1. © 2013 Galaz, Yamazaki, Ruiz Urquiza, S.C. November 2013 Maquiladora Tax Regime 2014 Tax Reforms Maquiladora Regime Blanca Montaño Riqué CPC & MF

2. Background

3. © 2013 Galaz, Yamazaki, Ruiz Urquiza, S.C. 3 Tax Reform 2014 Maquiladora Regime Background The reform seems to deliver a message of increasing tax collections through: Increase of tax rates Elimination of many tax benefits Elimination of preferential tax regimes

4. © 2013 Galaz, Yamazaki, Ruiz Urquiza, S.C. Tax reforms constitutional approval process 4 September 8The Mexican president Enrique Peña Nieto presented to Congress the economic package for the 2014 fiscal year. October 18Congress approval by the house of representatives. October 31Congress approval by the senate. Tax Reform 2014 Maquiladora Regime

5. © 2013 Galaz, Yamazaki, Ruiz Urquiza, S.C. 2014 economic package 5 Economic Policy Guidelines Initiative of the Income Law Federal Expenditure Budget Project Tax Laws Initiatives 2014 Economic Package Sets public expenditure according to their nature and amount Sets the amount of income of the Federation Reforms or modifies the tax laws relating to revenue collection Strategies, objectives and targets of income, expenses, debt and public rates Tax Reform 2014 Maquiladora Regime

6. Current Maquila Regime

7. © 2013 Galaz, Yamazaki, Ruiz Urquiza, S.C. 7 Tax Reform 2014 Maquiladora Regime Introduction Mexico’s economy is driven by external trade. Export earnings are fueled by among other things, of manufacturing. IMMEX companies represent 85% of Mexico’s manufacturing exports. The US remains Mexico’s largest trading partner, due to its geographical proximity and the benefits of the North American Free Trade Agreement (NAFTA).

8. © 2013 Galaz, Yamazaki, Ruiz Urquiza, S.C. ©2009 Galaz, Yamazaki, Ruiz Urquiza, S.C. Todos los derechos reservados. Maquiladora general operation ©2013 Galaz, Yamazaki, Ruiz Urquiza, S.C. Todos los derechos reservados. 8 US COMPANY US COMPANY MX COMPANY MX COMPANY USAMEX - Sends raw material or processing - Sends machinery and equipment - Pays maquila service fee MAQUILA AGREEMENT - Processes the raw material - Charges a maquila service fee on a cost plus basis - Exports (returns to US) the processed goods Tax Reform 2014 Maquiladora Regime

9. © 2013 Galaz, Yamazaki, Ruiz Urquiza, S.C. 9 Tax Reform 2014 Maquiladora Regime Maquiladora’s up to 2013 IMMEX companies currently operate under a preferential tax and customs regime. They are allowed to import raw materials, parts, components and other assets on a temporary basis, a transaction that is exempt for VAT purposes. Maquiladoras have a Permanent Establishment protection, provided they comply with transfer pricing issues trough: -Transfer pricing study. -Safe harbor.

10. © 2013 Galaz, Yamazaki, Ruiz Urquiza, S.C. 10 Tax Reform 2014 Maquiladora Regime Maquiladora’s up to 2013 (2) These companies have special benefits concerning income tax and flat tax that allows them: Partial exemption of income tax, equal to 3% of base that is higher between: -6.5% over expenses or -6.9% over assets Tax Credit for flat tax purposes, so that the flat tax never goes higher than 17.5% of the taxable base for income tax.

11. Repealed Laws

12. © 2013 Galaz, Yamazaki, Ruiz Urquiza, S.C. 12 Tax Reform 2014 Maquiladora Regime Business Flat Tax (IETU) The Business Flat Tax Law is repealed. -Transition provisions are established to secure the rights and obligations acquired during the effective term of the law. -Under a transitory provision, the receivables from activities performed up to December 31, 2013 collected after the law is repealed could continue to have IETU effects.

13. © 2013 Galaz, Yamazaki, Ruiz Urquiza, S.C. 13 Tax Reform 2014 Maquiladora Regime Cash Deposits Tax Law (IDE) The Cash Deposits Tax Law is repealed -Transition provisions are established to uphold the rights and obligations acquired during the effective term of the law.

