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back to index backLATINtalk June,  2004


Mexican Tax Authorities Step In On The Subcontracting Regime

The subcontracting regime concept has evolved in the Mexican legislation in recent years. In 2009, the Social Security Law (“SSL”) was amended mainly to provide the authorities with better means to scrutinize the compliance of social security obligations in subcontracting structures in order to abolish elusive practices. It also establishes the obligation for the service providers and the beneficiaries of subcontracting services to provide the Mexican Social Security Institute ("IMSS") with corporate and tax information related to the parties executing the services agreement, the terms of the agreements (amounts agreed to be paid, type of services to be rendered, length of the agreement, etc.) and the names, social security numbers and compensations to be paid to the employees assigned to the beneficiary of the services.

At the end of year 2012, the Mexican Federal Labor Law (“FLL”) was also amended to further regulate the subcontracting regime in order to abolish or prevent elusive practices with respect to the compliance of labor obligations.

According with Article 15-A of the FLL, subcontracting is a labor regime by which a service provider (a corporate entity or individual), performs tasks or provides services with its own employees, under its control in favor of a contracting party (client or beneficiary of the services) that shall determine the tasks to be performed and supervises the contracted services. In this regard, the supervision and determination of the work to be performed shall be a responsibility of the beneficiary of the services.

Moreover, Article 15-A of the FLL provides that this type of work, must comply with the following three conditions: (i) It shall not cover all of the activities performed in the work place; (ii) the work or services must be of a specialized nature; and, (iii) the services cannot include the same or alike tasks or activities to those performed by other employees hired directly by the beneficiary of the services. If the three conditions are not met then, the beneficiary of the services shall be deemed the employer in fact for all labor and social security obligations.

On the other hand, the Tax Administration Service (the "Tax Authority") issued a non-binding criteria (31/ISR) seeking to prevent aggressive structures aimed to erode the taxable base of salary and wage payments and the undue crediting of Value Added Tax ("VAT") shifted by the entity rendering the services in those cases in which the beneficiary of the services did not receive from the service provider evidence of payment of the VAT.

Based on this non-binding criteria, local offices of the Tax Authority evolved the concept and began to reject the crediting of the input VAT paid by the beneficiary of the services whenever the contractual relationship did not meet the conditions established by the FLL for services being subcontracted regime arguing that the beneficiary of the services (i.e. the operating company in a service company and operating company corporate structure) was in fact paying indirectly subordinated personal services which were not subject to VAT.

Following the tendency of the Tax Authority to reject the refund of favorable balances of VAT, the Taxpayers Ombudsman (PRODECON for its acronym in Spanish language) issued a criteria seeking to inhibit the Tax Authority from attempting to reject VAT refund requests on the basis of labor concepts (i.e. in the view of the PRODECON, the  Tax Authority  should only analyze that the services were in fact rendered, that complied with market prices, that the beneficiary of the services received the corresponding invoices and that the VAT was in fact shifted without analyzing any other labor concepts on the structure). However, the Tax Authority did not follow the recommendations issued by the PRODECON and continued to challenge the crediting of VAT charged to taxpayers by service providers whenever they did not evidence the compliance with the three conditions established in Article 15-A of the FLL whenever the services being subcontracted were deemed to fall within the scope of the subcontracting regime for labor proposes. The position of the Tax Authority has been subject to litigation in different regions of the country, and the Third Federal Circuit Court issued a court precedent sustaining the position of the Tax Authority, which in turn motivated a greater number of VAT refunds being scrutinized in Mexico.

Based on the foregoing auditing trends, there are new rules that entered into force as of January 1st., 2017. Specifically, under the Income Tax Law, the beneficiary of the services under the insourcing regime shall be entitled to claim a valid deduction whenever it obtains the following documents from the service provider:

- Copy of the payroll tax receipts issued by the service provider to its own employees that were engaged in the rendering of services;

- Copy of the acknowledgement of reception of the payroll tax receipts by the employees;

- Monthly information returns related to the tax withholding on salary and wage payments; and,

- Evidence of payment of social security contributions.

In addition, the Value Added Tax Law ("VAT Law") was amended to establish that for purposes of the services falling within the insourcing regime under the FLL, the beneficiary of those services shall be entitled to credit the input VAT against its output VAT whenever it obtains the following documents from the service provider:

- Copy of the monthly VAT return filed by the service provider;

- Copy of the official acknowledgement of filing of the VAT return by the service provider;

- Information of the VAT breakdown carried out by the service provider as reported to the Tax Authority.

Based on such reforms to the VAT and the Income Tax Law, if the service provider does not furnish to the beneficiary of the services the above documentation, the beneficiary shall consider the expense as non-deductible and the input VAT would be treated as non-creditable.

In addition to the above, the Tax Authority amended several fields of the electronic tax receipts for payroll, in order to include additional information to identify subcontracting activities and to facilitate the cross reference with the information to be declared by the beneficiary of the services (i.e. the payroll tax receipts will include information of the type of services or work, origin of the funds, overtime work, amount of payroll and benefits, among other).  Note that the service provider will not be able to deduct the payroll and other related expenses if the electronic tax receipts are not filed with specific fields if they relate to the subcontracting regime under the FLL.

Note however that the Tax Authority issued a communiqué dated May 31, 2017 to delay the entrance into force the electronic tax receipt for payroll until July 1st, 2017. The communiqué also establish the obligation for tax payers to keep abreast of any further developments that will be published in the days to come in connection with these obligations regarding the electronic tax receipts.

According to our interpretation of the new rules, if the employees of the contractor are assigned to a contracting party to render their services primarily in the contracting party's facilities (or contracting party's related entities), even if the faculty to direct and supervise the employees remains or not as a faculty of the contractor, this will not trigger a presumption that that the work is performed under the subcontracting regime.  In this context, the contractor and the contracting party may comply, for tax purposes, the obligations applicable to work provided and received under the subcontracting regime, with the benefit that this should not trigger the presumption that the services were provided and received under the subcontracting regime.

In conclusion, even when the FLL incorporated the figure of the subcontracting regime since 2012, Labor Courts of Appeals have not yet issued binding resolutions nor even precedents regarding the analysis of the subcontracting regime, its elements and legal effects. However, Mexican Tax authorities have stepped in using this concept for a better audit process in connection with VAT refunds and Income Tax deductions.

Source: Baker McKenzie - GAI






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