With NAFTA rapidly dissolving the commercial border between Mexico and the US, what advantages will maquiladoras offer in the future? Among other events, the Mexican government has reversed a previous decision that would have raised taxes on maquiladoras.

The move, which is essentially a 3-year extension of the current tax law, was somewhat of a surprise, given that the country was experiencing a serious decline in oil export revenues. Nonetheless, Mexican Commerce Secretary Herminio Blanco stated that 1 million jobs would be at risk if taxes on maquiladoras were raised. Other issues related to taxes, customs regulations, and pending NAFTA changes are of equal concern to companies involved in the maquiladora program, and they all warrant a closer look.

A Reprieve from Double Taxation-For Now

The significance of maquiladoras to the Mexican economy cannot be overstated. Maquiladoras-or the nearly 4,000 export manufacturers located along the US-Mexican borde-employ more than 1 million people. Moreover, they are the source of $40 billion in Mexican exports-about half of the country's total exports. On the other side of the border, hundreds of US companies have invested in Mexico's lucrative maquiladora industry. Understandably, changes in the tax law have the potential to affect the maquiladora industry in a big way.

Mexico's "permanent establishment" tax program would have subjected US companies in the maquiladora industry to double taxation, had it not been delayed. Under this program, US companies with manufacturing operations in Mexico would be forced to pay millions of dollars in Mexican taxes; however, they could not receive a foreign tax credit from the US Internal Revenue Service. Instead, US and Mexican tax officials have decided that maquiladoras could avoid permanent establishment status if they agreed to pay higher taxes on safe-harbor or advanced-pricing pacts. Safe-harbor pacts require maquiladoras to pay 6.5% of costs and operating expenses or 6.9% of assets, whichever is higher. Before, the rates were 5%. Advance-pricing arrangements require maquiladoras to pay roughly 40% of the value of their services.

Satisfying both Customs and the IRS

Meanwhile, the related topic of transfer pricing has also become a hot issue in the maquiladora industry. Transfer pricing involves parent companies in the US, for example, and their foreign subsidiaries, which are required to negotiate for goods and service "at arm's length." This means that maquiladoras must operate for profit, not just as cost centers. Many maquiladoras perform a comprehensive transfer pricing study to determine if they are in compliance with transfer pricing rules. Lately, however, US Customs has stepped up its enforcement of transfer pricing rules because it suspects numerous multinational companies are undervaluing their imports, which results in lower duties paid to US Customs. Officials from US Customs say these same companies routinely report higher values to the US Internal Revenue Service for the same shipment, which therefore results in corresponding and sizeable tax deductions.

According to the US Department of Commerce, 17% of US imports are transfers within multinational companies. To crack down on companies that violate transfer-pricing rules, US Customs in recent years has increased the number of attorneys who monitor transfer pricing. While companies have the option of forging an Advance Pricing Agreement with the US Internal Revenue Service to get advance approval of the way it calculates the value of its imports, these types of agreements are sometimes called into question by US Customs. The best advice, say experts, is to have accountants audit the books to be sure the company is satisfying the competing expectations of US Customs and the Internal Revenue Service.

Keeping Up with US Customs and NAFTA

On January 1, US Customs eliminated the 30-year old Automated Export Reporting Program (AERP). The program has been replaced by AES, the Automated Export System. Although many companies were prepared for the changeover, there are some still playing catch up. Mexican customs brokers are required to handle most imports into Mexico, and a large volume of those imports are handled by small brokerages along the border, some of which may not be aware of the change. US exporters not prepared to participate in the electronic filing of documents via AES must file documents manually.

At the same time, US exporters claiming duty preferences under NAFTA have also noticed a stricter stance by US Customs concerning the certificate-of-origin document. The certificate of origin is used to substantiate whether, to qualify for NAFTA preferences, the goods were manufactured or substantially transformed. Although US Customs initially gave importers some leeway in producing the certificate of origin, the agency is now assessing penalties when importers fail to produce the document on demand. The penalties range from two times the loss of duty revenue for negligence, to four times the loss of revenue for gross negligence, up to eight times the loss of revenue for fraud.

More changes lie ahead for the maquiladora industry. Companies that import materials from outside North America and sell the finished goods within North America will see considerable changes beginning November 1. For instance, while current laws permit intermediate products to be shipped from one maquiladora to others in Mexico with the appropriate documents, after November 1 only one level of transfer will be permitted. The transfer must be from the intermediate maquiladora to the next higher level maquiladora, which then must export the product. Multiple transfers will not be allowed. Another pending change, albeit one that may conflict with NAFTA, states that, to qualify for the maquiladora program, companies will be required to export over 30% of their production annually.

Also starting on November 1, general or most-favored nation duty rates will be levied on machinery and equipment imported under the maquiladora program as though they were imported definitively (permanently). Some companies, such as those that qualify for one of the 10 Sectoral Promotion Programs, will be exempted. The Mexican government is expected to publish a list of products that qualify for the exemption in late August. The Sectoral Promotion Programs cover such industries as electronics and electrical, chemical, textile, and automotive.

The Imminent End of Duty Drawbacks

Additional changes to the maquiladora program will be ushered in with Phase II of NAFTA, which begins on January 1, 2001. This date marks the end of duty drawbacks or other duty deferrals on products exported between the US and Mexico, as well as between Canada and Mexico. Maquiladoras that use non-NAFTA components will be forced to pay tariffs on foreign goods and materials that were previously duty free. The goal of this NAFTA provision is to give maquiladoras incentive to source from NAFTA-member suppliers.

According to the law firm Neville, Peterson & Williams, the practice known as "platforming," whereby a NAFTA country is used as a platform for introducing non-NAFTA goods into North American commerce without the payment of external tariffs, is a common and legal practice under NAFTA. That means, for instance, that a company that manufactures medical device cartridges in Mexico using chemicals from a Japanese supplier could avoid duties altogether, providing the chemicals were entered into Mexico under a maquiladora bond, then subsequently exported to the US under NAFTA. Although about 85% of maquiladoras already source their components and raw materials from NAFTA suppliers, some US companies that do not may be forced to reconsider their use of maquiladoras once the duty drawbacks and other duty deferrals are eliminated. The Mexican government has stated that it is willing to make certain exceptions for companies that cannot find a comparable NAFTA supplier for their components.

As for the future of the maquiladora industry, despite the pending changes, it's important for companies to remember that maquiladoras that export outside the US and Canada will not be affected by the new laws. There are other advantages associated with maquiladoras, such as more streamlined customs procedures, which alone translate to appreciable savings for any company.