14. Income Tax Law

15. © 2013 Galaz, Yamazaki, Ruiz Urquiza, S.C. 15 Tax Reform 2014 Maquiladora Regime Main reasons to reform the Income Tax Law regarding Maquiladoras The tax benefits granted to the maquiladoras in the nineties, through time got generalized, therefore causing distortions and abuses. A review of the maquila regime shows that the requirements for a program have been made ​​ flexible and the maquila tax scheme has not been adjusted: For those maquiladoras that also have domestic sales (national operation), the current regime makes them possible to manipulate its tax base.

16. © 2013 Galaz, Yamazaki, Ruiz Urquiza, S.C. 16 Tax Reform 2014 Maquiladora Regime Main reasons to reform the Income Tax Law regarding Maquiladoras (2) In some cases, companies other than maquiladoras get disguised as one, in order of applying unlawfully the tax benefits. The reform tries to differentiate those taxed as maquiladoras for Income Tax purposes from those that solely apply the benefits for customs purposes. Proposal according to the recommendations by the OECD regarding the elimination of special tax regimes. -The maquila regime establishes a preferential treatment that complicates the administration of tax laws and facilitates base erosion.

17. © 2013 Galaz, Yamazaki, Ruiz Urquiza, S.C. 17 Tax Reform 2014 Maquiladora Regime Maquila new definition Maquila operations will be those that fulfill the following requirements: Under a maquila agreement, a non-mexican resident must provide to the maquiladora goods: -That are temporally imported into Mexico -Subject to a transformation process (the law incorporates a definition of transformation). -The Maquiladora should export the manufactured products, either physically or through a virtual export under the terms of the customs law and corresponding regulation.

18. © 2013 Galaz, Yamazaki, Ruiz Urquiza, S.C. 18 Tax Reform 2014 Maquiladora Regime Maquila new definition (2) That Maquiladora’s revenue associated with productive activities must be derived solely from its maquila activities. -Some uncertainty about what a Maquiladora should understand as “productive activities”. That the transformation process is performed using machinery and equipment property of the foreign resident that has signed a maquila agreement. -The foreign resident must provide at least 30% of the M&E used in the maquila process. -A serious concern has been created in the approved reform due to the fact that, it doesn’t consider current maquiladoras that are below the 30% threshold. -Therefore all maquiladoras would have to satisfy the 30% M&E requirement or risk being in a position to lose the PE protection.

19. © 2013 Galaz, Yamazaki, Ruiz Urquiza, S.C. 19 Tax Reform 2014 Maquiladora Regime Transfer pricing compliance To protect against permanent establishment of the foreign resident, the maquiladora still needs to satisfy the obligations of using the arm’s length principle for the maquila services. The maquiladora that is required to obtain PE protection for its non-resident party would only have available the following options: -Applying the Safe Harbor, requiring to report as the minimum taxable profit, the higher between 6.5% over expenses and 6.9% -Obtaining an Advanced Price Agreement (hereinafter “APA”) with Mexican tax authorities.

20. © 2013 Galaz, Yamazaki, Ruiz Urquiza, S.C. 20 Tax Reform 2014 Maquiladora Regime Transfer pricing compliance (2) The tax reform eliminates the transfer pricing study, option that had been available since 2003 for a Maquiladora to comply with the arm’s length principle: -Largely used by Maquiladoras when the Safe Harbor resulted in profit margins that were not appropriate to a Maquiladora’s specific circumstances or consistent with the economic performance of its respective industry.

21. © 2013 Galaz, Yamazaki, Ruiz Urquiza, S.C. 21 Tax Reform 2014 Maquiladora Regime Income Tax Partial Exemption On October 30, 2003, Mexican president Vicente Fox enacted a presidential decree: -To grant an income tax partial exemption to Maquiladoras -In order to continue to promote investment in Mexico -And avoid them shifting their operations to other countries. The most likely scenario is that such presidential decree exemption will be abolished. Considering these changes, Maquiladoras would be expected to pay Income tax at the regular corporate tax rate of 30%, thus increasing their current 17.5% rate paid, combining both Income tax and IETU together.

