Labor Legislation and Switch Pricing – Taxes

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background

There are many companies in Mexico that provide human resources, administrative or specialist services. These services can be provided by related or unrelated parties within a multinational corporation. The most common services include the provision of administrative (accounting, tax, legal, finance, human resources, among others), IT, marketing, engineering and manufacturing services.

Operating companies have made use of services from these service providers. Such service structures, as they are commonly known, have been a business strategy for operational units as it relieves human resources, legal, social security and other risks associated with the direct hiring of their staff, as the staff was hired directly by service companies providing the has performed the necessary activities or services, i.e. has taken on the burdens arising from the work perspective.

Workers in Mexico are constitutionally entitled to 10% of the profits of the company they employ (the employer), this is defined as employee profit-sharing (commonly known as PTU in Spanish). This PTU obligation is calculated based on a pre-tax income of the hiring company under the Mexican Income Tax Act (MITL).

In this sense, the employees hired by a service company calculated the PTU based on the pre-tax profit of the service company and not the operating unit or any other company in the group.

In general, the provision of these services is a consideration that could be analyzed on a cost-plus basis. The service company charges a consideration that includes all costs and expenses incurred in providing the service, plus a profit mark-up. This consideration could be determined as a variable fee, a fixed fee, or a direct cost-plus-consideration that could be billed monthly, quarterly, etc. Given this equalization scheme, it is implied that the PTU obligation, which is an operating expense of the applicable accounting standards in Mexico (NIFs per is an acronym in Spanish), was part of the fee that the service company charged the operator.

It is understood that multinational corporations operating in Mexico are more likely to have related party transactions that involve the provision of personal services.

Mexican labor and tax reform

On April 23, 2021, a labor and tax reform was published in the Mexican State Gazette with general effect on April 24, 2021, with the exception of certain provisions, such as tax regulations, which come into force on August 1. 2021. This reform is commonly referred to as the “outsourcing reform”.

As a result of such a reform, the provisions on outsourcing of labor were repealed and these new provisions expressly prohibit these structures. Outsourcing is known as subcontracting staff.

The operating units are obliged to employ the staff to carry out their core business activities and / or the activities which, according to their articles of association, belong to their corporate purposes.

As a result of this outsourcing reform, service structures should be discontinued or restructured, as otherwise all departments involved run the risk of engaging in activities that are now prohibited from a labor and tax law perspective.

In general, under the new legislation, the outsourcing of personnel is defined as cases in which a natural or legal person makes their own employees available or makes available for the benefit of another natural or legal person.

Exceptionally, employment agencies that intervene in the process of recruiting staff can continue to participate in the recruitment, selection and training of staff as they would not be considered an employer as this function is carried out by the person / body benefiting from the services provided.

The outsourcing reform provides that, in exceptional cases, specialized services or the execution of specialized work are permitted that are not part of the company’s purpose or the main economic activity of the beneficiary (operating company). These specialized companies have to meet some requirements, including registration with the Ministry of Labor and Social Affairs.

For services provided by related parties, complementary or shared services (such as back office activities) could be considered specialized, given the group concept as enshrined in Mexican law. In this sense, related parties could implement an updated service structure that only takes into account the provision of specialized services and / or the execution of specialized work according to the outsourcing reform, which could relate to IT, surveillance and security, cleaning, among others.

In all cases, the related parties should conduct a detailed functional analysis of the permissible provision of services in order to determine the fair market considerations applicable based on the functions performed, the assets used and the risks assumed by the companies involved.

Reviewing transactions that involve the provision of services is a top priority, as companies that undertake the now prohibited outsourcing of personnel or services without proper registration will be fined from 2,000 to 50,000 times the value of the unit of measurement and updating (approximately between $ 9,000 and $ 225,000).

In addition, companies would face the non-deduction of expenses related to the outsourcing services or VAT non-creditability and, in extreme cases, these services could be classified as tax fraud, which could be the result of a criminal act.

Given the scope of this outsourcing reform, in addition to labor and tax issues, effects on areas such as social security contributions, transfer pricing, companies, etc. could be dealt with under an all-inclusive approach.

Alternatives to attempting to comply with the new regulations may consider the employer replacement scheme, through which the operating company, as the new employer, assumes all labor and social benefit obligations; or a restructuring in which the operating and service companies could be merged.

Transfer pricing considerations

The effects of this outsourcing reform encompass various areas, including transfer pricing as a very important issue. With regard to the employer representation system, a common controversy is associated with the transition of workers from service companies to operating companies, with a particular focus on examining whether there should be consideration between both parties.

The outcome may change due to the specific characteristics and circumstances of the service structure, including the staff involved, the service provided and the possibility of transferring intangible assets as part of the transaction (know-how, intellectual property, formulas, etc.). A transfer pricing analysis should therefore be carried out with regard to the position of the companies involved before and after the restructuring.

In addition, labor liabilities generated by the service company can be analyzed during this restructuring and these items should also be taken into account in the transfer pricing analysis.

As stated in the MITL, taxpayers engaging in related party transactions must determine their income and deductions by taking into account the prices that would have been used in comparable transactions between independent parties. In addition, as part of the transfer pricing provisions of the MITL, it is specified that the transfer pricing guidelines for multinational companies and tax administrations (“OECD guidelines”) are the source for the interpretation of transfer pricing issues.

From the point of view of transfer pricing, there are no specific provisions in the MITL on the transfer of employees, so this point should be checked taking into account the OECD guidelines.

It is also advisable to review the company contracts to determine whether the transfer of personnel or the discontinuation of the provision of services could activate “termination clauses” that could trigger additional effects.

Another point to be checked is the PTU obligation for companies that directly hire new employees. In general, an increase in the expenses of the operating companies from the PTU obligation is to be expected.

This effect would have an impact on transfer pricing matters, since the PTU obligation is viewed as an expense for financial purposes, therefore this PTU obligation will adjust the profitability indicators (PLI) of the operating unit for the purpose of testing the arm’s length principle.

On the other hand, the effect of the profit mark-up, which was previously charged by the service providers to the operating units, would no longer apply, which would lead to a reduction in the expenses of the operating units.

A full functional and economic transfer pricing analysis should be performed to determine the operator’s applicable PLI as well as the financial impact of the new PTU obligation effect versus the previously paid performance premium.

Conclusion

The adopted outsourcing reform implies several relevant factors and effects in different areas (labor, taxes, transfer pricing, social security, companies, etc.), which should be assessed for each individual case, preferably through a holistic approach, in order to minimize all possible liabilities and Contingent liabilities that all units affected by the service provision could incur.

With regard to transfer pricing, a thorough functional and economic analysis should in any case be carried out in order to properly evaluate the positions of the companies involved before and after the restructuring in order to determine the corresponding remuneration at arm’s length

Originally published by Expert Guides.

The content of this article is intended to provide general guidance on the subject. You should seek expert advice regarding your specific circumstances.