Relevance of HK–Mexico Tax Treaty for Maquiladora Operations

The Mexican Income Tax Law implies that a foreign resident has a PE in Mexico when said foreign resident has economic and legal relationship with legal entities that carry out in-bond assembly (maquila) operations (also known as IMMEX companies), which habitually process goods or merchandise maintained in Mexico by a foreign resident using assets provided, directly or indirectly, by the foreign resident or any related enterprises. However, it may secure PE protection in Mexico, including a number of conditions. One of such conditions is that the foreign resident’s country of residence should have entered into a tax treaty to avoid a double taxation with Mexico. This means that the recently signed tax treaty to avoid double taxation between Hong Kong and Mexico will secure PE protection in Mexico for Hong Kong principals of Maquiladora operations in Mexico.

But besides the very important treaty requirements, other conditions apply, including that the maquiladora company should comply with any of the following Mexican transfer pricing options to the election of the Maquiladora:

A) Transfer pricing study

When they keep the supporting documentation enabling them to demonstrate that the amount of their income and deductions (from transactions carried out) with related parties results from the sum of the following values:

(i) Consideration for the manufacturing services on an arm’s length basis as established in the Law and according to the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations approved by the Council of the OECD in 1995 or those that replace said guidelines, without considering the assets not owned by the taxpayer, and adding

(ii) an amount equivalent to 1% of the foreign resident’s accounting net value of the M&E owned by the foreign resident that Mexican residents are permitted to use in conditions other than leases.

B) Safe Harbor

When they obtained a taxable profit representing at least the greater of any of the two following provisions:

a) 6.9% on the aggregate value of assets used for the maquiladora operation during the fiscal year, including those owned by residents of Mexico or by foreign residents or by any party in a relationship with the latter, notwithstanding that the use or advantage thereof so granted to said maquiladora be temporary.

b) 6.5% on the aggregate costs and operating expenses (determined in accordance to Mexican Financial Reporting Standards) of such operation, incurred by the Maquiladora and those incurred by foreign residents that are directly connected with the Maquiladora, with some exceptions.

C) Full Transfer Pricing

Maquiladoras may elect to compute the arm’s length consideration for manufacturing services considering the Transactional Net Margin Method including, among other factors, all assets employed by the Maquiladora regardless of ownership.

Options A and B are the most common and may be changed each fiscal year. Option C is seldom times employed.

In summary, the Hong Kong – Mexico tax treaty has brought important benefits to many Hong Kong companies that export manufactured goods principally to the U.S. market, to which  manufacturing in Mexico in partnership with their Asian manufacturing operations may be more meaningful from a business standpoint.