22. © 2013 Galaz, Yamazaki, Ruiz Urquiza, S.C. 22 Tax Reform 2014 Maquiladora Regime Getting ready for 2014 Maquiladoras may perform a series of evaluations in order to try to reduce the exposure to a serious economic impact from the tax reform: Evaluate if their operations in fact create a PE in Mexico to the foreign resident. Perform a feasibility analysis to define requesting an APA option When a maquila has also domestic sales, it is advisable to study alternatives for 2014.

23. © 2013 Galaz, Yamazaki, Ruiz Urquiza, S.C. 23 Tax Reform 2014 Maquiladora Regime Other important dispositions for 2014 A transitory provision establishes the mechanism for calculating the opening balance of the CUCA for taxpayers who began operations before January 1, 2014. -However, there is missing regulation about initial balance of the CUFIN account. So there is no clarification of what happens to UFINES from 2000 and back. -No clarification on CUFINRE account. Worker remunerations that represent an exempt item of income for the employee, such as fringe benefits, employees’ savings and loan funds, severance payments, annual bonus, overtime, vacation premium, Sunday premium and exempt portion of PTU: -May only be deducted up to 53%. If an employer decreases such items of employee compensation the deductibility threshold shall be reduced to 47%.

24. Value Added Tax Law

25. © 2013 Galaz, Yamazaki, Ruiz Urquiza, S.C. 25 Tax Reform 2014 Maquiladora Regime Main reasons to reform the Value Added Tax Law regarding Maquiladoras The temporary imports, that are currently VAT exempt, presents control problems that can lead to practices of tax evasion and tax avoidance. The control problem got more difficult when the temporary import could be transferred to other maquiladoras instead of exporting them directly. Unequal treatment of domestic manufacturing companies (?)

26. © 2013 Galaz, Yamazaki, Ruiz Urquiza, S.C. 26 Tax Reform 2014 Maquiladora Regime VAT on temporary imports Elimination of exemption on VAT on the temporary importations of materials and M&E by maquiladoras. -This measure created a serious concern due to: 1.High volumes of temporary importation 2.Financial cost 3.Administrative burdens to recover the VAT with the tax authorities.

27. © 2013 Galaz, Yamazaki, Ruiz Urquiza, S.C. 27 Tax Reform 2014 Maquiladora Regime VAT on temporary imports (2) Applicable VAT credit to certified maquilas. -The VAT credit will be equal to the VAT liability in importation -That will reduce payment in such a way that they don’t have a cash VAT liability. A maquiladora that does not obtain certification status may guarantee the contingency of the tax liability via a bond with an authorized entity.

28. © 2013 Galaz, Yamazaki, Ruiz Urquiza, S.C. 28 Tax Reform 2014 Maquiladora Regime Maquiladora certification for VAT purposes A Maquiladora may obtain a certification status from the tax authorities that validates that they are properly operating the maquila program in compliance with the purposes it was designed for. The certification is on a one-year basis and the maquiladora may renew certification up to 30 days prior to expiration. The requirements for certification have not yet been published. The payment of VAT, when applicable, will start one year from the date the tax authorities publish the requirements to obtain certification status in order to give proper time to Maquiladoras to achieve certification.

29. © 2013 Galaz, Yamazaki, Ruiz Urquiza, S.C. 29 Tax Reform 2014 Maquiladora Regime VAT on change of importation status The VAT on a change of regime from temporary to definitive will not be subject to such taxes again, only if: -The temporary importation is already subject to taxes, such as the case where the maquiladora was not certified or did not elect to use the bond option. -If at the time of the temporary importation VAT is not paid, the taxes will be paid on the change of regime from temporary to definitive.

30. © 2013 Galaz, Yamazaki, Ruiz Urquiza, S.C. 30 Tax Reform 2014 Maquiladora Regime VAT on sale by foreign residents of temporary imported items The sale by foreign residents to an IMMEX company will be taxable and the VAT will be collected by the Mexican resident via a VAT withholding. The VAT withheld will be creditable to the Mexican resident in the VAT return of the following month.

