Regardless of the changing economic and political environment in the North American region, Mexico has constantly been an attractive option for companies and entrepreneurs of all shapes and sizes looking to establish in Mexico their hub for expansion throughout Latin America. While Mexico still has many challenges lying ahead in its road to becoming a competitive economic leader, there are many factors that make Mexico one of the best options for foreign direct investment in Latin America. Out of 183 economies, The Doing Business Guide 2010 published by The World Bank ranks Mexico 51st in the “ease of doing business” category and 41st in “investor protection”. On the other hand, Mexico has yet to improve in “paying taxes” (106th) and “employing workers” (136th), reflecting how the lack of reforms to tax and labor laws continue to be a burden for Mexico’s growth. These ranks may not be what Mexicans would wish for, but are better than other economies in the region. They also reflect the low labor costs that make Mexico a low cost but high quality option for manufacturing.
Mexico has signed 12 Free Trade Agreements (FTA) that cover 44 countries. In Latin America, Mexico has an FTA with Honduras, El Salvador, Guatemala, Costa Rica, Colombia, Bolivia, Chile, Nicaragua and Uruguay. Also, Mexico has entered into Economic Cooperation Agreements with Argentina, Brazil, Peru, Paraguay and Cuba. This strengthens Mexico’s position as a viable gateway to the Latin American market. In addition to the FTAs Mexico has bilateral investment promotion and protection agreements and a good number of treaties to avoid double taxation with several nations around the world.
It is undeniable that there are certain negative factors that may influence a decision to enter the Mexican market, namely, the impact of organized crime and the international economic instability. However, for those assessing the risks and potential opportunities of doing business in Mexico, here are a few selected considerations to take into account.
- Permanent Establishment. Mexican tax authorities and laws define this concept as a location in Mexico where business activities are carried out or independent professional services are rendered. The effect of being deemed a permanent establishment (“PE”) is that income obtained in Mexico is subject to the applicable taxes pursuant to Mexican law and any applicable treaty to avoid double taxation - like the one signed by the United States and Mexico. Examples of a PE include a branch, corporate offices, a mine, a manufacturing plant or a similar facility. Furthermore, there are some additional cases also deemed as a PE, such as having a legal representative to enter into agreements on behalf of the foreign party or an independent sales agent if such agent is working outside of his ordinary course of business.
- Foreign Investment Restrictions. In the past years, amendments to Mexican laws and regulations have been passed aimed to help the country become a more receptive and open economy to foreign investment. However, Mexican foreign investment legislation still sets forth limitations to foreign equity for business activities in certain industries, and reserves to the Mexican State activities deemed strategic to the country’s interests, for example the petroleum sector. Make sure to verify, with the advice of a Mexican attorney, that the business you intend to carry out in Mexico is not limited or restricted by these provisions. In any case, a company with foreign investment must be recorded, and file periodic reports, before the National Registry of Foreign Investments.
- Immigration Status. A visa is required by foreign citizens who enter Mexico to do business. If you travel to Mexico to search for investment opportunities, make an investment, actually work in such investment project, represent foreign companies or enter into commercial transactions of any type, you need to have the proper legal immigrant status. To that effect, there are different types of visas depending on the purpose and length of the visit to Mexico: visa for visiting business persons, visiting investors, commercial representatives or visitors who will carry out commercial transactions. It is advised that you plan ahead for these proceedings as they can be long and complex.
- Due-Diligence. This is a key element when your investment in Mexico will involve a local partner, be it in the form of a distributor, sales agent or representative, joint-venture or even the purchase of assets (all of these discussed below). For real estate investments, it is just as important to make a thorough title search and research on the property. An extensive and detailed due-diligence may be the precaution that greatly mitigates the risk or exposure to any liabilities or any type of future loss.
There are different alternatives to enter the Mexican market. Below is a list of the most common vehicles or structures and a brief description of the process and its main implications:
1. Mexican Entity. If you decide to set up a business organization under Mexican laws, there are different factors to take into account. One of the first steps is deciding what kind of entity is the best alternative. The most common choices are the sociedad anonima (“S.A.”), most similar to a stock corporation, and a sociedad de responsabilidad limitada (“S.R.L.”), most similar to a U.S. limited liability company. Both the S.A. and the S.R.L. provide limited liability to its shareholders/members and status as a legal entity (they are companies, not partnerships) and have the same tax treatment in Mexico. Therefore, the criteria foreign investors generally use to decide between these two forms are: (1) transferability of equity, (2) the ability to go public, and (3) primarily for U.S. investors and purposes, possible tax advantages. If the strategic objective is to take the Mexican entity to go public, the S.A. would be the most appropriate form. If the strategic objective involves a pass-through structure for U.S. tax purposes for income derived from the Mexican operations, the foreign investor should consult with its U.S. tax advisors on whether the S.R.L. meets applicable tests under U.S. income tax rules.
