Year in review
Subcontracting or outsourcing structures are prevalent in Mexico, with a service company (either from the same corporate group or an external provider) directly hiring employees to render services to another company. These structures allow the profitable entities to focus on their core business activities while the service entities, with the personnel, focus on recruitment, hiring and other processes necessary to comply with applicable employment and social security obligations. One of the most important reasons for establishing such structures is to achieve a more cost-efficient administration of the profit-sharing of the operating company. This is of particular relevance considering that the current percentage of profit-sharing to be distributed is 10 per cent of each employer's business pre-tax profit.
Although subcontracting structures are not illegal per se, they have never been considered 'bulletproof'; indeed, they entail certain liabilities for the operating company:
- joint liability with the service company for compliance with labour and social security obligations in relation to the personnel, since the operating company is the real beneficiary of the services rendered by the personnel;
- being considered the employer of the service company personnel if subcontracting requirements under the Federal Labour Law are not met and, therefore, being directly liable for compliance with all labour and social security obligations, including payment of the operating company profit-sharing, as well as payment of social security contributions;
- constituting an economic unit with the service company, with both entities considered liable for labour and social security obligations; and
- subject to the imposition of fines in the event of a labour audit.
All employees in Mexico have the right to share in the profits of the business in which they work, as provided by the Constitution. The current percentage for employees' profit-sharing was set in 2009 at 10 per cent of each employer's business pre-tax profit. Employees are generally entitled to profit-sharing, except for managing directors, general managers, administrators or chief executive officers of the company. There is a relevant court precedent stating that the holder of the highest position in the company, regardless of the title given, is the only employee who is not entitled to profits as the compensation for this position warrants the exception.
Certain corporations are not obliged to share profits during specific periods, such as (1) new corporations during their first year of operation (i.e., first tax year, which in Mexico is the same as the calendar year), (2) new corporations devoted to the production of a new product, during the first two years of operations, and (3) new corporations devoted to an extractive industry during the exploration period. Considering that the rest of the companies in Mexico are required to profit-share at quite a high percentage, subcontracting structures have been used commonly and successfully for several years.
According to the Federal Labour Law's definition of 'subcontracting': (1) an employer (contractor) performs activities or provides services through its employees under its direction in favour of a contracting party (whether an individual or a legal entity); and (2) the contracting party determines the duties to be performed by the contractor and supervises the development of the services or the execution of the activities for which the contracting part was hired.
Subcontracting structures have to meet the following conditions: (1) none of the activities performed at the workplace can be subcontracted; (2) the services to be rendered must be justified because of their specialised features; and (3) subcontracted services may not involve like activities, or activities similar to those performed by the employees of the contracting party. Pursuant to the Federal Labour Law, a contracting party that does not comply with all these subcontracting conditions could be considered the employer of the contractor's employees for all legal purposes, including labour and social security obligations, and including profit-sharing. In addition, subcontracting must comply with certain obligations, such as the execution of a written contract, and verification that (1) the contractor has the proper documentation and its own and sufficient resources to comply with the labour obligations, and (2) meets with safety, health and environment requirements at all times, regarding subcontracted employees. Non-compliance may result in fines following a labour audit. Also, in accordance with the Federal Labour Law and other criteria, if an employer benefits from services rendered by employees of a third party and the latter lacked the proper and sufficient resources to comply with its labour obligations, both companies could be deemed jointly liable as beneficiaries of the services or as part of an economic unit by the labour and social security authorities for the payment of and compliance with obligations.
Subcontracting is not allowed when employees are deliberately transferred by the contracting party to the contractor to reduce their labour rights, in which case a fine of between 250 and 5,000 times the UMA may be imposed following a labour audit.
As of 2017, tax legislation has established new requirements for the income tax generated from services to be deductible under the Income Tax Law and for the credit of value added tax transferred on expenditures made in relation to subcontracting operations as set out in the Federal Labour Law. Under these requirements, the contracting party must obtain several documents in connection with the fulfilment of the contractor's fiscal and social security obligations (e.g., a copy of digital payroll tax receipts for wages issued by the contractor to its employees and statements of payment of taxes and social security contributions). Likewise, each subcontracted employee's salary receipts must include the contracting party's unique Federal Taxpayers Registry number (or RFC), as well as the percentage of time the employee spent rendering services in favour of the contracting party.
In 2016, the tax ministry, the Secretariat of Finance and Public Credit, published a statement determining that subcontracting regimes fall within the scope of a vulnerable activity; consequently, the contractor will be subject to compliance with the obligations provided in the Anti-Money Laundering Law and its regulations if the entity carries out administration and management of resources, securities or any other assets of the contracting party for the services rendered. In addition, the Department of Financial Intelligence has issued a criterion stating that subcontracting regimes will be considered vulnerable activities only when they are performed independently (i.e., through outsourcing companies) and are not performed by part of the same corporate group. However, this criterion serves for information purposes and is not binding. There is a possibility that the competent authorities will issue a further criterion clarifying whether 'insourcing' structures are considered vulnerable activities or not.
