Mexico Enacts Far-Reaching Labor Reform That Addresses Outsourcing Arrangements
This alert was updated August 2, 2021 to report on a new effective date for the measures in the reform.
The Mexican government on April 23, 2021, finalized new rules to regulate the tax treatment of labor outsourcing arrangements in Mexico. The reform, which encompasses sweeping changes to eight laws, including the labor and social security laws and the income tax and value added tax laws, may lead multinational groups with operations in Mexico to review their existing structures and consider reorganizing their Mexico operations to ensure compliance.
The tax provisions of the reform initially were to be effective August 1, 2021 (with the other elements of the reform entering into effect on April 24), but on July 31, the Mexican government issued a decree announcing that the effective date of the changes to various laws relating to the prohibition of labor outsourcing structures in the country is postponed for a month, from August 1 to September 1. The postponement aims to give taxpayers more time to take the steps necessary to comply with the new rules.
Subcontracting Reform
The general thrust of the reform is to prohibit the subcontracting or outsourcing of personnel, a common practice defined as providing or making available workers for the benefit of another person or legal entity.
The new laws provide some exceptions to the general rule. For example, subcontracting will be allowed when the services provided are specialized in nature and are not part of the core business purpose or the predominant economic activity of the company receiving the services. For this exception to apply, the labor supplier must be registered as a provider of specialized services with the Ministry of Labor and Social Welfare.
The new rules specify that specialized services include shared or complementary services rendered between entities of the same corporate group, if those services are not part of the beneficiary's corporate purpose or its economic activities.
Tax Implications
The amendments to the income tax law prohibit the deduction (or credit, as the case may be) of payments made in connection to outsourcing of personnel. However, deductions would be allowed for payments related to specialized services if the recipient of the services verifies that the service provider is registered with the appropriate labor authorities. Moreover, the recipient must obtain an array of documentation—which the service provider is obligated to supply—regarding employees’ salaries and evidence of the employer’s social security contributions.
Taxpayers will not be allowed a deduction or VAT credit for payments for subcontracted services if the personnel involved in the rendering of those services were formerly employed by the recipient of the services and transferred to the service provider.
Penalties for Noncompliance
The new laws provide various penalties, including criminal sanctions, for companies engaged in outsourcing schemes that are considered illegal. Using deceptive practices to simulate the provision of specialized services would constitute tax fraud, subject to criminal penalties including prison sentences.
Any individual or legal entity that subcontracts workers to perform specialized services from a contractor that does not meet the new labor, tax and social security obligations towards those employees will be jointly and severally liable on the amounts due with respect to the workers used for those engagements.
Profit Sharing
Under the Mexican Constitution and labor laws, employees are entitled to participate in their employers’ profits every fiscal year. To comply with the laws, companies must distribute 10% of their taxable profits to their employees.
Under the new rules, the amount employees may receive as profit sharing is limited to a maximum of three times the employee’s monthly salary or the average of the profit-sharing payments received in the last three years, whichever is higher.
Options
Prior to the reform, a common structure often seen in international groups involved two Mexican companies: a “services” entity that employed personnel and an “operating” entity to which workers were subcontracted or outsourced.
The new rules on the treatment of labor outsourcing arrangements will mean that, in many cases, operating using these structures will not be viable. As a result, many groups are expected to reorganize their structures, in particular by consolidating their activities into one Mexican entity or transferring their workforce to a single operating entity.
Conclusion
There are a number of alternatives available for groups looking to reorganize their operations in light of the labor subcontracting reform. The most effective solution will vary depending on each group’s specific circumstances, and it is important that all groups looking to reorganize their operations seek legal, tax and accounting advice prior to undertaking a merger or similar transaction.
While the delayed effective date of the new tax provisions may give businesses some time to adjust, it is important that affected groups consider their options to reorganize or restructure their operations now.
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