2. Distributors. Distribution agreements are a frequent way for foreign companies to “test the waters” or position their products within the Mexican market. In these relationships, the supplier has the ability to impose certain requirements to the distributor in order to act as such, such as a geographical presence or financial and human resources. Distribution agreements may allow a supplier to establish certain standards for the distributor such as minimum sales, stock inventories or pricing, in which case antitrust and price-fixing regulations may apply. If an exclusivity provision is included, it is commonly stipulated as exclusivity within a certain territory and/or for a specified period of time. A sensitive provision regarding exclusivity is the penalty or damages (it is unlikely that a Mexican court will award both) to which a manufacturer is entitled in the event of breach from the distributor.
3. Commercial Agents. Often (and in some cases, mistakenly) referred to by foreign investors as sales representatives, a commercial agent is defined by the law as a business entity or individual that enters into a commercial agency agreement, as an independent party, in order to promote and develop a principal’s business. There are different types of agents under Mexican law, but the easiest way to categorize is whether the agent has authority or not to act on behalf of the principal. Two of the most sensitive provisions in these agreements deal with labor and tax consequences, respectively. In the first, it is important to state that the agency shall not be construed as an employment relationship, especially given the Mexican pro-worker labor laws. The main criterion that Mexican courts will use in order to determine the existence or absence of an employer-employee relationship is the level of subordination. In connection with the second aspect, Mexican income tax law provides that a PE may be inferred when an independent agent receives its compensation regardless of its results or when such agent does not act in the ordinary course of its business activities.
4. Joint-Venture. A strategic alliance of this type (“JV”) may be an appropriate vehicle when the business strategy involves a more sophisticated and complex plan. Reasons that may justify a JV with a Mexican company can be restrictions to foreign investment (previously discussed) or the need for a local partner with knowledge of the market and political environment. It is worth noting that, when identifying potential JV partners, the importance of a social and personal relationship is often underestimated. The negotiation and documentation process of a JV generally includes a stock purchase agreement, a shareholders agreement or a subscription agreement. Key elements of these agreements are the provisions governing management, capital calls, non-compete clauses, dispute resolution, exit mechanisms and buyouts. Depending on the specific transaction, you may have ancillary agreements such as supply, technical/professional services, employment for key executives and license.
5. Mergers and Acquisitions. Just like some of the previously discussed alternatives, a stock acquisition in Mexico can be the subject of a separate analysis due to the wide range of issues that can arise. Purchasing the stock of a Mexican company brings advantages such as the simplicity of acquiring a going concern and, in some cases, certain tax benefits depending on the target’s profitability. However, a very thorough due-diligence should be performed to assess the target from a financial, accounting, tax and legal standpoints. It is also important to document an extensive stock purchase agreement with comprehensive representations and warranties.
6. Asset Purchase. The main advantage of this option is that the buyer does not inherit liabilities from the target. Also, a less extensive due-diligence may be required, and is performed only in regards to the purchased assets. On the other hand, there may be some adverse consequences regarding value added tax or local real estate acquisition taxes. When all assets are acquired from a company with the purpose of continuing the same business activities, you will likely be required to go through the employer substitution process pursuant to Mexican labor laws, and have to pursue any licenses or permits to continue operating such business.
The purpose of this article is not to provide legal advice on doing business in Mexico, but to offer some guidance in connection with the main issues you may face in the process. In any case, it is strongly suggested that you consult with a Mexican attorney prior to making any decisions on how to structure your entry into the Mexican market.
Luis is a Mexican attorney who works as a foreign associate at BSA Legal Group, a boutique law firm specialized in international business transactions. Luis is based in El Paso, TX, and his firm has additional offices in Washington, DC; Lima, Peru; and Merida, Venezuela. Luis can be reached at email@example.com. For more information, please visit www.bsalegalgroup.com