A Farewell to outsourcing in Mexico.

The President of Mexico, Andrés Manuel López-Obrador, submitted a Bill on November 12th, 2020 before the House of Representatives of the Mexican Congress, in order to amend the Federal Labor Law, Social Security Law, Worker Housing Law (INFONAVIT), Federal Tax Code, Income Tax Law and the Value Added Tax Law.  The main purpose of this initiative is to eliminate the abuse of subcontracting.  The Bill argues that “outsourcing” or “insourcing” are detrimental to worker’s rights and facilitate tax evasion through simulation practices reporting lower wages.

If enacted, the Bill initiative amendment would become effective the next day following its publication in the Mexican Federal Gazette.  Tax amendments could become effective as early as January 1st, 2021.

Mexico Federal Labor Act

The initiative from Mexico’s Executive branch, prohibits the subcontracting of personnel, whether under the “outsourcing” or “insourcing” modality if labor is provided for the benefit of another party.

The proposed amendments differentiate between the figure of the intermediary and the real beneficiary of the services. The proposal defines intermediaries as “the individuals or entities that intervene in the hiring of personnel to provide services to an employer. These intermediation services can include recruitment, selection and training, among others. In no case will the intermediary be considered the employer, since this character belongs to those who benefit from the services.

Thus, the actual or material beneficiary of labor will be solely and directly responsible for payment of social security fees.

There is a narrow exception in the form of certain specialized activities and services not to be deemed subcontracting of personnel. Hence only the “rendering of specialized services or the execution of specialized works, which are not part of the corporate purpose or the economic activity of the beneficiary thereof, shall not be considered subcontracting of personnel.”  The definition is formulated in a negative sense. In other words, specific skill sets or know how that falls outside the scope of the regular conduct of business or corporate purpose of a company may fall within the safe harbor provisions.  However, this safeguard is subject to prior authorization from the Department of Labor (the “Department”).

Any such clearance will be effective for a period of three years and conditional to compliance with Labor, Tax and Social Security Regulations.

A registry of authorized specialized services providers will be created. Only those individuals or entities registered therein will be allowed to legally render specialized intermediation services with their own personnel. This registry will be public and will be available online.

The proposed amendments foresee the imposition of hefty fines for any party providing unauthorized subcontracting services or receiving such services.

Severe limitations to employer substitution apply, such as tying in the transfer of assets from a company to another to achieve substitute employer status.

Mexico Social Security Law

The proposal lays down that any party that subcontracts workers with another party which fails to comply with compulsory social security requirements, shall be jointly and severally liable in relation to the workers used to execute those services.

In addition, reporting requirements are expanded.  Any natural or legal person rendering specialized services or works, must provide the Mexican Social Security Institute (“IMSS”) quarterly reports of every agreement entered in connection thereof, as well as personnel data such as: name, national identification number (“CURP”), Social Security Affiliation Number, base salary and taxpayer identification number (“RFC”) of the beneficiary of the specialized services or works under such agreements.  Failure to inform in timely manner shall trigger more fines.

The Bill eliminates the possibility for a company to hold multiple employer registrations based on the risk degree of work performed.  This means that an employer would have to register all employees within a risk category associated with one type of activity that may not apply to employees engaged in work of another activity of lesser risk.  This would invariably result in an increase in social security fees.

Mexico Worker Housing Act (INFONAVIT)

With respect to the proposed amendments to the INFONAVIT Law, these relate to: (i) increased joint and several liability in the event of employer substitution, and (ii) increased reporting requirements.

Mexico Federal Tax Code

The Bill proposes to criminalize certain conduct associated with the use of simulated schemes for the provision of specialized services, the execution of specialized works, or the carrying out of personnel subcontracting.

A conviction for the crime of tax fraud carries a penalty from five (5) to fifteen (15) years in prison.  Furthermore, tax fraud could substantiate charges for organized crime. Bail would not be available to alleged offenders and companies could be subject to dissolution or winding down.

Other proposed amendments to the Federal Tax Code refer to subcontracting fees which will not be deemed an essential cost and thus cannot be deducted from the Income Tax Revenue nor can VAT be credited.

Income Tax Revenue and VAT can only be deducted as a result of the provision of specialized work if certain conditions are met and evidenced, such as (i) valid authorization issued by the Labor department, (ii) digital tax receipts (“CFDI”), (iii) statement of employees’ full income tax withholdings, (iv) declaration of VAT for services provided, (v) total of worker-employer contributions to IMSS and INFONAVIT.

The fines for failing to provide such information could range from $150,000 to $300,000 Mexican Pesos (about 7,500 to 15,000 USD.)

Mexico Income Tax Law

Deductions for income tax purposes in labor subcontracting are not authorized.

The deduction of payments for specialized services or the execution of specialized works shall only be allowed when the beneficiary of work can evidence certain clearances and permits regarding the persons rendering such specialized works. The obligation to withhold 6% of VAT for value of personnel services received during 2020, is repealed.

Preliminary Conclusions

All companies doing business in Mexico with personnel hired under outsourcing schemes, must plan for the potential termination of service agreements through which personnel is made available to them.

Companies that rely on contracted specialized service providers must adjust to increased filing requirements in order to be able to continue having access to the work product of special skill workers.

The Amendment has been controversial and subject to criticism from several sectors.  It has the potential of adversely impacting investors doing business in Mexico.  Companies would have to terminate existing outsourcing contracts and directly employ all workers.  The economic and legal impact would be significant.

However, please bear in mind that this Bill is being debated as part of the legislative process. It has not been enacted.  The Bill may undergo further modifications to mitigate adverse effects.  We will monitor events and keep our readers informed.

This report has been prepared in collaboration with our strategic alliance firm in Mexico City, IHMA Abogados y Consultores, S.C.

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