We explore the complexities surrounding the Mexico Maquiladora Tax Regime and the issue of Permanent Establishment (PE) mismatches. These mismatches can result in double taxation or double non-taxation, and with the Principal Purpose Test (PPT) measures being introduced from January 1, 2024, we will analyze how these changes aim to address these challenges. These updates hold significant implications for foreign companies operating in Mexico under the maquiladora regime, and we'll guide you through their potential impact on cross-border tax strategies.

THIS ARTICLE IS WRITTEN BY KSENIIA SHAKHNAZAROVA. ([email protected]), and LETICIA DE MOURA ([email protected]). Kseniia and Leticia are members of the International Consulting Practice team of RSM in the Netherlands with a strong focus on international tax.  

The Maquila Tax Regime and Permanent Establishment Mismatches

The maquiladora tax regime in Mexico was established to promote foreign investment, particularly in the manufacturing sector, by allowing foreign companies to operate in the country with significant tax advantages. These companies typically engage in the assembly or manufacturing of goods for export. The regime offers preferential tax treatment to foreign companies by minimizing their tax obligations in Mexico, provided that they meet certain conditions related to transfer pricing and Permanent Establishment (PE) status.

Key Elements of the Maquiladora Tax Regime

  1. Definition of a Maquiladora: A maquiladora (also called an IMMEX company) is a Mexican branch that engages in manufacturing or assembly on behalf of foreign companies. The maquiladora typically imports raw materials or components on a temporary basis, processes them in Mexico, and then exports the finished goods back to the foreign company without incurring import duties, VAT, or certain other taxes.
  2. Permanent Establishment (PE) Exemption: One of the primary benefits of the maquiladora regime is that the foreign company using the maquiladora can avoid being considered as having a PE in Mexico, as long as the maquiladora complies with certain requirements. This exemption is crucial because it ensures that the foreign company does not become subject to domestic Mexican income tax on its worldwide income.

To benefit from this PE exemption, the maquiladora must:

  • Operate exclusively for the benefit of non-resident foreign companies.
  • Satisfy Mexican transfer pricing requirements, ensuring that the maquiladora earns a reasonable profit (referred to as the "arm’s length principle") based on its functions, assets, and risks.

Dutch Tax Treatment of a Mexican PE under the Maquiladora Regime

In practice, foreign companies benefiting from the maquiladora regime may not recognise a PE in Mexico if the maquiladora meets the regime’s specific requirements. However, this can create tax mismatches between the company’s residence state (e.g., the Netherlands or a different head office state) and the source state (Mexico).

For instance, if a Dutch B.V. operates through a Mexican PE under the maquiladora regime, it is crucial to understand the Dutch tax treatment of such an operation. The main concern arises over whether the Dutch B.V. recognizes a PE in Mexico and how this recognition, or lack thereof, can lead to tax mismatches.

  • Under Dutch tax law, if a Dutch B.V. has a PE in Mexico, the profits attributable to the PE must be taxed in Mexico, while the Netherlands may grant a tax exemption to avoid double taxation.
  • However, the maquiladora regime in Mexico is structured to limit the recognition of a PE for foreign companies. Mexico offers tax incentives, including not recognizing the foreign company as having a PE, as long as specific conditions are satisfied.

This creates a potential mismatch under the Double Tax Treaty between the Netherlands and Mexico (in particular, Article 5). The treaty generally governs PE recognition, and due to differing interpretations, a fixed place PE may be recognized by one jurisdiction but not the other.

What is a Permanent Establishment Mismatch?

A permanent establishment mismatch occurs when two countries involved in a cross-border transaction have conflicting views on the recognition or treatment of a PE. In the case of the maquiladora regime, Mexico might not recognize a foreign company as having a PE due to the specific tax incentives offered under the regime. However, the foreign company’s home country (for instance, the Netherlands) could take a stricter interpretation of what constitutes a PE under the applicable tax treaty and domestic tax laws. This can result in a mismatch where the foreign company is not taxed in Mexico as a PE, but the home country (the Netherlands) still attributes profits to a PE in Mexico. These mismatches often lead to either double taxation or double non-taxation, depending on how profits are allocated and taxed in each jurisdiction.