31. © 2013 Galaz, Yamazaki, Ruiz Urquiza, S.C. 31 Tax Reform 2014 Maquiladora Regime VAT increase in Border States The Mexican Congress approved the Executive Proposal to generalize the VAT in all Mexico to 16% -Eliminating the preferential 11% VAT regime along Mexico’s borders and other strategic zones. Maquiladoras located in these zones will have to consider a 5% budget increase for payments to local vendors. -Their average favorable VAT balance is likely to increase as well.

32. Federal Tax Code

33. © 2013 Galaz, Yamazaki, Ruiz Urquiza, S.C. 33 Tax Reform 2014 Maquiladora Regime Tax postbox An electronic communications system is created between the tax authorities and taxpayers, -For notification of different administrative documents and acts and the latter may file petitions, requests (including refunds), notices, responses to requests from the authorities, consultations about their tax situation and file administrative appeals against acts of authority.

34. © 2013 Galaz, Yamazaki, Ruiz Urquiza, S.C. 34 Tax Reform 2014 Maquiladora Regime Tax postbox (2) An electronic audit procedure is established so that the authorities can exercise their official inspection through the tax postbox, -The taxpayer will be required to provide the necessary documentation and information for such purpose and also respond to official requests. It is established that this type of reviews will last for up to three months. Will go into effect for business corporations as of June 30, 2014 and for individuals on January 1, 2015.

35. © 2013 Galaz, Yamazaki, Ruiz Urquiza, S.C. 35 Tax Reform 2014 Maquiladora Regime Auditor's statutory report (dictamen) The filing of an auditor's tax opinion shall now be optional -Only individuals with business activities and corporations can choose to file the dictamen if: 1.in the immediately previous year obtained accruable revenues in excess of about USD$7,700,000 (MXP$100,000,000) 2.Or the value of their assets determined under general rules issued for such purpose by the SAT, exceeds about USD $6,000,000 (MXP $79’000,000), 3.or at least 300 of their workers rendered services in each of the months of the immediately previous year.

36. © 2013 Galaz, Yamazaki, Ruiz Urquiza, S.C. Deloitte se refiere a Deloitte Touche Tohmatsu Limited, sociedad privada de responsabilidad limitada en el Reino Unido, y a su red de firmas miembro, cada una de ellas como una entidad legal única e independiente. Conozca en www.deloitte.com/mx/conozcanos la descripción detallada de la estructura legal de Deloitte Touche Tohmatsu Limited y sus firmas miembro. Deloitte presta servicios profesionales de auditoría, impuestos, consultoría y asesoría financiera, a clientes públicos y privados de diversas industrias. Con una red global de firmas miembro en más de 150 países, Deloitte brinda capacidades de clase mundial y servicio de alta calidad a sus clientes, aportando la experiencia necesaria para hacer frente a los retos más complejos de los negocios. Los más de 195,000 profesionales de la firma están comprometidos con la visión de ser el modelo de excelencia. Tal y como se usa en este documento, “Deloitte” significa Galaz, Yamazaki, Ruiz Urquiza, S.C., la cual tiene el derecho legal exclusivo de involucrarse en, y limita sus negocios a, la prestación de servicios de auditoría, consultoría fiscal, asesoría financiera y otros servicios profesionales en México, bajo el nombre de “Deloitte”. Esta publicación sólo contiene información general y ni Deloitte Touche Tohmatsu Limited, ni sus firmas miembro, ni ninguna de sus respectivas afiliadas (en conjunto la “Red Deloitte”), presta asesoría o servicios por medio de esta publicación. Antes de tomar cualquier decisión o medida que pueda afectar sus finanzas o negocio, debe consultar a un asesor profesional calificado. Ninguna entidad de la Red Deloitte, será responsable de pérdidas que pudiera sufrir cualquier persona o entidad que consulte esta publicación. Blanca Montaño Riqué Tax Manager 011 52 (664) 622 7974 bmontano@deloittemx.com