In general terms, these amendments, as well as the regulations from a tax, labour and anti-money laundering perspective, seek to ensure that employees continue to receive their minimum statutory benefits, which include profit-sharing, and to eradicate the commonly known 'bad outsourcing structures' that do not comply with their employment obligations and leave employees defenceless. The authorities are not taking issue with subcontracting structures that are well implemented and provide their employees with benefits under the law, but are rather seeking to collect omitted contributions and punish those companies that save money either through non-compliance or at the expense of employees' minimum rights.
Given that subcontracting is an established practice for doing business in Mexico, and as reflected in the amendments to this structure, the authorities are constantly trying to identify potential wrongdoing; consequently it is important that companies conduct assessments of their respective subcontracting structures to verify their compliance with the aforementioned requirements and to reduce fiscal or labour contingencies.
It is quite common for domestic and foreign companies with internal service entities to seek to achieve the best, most cost-efficient options for their operations in Mexico while still meeting the specific requirements of the Federal Labour Law on subcontracting matters. It is becoming more commonly recognised that employees exempted from profit-sharing play a key role in these types of operating and service structures. Although there are certain preliminary regulations and proposals for legislative amendments regarding subcontracting and its requirements, there are currently no specific resolutions or prospective binding precedents regarding subcontracting requirements and compliance.
The administration of president-elect Andrés Manuel López Obrador (AMLO) is committed to the implementation of unannounced on-the-spot labour audits; therefore, we expect that the powers of labour auditors will be increased in the coming year with the purpose of verifying different kinds of employer obligations, including outsourcing structures, and companies' general obligations. Also, the Ministry of Labour, in this new administration, will focus on conducting more transparent dialogues between unions and workers to avoid 'sweetheart' unions and their arrangements with companies in Mexico, with the aim of defending labour rights in all types of industries. Considering the foregoing, employers in Mexico should deal with collective negotiations carefully to achieve a balance for both parties, complying at all times with labour, tax and social security obligations.
Outlook and conclusions
In general terms, subcontracting structures are feasible and can even be quite useful when doing business in Mexico, as long as legal requirements are consistently met and advice is taken from qualified counsel. Ideally, such a structure must be seen as an operational option to produce business cost-efficiencies and should never be used as a way to derogate employees' labour and social security rights. Non-compliance may trigger material liabilities from a labour, social security and tax perspective; it is therefore highly advisable to implement preventive and corrective controls, as well as internal policies and processes, when dealing with these structures in head-count analyses, including in relation to internal service companies, outsourcing companies, independent contractors and similar service providers where there is a possibility that an employment relationship could be presumed.
Mexico is an attractive jurisdiction for investment: the modernisation of its legal framework, its improving network of international agreements and its continuing efforts to adapt to international standards provide a reliable and predictable landscape for foreign investment. However, the transition to becoming a major economy is challenging as the worldwide financial crisis has delayed the development that countries with similar characteristics have experienced. Thus, strengthening government institutions, building a strong and independent judiciary and providing a safe environment for businesses would certainly increase the international business community's interest in investing in Mexico.
Mexico has improved its legal system in recent years to make it a suitable venue to conduct business and has sought to protect foreign investment through deregulation, liberalisation of its market and execution of bilateral and multilateral agreements on trade and investment. For several years, Mexico has been modifying its legal framework, including its employment-related laws. Despite these advances, additional will need to be taken to confront the challenges posed by new market trends and innovations. In 2012, Mexico underwent an employment-law transition with material amendments such as the changes to subcontracting requirements, and while these changes have yet to be reflected in the current business environment, the 2017 constitutional amendment and the corresponding secondary laws yet to be enacted are expected to provide the modernisation necessary to adapt to current needs and international standards.
This constitutional amendment, whereby the CABs have authority corresponding to that of the judiciary, aims to provide more efficient, speedier, creative judgments on labour matters. This amendment provides a window for Congress and the government to modernise employee–employer relationships to achieve balanced scenarios, continue to promote foreign investment and strengthen the country's economic growth. It will be interesting to see how the transition of labour and employment law enforcement from the executive to the judicial branch will evolve; however, positive effects can be expected, considering that (1) judicial procedures have the highest national levels of efficiency regarding dispute resolution, (2) they have better control over their proceedings, and (3) the level of responsibility enjoyed by judicial government representatives, and the sanctions available to them, are greater than those that currently apply to the representatives of the CABs.
Labour law in Mexico is undergoing constant change to meet international standards, such as the International Labour Organization, and to comply with the commitments made in the Free Trade Agreement, which has joined Canada, Mexico and United States as long-standing commercial partners and has generated $1,046 billion dollars to date in trilateral commerce. The AMLO government has already proposed a new labour law amendment, which seeks to comply with the previous constitutional reform, which is still awaiting a vote and confirmation by Congress. While this evolves, we expect that certain practices in the day-to-day business of a company will need to be adjusted to the policies and visions of this new government, including the Ministry of Labour.