Italian groups with a U.S. subsidiary should consider evaluating the new U.S. anti-hybrid provisions to avoid any surprises.

For additional information, please reach out to us.

U.S. Exports in the Post Covid-19 World

The impact of the COVID19 pandemic on global supply chains will play out throughout the world well into the foreseeable future.  In the U.S. the stark reality of relying on China as an integral manufacturer of many products that Americans gave little thought to prior to COVID19, has resulted in a groundswell cry to reevaluate this relationship moving forward.  From the C-Suite of large multinational corporations to closely held business owners the question of whether to move some manufacturing operations back to the U.S. is currently underway.  While it is impossible to move a foreign manufacturing facility overnight, some operations can be peeled back to the U.S. in short order.  This will likely result in the opportunity to export these products from the U.S., thus revisiting the vitality of the Interest Charge Domestic International Sales Corporation (IC-DISC) may be in order, especially for closely held businesses. 

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