Proposed Legislation in Mexico Would Curtail Employee Outsourcing
On November 12, Mexico President Andrés Manuel López Obrador introduced a bill to curb perceived employment abuses by eliminating two staffing techniques known as “insourcing” and “outsourcing.” Companies have used outsourcing and insourcing for many years, and practicing both has been hotly debated in recent years because of the perceived effect outsourcing may have on employee wages, benefits, and retirement pensions. Critics argue especially that outsourcing prevents collective bargaining, hinders employee wage growth, and limits employees’ ability to achieve workplace seniority, presumably resulting in missed valuable benefits.
For example, under Mexican law, all employers are required to distribute 10 percent of their annual pretax profits to their employees. As a result, many businesses operate using two separate Mexican companies: one company to hold the business operations and assets and a second company to hold the employees. Using transfer pricing, profits within the second employee company can be structured to reduce profits so the 10 percent mandatory profit share is assessed on a much lower value. As a result, most of the profits are retained in the first mentioned operating entity and escape the profit share. During parliamentary discussions, there has been a desire to allow taxpayers who are properly handling outsourcing or insourcing and paying their corresponding taxes to continue this practice. It is important to note that the bill submitted by the president for fast-track approval does not include this distinction.
However, should this legislation be enacted, operating structures such as these can no longer be used. Furthermore, it is expected the law would become effective on January 1, 2021, if enacted. It remains to be seen what type of transition guidance may be promulgated by the Mexican tax authority.
The proposed legislation contains guidance in three areas:
- Employee outsourcing: Subcontracting of personnel in an outsourcing arrangement would largely be eliminated by virtue of disallowing a tax deduction for employment services in any situation where one entity makes its personnel available for the use of a second entity.
- Specialized services: Outsourced specialized services that do not relate to an entity’s primary economic activity or intended purpose would still be permitted with advanced approval by labor regulators.
- Employment agencies: These agencies may participate in processes related to recruiting, training, and development but are not permitted to be the employer.
It is proposed that any type of act involving illegal or sham labor subcontracting structures would be considered criminal tax fraud.
Commentators opposed to the proposed legislation have suggested that if enacted, the legislation could stifle inbound investment, increase the cost of doing business in Mexico through higher labor costs, and create opportunities for fraud.
We recommend analyzing your structure and operations in those cases where insourcing or outsourcing of operations exist before the end of the year. It is important to note that the president’s party has the necessary votes to get the legislation passed, so this proposal must be taken seriously.
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Bernardo Del Río is managing partner of J.A. Del Rio in Guadalajara, Jalisco, Mexico. He can be reached by email at email@example.com.