TIJUANA — Lured by minuscule taxes, cheap labor and proximity to the U.S. market, corporate America has flocked to Mexico in the last two decades, opening thousands of maquiladora factories in a country hungry for jobs and investment dollars.
Now Mexico, brimming with confidence but hard up for money, wants to collect new taxes from the export-driven factories. And that has opened a taxing can of worms.
Barring a change in the U.S.-Mexico income tax treaty, a Mexican law due to take effect in January would suddenly subject the U.S. firms to double taxation--unless Uncle Sam is willing to give up its right to tax the firms' Mexican operations.
Predictably, the maquiladoras are howling. Some are threatening to move their factories to China or, more credibly, to Honduras, El Salvador and other Central American countries that have established equivalents to the maquiladora system.
Then again, abandoning a cheap-labor nation that shares a free-trade border with the world's largest market seems an unlikely course of action.
Indeed, the dispute brings into focus a maturing Mexico, one that has much to offer foreign businesses and no longer feels it has to give away the store to attract them.
"Mexico has tremendous leverage now with these companies," said Allen Delattre, a consultant for Anderson Consulting in Los Angeles. "It has gone from being a low-cost, convenient labor provider to being a viable competitor in its own right. The businesses there now have momentum bigger than the maquiladora program, bigger than NAFTA and bigger than international taxation issues."
Nor is there any doubt about the justification for greater tax revenue: It's needed to tend to the squalor that has accompanied the explosive growth of the maquiladoras themselves.
Still, resolving the tax dispute sensibly will be a measure of Mexico's maturity as a trading nation. A heavy tax burden, or a prolonged period of uncertainty, could cool the ardor of prospective maquiladoras. They could look to Honduras, where dozens of maquiladoras already employ more than 100,000 and enjoy comparable tax and duty advantages with the United States.
"Mexico has a fine line to walk," Delattre said. "If the [tax] changes become disadvantageous, that creates opportunities for other Latin American countries that also are trying to industrialize. Certainly, no plants will close in Mexico, but they may not open at the rate or scale that Mexico wants."
New Law Would Close Old Loopholes
The tax confrontation was triggered by Mexico's passage last December of a law that would reclassify most of the 4,500 maquiladoras from temporary to permanent business establishments as of this Jan. 1, eliminating tax loopholes they have enjoyed since the mid-1960s.
Under the current tax treaty, tax experts say, the result would be to suddenly subject U.S. manufacturers to corporate income taxes in both countries.
A flurry of talks is occurring this month in Washington, where Mexican tax officials are asking the U.S. to forgo tax revenues it now collects on the maquiladoras. But negotiators have been unable to reach agreement, and Mexican officials have indicated they will postpone the effective date of the new tax until the dispute is resolved.
The IRS refused to comment on the talks.
The industry, however, wants immediate clarity rather than a postponement so its members can plan long-term investment strategies. Kimberly Pinter, a tax attorney at the National Assn. of Manufacturers in Washington, said that in extreme cases companies could be subject to combined taxes of up to 75% under the new law.
"This would kill the maquila industry in Mexico," Pinter said.
John McLees, a Chicago-based Baker & McKenzie tax attorney and advisor to the National Maquiladora Trade Assn., said that even if double taxation is somehow eliminated, reclassifying maquiladoras from "processing centers" to "permanent establishments" would open the door to taxing a company's worldwide profits in the future.
But Mexican authorities from President Ernesto Zedillo on down have repeatedly sought to assure the maquiladoras that the government will do nothing to harm an industry that now employs 1.1 million people and whose work force is growing by 10% a year.
"We do want to charge more taxes. Certainly we feel we can and should charge more taxes on such a significant sector," Mexican Trade Secretary Herminio Blanco Mendoza said. "What we don't want is to have any of these firms close down. It is a very delicate balance."
Maquiladoras date from 1965, when the two countries created their special tax and duty status as a way to replace the jobs lost with the phasing out of the bracero program that had allowed Mexicans to work temporarily in the United States.
Maquiladoras boomed after the Mexican currency devaluations of the 1980s and 1990s. A weak peso made Mexican labor cheap enough that it could compete with other manufacturing countries, especially in Asia, that until then were reeling in most of the offshore plants.