Leobardo Tenorio and Ernesto Ocampo – Tijuana Office Baker & McKenzie International is a Swiss Verein with member law firms around the world. In accordance with the common terminology used in professional service organizations, reference to a “partner” means a person who is a partner, or equivalent, in such a law firm. Similarly, reference to an “office” means an office of any such law firm. “Decree for the Promotion of the Manufacturing, Maquiladora and Exportation Services Industry” Tax Implications

Background From the trade and regulatory perspectives, the rules applicable to maquiladoras and PITEX companies were similar, if not identical. From the transactional and tax perspectives there were several differences: –PITEX companies have typically acted as full fledged manufacturers. They usually own the inventory and the M&E used in their operations and they sell the products that they manufacture. –Maquiladora companies, typically act as contract manufacturers (services providers), using inventory and M&E provided by a foreign resident. Typically maquiladoras do not own the products that they manufacture.

Background Based on the special features of the maquiladora environment, which involves the use of foreign owned inventory and M&E in México, there are special tax rules that are applicable only to maquiladora companies and to the foreign residents contracting with them. Such rules are: –Permanent Establishment and Asset Tax exemption applicable to foreign residents that provide assets to maquiladoras, as long as such maquiladoras comply with transfer pricing regulations. –Application of the 0% VAT rate applicable on maquila and sub-maquila services. –Reduction of the income tax liability of the year by an amount determined based on the applicable rules. Such reduction could range between 43% to 100% of the yearly income tax.

Background The tax regime applicable to maquiladoras is included in several regulations, such as: –Income Tax Law, –Value Added Tax Law, –Presidential Decree issued on October 30 th, 2003, –Miscellaneous Tax Resolution. Such regulations make reference and are related to terms that were defined under the old Maquiladora Decree, such as: –Maquila operation –Submaquila operation –Maquiladoras –Maquila program –Maquila Decree

Merger of the Decrees and its tax implications The main concerns for the industry derived from the merger of the PITEX and Maquiladora Decrees proposed by the Mexican Government were tax related. Such merger was conditioned to achieve a wording that would: –Assure the continuity of the application of the tax regime applicable to existing maquiladoras and to companies that would obtain a program under the new Decree. –Restrict the application of such tax regulations to companies that do not operate as maquiladoras.

Tax related features of the IMMEX Decree For purposes of assuring the continuity of the tax regime applicable to maquiladoras, the IMMEX Decree has the following features: –The Maquila Decree is maintained and the merger is achieved by repealing the PITEX Decree and incorporating it into the IMMEX Decree. –The term Maquiladora is maintained in the name of the Decree itself. –The definition of maquiladora and submaquiladora operations is maintained in the Decree which is now equivalent to manufacture and sub-manufacture operations. –A new definition of maquiladora operation for tax purposes is included which is focused towards restricting the application of certain tax benefits to companies that do not operate under such definition. –The terms included in the IMMEX Decree will be equivalent to the terms included under the former Decree for purposes of linking such terms to the various tax regulations that are applicable.

Definition of Maquiladora Operation for tax purposes Article 33 of the IMMEX Decree includes a special definition of maquiladora operation for purposes of: –The PE exemption applicable to the foreign resident that provides inventory and M&E to the maquiladora, and –Defining the companies that will be subject to apply the income tax reduction benefit provided in the Presidential Decree of October 30 th, 2003 The maquiladora operation for purposes of these regulations is the one that: –Uses inventory and other goods provided directly or indirectly by the foreign resident that is part of the maquiladora agreement –For purposes of the transformation, elaboration and repair of such goods or to provide services with them.

Such maquiladora operation has to meet these conditions: –That the foreign resident is a resident of a country with which Mexico has a tax treaty, and –That the maquiladora complies with transfer pricing regulations. This new definition is similar to the one included in the current regulations, which is the one that should prevail from a legal perspective. The new definition clarifies that the IMMEX company may use goods that are not under the temporary importation regime or national goods. Definition of Maquiladora Operation for tax purposes

Continuity of other tax regulations The Asset Tax exemption will continue to apply to foreign residents that: (1) maintain inventories in Mexico for transformation by IMMEX companies or (2) that provide the use of foreign owned goods to IMMEX companies Same as before the exemption will be limited to the production that is exported and subject to compliance with transfer pricing regulations by the IMMEX company. For purposes of VAT, the application of the 0% VAT rate on maquiladora and sub-maquila services will be applicable to all IMMEX companies as long as such services are provided within the terms of their authorized program

Additional Tax Regulations IMMEX companies that operate under the Certified Company regime will be able to obtain VAT refunds in 5 days. IMMEX companies that do not operate as a Certified Company will be able to obtain VAT refund in 20 days. Subject to compliance with rules that will be issued by the tax authorities.

Tax Implications of the IMMEX Decree Tax authorities have raised their concern toward the application of the maquiladora tax rules by companies that do not operates as maquiladoras. Their main concern is the application of the Income tax benefit provided in the Presidential Decree of October 30th, Such concern has been reflected in the drafting of a proposed addition to the Income Tax Law Regulations that seems to be aimed to provide additional limitations for the application of the tax benefits applicable to maquiladoras –Such proposal is still been discussed and reviewed by the tax authorities

Final Thoughts The application of the tax benefits of the maquiladora regime is maintained. The rules and regulations that were applicable under the previous decree are still applicable, –Including the areas that were subject to interpretation The new Decree will create an environment under which the tax authorities will become vigilant about the application of the tax benefits. Such vigilance will be reflected in: –Audit procedures to review the operational structure of the IMMEX companies. –Modifications to the current tax rules and regulations