Key Mismatches and Tax Risks for a Dutch BV

  1. Inconsistent PE Recognition: The Dutch tax authorities may take a stricter view on whether a PE exists, even if Mexican authorities do not. The maquiladora tax regime might exempt the Dutch BV from being treated as having a PE in Mexico, but the Dutch tax authorities could argue that the Dutch BV has a substantial enough presence to qualify as a PE. This inconsistency leads to a situation where Mexico may not tax the B.V. as a PE, as the Netherlands could apply the provisions of the Double Tax Treaty imposing that the profits arising from a PE may be taxed at the level of the source state. This difference in treatment leads to double non-taxation.
  2. Profit Attribution Issues: Even if both Mexico and the Netherlands agree that a PE exists, there can be mismatches in how profits are attributed to the Mexican PE versus the Dutch parent. Under the maquiladora regime, the maquiladora is often treated as a low-risk service provider with a limited margin of taxable income. However, the Dutch tax authorities may not accept this characterization and might argue for a higher allocation of profits to Mexico, especially if the maquiladora performs substantial activities. This can result in a higher amount of double tax relief in the Netherlands and as such a lower taxable profit in the Netherlands without an equivalent tax liability in Mexico, again creating double non-taxation.

ATAD 2 and Hybrid Mismatches

Furthermore, it is essential to consider the implications of the EU Anti-Tax Avoidance Directive (ATAD 2) and the consequences of these rules on hybrid mismatches as implemented in EU member state legislation. ATAD 2 aims to prevent tax avoidance strategies by neutralizing hybrid mismatches that result in mismatches between related entities, often caused by differences in tax treatment between EU member states and third countries, such as Mexico. Hybrid mismatches occur when entities or financial instruments are treated differently for tax purposes in different jurisdictions, leading to double deductions or deductions without inclusion.

Based on local implementation of these hybrid mismatch rules, the Netherlands would for instance no longer allow the mismatch in profit allocation for the maquiladora PE and would disallow (part of) the PE exemption in the Netherlands. As a result, the benefit of the maquiladora PE would be reduced significantly. However, the Dutch tax authorities have confirmed that under the double tax treaty between the Netherlands and Mexico, a full exemption would still be required as the double tax treaty overrules the local Dutch legislation in this respect. 

Measures to Prevent PE Mismatches

As a measure to prevent a PE mismatch leading to double non-taxation, from January 1, 2024, Principle Purpose Test (“PPT”) is applicable under provisions to which the Netherlands does not have to provide a tax exemption under to the income attributable to a Mexican PE disregarded under maquiladora regime. 

Under the PPT clause, tax treaty benefit shall not be granted if it is reasonable to conclude that benefit was one of the principal purposes of any arrangement or transaction unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the treaty. It allows the Netherlands to grant a tax exemption based on a detailed case-by-case analysis since it requires an in-depth assessment of the reasons for setting up a Permanent Establishment (PE) in Mexico

However, if a PPT is missing from a tax treaty, (e.g., Brazil) or where the requirements for denying a treaty benefit are not met, the tax exemption will still apply, leaving the mismatch unresolved.

Forward thinking

The maquiladora tax regime offers significant benefits for foreign companies operating in Mexico, particularly by providing a different PE profit allocation, thus minimizing tax obligations.

However, the ongoing trend towards reducing cross-border mismatches, increasing transparency, and addressing international tax planning structures can significantly impact the benefit of this structure when foreign jurisdictions, such as the Netherlands, adopt stricter interpretations of the profit allocations to a foreign PE under tax treaties. The exact impact for companies operating these structures will need to be reviewed on a case-by-case and country-by-country basis. RSM Netherlands can help you navigate these complexities by offering strategic guidance on cross-border tax structures, ensuring compliance with both local and international tax rules, and advising on measures like the Principal Purpose Test (PPT) to minimize potential tax risks and optimize tax outcomes.